Equitas Small Finance Bank
Profile of the company
The bank was 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 Fiscal 2019. 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. The bank’s strength lies in promoting financial inclusion within these segments, with its group beginning operations in 2007 as an NBFC providing microfinance loans through EMFL. The bank has been providing housing finance since 2011 through EHFL. The bank has also been providing vehicle finance and MSE finance through the Erstwhile NBFC that received its asset finance license in 2012, primarily to economically disadvantaged households. While its business model has transitioned over the years, the provision of sustainable credit to unserved and underserved segments has remained its core focus.
The bank’s focus customer segments 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 bank’s asset products are suited to a range of customers with varying profiles. These include provision of small business loans comprising LAPs, housing loans, and agriculture loans to micro-entrepreneurs, microfinance to 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, its target customers comprise mass and mass-affluent individuals to whom it 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.
Objects of the Issue:
The bank proposes to utilize the net proceeds from the offer towards augmenting the Bank’s Tier I capital base to meet its future capital requirements.
In order to promote financial inclusion, the Indian banking industry has seen several changes in recent years. NBFCs such as Bandhan and IDFC received permission to set up universal banks. Further, a few microfinance companies, local area banks and NBFCs have received permission to set up SFBs. SFBs are allowed to take deposits, which provide them an edge of having lower cost of funds in comparison with NBFCs. MFIs turned into SFBs are now diversifying their advances mix, and focusing on other retail and corporate lending business. SFBs have a sizeable growth opportunity as most of them were previously functioning as NBFCs/ MFIs. In the last one year, all SFBs have focused on increasing their deposit base immediately after commencement of their operations. Overall deposit base of SFBs has grown by 109% to around Rs 555 billion in Fiscal 2019. However, the CASA deposit reduced from 24% in Fiscal 2018 to 20% in Fiscal 2019.
However, SFBs face stiff competition from public sector and private sector banks as these banks benefit from greater trust among the customers in the rural region. Cost of accepting deposits is also expected to be high in the initial years of operation due to high interest rate offerings in order to attract the customers. Further, the average deposit per customer in the rural region is low. In the long run, with a customer centric approach, use of technology, stability of the business model and improved reach, the cost of acquisition and interest paid is expected to reduce.
Meanwhile, it is expected that deposits will grow at a CAGR between 60% to 65% from Fiscal 2019 to Fiscal 2022, as players focus on promoting convenient banking habits in order to make it accessible to the last mile and enhance financial inclusion. In addition, few players are also contemplating capital injections to grow asset size and deepen their penetration in untapped geographies by expanding their network of branches/ banking outlets. Going forward, non-banks are expected to lose market share to well capitalised banks and SFBs amid ongoing crisis of confidence and consequent liquidity crunch. The NBFCs are heavily reliant on banks for funding which has led to a rise in cost of funds. However, access to deposits, resulting in lower cost of funds will allow SFBs to compete with NBFCs on pricing in the underpenetrated region and take away some share from NBFCs resulting in overall business growth for SFBs.
Pros and strengths
Diversified asset portfolio: The bank was the largest SFB in India in terms of number of banking outlets, as of March 31, 2019, and in Fiscal 2019 it recorded the fourth lowest yields indicating its diversification away from microfinance. It has been able to successfully diversify its loan portfolio and significantly reduce its dependence on its microfinance business as compared to other microfinance companies that have converted to SFBs. The bank’s asset products include provision of small business loans comprising LAPs, housing loans, agriculture loans, microfinance to JLGs, used and new commercial vehicle loans, gold loans, MSE loans, and corporate loans.
Strong retail liability portfolio with a strategic distribution network: The bank’s total deposit has grown at a CAGR of 38.75% from Rs 56,039.73 million as of March 31, 2018 to Rs 107,884.05 million as of March 31, 2020, and was Rs 117,871.27 million as of June 30, 2020. The bank offers a variety of demand deposits and savings bank account options including deposits and other services through which its customers can realize their savings goals. These deposits are primarily sourced from mass and mass-affluent customer segments, which has enabled low cost of funding opportunities and has been a source of strength for its liability portfolio. In order to complement the profile of these customers, certain of its Banking Outlets are equipped with customer waiting areas, teller counters, lockers, ATMs and cash deposit machines. As of June 30, 2020, the bank’s deposit base was spread across 17 States and union territories in India, through a network of 856 Banking Outlets, with 37.99%, 41.88%, and 20.14% of its deposits in the Northern, Southern, and Western regions of India, respectively.
Customer centric organization: The bank is an SFB offering a range of banking 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, beginning from its operations in 2007 as an NBFC providing microfinance loans through EMFL. The bank has also been providing vehicle finance and MSE finance through the Erstwhile NBFC that received its asset finance license in 2012, primarily to economically disadvantaged households. While its business model has transitioned over the years, the provision of sustainable credit to unserved and underserved segments has remained its core focus.
