Detailed Rationale

CRISIL Ratings has reaffirmed its ratings on the debt instruments of Equitas Small Finance Bank Limited (Equitas SFB) at ‘CRISIL A+/Stable/CRISIL A1+’. CRISIL Ratings has also withdrawn its rating on Rs 500 crore Certificate of Deposits based on the bank's request for the same. The withdrawal is in line with CRISIL Ratings’ policy on withdrawal of ratings.

 

The ratings factor in the bank’s diversified product portfolio with increasing focus on secured lending, the adequacy of its capitalization in relation to the scale, sustained ramp up in its deposit franchise and experienced management team with strong focus on process orientation. These strengths are partially offset by a modest credit risk profile of the borrower segment, average profitability and moderate geographical concentration in business.

 
Overall AUM grew at 15% over fiscal 2022 to Rs 20,597 crore, driven by a 19% growth in Small Business Loans which accounts for the largest share in the bank’s overall AUM. Vehicle loans, the second largest portfolio for the bank, grew at 11% over the same period. Microfinance business, which has remained volatile since the outbreak of Covid-19, revived and registered a growth of 21%. Other smaller segments like gold loans have also grown at a moderate pace, though its share in the AUM remains relatively small.

 

On March 31, 2022, the bank had a GNPA of 4.1% and NNPA was 2.4% as compared to peak GNPAs (excluding write offs) of 4.4% and 2.4%, respectively, reported on December 31, 2021. As at the close of Q4 2022, the bank's PCR stood at 42.7%. Total stressed assets (including GNPAs, restructured assets and annual write offs) constituted about 13.1% of the AUM as on March 31, 2022.

 

The bank made Rs 869 crore of cumulative provisioning over fiscal 2021 and 2022, of which Rs 605 crore was written off. Resultantly, credit costs for fiscal 2021 were 1.6% whereas for fiscal 2022 – it was 1.8%. RoMA for fiscal 2021 was 1.7% and for fiscal 2022, it was 1.1%.

 

On the liability side, the bank’s deposit base has grown by 15.6% over fiscal 2022 – driven by an increasing base of retail term deposits and CASA. In the total deposit base of Rs 18,951 crore as on March 31, 2022, the share of retail deposits (including CASA) was 89% as compared to 70% a year ago. The bank’s CASA, as a proportion of total deposits – has increased substantially to 52.1% as compared to 34.0% over 12 months through March 2022. On this metric, Equitas SFB is now comparable with universal banks however, its ability to sustain the share of CASA and retail deposits at current levels while being able to reduce the cost of funds, remains to be seen.

Analytical Approach

To arrive at the ratings, the team has looked at the standalone credit risk profile of Equitas Small Finance Bank, referred to herein as 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 SBL (46%), vehicle loans (25%), and microfinance loans (19%) - which the bank intends to bring down gradually to sub 15%. Other segments like MSE Finance and loans to NBFCs (corporate loans) have grown in the last few quarters and accounted for 6% and 4% of AUM as on March 31, 2022, respectively. 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 has helped the bank in curtailing the influence of disturbance in any one segment, on the overall asset quality of the bank.

 

Overall AUM grew at 14.9% over fiscal 2022. This was a result of improvement in market demand in latter part of 2022 after the muteness on account of the second pandemic wave and allied challenges. Among segments, Small Business and home Loans grew at 19%, vehicle loan segment at another 11%, and -1% growth was witnessed in the MSE Finance portfolio. Microfinance business grew at 21% on a year-on-year basis. Other smaller segments like gold and unsecured loans, declined by 12% y-o-y which has resulted in its share in the AUM remaining relatively small.

 

Apart from diversity, the secured portfolio has also been contributing to the overall growth of advances (including IBPC).

 

Adequate capitalization

The bank's capital position remains adequate for its scale and nature of operations, as indicated by reported networth of Rs 4,246 crore on March 31, 2022. Since its transformation into a bank in September 2016, Equitas SFB has maintained CAR over 20%. As on March 31, 2022, the tier I and overall CAR stood at 24.53% and 25.16%, respectively. To comply with the regulatory requirement of 25% public shareholding, the bank has raised Rs 550 crore through Qualified Institutional Placement (QIP) in February 2022. Gearing remained moderate at 5.1 times on March 31, 2022, and is expected within 6 times over the medium term.

 

Sustained ramp up in deposit franchise alongside increasing granularity

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 mobilize deposits.

 

Over fiscal 2022, its deposit base has grown at 15.6% to reach Rs 18,951 crore, which accounts for 87.9% of its total external liabilities. This growth was driven by traction in the bank’s retail deposit base (retail term deposits and CASA of ticket size <Rs 2 crore) which grew from 52% to 80% over this period. CASA, after remaining within 30% for most of Equitas SFB’s banking history, has sharply increased over the last 6-8 quarters to reach 52.2% as on March 31, 2022 which is higher than most banking peers. As on March 31, 2022, the aggregate share of retail deposits and CASA was 89% which is highest among SFBs and comparable with most universal banks. This robust traction in retail deposits was a factor of some of the initiatives the bank had implemented in the previous fiscal. Equitas SFB had launched the 3-in-1 deposit account, a deposit product exclusive for women and a customised product for NRIs, all of which have propelled customer acquisition.

