Equitas Small Finance Bank (ESFB) - Subscribe - YES Securities

Price Band Rs32-33 - IPO Size Rs5.1-5.2bn (Fresh Issue Rs2.8bn)

Promoter's stake (Equitas Holding Ltd.) to decline from 95.5% pre-issue to 82.1% post-issue

A diversified and growing SFB franchise

- The promoter, Equitas Holdings Limited (EHL) was granted RBI's final approval in June 2016 to establish a Small Finance Bank (SFB). Subsequently, the SFB commenced operations in September 2016.

- ESFB is one of the leading small finance banks in India, having witnessed significant growth both in terms of size and franchise over FY18-20. Gross advances and deposits witnessed a CAGR of 38-40%. CASA and retail TDs stands at 21% and 40% respectively of the total deposits.

- The SFB has been able to successfully diversify loan portfolio and significantly reduce its dependence on microfinance. Presently, its largest lending segment is small business loans (42% of AUM), followed by vehicle finance (24%) and then microfinance (23%). Share of secured loans has increased to 75% from 66% as of FY18.

- 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.

- As of March 31, 2019, ESFB had the largest network of banking outlets among all SFBs in India. As of June 30, 2020, its distribution channels comprised 856 banking outlets and 322 ATMs across 17 states and union territories in India. The SFB also distributes products through digital channels.

- While diversification of loan assets has mitigated credit risk, the diversification of liabilities and granularization of deposits has consistently brought down the funding cost, paving the way for introducing secured and relatively safer products.

- Return ratios (RoA 1.4% and RoE 10% for FY20) have rebounded in recent years driven by operating leverage (sweating of strategic investments and franchise growth). NIM was maintained near 9% despite SFB coming down the risk curve.

- The fresh issue worth Rs2.8bn would augment an already strong capital position. CET-1 capital ratio would likely increase from 21% to 23%.

- ESFB is seeking in-principle approval from RBI to undertake a merger of EHL with itself, such that the merger would be effective from September 4, 2021; and seeking in-principle approval from the RBI to permit the dilution of EHL's shareholding in the SFB pursuant to such merger.

High moratorium represents substantial asset quality risk

- 36% of the portfolio was under moratorium as of August 31, 2020; higher in vehicle finance and small business loan segments. Since ESFB's customers belong to informal and semi-formal segments, their financial resilience to longer business disruptions is typically lower.

- While September will provide the true picture on the impacted customers, it highly probable that ESFB could witness significant restructuring and NPL flows in coming quarters, and thus a steep spike in credit cost.

Rate Subscribe - Robust capital buffer + Profitability rebound from FY22 + Inexpensive valuation

While ESFB will see its profitability erode in FY21 on account of significant increase in credit cost and deceleration in growth, recovery in return ratios will ensue from FY22 as return to normalization begins. Strong capital buffer lends comfort on liquidity and growth fronts, and represents a substantial cushion to absorb even a worst-case credit shock. On post-money basis, the IPO has been priced at 1.2x current P/BV which we believe is attractive considering the long-term growth and profitability potential of the SFB.

Shares of Equitas Holdings Ltd was last trading in BSE at Rs.49.65 as compared to the previous close of Rs. 49.95. The total number of shares traded during the day was 261979 in over 1778 trades.

The stock hit an intraday high of Rs. 50.75 and intraday low of 49.5. The net turnover during the day was Rs. 13079121.

Source : Equity Bulls

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