Equitas Small Finance Bank

Small is no longer beautiful

Caters to unserved and underserved customers impacted by the economic downturn caused by COVID-19 outbreak

CM RATING

42/100

Equitas Small Finance Bank is the largest small finance bank (SFB) in India in terms of number of banking outlets and the second largest SFB in India in terms of assets under management and total deposits in FY2019. The bank has successfully diversified its loan portfolio and significantly reduced its dependence on microfinance business as compared to other microfinance companies that have converted to SFBs.

The bank offers a range of banking products and services to customers with a focus on serving the financially unserved and underserved customer segments in India. Its strength lies in promoting financial inclusion within these segments

The bank started operations in 2007 as a non-banking finance company (NBFC) providing microfinance loans through its subsidiary Equitas Micro Finance (EMFL). It has been providing housing finance since 2011 through Equitas Housing Finance (EHFL). The erstwhile NBFC received its asset finance license in 2012 and has been providing vehicle finance and micro and small enterprise (MSE) finance primarily to disadvantaged households.

The bank commenced operations as an SFB on 5 September 2016, pursuant to receipt of the RBI Final Approval. The bank was included in the second schedule to the RBI Act, as a scheduled bank pursuant to a notification dated 23 December 2016.

PN Vasudevan is the MD and CEO of Bank who had served as the executive vice president and head of consumer banking group in Development Credit Bank, for more than one and half years. He had also worked for about two decades in Cholamandalam Investment and Finance Company, part of the Murugappa Group, where he joined as a management trainee and resigned as the vice president and head of vehicle finance.

The business model of the bank has transitioned over the years, while the credit to unserved and underserved segments has remained its core focus. The focus customer segments of the bank include individuals with limited access to formal financing channels on account of their informal, variable and cash-based income profile. The bank offers a range of financial products and services that address the specific requirements of these customer segments by taking into account their income profile, nature of business and type of security available.

The loan products of the bank suited to a range of customers with varying profiles include provision of small business loans comprising loan against property (LAP), housing loans, and agriculture loans to micro-entrepreneurs, microfinance to joint liability groups (JLGs) predominantly comprising women, used and new commercial vehicle loans to drivers and micro-entrepreneurs typically engaged in logistics, MSE loans to proprietorships, and corporate loans.

On the liability side, target customers comprise mass and mass-affluent individuals to whom the bank offers current accounts, salary accounts, savings accounts, and a variety of deposit accounts. In addition, the bank also provides non-credit offerings comprising ATM-cum-debit cards, third party insurance, mutual fund products and issuance of FASTags.

The bank has exhibited significant growth in business, and in FY2019 had a market share of 16% in terms of AUM among SFBs. Gross Advances (including IBPC issued) have grown from Rs 7937 crore end March 2018 to Rs 11703 crore end March 2019 and Rs 15367 crore end March 2020 and further rose to Rs 15573 crore end June 2020.

The share of secured advances has moved up to 75.8% end June 2020 from 66.3% end March 2018. The gross secured loan product portfolio has grown at a CAGR of 48% from Rs 5264.95 crore end March 2018 to Rs 11585 crore end March 2020 and moved up to Rs 11797 crore end June 2020. Within credit portfolio, small business loans (including housing loan) and vehicle finance product segments recorded significant growth with a CAGR of 53% and 30%, respectively, from March 2018 to March 2020. The bank is primarily engaged in providing small business loans, microfinance, and vehicle finance to unserved and underserved customer segments which represented 41.6%, 23.2%, 24.3% of Gross Advances (including inter-bank participation certificate (IPBC) issued) end June 2020.

Deposit has grown at a CAGR of 39% from Rs 5604 crore end March 2018 to Rs 10788 crore end March 2020 and moved up to Rs 11787 crore end June 2020. Retail deposit has grown at a CAGR of 143% from Rs 643 crore end March 2018 to Rs 3811 crore end March 2020 and moved up to Rs 4377 crore end June 2020. The ratio of retail deposits to total deposits has jumped from 16.2% end March 2018 to 44.4% end March 2020 and 46.4% end June 2020. The bank has posted the second fastest growth in deposits. CASA has grown at a CAGR of 16.11% from Rs 1638 crore end March 2018 to Rs 2208 crore end March 2020 and increased to Rs 2354 crore end June 2020. CASA ratio stood at 20.0% end June 2020.