Technology as an enabler to drive operating procedures: The bank leverages technology to identify opportunities, and deliver products and services to its target customer segment. It has created a paperless onboarding process for originating microfinance loans, opening savings bank accounts and fixed deposits. Tablets are used by field teams that enable straight through processing of applications. As of June 30, 2020, 8,083 employees use tablets/ digital services for their savings account customer onboarding operations, and 13,790 savings accounts (including zero balance accounts) were opened using tablets. The bank also records collections digitally by using pre-printed stickers for evidencing cash receipt, to mitigate the operational risks in its microfinance business. This is followed by SMS based collection tracking processes that enable field staff to update transaction record systems with collections report on a real-time basis.
Risks and concerns
Deposits depend on limited number of customers: The bank is dependent on a limited number of customers for a substantial portion of its deposits. Deposits from its 20 largest depositors (excluding certificates of deposit issued) represented 31.95% and 32.25% of its total deposits as of March 31, 2020 and June 30, 2020, respectively. Further, deposits from its 10 largest depositors, primarily comprising wholesale depositors, represented 23.94% and 24.94% of its total deposits as of March 31, 2020 and June 30, 2020, respectively. Reduction or loss of such deposits exposes it to an increasing funding risk, which could in turn adversely affect its financial performance and results of operations.
Limited operating history: The bank commenced operations as an SFB on September 5, 2016. Prior to commencement of operations as an SFB, it operated as an NBFC -AFC carrying out, inter-alia, vehicle finance and MSE finance business as a wholly owned subsidiary of EHL. As an SFB, its operations additionally include the businesses of the other two erstwhile wholly-owned subsidiaries of EHL. As a result of its limited operating history as an SFB, there is limited historical financial and operational information available to help prospective investors evaluate its past performance as a commercial banking entity. Accordingly, investors should evaluate its business and prospects in light of the risks, uncertainties and difficulties frequently encountered by banks that are in the early stages of development. Its failure to mitigate these risks and uncertainties successfully could materially affect its business and operating results, and consequently result in a decline in the trading price of its Equity Shares.
Continuous requirement of funds: Prior to operating as an SFB, the bank met its funding requirements through a combination of term loans from banks and financial institutions, issuance of non-convertible debentures, refinancing arrangements and securitization/ assignment of receivables. However, upon transitioning into an SFB, its primary sources of funding have been deposits and refinancing. As of March 31, 2020 and June 30, 2020, majority of its funding consists of retail deposits accounting for 44.42% and 46.40%, respectively, of its total term deposits, with a CASA ratio of 20.47% and 19.97%, respectively. Considering the growth of its business, it will have a continuous requirement of funds for expanding its outreach and enhancing its loan portfolio. The bank’s cost of borrowings are partly determined by the credit ratings it has obtained from various agencies in the past, and there can be no assurance that it will continue to be granted strong credit ratings and any downgrade in its credit ratings may increase interest rates for refinancing its outstanding debt, which would increase its financing costs, and adversely affect its future issuances of debt and its ability to raise new capital on a competitive basis.
Significant exposure to loans against property: The primary security for housing loans and other micro-loans disbursed by the bank under its small business loans segment is the underlying property. As of June 30, 2020, exposure to loans against property represented 37.12% of its Gross Advances (including IBPC issued). The value of this security is largely dependent on housing and property market conditions prevalent at that time, and may decline due to adverse market conditions including an economic downturn or a downward movement in real estate prices. Failure to recover the expected value of collateral could expose it to significant losses and, in turn, result in a material adverse effect on its business, results of operations, financial condition and cash flows.
Equitas Small Finance Bank was the largest small finance bank in India in Fiscal 2019 considering banking outlets and the 2nd largest small finance bank considering assets under management and total deposits. Unlike other microfinance companies, it has a diversified loan portfolio and less dependence on microfinance business. On the concern side, the bank’s deposits depend on a limited number of customers and a loss of such customers could materially and adversely affect its deposit portfolio, funding sources, financial condition, results of operations and cash flows. Moreover, the bank’s microfinance loan portfolio and unsecured business loans portfolio are not supported by any collateral that could help ensure repayment of the loan, and in the event of non-payment by a borrower of one of these loans, it may be unable to collect the unpaid balance.
The issue has been offered in a price band of Rs 32-33 per equity share. On the performance front, interest earned by the bank increased by 25.26% from Rs 21,119.34 million in Fiscal 2019 to Rs 26,454.44 million in Fiscal 2020, primarily due to an increase in interest on advances by 32.70% from Rs 18,236.56 million in Fiscal 2019 to Rs 24,200.07 million in Fiscal 2020 on account of an increase in advances. Meanwhile, net profit for the year was Rs 2,105.66 million in Fiscal 2019 compared to Rs 2,436.35 million in Fiscal 2020. The company will primarily focus on improving productivity across all its channels. It seeks to improve monthly deposit generation and customer acquisition at its Banking Outlets that it has established with features such as instant account opening, customer service resources, mobile and banking applications with enhanced features and other value-added services to attract mass and mass-affluent customers. It also intends to increase distribution of third-party products by offering and marketing them across all its channels, including Banking Outlets and digital channels. Moreover, the bank is aiming to reduce the Cost to Income ratio which was 66.38% and 67.27% as of March 31, 2020 and June 30, 2020, respectively, by leveraging its existing infrastructure of Banking Outlets and large customer base to cross-sell its range of products.