Equitas Small Finance Bank or Equitas SFB does not boast of having a clean loan portfolio. With assets of ₹19,687 crore as of December 31, 2021, it still has a long way to go to secure a place in the country’s banking landscape as a serious contender.
Yet, for investors looking for affordable options in the financial space, Equitas SFB presents itself as a valid option for its ability to anticipate its peers, without taking its eyes off its main clientele – the low-to-middle income categories. When the SFB licenses were handed over in 2015, Equitas was one of the nine actors from the microfinance sector (MFI). But in seven years, it managed to reposition itself as a lender offering a range of products rather than MFI loans. At 1.7x the estimated price for FY23, valuations are not very demanding given the long-term potential.
However, taking a short-term view (12-18 months) on the stock may not work due to likely changes in corporate structure and short-term pressures on asset quality. It is imperative to take a longer time horizon (3 to 5 years) while considering the Equitas SFB share.
Progress so far
In 2016, the holding companies of Equitas and Ujjivan, its closest competitor, went public around the same time. The share of MFI loans was then 50% and 86% respectively. Subsequently, to meet the licensing requirements of the RBI, both had to list their SFBs. Ujjivan SFB (which enjoyed a premium to Equitas) had an exceptional listing in December 2019, while Equitas SFB was listed about a year later when Covid had already impacted the economy. But since their IPOs, Equitas SFB stock has appreciated 67%, while Ujjivan SFB stock price has fallen 69%. Here’s what helped Equitas SFB stay ahead of the competition.
The most important distinguishing factor for Equitas is its ability to take the risk of diversification.
The share of MFI loans fell from 50% in 2016 to 19% in the December quarter of FY22 (Q3 FY22). The objective is to further reduce it to 400 basis points in the coming years. Ujjivan SFB and Suryoday SFB remain dependent on loans from MFIs. Interestingly, despite Bandhan Bank’s acquisition of Gruh Finance (NBFC housing finance) in 2019, it is still considered an MFI-led business (see chart). Of the MFI-turned-bank players, Equitas is the only one to have made decent progress in diversification.
Most new products were built around its existing or similar customer profile. Even though SFB has moved into vehicle financing (used and new) and small business loans (including home loans), 40% and 49% of the respective books are made up of loans whose amount is less than ₹5 lakh. In vehicle finance, the bank has an exposure of around 16% to loans amounting to ₹10 lakh or more, while it is 31% for SME loans. For a bank specializing in low- to middle-income groups, these loans are a natural extension of its risk management framework. Equitas has also ventured into housing finance and agricultural loans. All of its product forays thus far have been organic efforts. Secured loans make up 81% of the bank’s portfolio, which puts Equitas as a safer bet compared to others at less than 35% of the total portfolio.
Additionally, with more granular note sizes compared to established banks (largely targeting the ₹10-15 lakh range for car loans and ₹50 lakh – ₹1.5 crore for SME and housing loans), recovery may be easier.
Equitas also leads the segment in CASA (current account – savings account). With a CASA ratio above 50% in the third quarter, the competition has not even reached the 30% mark yet despite more than five years of operation.
Asset quality, management
At 4.4% non-performing assets (NPA), the quality of the loan portfolio is a concern. Uneven collection efficiencies and late collection across the vehicle finance portfolio could remain pain points. With 9.8% of total restructured accounts, any significant respite in asset quality can only be expected in FY24, when the settlement of restructured accounts will take place. Therefore, reaching an NPA below 3% observed before the pandemic could be difficult in the short term.
However, SFBs as a class expect FY23 to be another high stress year. For Equitas, the analyst consensus points to a gross NPA of 4% for FY23, although delayed improvement in the quality of the loan portfolio (trend in the second quarter of FY23) is a key risk for Equitas. investors. What is comforting is that despite exceeding the 5-year average by 3.2%, Equitas’ NPA is still better compared to Ujjivan or Suryoday where the raw NPA is above 10% each.
Unlike AU SFB or Ujjivan, which faced heavy senior management attrition last year, Equitas has been a steady ship, especially when it comes to leadership. Led by a team that has been intact since its inception as a bank, this is a very comforting factor for investors.
Merger with holdco
Following the RBI’s waiver of the mandatory holding company structure for SFBs, Equitas SFB has put in place a merger plan, under which shareholders of Equitas Holdings will be allocated 2.31 equity shares in Equitas SFB. While Equitas Holding’s market capitalization is ₹3,770 crore, based on the swap ratio, its value works out at ₹4,145 crore – at a 10% premium to its market capitalization. However, given its stake in Equitas SFB at 74.63%, the value of which is ₹4,905 crore, the swap ratio implies that the holding company remains at a 15% discount to SFB.
However, there is an approximately 10% arbitrage opportunity for investors based on the swap ratio and therefore buying shares of Equitas Holdings in anticipation of the merger is also a favorable proposition. Given the current market capitalization of Equitas SFB compared to post-merger shareholding, Equitas SFB stock could be valued 11% above the current closing price, also leaving an advantage for existing shareholders.
After five years of operation as an SFB, Equitas envisions the next level – a Universal Banking License, which will allow the bank to offer a wider range of loans and services and meet the needs of a wider. However, this can deplete the profitability of the bank. With a cost-to-income ratio of 64.7% (which has increased due to the pandemic), the bank’s efficiency is 200 to 220 basis points lower than its established counterparts such as City Union Bank and Federal Bank. In fact, when Equitas moved from NBFC-MFI to SFB, its cost-to-income ratio was above 70% and only fell below 55% in FY20. Aiming for a universal banking license can once be a costly affair.
Having a diversified loan book has its downside. Although Equitas’ portfolio is relatively short (12 months to 5 years; except housing 15-20 years), disruption in asset quality is inevitable in the early stages of experimentation with its loan portfolio. Until the assets mature and the bank has experienced 2-3 full behavioral cycles of these loans, there can be a tightrope between growth, asset quality and capital consumption.
March 26, 2022