The certificate of deposits program of the bank has been rated CRISIL A1+ by CRISIL and long-term borrowings and non-convertible debentures/ subordinated debt have both been rated CRISIL A+/ Stable.

The bank had the largest network of banking outlets among all SFBs in India end March 2019. As of June 2020, the distribution channels comprised 856 Banking Outlets and 322 ATMs across 17 states and union territories in India. The bank also distributes products through digital channels, and leverage technology to identify opportunities to better serve its target customer segment.

The bank had the third largest number of employees among SFBs in India end March 2019. As of June 2020, the bank had 15,843 employees.

The bank aims to continue to build its brand and develop a wide range of asset and liability products and services that will help in attracting new customers and deepen relationship with existing customer base. The bank intends to increase the use of technology in operations, by monetizing back-end banking capabilities and applying data analytics to gather a deeper understanding of the segments it serves. It will supplement ongoing efforts to reduce costs, increase operating efficiencies and move customers from an assisted mode to a self-service mode of digital and phone banking.

Gross NPAs level stood at Rs 416.67 crore or 2.68% and Net NPAs at Rs 213.37 crore or 1.48% of net advances end June 2020.

The CRAR of the bank stood at 22.02% end June 2020 against the regulatory requirement of 15%. Tier I capital ratio was 21.04% against the regulatory requirement of 7.5%.

The bank aims to leverage existing network for deepening penetration and driving operational efficiency. The bank would also leverage data for analytics to drive operational efficiency. It would strengthen liability franchise and focus on increasing retail base to further improve cost of funds. The focus would continue on digital products and technology to grow operations. The bank would also continue to diversify product offerings and leverage cross-selling opportunities An important strategic focus for the bank is to diversify its fee and non-fund based revenues and it intends to achieve this by further cross-selling existing fee income products like distribution of mutual funds and insurance products, and introducing newer products and services.

Objects of the Offer

The initial public offer (IPO) consists of fresh issue of shares amounting to Rs 280 crore by issuing 8.75 crore shares at the lower band of Rs 32 per share (face value Rs 10 per share) and 8.485 crore shares at the upper band of Rs 33 per share.

Further, the offer of sale comprises of 7.20 crore shares aggregating up to Rs 230 crore at lower price band and Rs 238 crore at upper price band.

The issue is to be made through the book-building process and will open on 20 October 2020 and will close on 22 October 2020.

Bank proposes to utilize the Net Proceeds from the Offer towards augmenting Bank's Tier I capital base to meet Bank's future capital requirements.

The listing of the bank is also in line with terms of the RBI In-Principle Approval, RBI Final Approval and SFB Licensing Guidelines, requiring the bank to list its Equity Shares on the Stock Exchanges within three years from the date of commencement of business by the Bank.

Strengths

The bank has a deep understanding of the unserved and underserved customer segments it serves with a range of products and services that also enables it to comply with RBI's requirements for SFBs including meeting "priority sector" lending requirements. Advances to the unserved and underserved segments represented 89.1% of Gross Advances (including IBPC issued) end June 2020.

The bank is the largest SFB in India in terms of number of banking outlets end March 2019, and it has successfully diversified its loan portfolio and significantly reduced dependence on microfinance business as compared to other microfinance companies that have converted to SFBs.

The risk management and credit evaluation processes, together with the bank's ability to evaluate risk, have enabled to contain level of NPAs, restructured standard asset and special mention accounts category 2 levels.

Certificate of Deposit (CD) program has the highest rating of CRISIL A1+ and long-term borrowings and non-convertible debentures/ subordinated debt have both been rated CRISIL A+/ Stable.

The bank leverages technology to identify opportunities and deliver products and services to target customer segment. The bank has created a paperless onboarding process for originating microfinance loans, opening savings bank accounts and fixed deposits.

About 94% of overall banking transactions in FY2020 and 97% in Q1FY2021 were through digital channels.

