Equitas Holdings Limited

Rating Reaffirmed

Governance and Value Creation Rating CRISIL GVC Level 2 (Reaffirmed)

CRISIL has reaffirmed its Governance and Value Creating (GVC) rating of 'CRISIL GVC Level 2' on Equitas Holdings Limited (Equitas; part of the Equitas group). The rating indicates that the Equitas group has 'Very High' capability with regard to corporate governance and value creation for all its stakeholders¹.
 
The Equitas group comprises the holding company, Equitas, and Equitas' three wholly owned subsidiaries-one each for microfinance (Equitas Microfinance Ltd. [EMFL]); vehicle finance, loan against property (LAP), and small and medium enterprise (SME)-LAP (Equitas Finance Ltd [EFL]); and housing finance (Equitas Housing Finance Ltd [EHFL]). The group also has a trust, Equitas Development Initiatives Trust (EDIT), to carry out corporate social responsibility (CSR) initiatives. Equitas is the non-operating holding company of the group. It has been awarded an in-principle licence to setup a small finance bank (SFB). The group plans to merge the three subsidiaries to form a SFB and Mr. P. N. Vasudevan is expected to head the SFB.
 
The rating continues to reflect the Equitas group's high level of transparency and fairness in dealing with all its stakeholders, and its sound broad-based boards with a majority of independent directors across the group. The rating also factors in the significant industry experience of the management and its strong commitment to CSR initiatives. The group is highly process-oriented and has a strong audit and internal-control mechanism. These rating strengths are partially offset by the challenges in transformation to a SFB, continued reliance (although declining) on the managing director, Mr. Vasudevan, and moderate, though improving, track record in generating returns for shareholders.
 
The Equitas group has high value for transparency and fairness in dealings with all its stakeholders. For instance, it was the first microfinance institution (MFI) to declare interest rates in its passbooks and on its website. It is also proactive in adopting good disclosure practices. The group voluntarily adopted several best practices applicable to listed companies. Its investor base has also diversified over the years with the majority comprising of social and developmental institutions. The group withdrew the veto power vested with its managing director, Mr. Vasudevan, to prevent management takeover. This is in line with the spirit of good corporate governance.
 
The group continues to have high quality, broad-based boards with a majority of independent directors.  It has 31 directors, an increase from 21 in July 2012. The boards comprise well-accomplished and highly reputed members who have a distinguished presence in their respective fields. The members have domain expertise and extensive experience in the fields of microfinance and self-help groups, law and arbitration, audit and accounts, taxation, technology, and strategy. Induction of new directors with experience in banking, human resource, and social sectors, has further enriched the quality of the boards. The share of independent directors in the group has increased to 76 percent from 67 percent over the past three years.  Furthermore, the chairmen of most of the committees, including audit committee, continue to be independent. High degree of stability is visible within the boards, which have had a track record of smooth and cohesive functioning over the past four years. The key strategic decisions include launching new product segments of SME finance and LAP, identification of chief executive officers (CEOs) for each vertical, and conversion to a small finance bank. The boards have formed sub committees to have focused and in-depth discussions before arriving at decisions. They have been objective in their functioning and guided the group through challenging times apart from facilitating tapping of newer opportunities.
 
The management actively seeks and takes full cognisance of the opinion of the boards.  The group has also put in place a policy for evaluation of the performance of board members and all senior management personnel who form part of the management committee. The management team is proficient, comprising well-qualified and highly experienced members in MFI, vehicle, and retail finance businesses. There is a strong second line of management. Each functional head is highly experienced and all operational decisions are taken at a functional level. The senior management team has largely been stable over the past few years.
 
The Equitas group has a well-designed CSR plan implemented with strong spirit and passion. The CSR activities are implemented through EDIT, the trustees of which are well-respected members of society. These initiatives are well supported by regular contribution of funds from the group and a strong organisation structure. The financial commitment is demonstrated through allocation of 5 per cent of profits for CSR initiatives. The group has dedicated employees, who are well-experienced professionals, to manage these operations, both at the senior management and operational levels. Over the past three years, CSR activities have been broad-based to include running schools, skill-development courses, non-profit grocery stores, and organising health camps; these aim at providing holistic assistance not only to the group's customers but also to society. It has increased its focus on healthcare and employment generation, apart from increasing its contribution to existing activities in the field of education and food distribution.
 