 

Another stimulus to CASA has been the rate which Equitas SFB has been offering for savings accounts and retail term deposits. For Q4 2022, the deposit cost for savings accounts was 6.05% and for retail term deposits was 6.7%. This rate, though lower than the preceding quarters, remains higher than that charged by banking peers. Blended cost of funds for Q4 2022 was 6.2% as compared to 7.2% for the corresponding quarter of previous fiscal.

 

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.

 

CRISIL Ratings has taken note of the announcement made by the bank on May 19, 2022 with regards to correspondence received from the founder and Managing Director - Mr P N Vasudevan, to find his successor who can spearhead the bank after his exit from his executive role, It is also noted that the founder’s decision to exit was on account of personal reasons.. Until the handover in leadership is through, Mr. Vasudevan shall continue in his current role. The smooth transition in leadership and the new management’s strategy and philosophy for the bank’s future growth will remain a monitorable.

 

Nonetheless, many other members of the senior management team have been with the bank for many years which indicates 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:

Asset quality has remained vulnerable, susceptible to weak credit profile of most customers and high geographical concentration

Despite segmental diversification in portfolio 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 and peaked at 4.6% on September 30, 2021, vis-à-vis GNPAs of sub 3% reported for pre-Covid period. On March 31, 2022, the bank had a GNPA of 4.1% and NNPA was 2.4%. The bank's PCR stood at 42.7% as on March 31, 2022 as compared 58.6%, a year ago.

 

As on March 31, 2022, the bank had a restructured portfolio of Rs 1500 crore, most of which was restructured under the second scheme. This formed 7.2% of the AUM as on that date. Total stressed assets (inclusive of GNPA, restructured portfolio and write offs over fiscal 2022) constituted approximately 13.1% of the overall AUM as on March 31, 2022.

 

As a bank, Equitas has been lowering its exposure to the microfinance segment in order to limit the volatility in asset quality. Historically, microfinance portfolio has been susceptible to regional, social and political issues and given the high degree of vulnerability for microfinance segment, the bank intends to cap its exposure to the segment at 15% and replace what’s remaining of it by secured loans. In terms of geographical diversity, 54% of Equitas SFB’s portfolio is housed in Tamil Nadu which makes the book susceptible to local socio-political issues and this, in CRISIL Ratings’ opinion, remains a challenge for the bank.

 

Average profitability, ability to curtail credit costs amidst prevailing asset quality challenges remains critical

Despite marginal elevation in credit costs to 1.6% for fiscal 2021 from 1.3% for fiscal 2020, the bank reported a RoA of 1.7% for the fiscal as compared to 1.4% for the previous year. The impact of elevated credit costs was offset by higher treasury income and low operating expenses for the year. For fiscal 2022, the bank reported a net profit of Rs 281 crore which translates to an annualized RoA of 1.1%. Elevated credit costs, marginally higher operating expenses and compression in NIMs on account of interest reversals, were the key reasons behind lower RoA for the period.

 

As the bank scales its secured portfolio, yields may decline marginally with some of its impact being offset by a corresponding decline in cost of funds. This may result in compression of interest margins. In such a scenario, the bank’s ability to diversify streams of income and optimize operating expenses (which are still relatively high), remains a key monitorable. Additionally, the bank has already provided for Rs 800 crore as pandemic imposed credit costs. However, any further provisioning requirements would impose pressure on the profitability margins and may be a rating sensitivity factor.

Liquidity: Strong

The bank had an excess SLR of Rs 1847 crore and a Liquidity Coverage Ratio (LCR) of 192% on April 30, 2022. The bank’s liquidity profile is also supported by its on-tap access to avail refinance limits from FIs. As on March 31, 2022, the bank did not have any exposure to CDs. Incrementally, Equitas SFB’s liquidity position will remain supported by its scheduled commercial bank status which allows it access to systemic liquidity of RBI.

Outlook: Stable

The liability profile of Equitas SFB would continue to evolve by way of shift to deposits from wholesale borrowings and more particularly the increasing share of granular and stable retail deposits. The bank is expected to maintain momentum in loan book growth observed in the past few quarters along with gradual diversification of product mix. As greater scale is achieved, the bank’s capitalisation is also expected to remain at adequate levels. However, the ability to profitably scale across newer segments would remain a key monitorable.

Rating Sensitivity Factors

Upward Factors

• Sustained and significant growth in deposits - primarily driven by retail deposits, with the share of CASA as a proportion of 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 in the scheme of growth, leading to potential weakening in profitability and capital position.
• Inability to garner retail deposits leading to its share in the total deposit base falling to, and remaining below 30% for a prolonged time.

About the Company

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 Small Business Loans 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 Equitas SFB.scheduled commercial bank license in September 2016 and commenced its banking operations.

Any other information: Not applicable