Equitas Small Finance Bank (NS:) (ESFB) is India’s new generation small finance bank, having its HQ in Chennai, began banking in Feb’17 after receiving a license from RBI in June’16. Erstwhile ESFB was known as Equitas Microfinance Ltd and was founded originally in 2007 as a South India-based microfinance lender (MFI). ESFB now operates through three segments: Treasury, Wholesale Banking, and Retail Banking business. The Treasury segment includes all investment portfolios, profit/loss on sale of investments, priority sector lending certificates (PSLC) fee, profit/loss on foreign exchange (FX) transactions, equities (in collaboration with HDFC (NS:) Sec and Aditya Birla Money) income from derivatives and money market operations.
The Corporate / Wholesale Banking segment includes all advances to trusts, partnership firms, companies, and statutory bodies, which are not included under Retail Banking. The Retail Banking segment includes lending to and deposits, from retail customers and identified earnings and expenses of the segment. Its products or services include micro-loan against property, commercial vehicle finance lending, microfinance lending, demand deposits, time deposits, and fee-based products through its distribution of insurance and mutual fund products, which provides a locker facility.
Equitas Holding Company is the promoter of the ESFB, controlling around 74.5% of shares issued. Small Finance Banks (SFB) is a specific segment of banking created by RBI under the guidance of the Government of India to further financial inclusion by primarily undertake basic banking activities for un-served and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganized entities.
Like other commercial banks, these banks can undertake all basic banking activities including lending and taking deposits, but can’t lend to corporates and have to provide a minimum of 75% of loans to the priority sector. Also, commercial banks do not have restrictions on the customers that they need to serve, whereas the target customers of small finance banks are unorganized workers, small businessmen, and small farmers, micro small, and medium enterprises. The other difference between small finance banks and commercial banks is Commercial banks can open their branches anywhere whereas small finance banks have to open 25% of their branches in rural areas, in the initial 3 years.
Most of the SFBs are erstwhile MFIs or NBFCs. SFBs were granted limited banking licenses for the dual objective of promoting financial inclusion to those sections of the Indian economy/society not serviced by commercial banks. SFBs were set up with the dual objective of promoting an institutional mechanism to provide rural and semi-urban savings/deposits and also lending for viable economic activities even for borrowers having very little credit history; i.e. SFBs are the last resort for India’s sub-prime borrowers. Most of the SFBs enjoy very high NIMs, almost double that of private banks despite providing much higher deposit rates/cost of funds as they do charge much higher interest rates to sub-prime or informal borrowers (as the last resort of sub-prime lenders). Equitas Small Finance Bank (ESFB) is now a leading small finance bank in India, having operations in 18 states and UTs with a digital thrust.
Highlights of Q2FY23 report card: Equitas Small Finance Bank
· NII Rs.6.10B vs 5.81B sequentially (+5.01%) and 4.84B yearly (+26.01%)
· Total operating income Rs.7.55B vs 7.14B sequentially (+5.73%) and 6.32B (+19.48%)
· Total operating expenses Rs.4.91B vs 4.28B sequentially (+14.92%) and 4.18B (+17.56%)
· Core operating profit (EBTDA) Rs.2.63B vs 2.86B sequentially (7.99%) and Rs.2.14B yearly (+23.25%)
· NPA/Loan/SR provisions Rs.0.90B vs 1.42B sequentially (-36.37%) and 1.38B yearly (-34.62%)
· EBITDA (notional profit after NPA/SR provisions) Rs.1.73B vs 1.45B sequentially (+19.80%) and 0.76B (+128.43%)
· Core operating EPS (EBTDA/Share) Rs.2.10 vs 2.28 sequentially (-8.02%) and 1.87 yearly (+12.59%)
· Reported NIM 9.00% vs 9.05% sequentially and 8.14% yearly
· EBTDA/PPOP margin 34.89% vs 40.09% sequentially (-5.20%) and 33.82% yearly (+1.07%)
· GNPA Rs.8.71B vs 8.56B sequentially (+1.67%) and 8.37B yearly (-1.20%)
· Gross advance Rs.227.79B vs 216.88B sequentially (+5.03%) and 189.78B yearly (+20.03%)
· Gross deposits Rs.217.26B vs 203.86B sequentially (+6.57%) and 180.94B yearly (+20.07%)
· Gross advance/deposit ratio 104.85% vs 106.39% sequentially and 104.89% yearly
· GNPA/Gross advance 3.82% vs 3.95% sequentially and 4.64% yearly
· PCR 50.49% vs 48.40% sequentially and 50.09% yearly
