1st May 2021, Current Market Price Rs.81 per share.
India, despite being one of the largest economies in the world has close to 200 million Indians who still form a part of the unbanked population!
To tackle this problem, the year 2015 saw a significant change in the Indian banking landscape - the Reserve Bank of India gave an in-principle approval to 10 small financial institutions to set up banking operations, giving birth to a new spectrum of banking services called the Small Finance Bank (SFB). The fundamental idea behind the SFB was to promote the financial inclusion of the deeply underserved/ unserved strata of society. This included small business owners, farmers, and people working in the unorganised sectors of the economy.
So, what is the correlation between financial inclusion and the growth of a nation?
One of the main arguments made towards banking the 'bottom of the pyramid' is inculcating the habit of saving. With formal inclusion into the banking setup the money saved by the unbanked population of the society can be converted into useful capital that can further be lent for growth and development of the nation. With roughly 200 million customers being introduced to the banking setup, the potential wealth created could be enormous.
The other big reason for pushing financial inclusion is the access to credit provided to the masses. The provision of credit can drive radical entrepreneurship, create self-sufficiency and generate wealth. To this effect, the Government of India, along with RBI have also undertaken other key initiatives such as providing basic savings deposit accounts under Pradhan Mantri Jan Dhan Yojana (PMJDY) in addition to the the approval of Small Finance Banks (SFB).
So how does a small finance bank differ from a conventional commercial bank and what problems do SFBs solve better so as to justify their existence?
Before answering this question let us understand some of the key differences between both the entities, as explained in the table below.
From the above table, it may seem as though the scales are tipped in the favour of a standardised commercial bank. However there are significant advantages that SFBs have which may not be applicable to the latter.
To begin with, the granulated lending profile of the SFB significantly reduces the risks of large NPAs unlike the case of a commercial bank, where a default by a single large corporate may have significant repercussions on the liquidity of the bank.
Moreover, commercial banks who largely focus on acquiring HNIs, affluent individuals and large corporates may not be the best equipped to serve the needs of the underbanked/ unbanked segment of society. The SFBs however specialise in this segment by fine tuning their operational processes to handle large volumes and small ticked sizes.
The net interest margin (NIM) for SFBs is also significantly higher than what is made by a commercial bank, and hence, a well run SFB could be a highly profitable business.
In this article we further delve into Equitas Small Finance Bank and its holding company Equitas Holdings Ltd.
Equitas was founded in 2007 by Industry veteran PN Vasudevan, the former head of Vehicle Finance division of Cholamandalam Finance and ex-banker from DCB bank. The SFB with its headquarters in Chennai, is the first private sector bank originating from Tamil Nadu since Independence. The bank was setup under a holding company which was called Equitas Holdings Ltd., this structure enabled large investments from foreign institutional investors (FIIs) that served as the initial capital base for the bank.
Currently, Equitas is one of the largest SFBs in India with an asset base of roughly INR 20,000 crores, providing its services to more than 2.7 million customers through some of its 800+ outlets. Equitas was also one of the first lenders to structurally bring down the interest rates for its borrowers to less than 30% in an industry otherwise known to charge upto 40%.
The company possess a highly diversified and granulated portfolio of advances as depicted below. The diversification shields the company from the occurrence of large NPAs.
Small Business Loans: Fastest growing segment with a CAGR of 65% over the last 3 years. Advances are disbursed mainly to small businesses looking for secured loans.
Vehicle Finance: Financing used or new commercial vehicles for first-time formal banking users. It is the second-most attractive segment for Equitas in terms of yield.
Micro Finance: A specialised and niche segment for Equitas. Mainly provides group loans to micro-level entrepreneurial women. Generates the highest yields amongst all the other segments
MSE Finance: Provides Working Capital Loans, fund based (cash credit, OD etc.) and non-fund based (Line of Credit, Bank Guarantee etc.) to manufacturing and trading companies which are part of the formal setup with annual turnover of less than INR 15 crores.
Corporate & NBFC Loans: New segment for Equitas to lend to NBFCs who cater to businesses with an annual turnover of Rs.15-50 cr.
On the liability front, the bank accepts both current and savings deposits from its customers along with providing term deposit services in its 854 banking outlets. The liability franchise has seen a strong growth of 200% in the last 3 years which has been the main driver of growth in net interest margins, as a result of the lowered cost of funds.
Despite serving the financially neglected segments of the country where most activities take place in cash, the bank was able to navigate through turbulent months post demonetisation and through macro headwinds like the introduction of Goods and Services Tax. The company was also able to wade through the pandemic-induced threat of high NPAs and the consequent loan moratorium declared by the RBI in April 2020. After having successfully navigated through a highly challenging economic landscape over the past few years, the company has emerged stronger and is poised for sustainable growth in the future ahead. A large contributor to the company's financial stability is its robust balance sheet with a high degree of liquidity and the managements ability to avoid over-leveraging its books.
On the financial front, since the beginning of its small finance banking operations 4 years ago, Equitas has roughly doubled its Revenue at a staggering compounded aggregated growth rate of 23%.
Small Finance banks have been an attractive industry in India, mainly due to the large size of its target demographic and substantially higher yields. However, only a few have been able to match or surpass the success of Equitas. One amongst them is the Rajasthan based AU SFB that has emerged as the leader of the pack with a market capitalisation of roughly INR 40,000 Crores.
The closest competition for Equitas has come from its neighbouring state of Karnataka, through Ujjivan SFB. Both are similar in terms of their origins as microfinance lenders lending to a marginalised section of society. However, Ujjivan unlike Equitas has not been able to fully diversify its portfolio of advances as it still lends heavily (about 80%) to the microfinance sector alone.
*Equitas Holdings is a holdco. that holds 82.05% of Equitas Small Finance Bank.
Liability Franchise: Equitas has one of the lowest cost of funds, 7.39% versus the industry average of 10.29%. This is a result of the higher current and savings account deposits (CASA) the company has been able to garner over time. A higher CASA ratio translates to a lowered cost of funds for the bank.
Diversification of Loan Book: Equitas has diligently worked on diversifying its loan book by bringing down its exposure towards the micro finance segment from 46% in 2016 to 24% in 2020.
Adequate Capitalisation: Total capital to risk-weighted asset ratio (CRAR) is at about 21.5% and Tier-I CRAR is at about 20% which are well above the minimum regulatory requirements of 15% and 7.5% set by the RBI. This excess capital can be used to further fund the growth of the SFB in the coming years.
Relative Valuation: Second largest listed SFB in terms of banking outlets & advances, but trading at 1/10th the valuation of its next largest peer.
Holdco. Discount: Holding company trades at approximately 50% of the value of its underlying banking entity. A potential reverse merger which is on the cards may result in a significant value unlocking for the share holders of the holding entity.
The management of Equitas have always been keen on running one single entity in the future and have been in constant touch with the RBI for the approval for the same. RBI in its Guidelines for Licensing of New Banks released in 2013 had prescribed several structural requirements of promoting a bank under a Non-operative Financial Holding Company (NOFHC). However, as per the recent recommendations from an Internal Working Group of RBI, Banks under such holding structure may be allowed to exit if they do not have other group entities. We see this as a positive development for Equitas Holdings and its shareholders as a potential reverse merger of the banking entity with the hold co will unlock great value. This, coupled with Equitas' strong financial performance should catapult the company to the big leagues in the future.
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