The management is highly process-driven. Robust systems and processes, with strong technology support have been established since inception of the microfinance business. These enabled the rapid scale-up of the operationally intensive microfinance business in a short period of two to three years. Similar systems, with appropriate modification, have also been replicated for the vehicle finance business, which has also largely stabilised. Strong audit and internal control mechanisms are in place; these include a separate operational risk function with a mandate to conduct concurrent audit. An external audit firm conducts internal-audit for the group, covering all its functional areas and branch operations. The roles of these teams are well-defined and complement each other well. Audit is adequately supervised at the board level. The external audit firm and the statutory auditors are given independent access to the internal audit committee, which is chaired by an independent director.
 
Conversion to a SFB is a comprehensive change for the group as banking is a far more competitive activity. The group will face several challenges during transformation. The key challenges include inducting board members with relevant banking expertise, beefing up the top and middle management with banking expertise, and recasting the borrowing profile to be in line with banking requirements.  Furthermore, retail liability-side products would need to be launched, asset-side products fine-tuned and broad-based, and current systems and processes operationally improved to suit banking operations. The challenge regarding human resources is greater on account of the need to find personnel who are culturally in sync with the ethos and philosophy of the group. In addition, as a SFB the group will have to operate under a far more intensive regulatory compliance mechanism as compared with a non-banking financial company (NBFC). These challenges are very strategic in nature and would require management's undivided attention.
 
The Equitas group is moving swiftly towards addressing a few of these challenges. The foreign shareholding has reduced to about 35 percent through an initial public offering (IPO) during April 2016. As the three subsidiaries are to be merged to become a SFB, the board of this bank would be constituted out of this merged pool of board members apart from a few new members with relevant banking experience. Therefore, the character and composition of the board is unlikely to vary substantially from the present boards. CRISIL believes that the challenges are formidable as the transformation is all-encompassing and the path is unchartered not just for Equitas but for the entire sector. 
 
The track record of Equitas group in generating returns for its shareholders is moderate, although improving. This is mainly because of the early growth stage of new businesses of vehicle, SME, LAP, and housing finance. The group's return on equity (RoE) was at 11.1 percent during 2014-15 (refers to financial year, April 1 to March 31). However, RoE of the microfinance business, which was affected by the crisis that industry underwent in 2010, has improved substantially, to over 20 percent, in 2014-15. In addition, the increasing valuation of the overall group business, as indicated by equity valuations for capital raised in the past few tranches, also indicate the improving value creation to shareholders. Nevertheless, the proposed transformation to a SFB is likely to pose challenges to the improving trend given the likely impact on overall profitability in the initial years of banking operations. CRISIL, therefore, believes that a longer time frame is required for achieving a stable return on equity, indicating consistent value creation for shareholders.
 
The Equitas group's dependence on its managing director, Mr. Vasudevan, continues, though it has declined. He along with top management at Equitas, is instrumental in uniquely positioning the group in the MFI industry and, overall, in the NBFC sector. The philosophy, culture, and values of the group and its CSR initiatives have been identified, nurtured, and developed by the core team under his leadership. Mr. Vasudevan continues to be the face of the group for the external world. Investors, lenders, regulators, and other external stakeholders derive significant reassurance from his presence and leadership.
 
However, good progress has been made towards institutionalisation of culture and values as well as developing a strong second line leadership. The group had identified key individuals to head each of its business verticals and adequately empowered them to manage their businesses with a view to ultimately takeover the responsibilities from Mr. Vasudevan. However, the proposed transformation to a SFB has necessitated induction of a few senior banking professionals from outside the group to be part of senior management. Therefore, the Equitas group needs to recalibrate its plans on developing a strong second line leadership. CRISIL, therefore, believes that dependence on Mr. Vasudevan will continue over the medium term until his successor is identified and accepted by all stakeholders, and the group's current philosophy, culture and values are completely institutionalised. 

The Equitas group, set up by Mr. Vasudevan in 2007, started operations in the microfinance segment. In 2011, the group diversified into vehicle and housing finance. It further diversified into SME loans and LAP in 2013. The group had AUM of Rs.55.1 billion and a network of 539 branches as on December 31, 2015. Its consolidated net worth was Rs.12.9 billion as on December 31, 2015, against Rs.11.7 billion as on March 31, 2015 and gearing (including securitisation loans) was 3.7 times as on that date.
 
On a consolidated basis, profit after tax (PAT) was of Rs.1.1 billion on total income of Rs.7.6 billion in 2014-15, vis-a-vis a PAT and total income of Rs.0.74 billion and Rs.4.8 billion, respectively, in the previous year. For the nine ended December 31, 2015 the group reported PAT of Rs.1.2 billion on a total income of Rs.8.0 billion.

¹ Please refer to rating definitions of the CRISIL governance and value creation ratings.