Why Equitas Small Finance Bank shares are a good investment
Equitas Small Finance Bank (SFB) shares have lost 15% since peaking in early March. The stock seems an attractive bet for the long term, given the good growth of its diversified loan portfolio. That aside, the bank should also benefit from the continued ramp-up of its retail deposits.
In addition, SFB’s current valuations are also reasonable at just 2 times its FY21 book value. While its direct peers Ujjivan SFB and Suryoday SFB are trading down to 1.5-1.9 times their book value. (end of December 2020), Equitas SFB benefits from a higher valuation given its relatively less risky business model. While Ujjivan SFB and Suryoday SFB (the latter currently has a much smaller loan portfolio), currently enjoy a better return on assets (ROA) – above 2% (as of December 2020), any deterioration in the asset quality can alter their return ratios. . This is because only 25 percent of each of their portfolio is guaranteed. In the case of Equitas SFB, approximately 81 percent of the loan portfolio is secured loans. In FY21, although the pandemic hampered collection efficiency, Equitas SFB posted a RoA of 1.8% in the March 2021 quarter, with GNPA (gross non-performing assets) at 3.59%.
The bank’s gross advances increased by 39% CAGR (compound annual growth rate) between FY18 and FY20, reaching ₹ 15,367 crore. In FY21, SFB also resorted to cautious growth amid uncertain times – advances increased 17% year-on-year to ₹ 17,925 crore. About 45 percent of the loan portfolio consists of small business loans (including home loans) and microfinance accounts for an additional 18 percent. Vehicle financing (25 percent), MSE financing (7 percent) and loans to NBFCs (4 percent) make up the remainder.
Addressing unbanked clients, SFB enjoys higher returns on its assets (19% and more up to FY20). That aside, an increase in retail deposits has also helped drive down the cost of funds for the bank – deposits now represent 77% of its total borrowings. Additionally, about 34 percent of the bank’s deposits are low-cost CASA deposits. In the fourth quarter of fiscal 21, after a 55 basis point (bps) decline in its cost of deposits, the bank’s cost of funds fell 57 bps (year-on-year).
Given its exposure to low-cost, unbanked customers, the bank’s collections were affected following the FY 21 foreclosure. However, the scenario improved towards year-end. After the Supreme Court ruling on the recognition of the NPA (on the moratorium book), the bank’s GNPA was 3.59% in the March 2021 quarter, compared to 4.16% in the December 2020 quarter (proforma) . In addition, about 2.4 percent of the bank’s loan portfolio has been restructured under the RBI. The bank’s provision coverage ratio stood at 58.6 percent in FY 21. However, the cumulative provisions on the bank’s balance sheet, including standard provisions, floating provisions, and provisions for NPA , cover about 71.9 percent of the bank’s bad debts.
While the spike in NPAs was lower than expected, the bank’s net interest margin (NIM) was hit. Despite a fall in the bank’s cost of funds, NIMs fell 197bp year-on-year to 7.57% in the fourth quarter of FY21, due to the write-backs of interest on bad loans.
Given its focus on unbanked niche segments and its presence in more than 17 states and EU territories, SFB is poised for long-term growth. However, short-term risks persist for the bank. While the bank saw a return to normal in the March 2021 quarter, in terms of collection efficiency, the second wave of the pandemic and the resulting partial lockdowns in various parts of the country could still hamper collections. . In April 2021, with a surge in covid infections, the bank has already seen a drop in overall billing efficiency (percentage of IMEs collected for that month) to 88.12%, down from 94.46% in March. 2021. Other lockdowns were imposed later. months, the next few quarters could see a further deterioration in asset quality, thus impacting margins and yield ratios in the short and medium term.
While the lockdown this year is not as severe as last year, the impact on collections could be more difficult following financial burdens destroyed by the pandemic. However, we are reassured by one, the higher share of guaranteed securities in Equitas SFB’s portfolio and two, the return to normal is perhaps not exaggerated, as has been observed during the last year. ‘exercise 21.
The bank’s geographic concentration (Tamil Nadu, Maharashtra and Karnataka account for 54%, 13% and 10% of advances respectively) is also a drag – given the surge in Covid cases in these states.
Another major overhang for the title comes from the RBI’s mandate to dilute the promoter’s stake. While the RBI’s internal working group has spoken out in favor of removing sub-targets for dilution in the sponsor’s stake, existing guidelines require dilution for the bank by September 2021. Equitas Holdings (sponsoring entity ) currently holds around 81.98% of the bank’s capital. , which is to be reduced to 40 percent by September 2021 (another 30 percent and 26 percent, respectively by September 2026 and September 2028).
However, management is considering several possibilities to bring down the developer’s stake in a less dilutive way (for existing shareholders) – such as the merger with the group’s housing finance arm.
These risk factors seem to have already been assessed in the stock. In addition, given the current economic scenario and its capital adequacy of 24.18%, the bank’s loan portfolio is well positioned for growth, which could lead to a reassessment, if the quality of assets is demonstrating such resilience, in future finances as well.