· The reported yield on advances is 17.10% vs 17.15% sequentially and 17.75% yearly
· Continued to scale up SME, vehicle, and home loans along with deposit mobilization through HNI, corporate salary, and NRE accounts coupled with digital push
· Healthy profit, stable asset quality, and a strong capital buffer
· Reported annualized credit cost 1.62% excluding onetime impact 1.35% (restructured COVID) vs 2.68% sequentially and 3.09% yearly
Highlights of Q&A session (analyst concall): Q2FY23
· Management is cautious about India/domestic growth/consumption story amid various local and global macro headwinds coupled with the chorus of synchronized global slowdown
· The cost of funds is getting higher amid tight money market/liquidity conditions as credit growth almost doubles the deposit
· Almost all banks are now reporting double-digit credit growth
· Credit demand in the informal economy, where ESFB largely operates is also booming similar to the formal economy
· Robust credit demand in CV, SME, and affordable housing finance
· Overall credit and deposit growth around +20% (y/y); sequential growths around +5% and +7%
· Guidance for FY23: Credit cost 1.5%; loan growth 25-30% (y/y)
· Loan growth guidance degraded to around 25% from earlier 30% (y/y) due to the slow start of the year
· Overall liquidity position remains comfortable, but the rise in an incremental cost of funds would be a concern for the next 2-3 quarters despite tapping into bulk deposits and wholesale funding
· Focusing now on digital sourcing of assets & liabilities- lending & deposit (app-based)
· Merger/amalgamation with the Equitas holding company is on track and may be completed by Dec’22 or Jan’23
· Disbursement growths around +19% sequential and +22% yearly
· Robust collection efficiency
· Thrust on SME loan outside TN through a digital lending platform
· Solid CV loan demand along with used vehicles
· MFI (Microfinance) portfolio has shown remarkable recovery with strong/improved collection efficiency
· Resilient growth in affordable housing finance to around Rs.1B per month
· Robust loan growth in CV, PV, 2W, SME, affordable housing finance and MFI expected in coming quarters
· Overall guidance for FY23: Loan growth +25% with annualized credit costs +1.5%
· Robust deposit mobilization and cross-sells through the digital channel
· Launch of 3-in-1 account concept through association with HDFC Securities (Savings, Demat and Trading account)
· Major global central banks led by US Fed are embarking on rapid tightening to tame inflation-
· This coupled with the Chinese slowdown (due to zero COVID policy) and the Russia-Ukraine war/supply chain disruptions/higher commodity prices are creating various macro headwinds across the globe
· Overall global economic outlook bleak
· Indian economy may grow around +6.8% in FY23, lower than RBI projection+7.2%, while headline inflation (CPI) was +7.41% in September, higher than RBI’s upper tolerance band of +6.00% consistently
· Although India fared better than some of its peers, RBI was forced to hike rates successively to tame inflation
· Very tight liquidity in the banking system/money market as credit growth (17.9%) is almost double that of deposit growth (+9.6%)
· India’s macros are stable despite some Rupee devaluation and higher commodity/oil prices
· RBI is set to hike rates by 25-35 bps in the upcoming December meeting to counter currency (INR) depreciation and elevated inflation
· Overall stable treasury performance for ESFB; the bank may add bonds to HTM portfolio at lower prices (when yield spikes further)
· Opportunities for some additional income through IPO and wholesale funding market
· Higher OPEX was due to higher employee compensation due to the addition of headcounts; also there were higher business costs like increased commission and brokerages, branding, and technical expenses
· The expected cost-to-income ratio is 60-63% in the medium term
· Higher employee expenses by around 18% were due to employee addition to meet higher business targets and salary increase/incentives, which usually take place in Q1/Q2; looking ahead expect some moderation in employee cost although the overall yearly increase would be +18% on an annualized basis
· Hiring fresh for meeting business/sales targets, while collection side fresh employment remains muted as there is no need to scale up the collection now and the overall condition is normal (unlike during COVID times)
· Around Rs.2.50B write-off from Rs.9.90B restructured book
· Going forward, expect around Rs.1B in slippages from the restructured book (FY23)
