ESAF Small Finance Bank

Fastest growing SFB

Strong growth, geographical reach, healthy assets quality, diversified loans and presence in underpenetrated rural areas

ESAF Small Finance Bank incorporated in 2016 is a small finance bank (SFB) promoted by ESAF Financial Holdings. The bank received in-principle approval to set up SFB in 2015 and final approval in 2016. ESAF Financial Holdings transferred its lending and financing business to ESAF SFB on 22 February 2017. The bank commenced business as a SFB on 10 March 2017 and the bank was included in the second schedule to the RBI Act pursuant to a notification dated 12 November 2018 issued by the RBI.

The ESAF brand has been built over 27 years with the founding of ESAF Foundation by ESAF SFBs individual promoter Kadambelil Paul Thomas in 1992. ESAF Foundation commenced micro loan activities in Kerala in 1995, which were taken over by ESAF Financial Holdings in 2008.

On the advances side, the bank offers (a) Micro Loans, which comprises Microfinance Loans and Other Micro Loans; (b) retail loans, which includes gold loans, mortgages, personal loans, and vehicle loans; (c) MSME loans; (d) loans to financial institutions; and (e) agricultural loans. The liability products comprise current accounts, savings accounts, term deposits and recurring deposits.

The business of the bank is focused on lending to unbanked and under-banked customer segments, especially in rural and semi-urban centers. The gross advances to customers in rural and semi-urban centers (combined) accounted for 62.97% of gross advances and 71.71% of banking outlets were in rural and semi-urban centers.

The bank offers services like safety deposit lockers, foreign currency exchange, giving customers access to the Bharat Bill Payment System, money transfer services and Aadhaar Seva Kendra services. It also distributes third-party life and general insurance policies and Government pension products.

AUM of the bank has grown at a strong CAGR of 39.22% to Rs 16331.26 crore end March 2023 from Rs 8425.93 crore end March 2021 and increased to Rs 17203.97 crore end June 2023. The deposits also increased at a sturdy CAGR of 27.66% from Rs 8999.43 crore to Rs 14665.63 crore and increased to Rs 15655.85 crore end June 2023.

The bank has placed an emphasis on increasing Retail Deposits. Retail Deposits have increased to Rs 13977.27 crore end June 2023, which accounted for 89.28% of total deposits. The bank had 6.74 million deposit accounts.

The bank has a wide network of 700 banking outlets (including 59 business correspondent-operated banking outlets), 767 customer service centers (which are operated by business correspondents), 22 business correspondents, 2,116 banking agents, 525 business facilitators and 559 ATMs spread across 21 states and two union territories, serving 7.15 million customers end June 2023. While operations are spread out across India, business is concentrated in South India, particularly in the states of Kerala and Tamil Nadu. The bank had 5,160 employees at the end of June 2023.

The bank uses business correspondent entities to source and service customers for micro loans. Business correspondents also source customers for mortgage loans, vehicle loans, MSME loans, agricultural loans and select deposit products. In addition, business correspondents are responsible for sourcing and servicing banking agents.

The bank focuses on leveraging technology to deliver products and services and the bank continuously works towards improving customers experience through technology.

Kadambelil Paul Thomas is the MD&CEO of the bank, who has over 27 years of experience in the banking/microfinance industry in India. He is also one of the founders and promoters.

The bank has maintained healthy asset quality with gross non-performing advances (NPAs) ratio at 1.65% and net NPAs at 0.81% end June 2023. The Provision Coverage Ratio was strong at 74.35%

The bank has posted a healthy net interest margin of 3.08% (not annualized) in Q1FY2024, 10.67% in FY2023, 8.64% in FY2022 and 8.98% in FY2021.

The bank has maintained a healthy capital to risk weighted asset ratio (CRAR) of 20.56% and 18.95% end June 2023. The bank has adopted various policies including an Environmental, Social and Governance (ESG) policy.

Tier II bonds (Basel III) issued by the bank in the form of subordinated debt instruments and proposed Tier II Bonds are rated by CARE Ratings Limited as “CARE A; Stable”.

The bank aims to penetrate deeper into existing geographies, while it would continue to grow micro loans while increasing other categories of advances both in absolute terms and as a percentage of total AUM. The bank intends to increase fee-based income by cross-selling, expanding third-party products and service offerings and expanding fee-based offerings.

The Offer and the Objects

The initial public offer (IPO) consists of fresh issue of Rs 390.7 crore through issuance of 6.85 crore equity shares at the lower band of Rs 57 per share (face value Rs 10 per share) and 6.51 crore shares at the upper band of Rs 60 per share. The issue also consists of offer-for-sale of Rs 72.3 crore through issuance of 1.27-1.21 crore equity shares.

Among the promoters, ESAF Financial Holdings is proposing to raise Rs 49.26 crore in OFS. Among the selling shareholders, PNB MetLife is raising Rs 12.67 crore and Bajaj Allianz Life Rs 10.37 crore.

The promoter and promoter group shareholding would decline to 63.4% post IPO from 74.4% pre-IPO.

The issue is to be made through the book-building process and will open on 3 November 2023 and will close on 7 November 2023.

The bank proposes to utilize the Net Proceeds from the offer towards augmenting Banks Tier I capital base to meet future capital requirements. The listing of the bank is also in line with the terms of the RBI SFB licensing guidelines, requiring the bank to list its Equity Shares on the stock exchanges within three years from reaching network of Rs 500 crore.

Strengths

The bank is the first largest and fastest growing SFB with a strong CAGR of 39% in AUM growth for FY21 to FY23.