Weaknesses

The bank has experienced and may continue to experience a significant decline in collection efficiencies as a significant portion of collections are cash-based and involve physical presence of employees and collection agents, which has not been possible due to the nation-wide lockdown and travel restrictions that have been imposed. This decline in collections could persist through and beyond a recessionary period.

There may be a significant increase in the bank's NPA levels due to possible deterioration in the credit quality of its customers, as the bank's target borrower segment primarily comprises unserved and underserved customers, who are most impacted due to the economic downturn caused by COVID-19 related measures.

The unserved and underserved customers that the bank targets are also particularly susceptible to event-based risks, such as, demonetization and natural calamities like cyclones, draughts, famines etc.

While the bank is seeking to increasingly transform its operations to a cashless model, a significant portion of the business, particularly with respect to collections, continues to be cash based. Employees at banking outlets are responsible for the collection and deposit of cash, thereby exposing the bank to the risks of loss, fraud, misappropriation, theft, assault and unauthorized transactions by the employees.

Current promoter holding is 82.1%. Promoter is required to reduce its shareholding in Bank to 40% within a period of five years from the date of commencement of SFB operations and further to 30% within a period of 10 years and to 26% in 12 years. Except for the Offer for Sale, as of the date of this Red Herring Prospectus, Promoter has not approved any specific method to achieve such compliance. Bank and Promoter will be subject to penalties for non-compliance.

SFBs are required to extend 75% of loans to sectors eligible for Priority Sector Lending. At least 25% of total banking outlets need to be in unbanked rural areas. At least 50% of loan portfolio is required to constitute loans and advances of up to Rs 25 lakh. These regulations forces SFBs to grow in certain directions only even when that may not appropriate during certain times.

The bank has a limited operating history as an SFB and future financial and operational performance cannot be evaluated on account of evolving and growing scale of operations.

Many banking outlets are in the State of Tamil Nadu. Consequently, most of the advances are towards customers in Tamil Nadu. End June 2020, advances towards customers in Tamil Nadu represented 54.3% of Gross Advances (including IBPC issued).

The bank is dependent on a limited number of customers for a substantial portion of deposits. Deposits from 20 largest depositors (excluding certificates of deposit issued) represented 32.3% of total deposits end June 2020. Further, deposits from 10 largest depositors represented 24.94% of total deposits end June 2020.

Microfinance loan portfolio and unsecured business loans portfolio are not supported by any collateral, which accounts for 24.3% of Gross Advances (including IBPC issued).

The primary security for housing loans and other micro-loans disbursed by under small business loans segment is the underlying property. The exposure to loans against property represented 37.1% of Gross Advances (including IBPC issued) end June 2020. The value of this security is largely dependent on housing and property market conditions.

The provision coverage ratio was only 45.22% and 48.79% in FY2020 and in the three months ended June 30, 2020, respectively

The bank has not paid dividend in the past on Equity Shares.

Valuation

The annualized EPS on post-issue equity works out to Rs 2.1 for FY2020. At the price band of Rs 32 to Rs 33, P/E is 15.0 to 15.4 times of FY2020 EPS.

Post-issue, the book value (BV) will be Rs 27.1, while adjusted BV (ABV) net of net non-performing assets works out to Rs 25.2 per share at upper price band.

The scrip is being offered at price to Adj BV multiple of 1.3 times at the upper price band. Among peers, AU Small Finance Bank is trading at P/Adj BV multiple of 5.1 times and Ujjivan Small Finance Bank at P/Adj BV of 1.8 times. Perceived higher NPA potential of Equitas' vehicle finance book justifies lower P/Adj BV compared to Ujjivan.

In terms of PE, Equitas Small Finance Bank is offered at 15.4 times, while AU Small Finance Bank is trading at 33.1 times and Ujjivan Small Finance Bank at 15.2 times.

Pre-Covid, new small finance banks were fancied by markets, in preference to traditional small old private sector banks, due to their higher and faster growth potential as they cater to underserved clients. However post-Covid, this target market segment is the most challenged and faster growth by most of the small finance banks will not only be difficult but also imprudent.

Equitas Small Finance Bank: Financials

Equitas Small Finance Bank: Indicators