· Credit costs will be coming down sequentially looking ahead (as COVID times over)
· Credit growth projection degraded from earlier 30% to 25% due to expansion outside TN and the subsequent gestation period
· The bank is apprising credit proposals carefully to avoid large-scale NPA in future
· Some moderation in deposit amount due to the opening of a 3-in-1 account (savings, DEMAT, and trading)
· Overall OPEX would be increased by 20-23% in FY23
· ROA around 2% is not a guide, but an aspirational model
· The bank is calculating/recognizing NPA, upgradations, and net slippage on monthly basis for QTR reporting as per RBI norm
· Credit cost calculation as per RBI format
· Vehicle finance delinquencies will be less as fleet owners now have pricing power and better cash flow
· No concern about deposit mobilization amid the support of employed professionals (salary accounts), corporate accounts, senior citizens, and NRI accounts despite some shifts from the savings account to time deposits
· Cost to income ratio is elevated compared to pre-COVID levels because of lower growths in overall business and higher OPEX; expected to be below 60% from FY24 amid expectations of 30% advance growth
· Comparatively higher cost-to-income ratio because the bank does business with almost 100% bank staff (on the roll) rather than off roll (outsourcing)-like collection, new business, etc
· Downgraded advance growths guidance to 25% from earlier 30% for FY23 because the expansion of branch office outside TN is being delayed and thus as a prudent measure, the bank issued a guidance warning; till H2FY23, the bank recorded credit growths around +20%; the bank will achieve minimum 25% growth for FY23 as a whole, if not 30%
· Q2FY23 loan/disbursement growths were hampered by muted advance growths in MFI and SME, while vehicle and affordable housing finance were robust
· The bank is now cautiously optimistic about MFI loan growth going forward because of the application of new RBI regulation, whereby the bank has to take care of the net worth credibility (solvency) of each microfinance borrower; i.e. his cumulative exposures/loans to all banks & financials, total EMI (loan servicing amount) related to his monthly income/free-cash-flow
· The new RBI regulation of MFI finance will be effective from October (Q3FY23), but ESFB was already implementing it from 1st September, which has affected the credit growths in the segment
· The bank is also cautious about MFI lending because it’s an unsecured form of lending
· Thus ESFB is now emphasizing SME and agri loans, especially in the non-TN area; agri loan demand should be picked up in H2 and thus overall loan growths should be also improved from the present 20% at H1 to 25% by H2 (FY23)
· The bank is largely comfortable with deposit growth
· As of now, NIM is stable around +9.0% levels, but going forward, it may dip a bit because of a change in focus from unsecured to secured lending; the bank will now give higher priority to the secured vehicle and affordable housing finance rather than unsecured MFI or even used CV
· But the bank also expects moderation in OPEX and credit costs along with NIM; so the overall effect would be almost nil/minimal
· Bank has now comfortable liquidity at around 200% LCR and 20% SLR, but it would be more efficient for financials if the SLR comes down to around 19% levels (against minimum regulatory 18%)
· It’s a little disappointing that the bank’s FY23 credit growths would be around 25% instead of earlier guidance of 30%, but the bank will try its best to return 30% growth trajectory from FY24, if not from Q4FY23
Overall Q2FY23 report card of Equitas SFB was subdued amid muted credit growths and higher operating expenses amid elevated employee costs. The NPA/asset quality was stable along with healthy NIM. But the bank virtually issued a guidance warning about FY23 credit growth from earlier 30% to 25%; actual credit growth till H1FY23 was around +20%. The FY22 credit growth was around +15%. The Bank kept the earlier guidance of credit costs at 1.5% for FY23 (vs 2.5% in FY22). In Q2FY23, overall credit growth was subdued because expansion outside TN was not in full swing and also for an inexperienced (fresher) workforce (front-end sales personnel).
Fair Valuation: Equitas SFB Bank: Rs.73.00-87.00-105.00-125.00 for FY: 23-24-25-26
Equitas SFB reported a core operating EPS (without NPA/other provisions) of around Rs.7.57 in FY22 against 8.45 in FY21, down by 10.50% as the bank focused on NPA management rather than business/credit growths for most of the year.