The bank knows the micro loan segment well, enabling it to grow business outside of Kerala, home state. Gross Micro Loans to customers outside of Kerala accounted for 42.30% of total gross Micro Loans end June 2023. Since April 2020, the bank has considerably expanded the number of states and territories the bank operates in.

The banks focus is on the rural and semi-urban banking franchise, which accounted for 62.97% of gross advances, 56.92% of total customers, and 71.71% of total banking outlets. There are growth opportunities in rural centers in India as rural centers account for just 8% of banking credit against 47% share in GDP.

The bank has placed an emphasis on increasing Retail Deposits growing at CAGR of 23.07% from FY2021 to FY2023. CASA deposits, a stable and low-cost source of deposits, also grew at a healthy CAGR of 33.99%.

The bank began offering NRIs savings bank and term deposits in June 2018 and current accounts in June 2021. The deposits from NRIs have increased soon to 20.98% of the total deposits.

The bank has built strong customer connections driven by customer-centric products and processes and other non-financial services for Micro Loan customers.

The bank continuously works towards improving customers experience through technology. The bank offers customers various digital platforms, including an internet banking portal, a mobile banking platform, SMS alerts, bill payments and RuPay branded ATM cum debit cards.

Weaknesses

The business is significantly dependent on the micro loan segment, which accounts for 74.7% of the loan book. Microfinance loans are provided to individuals without the security of collateral and are at a higher credit risk than secured loans.

Micro Loan borrowers generally have limited sources of income and credit histories through which the bank can accurately assess their credit worthiness.

The business is concentrated in southern region with 62.43% of banking outlets located in South India (including 43.43% in Kerala and 13.86% in Tamil Nadu), 73.09% of gross advances are from customers in South India (including 43.45% from Kerala and 22.14% from Tamil Nadu) and 86.90% of deposits are from banking outlets in South India (including 80.04% from Kerala and 3.36% from Tamil Nadu). Any adverse change in the economy of South India could have an adverse effect on business.

The attrition rate of employees was 3.87% (not annualized) in Q1FY2024 and 24.07% in FY2023. The elevated employee attrition may need to increase the compensation paid to employees to retain employees.

The business correspondents sourced or serviced 74.75% of gross advances end June 2023. All the business correspondents work on a nonexclusive basis. If any of the business correspondents prefer to promote competitors loans or the agreements with them are terminated or not renewed, it would adversely affect business.

Valuations

EPS on post-issue equity for TTM ended June 2023 works out to Rs 6.3. At the price band of Rs 57 to Rs 60, P/E works out to 9.0 to 9.5 times of EPS for TTM ended June 2023.

Post-issue, the book value (BV) will be Rs 43.3, while adjusted BV (ABV) net of net non-performing assets and 10% of restructured loans works out to Rs 41.0 per share at upper price band.

The scrip is being offered at a price to Adj BV multiple of 1.5 times at the upper price band.

Among peers, AU SFB is trading at P/ Adj BV multiple of 4.3 times, while Ujjivan SFB is trading at P/ Adj BV multiple of 2.4 times, Equitas SFB at 2.1 times, Utkarsh SFB at 2.1 times, Bandhan Bank at 1.9 times and Suryoday SFB at 1.1 times.

In terms of PE, Au SFB is trading at 28.9 times its EPS for TTM ended June 2023, Bandhan Bank at 16.9 times, Equitas SFB at 15.8 times, Suryoday SFB at 13.7 times, Ujjivan SFB at 12.9 times and Ujjivan SFB at 8.4 times.

ESAF SFB has recorded a relatively lower ROA at 1.5% and RoE at 11.1% on post-issue equity basis for the TTM ended June 2023, which is lower than average 2.0% RoA and 14.8% RoE average for six peer SFBs.

ESAF SFB is the fifth largest SFB in India in terms of AUM end June 2023. Among the compared SFBs, ESAF posted the fastest AUM CAGR of 39% over FY2021 to 2023. AUM growth of ESAF SFB was robust at 35.1% end June 2023, which is slightly behind Equitas SFB, which posted the fastest growth at 36.5%.

ESAF SFB reported the fourth highest deposit growth of 28% over FY2021 to 2023 among the compared peers. Ujjivan SFB reported the highest deposit growth of 40% over FY2021-23. However, the deposit growth of ESAF SFB moderated to 16% end June 2023, which is slowest among the compared SFBs and half of average deposits growth of 33.3% for SFBs end June 2023.

ESAF SFB had the highest retail deposits as a percentage of total deposits at 89.3% end June 2023. However, the CASA ratio of ESAF SFB was moderate at 18.2% end June 2023 compared with 25% average CASA for SFBs.

For Q1FY24, ESAF SFB has the highest growth rate of banking outlets among its peers, growing by 21.5% year on year. It had the highest AUM per employee end June 2023. It also ranked highest in yield on advances among the compared SFBs.

ESAF SFB had the best asset quality among compared peers end June 2023. Its GNPA ratio is lowest among SFBs at 1.65% end June 2023 against 2.5% average for SFBs.

Except for AU SFB, all the compared SFBs were pure MFIs turned SFBs, resulting in a huge concentration of MFI products. Equitas SFB has relatively lower concentration of MFI products is due to its diversification into other businesses. ESAF SFB still has highest share of micro loans at 74.7%, followed by Utkarsh SFB at 62.9%, Ujjivan SFB at 58.5%, Suryoday SFB at 39.7% and Equitas SFB at 19.0% end June 2023.

ESAF SFB has a relatively better cost-to-income ratio at 55.7% for Q1FY2024 as against the 59% average for SFBs. Net interest margins of ESAF SFB were the best among SFBs, at 11.1% (annualized), for Q1FY2024.