Detailed Rationale

CRISIL Ratings has reaffirmed its ‘CRISIL A+/Stable/CRISIL A1+’ ratings on the bank facility and debt instruments of Equitas Small Finance Bank Ltd (Equitas SFB).

 

CRISIL Ratings has withdrawn its ratings on the Rs 50 crore non-convertible debentures and Rs 50 crore subordinated debt of the bank. The withdrawal is in line with the CRISIL Ratings policy on withdrawal of ratings.

 
The ratings continue to reflect the diversified product profile, adequate capitalisation, and growing deposit base of the bank, and the experience of its senior management. These strengths are partially offset by the modest credit risk profiles of borrowers, average profitability, and geographical concentration in business and relatively high cost of funds compared with the banking system.

 

Assets under management (AUM) of Equitas SFB grew by 17% (annualised) over the nine months ended December 31, 2020, to Rs 17,373 crore, driven by a 24% (annualised) growth in small business loans which have the largest share in the AUM. Vehicle loans, the second largest portfolio for the bank, grew 18% (annualised). Microfinance, which saw muted growth in the first half of fiscal 2021, declined 5% because of ground level issues and the bank’s strategy to reduce exposure to this segment. Smaller segments such as gold loans and others grew at a moderate pace.

 

Imposition of the nationwide lockdown towards the beginning of fiscal 2021 to contain the spread of Covid-19 disrupted cash inflows of majority of the borrowers of Equitas SFB, thereby restricting their repayment capacity. Resultantly, collection efficiency declined drastically to 11-12% for April and May 2020. As the lockdown restrictions were eased and business activity resumed across segments, collection efficiency (including overdues/foreclosures/advance payments) improved to 105% for December 2020. Current collection efficiency for December 2020 stood at 88.7%.

 

Pro-forma gross non-performing assets (GNPAs) surged to 4.2% on December 31, 2020, from 2.7% as on March 31, 2020. Reported GNPAs were at 2.2%. Provisioning coverage for the pro-forma GNPAs was 59.9% (including total provisioning held as on December 31, 2020. The vehicle loan book had pro-forma GNPAs of 5.49%, microfinance portfolio - 5.22%, and small business loans - 3.02%. For other segments, GNPAs were below 2%. The bank has approved restructuring of 1.97% (Rs 340 crore) of its advances (largely vehicle loans) as of December 31, 2020.

 

Despite cumulative provisioning of Rs 278 crore over the three quarters through December 2020, the bank reported a net profit of Rs 271 crore translating to return on managed assets of 1.7% (annualised) for the first nine months of fiscal 2021. This was supported by sustained operating margin and income from sale of investments.

 

Deposit base grew at a healthy 63% (annualised) to Rs 15,862 crore as on December 31, 2020. The share of retail deposits (including term deposits and current account and savings account [CASA] deposits of ticket size of < 2 crore) grew to 52% on December 31, 2020, from 49% nine months earlier. The share of CASA in total deposits was 25% and in total borrowings was 19% on December 31, 2020. On this metric, while Equitas SFB remains better than other small finance banks (SBFs), it remains weaker than most universal banks.

 
Capitalisation was healthy, reflected in tier I capital adequacy ratio (CAR) of 20.8% as on December 31, 2020.

Analytical Approach

CRISIL Ratings has considered the standalone business and financial risk profile of Equitas SFB.

Key Rating Drivers & Detailed Description

Strengths:

• Diversified product profile with increasing focus on secured lending

Equitas SFB is the second largest small finance bank in the country and has presence in product segments such as microfinance (20% of the overall advances [including IBPC), vehicle finance (25%), small business loans (34%), corporate loans (5%), MSE (6%) and other products (10%). The bank has been able to diversify its portfolio reaping the benefits of its legacy book across retail asset segments. After transforming into a bank, it has expanded focus from core segments such as microfinance and vehicle finance to small business loans, MSE, corporate lending, housing finance and others. The diversity in asset mix helped curtail the impact on collections post demonetisation and subsequent political issues faced by microfinance players in some geographies, as well as Covid-19. As the bank continues to grow its secured loan book, replacing a large portion of the existing unsecured portfolio, the volatility in asset quality due to inherent shortcomings of the unsecured segment will reduce. Apart from diversity, the secured portfolio has also been contributing to the overall growth of advances (including IBPC).

 

• Adequate capitalisation

The bank's capital position remains adequate for its scale and nature of operations, as indicated by reported networth of Rs 3,281 crore on December 31, 2020. Since its transformation into a bank in September 2016, Equitas SFB has maintained CAR over 20%. As on December 31, 2020, the tier I and overall CAR stood at 20.8% and 21.6%, respectively. The bank raised around Rs 1,620 crore between fiscals 2016 and 2020 and another round of Rs 280 crore through its Initial Public Offering for Rs 518 crore in November 2020.