Looking ahead Equitas SFB may report a +20% CAGR in core operating EPS due to the:
· The normalization of the COVID situation- the full reopening of the economy,
· Huge infra and targeted rural/agri stimulus by the government
· Bank’s dominant area of MFI (where competition is lesser); almost 18% of the loan book is MFI based
· Bank’s foray into formal lending, and increased focus on secured lending (home, car/commercial vehicle)
· Cross-selling of unsecured lending products (credit card, personal loan) for its blue-chip customers being acquired through digital and physical mode
· Past average run rate and companies guidance (25-30% loan growths) along with various pros & cons as discussed above including new lending rule for MFI
· The effort to improve the CASA ratio through ties up with various Fintech like Niyo in compliance with RBI regulations (after failure with Google (NASDAQ:) Pay)
· Increasing thrust for secured formal lending rather than unsecured informal lending
· Increasing thrust to expand outside TN which contributes around 53% of advances; other big potential markets Karnataka (10%); MH (13%); rest low single digit with almost nil presence in North-East zone
The Equitas SFB may deliver 20% CAGR on average in core operating EPS from FY23 to FY26:
Although Equitas SFB indicated credit growth of around 25-30% in FY23-26 along with an EBITDA margin of 40-50%, considering synchronized global stagflation/slowing economic growths and possible spillover effect of that in India, RBI tightening, higher borrowing costs, higher inflation/lower discretionary spending and possible higher NPA, 20% CAGR of core operating EPS may be appropriate (on the conservative side) rather than 25%. The ESFB is also cautiously optimistic about overall business growth amid global/local economic slowdown, new MFI lending rule, higher inflation/macro headwinds, and higher borrowing costs.
Thus assuming core operating EPS around Rs.9.408-10.89-13.07-15.69 and an average core operating PE of 8 (against a sectoral average of 10), the fair valuation of Equitas SFB may be around 73-87-105-125 between FY23-26 (with valuation risks on the upper side as there may be 25% CAGR instead 20% from FY24). As the stock/financial market generally discounts at least 1-year projected earnings in advance, Equitas SFB may scale 73/75-87 by Mar’23, 105 by Mar’24, and 125 by Mar’25.
The Equitas SFB board has been rejigged with the elevation of Murali Vaidyanathan (Head Liabilities & instrumental in CASA ramp-up) and Rohit Phadke (current head retail assets/ex-Cholamandalam Finance) as Executive Directors.
In his Q4FY22 concall address, Vasudevan, the MD, and CEO of Equitas SFB said:
“I’m very happy to inform all of you that the Board yesterday appointed two of our senior managers, Rohit and Murali as Executive Directors which is subject to RBI and shareholder approval. All of us know that between them, they run the entire business of the Bank.”
Further in another key management reshuffle and surprising move, on 19th May, Vasudevan, the key person and face of Equitas SFB resigned as MD & CEO of the bank. Vasudevan cited he wants to devote his time more to social welfare (philanthropic activities) through his public charitable trust. Subsequently, the stock crashed from 60 levels in late May to around 38 in mid-June as traditionally, such big management rejig is followed through higher NPA/stressed assets, which may be kept under carpet (ever-greening) under a long-time influential MD/CEO of a bank. After Yes Bank (NS:), ICICI Bank (NS:), and various other private banks’ NPA fiasco under such long-time CEO tenure, RBI is now not allowing any private bank CEO to stay in the bank after a stipulated period as a part of risk management perspective.
After tendering his resignation letter, Vasudevan, however, would continue as the MD & CEO of the SFB till his successor is finalized. The board has formed a search committee to undertake the process of finding his replacement. The Equitas SFB board has accepted his resignation letter and expressed “deep appreciation of the contribution made by Vasudevan over the years”.
The bank further said: “Post the transition, the board desires that he (Vasudevan) may be associated with the bank in any other capacity, as permissible under applicable statute and regulations”. Subsequently, RBI approved the extension of Vasudevan as MD & CEO of Equitas SFB for 1-year beginning on 23rd July’22.
As per some sources, Murali Vaidyanathan, Senior President & Country Head (Branch Banking, Liabilities, Products & Wealth) also the designated Executive Director is in line to be the next MD and CEO of the bank. But another source also pointed out that Rohit Phadke, Senior President & Head (Asset) and the designated Executive Director is also in the fray.
Bank sources are indicating as both Vaidyanathan and Phadke are popular and familiar with the top to bottom of the Bank, the board may appoint either of them as the next MD & CEO or even one of them as MD and another as CEO rather than bringing someone from outside the organization (external candidate)-as we have recently seen with HDFC Bank (NS:) rejig. Incidentally, both Vaidyanathan and Phadke are favorites to outgoing MD & CEO Vasudevan and acknowledged their dual leadership in running the entire business of the bank. The consolidated/credit growth of Equitas SFB is now expected to be around 25-30% (y/y), thanks to the incredible leadership team, led by Vaidyanathan and Phadke. But in H1FY23, overall loan and deposit growths were around 20% (y/y) under the dual leadership of Vaidyanathan and Phadke.
