MFI Pricing and Valuation- An Analysis of Key Drivers

This paper explores the pricing model of MFIs involved in on-lending in order to understand the factors that motivate prevailing interest rates. The analytics in the paper pivot around the stylized model of a twenty branch unit (TBU) that mirrors a typical Indian MFI's operations.In the experiment, the TBU cost structure was "“shocked"” with a number of variants to understand the effects of varying field officer productivity, loan sizes and growth rate. Transaction costs, as percentage of loans outstanding, are very sensitive to average loan sizes and field officer productivity. Study findings include:

• Operating cost as a percentage of loan outstanding falls sharply as the TBU approaches full capacity utilization;
• At full capacity utilization, operating costs are insensitive to historical growth rates;
• Range of operating costs is 3.7 percent to 11.5 percent;
• Divergence between actual interest rates and what the model suggests may be explained by the fact that MFI expansion is being financed through revenues rather than equity;
• Prevalent MFI pricing, even accounting for most pessimistic operating cost assumptions, provides the equity investor returns of 50 percent and upwards.