 

Gearing remained moderate at 6.4 times on December 31, 2020, and is expected within 6 times over the medium term. Flexibility to raise capital has been enhanced by conversion into a bank and the nearing timeline for dilution of promoter stake to the stipulated 40%. Continued product diversification has significantly reduced potential asset quality issues.

 

• Growing deposit franchise driven by an increasing share of retail deposits

Being the first among SFBs to transform into a bank, Equitas SFB had the first mover advantage in context of deposit mobilisation. After conversion to a bank in September 2016, Equitas SFB started to mobilise deposits from the first quarter of fiscal 2018. Over the nine months ended December 31, 2020, its deposit base grew at a robust 63% (annualised) to reach Rs 15,862 crore, which accounts for 75% of its total external liabilities. This growth was driven by traction in its retail deposit base (retail term deposits and CASA of ticket size <Rs 2 crore) which grew from 49% to 52%. During this period, the bank launched the 3-in-1 deposit account, a deposit product exclusive for women and a customised product for NRIs, all of which resulted in increased customer acquisition. The bank also targeted a few high ticket accounts which took its average cost of funds lower than that for SFBs.

 

While the traction in retail deposits imparts granularity to liabilities, CASA share, at 25% of total deposits and 19% of total borrowings as on December 31, 2020, is higher compared with SFBs but lower than other universal banks. Ability to sustain growth in retail deposits and increase the share of CASA in the overall deposit and liability base remains a key monitorable.

 

• Extensive experience of senior management, strong process orientation and conservative risk policies

As Equitas SFB transformed into a bank, its senior management team was strengthened to enhance smooth ramp-up of banking operations. Eminent professionals from different fields of the financial sector have been brought on board. Along with Mr P N Vasudevan, the founder of Equitas and MD & CEO of Equitas SFB, many other members of the senior management team have been with the bank for many years. There is also a strong second line of management.

 

• Equitas has been a highly process driven entity having robust systems and processes with strong technical backing ever since the commencement of microfinance operations. This attribute has helped scale up the business fast and to replicate similar models with modifications for vehicle and other portfolios.

 

Weakness:

• Weak credit risk profiles of borrowers

Despite diversification in the portfolio across asset segments and increased focus on secured lending, the bank’s customer base has not changed materially. The borrower base still comprises people living in rural and semi-urban areas, carrying out small business operations or doing petty jobs which may be associated with irregular cash flows. Most of the borrowers witnessed cash flow pressure after the lockdown to contain the pandemic, which has hindered their repayment capability. In the aftermath of the pandemic, the bank’s pro-forma GNPAs surged to 4.2% on December 31, 2020, vis-à-vis reported GNPAs of 2.2%.

 

The microfinance portfolio is inherently susceptible to regional, social and political issues, because of which the bank intends to cap its exposure to the segment at 15% and replace the excess with secured loans.

 

• Average profitability

After volatility in profitability over most of fiscal 2018 due to aftershock of demonetisation and transition related challenges, Equitas SFB reported an average RoMA of 1.4% for fiscal 2020 which improved to 1.7% (including Rs 38 crore of income from sale of government securities) in the first nine months of fiscal 2021. The bank has sustained net interest margin (NIM) at 8-9% throughout its banking history while keeping operating expenses and other income steady, resulting in stable pre-provisioning profitability over the past few quarters.

 

Credit costs, after spiking to 3% in fiscal 2018, has returned to 1.5-2.0% in fiscal 2020, resulting in a better earnings. With the increasing proportion of secured loans in the asset mix, yields may decline marginally but the impact will be mitigated by a corresponding decline in cost of funds. However, net interest margin may shrink. In such a scenario, ability to diversify streams of income and optimise operating expenses (which are still relatively high) remains a key monitorable. The bank has made provisioning of Rs 408 crore over the past four quarters (March 2020 to December 2020) which includes, apart from general provisioning, Rs 113 crore of provisioning made in anticipation of Covid-19 losses and another Rs 180 crore worth of contingency provisions. Any material provisioning requirement hereafter may strain earnings and will be a key rating sensitivity factor.

 

• Geographical concentration in operations

As on December 31, 2020, 54% of the bank’s portfolio was in Tamil Nadu. While the bank is taking measures to diversify its geographical presence, the transition will be gradual. Microfinance and personal loans are particularly vulnerable to regional socio political issues.

 

• Cost of funds and CASA relatively weaker than that for the banking system

Despite good traction in retail deposits over the past few quarters, the proportion of CASA in the total deposit and borrowing base remains low. While the share of CASA in the total deposit base has increased over the past four quarters from 20.5% to 25.0% as on December 31, 2020, it remains lower compared with universal banks. As a proportion of total borrowings, CASA is even lower at 19% compared with the banking industry average of 30%. Cost of funds, at 7.3% for the third quarter of 2021, remains higher compared with 5-6% for other mid-sized banks. While this metric has improved gradually since Equitas SFB transitioned into a bank and is expected to improve over the medium term, it will remain high compared with other mid-sized banks.