Meanwhile, on 22nd March, Equitas SFB announced a reverse merger plan with parent Equitas Holdings (NS:), whose shareholders will get 231 shares for SFB for every 100 shares held (against earlier proposals of 226 shares). After the reverse merger/amalgamation process, the holding company (Equitas) will cease to exist and Equitas SFB will have 100% public shareholding. This and other normal ESOP/fundraising processes may result in around equity dilution of around Rs.0.10B (after all regulatory approval) for the Equitas SFB and thus being seen as EPS dilutive to some extent rather than accretive. Thus Equitas SFB slips even after initial positive sentiment on the scrip.
Vasudevan said the eventual goal is to get a universal banking license after the completion of the reverse merger by FY23 (expected). If Equitas SFB will get a universal banking license, the cost of funds will get substantially lower and it can offer loans more competitively. This will be a big stimulus for the script. But as a universal bank with an essence of MFI business, the NIM may be lower and there will be a requirement of much higher regulatory capital.
Banks like Equitas SFB generally lend to a low-income group or to those entities that have poor/no credit scores/history and are unable to get credit from mainstream banks (sub-prime informal/formal borrowers). Although sub-prime lending is always risky, Equitas/MFI business model ensures very good recovery with a comparatively high-interest rate as typical sub-prime borrowers do not access mainstream lenders at relatively lower interest rates. In the case of Equitas SFB, the MFI collection efficiency is almost 99%; i.e. robust collection mechanism.
As with other credible SFBs, Equitas bank is also expected to grow its business in the coming days’ post-COVID economic recovery. As with other MFIs, erstwhile Equitas was also hit by demonetization in late 2016, but it overcame the problem with a digital thrust and the subsequent conversion from NBFC to a full-fledged bank; it was an important evolution for the former MFI lender. The Equitas SFB network of MFI business, which has the Main Street (real) experience of sub-prime lending in both rural and urban India is helping a lot in getting new business (loan growth) for the bank. Equitas SFB offers loans and other financial products according to customers’ income profile, the type of security available, the nature of the business, and the ultimate free cash flow.
And Equitas SFB operates a centralized strong credit assessment procedure through a robust risk management system with a focus on India’s sub-prime market (unserved/underserved segment). Equitas SFB has a well-diversified asset portfolio with a focus on retail liability (household/SME loans). For the sub-prime segment, having little formal accounting/financial/past credit record, Equitas SFB credit officers generally visit the shop/workplace of a prospective borrower several times to understand the business/revenue model to assess the underlying real cash flow before extending any loans.
Equitas SFB is soon projected to be a prominent full bank/lender with an MFI background (experience/networks) in South India like Bandhan Bank (NS:) in East India. Equitas SFB is also expanding its digital banking quite rapidly for both rural as-well-as urban customers. Due to the attractive deposit/savings rate and credible management, Equitas SFB so far has no great issues with CASA.
Some Indian private banks like Yes Bank and LVB (Lakshmi Vilas Bank) failed miserably because of the immense stress on corporate loans on a relatively large scale. A lot of the time these loans were issued to stressed corporate borrowers without adequate and tangible collateral security (to cover their old NPAs); it simulated a great Ponzi scheme. Some of India’s biggest public sector banks are also involved in such fraudulent corporate lending.
But small finance banks like Equitas SFB have not indulged in such irresponsible corporate lending and have focused solely on small-ticket and prudent retail/business lending which has proven to be less risky. Thus, the customer’s confidence in Equitas SFB is significant and unmatched. Equitas SFB may be the ‘HDFC’ Bank (trusted leader) in India’s Small Finance Bank space with a ‘Bandhan’ (MFI/business model) flavor in South India, even if it may not be granted a universal banking license by the RBI in the coming days due to increasingly congested sector (no need for a new universal bank) and various regulatory/risk hurdles.
Looking ahead, whatever may be the narrative, technically, Equitas SFB now has to sustain over 56.00-60.00 zones for a target of 70/75-87 in the medium term; otherwise sustaining below 55, it may again fall towards 47/42-37, which should offer strong buying zones.