Liquidity: Strong

The bank had excess statutory liquidity requirement of Rs 4,407 crore and liquidity coverage ratio (LCR) of 196% on December 31, 2020. Based on its structural liquidity statement dated December 31, 2020, the bank had a negative cumulative mismatch of 1% in the six months to one year maturity bucket. However, after factoring in the line of funds available from development banks, there was no material negative gap in any buckets up to one year. Liquidity is supported by access to refinance limits from financial institutions. Certificates of deposits (CDs) formed 1.1% of the total deposit base on December 31, 2020, and are availed only for liquidity management purpose. Maturity of CDs is staggered and adequate balance is kept to honour the same. Liquidity will remain supported by the scheduled commercial bank status also which allows Equitas SFB access to systemic liquidity of the Reserve Bank of India.

Outlook Stable

The liability profile of Equitas SFB would continue to evolve by way of shift to deposits from wholesale borrowings and the increasing share of granular and stable retail deposits. The momentum in loan book growth observed in the past few quarters should continue, along with gradual diversification of product mix. As the bank scales up, capitalisation is expected to remain adequate. Ability to scale up profitably in newer segments will remain a key monitorable.

Rating Sensitivity factors

Upward factors

• Sustained and significant growth in deposits as a proportion of total borrowing - along with the share of CASA and retail deposits (including CASA) in the total borrowing - being maintained at above 25% and 50%, respectively; while reducing the cost of funds.
• Sustenance in asset quality and profitability, alongside growth in newer asset segments

 

Downward factors

• Moderation in asset quality leading to weakening profitability and capital position
• Inability to garner retail deposits - leading to its share in the total borrowing base falling to, and remaining below 30% for a prolonged time.

About the bank

Equitas Holdings Ltd – the holding entity of Equitas SFB - started operations in 2007 in the microfinance segment. It diversified into vehicle and housing finance in 2011, and entered SME loans and loans against property (LAP) in 2013. The company received in-principle approval in September 2015 to transform into an SFB. It obtained a scheduled commercial bank license in September 2016 and commenced banking operations under Equits SFB.

Key Financial Indicators

As on / for the period ended March 31		2020	2019
Total reported assets	Rs crore	19,315	15,762
Total income	Rs crore	2928	2,395
Profit after tax	Rs crore	244	211
Gross NPA	%	2.7	2.5
Overall capital adequacy ratio	%	23.6	22.4
Return on managed assets	%	1.4	1.5

 

As on / for the period ended December 31,		2020	2019
Total reported assets	Rs crore	25,414	18,510
Total income	Rs crore	2616	2,128
Profit after tax	Rs crore	271	201
Gross NPA	%	2.2/4.2^	2.8
Overall capital adequacy ratio	%	21.6	23.7
Return on managed assets	%	1.7	1.6

^pro-forma

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of Instrument/Facility	Date of Allotment	Coupon Rate (%)	Maturity Date	Issue Size (Rs. Cr)	Complexity Level	Rating Assigned with Outlook
INE186N08033	Subordinated debt	16-Sep-15	13.80%	16-Sep-22	30	Complex	CRISIL A+/Stable
INE186N08041	Subordinated debt	28-Sep-15	14.05%	28-Sep-22	120	Complex	CRISIL A+/Stable
NA	Certificate of Deposits	NA	NA	NA	1000	Simple	CRISIL A1+
NA	Term Loan	31-Oct-14	NA	01-Oct-21	3.8	NA	CRISIL A+/Stable
NA	Term Loan	21-Nov-14	NA	01-Oct-21	6.2	NA	CRISIL A+/Stable
NA	Term Loan	11-Feb-15	NA	01-Jan-22	3.36	NA	CRISIL A+/Stable
NA	Term Loan	11-Feb-15	NA	01-Jan-22	6.64	NA	CRISIL A+/Stable
NA	Term Loan	28-Jan-16	NA	01-Jan-22	5	NA	CRISIL A+/Stable
NA	Term Loan	24-Jun-16	NA	01-Apr-23	4.24	NA	CRISIL A+/Stable
NA	Term Loan	29-Jun-16	NA	01-Apr-26	15	NA	CRISIL A+/Stable
NA	Term Loan#	NA	NA	NA	5.76	NA	CRISIL A+/Stable
NA	Term Loan	31-Aug-16	NA	10-Feb-22	300	NA	CRISIL A+/Stable
NA	Term Loan	27-Jul-16	NA	30-Jul-21	250	NA	CRISIL A+/Stable
NA	Term Loan	26-Aug-16	NA	10-Aug-19	300	NA	Withdrawn

 

Annexure - Details of Rating Withdrawn

ISIN	Name of Instrument/Facility	Date of Allotment	Coupon Rate (%)	Maturity Date	Issue Size (Rs. Cr)	Complexity Level
NA	Certificate of Deposits	NA	NA	NA	1000	Simple