Rating Rationale

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 small business loans (SBL;36%), vehicle loans (25%), microfinance loans (19%) and housing finance loans (10%). Other segments like MSE Finance and loans to NBFCs (corporate loans) accounted for 4% each, of gross advances as on March 31, 2023, respectively. The bank has been able to diversify its portfolio reaping the benefits of its legacy book across retail asset segments. Ever since it became a bank, Equitas SFB has expanded focus from core segments such as microfinance and vehicle finance to small business loans, MSE sector, 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, gross advances grew 35% over fiscal 2023 as compared to 15% for the previous fiscal. This growth in portfolio was a factor of economic recovery, cyclical tailwinds and strong credit demand. Among focus segments, small business grew 28%, vehicle finance 38% and home Loans grew 88% during the fiscal. Microfinance business grew 34% year-on-year. Other smaller segments such as gold and unsecured loans, grew by 4% year-on-year which has resulted in its share in the gross advances remaining relatively small. The bank has been focusing on de-risking its balance sheet by shifting focus to the secured portfolio, which is also contributing to the overall growth of advances (including inter-bank participation certificate [IBPC]).

Adequate capitalisation

The bank's capital position remains adequate for its scale and nature of operations, as indicated by reported networth of Rs 5,158 crore as on March 31, 2023. Since its transformation into a bank in September 2016, Equitas SFB has maintained capital adequacy ratio (CAR) of over 20%. As on March 31, 2023, the tier I and CAR was 23.1% and 23.8%, respectively. Gearing remained moderate at 5.5 times as on March 31, 2023 and is expected to be within 6 times over the medium term.

Sustained ramp up in deposit franchise alongside increasing granularity

Over fiscal 2023, the bank’s deposit base has grown 34% to reach Rs 25,381 crore, which accounts for 85% of its total external liabilities. This growth was driven by traction in the bank’s retail deposit base (retail term deposits and current account and savings account [CASA] of ticket size less than Rs 2 crore) which stood at 68% as on March 31, 2023. CASA as a percentage of total deposits has also been stable. However, CASA ratio has sequentially fallen in fiscal 2023 to 42% as on March 31, 2023 as compared to 52% as on March 31, 2022, on account of sizable increase in retail term deposit. Nevertheless, the CASA ratio is higher than most banking peers. As on March 31, 2023, the aggregate share of retail deposits and CASA was 77% 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 fiscal 2020-2021. Equitas SFB had launched the 3-in-1 deposit account, a deposit product exclusively for women and a customised product for non-resident Indians (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 through its program “Elite” which caters to the mass affluent customer segment. The deposit contribution from this program has crossed Rs 11,550 crore in fiscal 2023. For the fourth quarter of 2023, the deposit cost for savings accounts was 6.2% and for total term deposits was 7.0%. This rate remains higher than that charged by banking peers. Blended cost of funds for the fourth quarter of 2023 was 6.6% as compared to 6.2% 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.

In May 2022, the founder, managing director and chief executive officer of Equitas SFB, Mr PN Vasudevan, had expressed his intention to step down from his role. However, in December 2022, he decided to continue with the bank in executive role as MD & CEO. In June 2023, RBI has approved his extension for further period of three years.

The bank has had a stable senior and middle management team with most members having been associated with the bank for many years.

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

Weaknesses:

Asset quality, though improving, remains moderate, susceptible to modest 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 flow. Most of the borrowers witnessed cash flow pressure after the lockdown to contain the Covid-19 pandemic, which has hindered their repayment capability.

In the aftermath of the pandemic, the bank’s pro-forma gross non-performing assets (GNPAs) surged and peaked at 4.6% as on September 30, 2021, against GNPAs of sub 3% during the pre-Covid period. However, things have stablised thereafter. On March 31, 2023, the bank had GNPA of 2.6% and net NPA (NNPA) of 1.1%. The bank's provisioning coverage ratio (PCR) stood at 57% as on March 31, 2023 as compared to 43% a year ago.

As on March 31, 2023, the bank had a restructured portfolio of Rs 235 crore (reduced from Rs 1500 crore a year ago), most of which was restructured under the second scheme. This formed 1% of the gross advances as on that date. Total stressed assets (inclusive of GNPA, restructured portfolio and write offs over fiscal 2022) constituted approximately 4.9% of the gross advances as on March 31, 2023.

As a bank, Equitas SFB has been lowering its exposure to the microfinance segment in order to limit the volatility in asset quality. Historically, the microfinance portfolio has been susceptible to regional, social and political issues and given the high degree of vulnerability for the microfinance segment, the bank intends to cap its exposure to the segment at 15% and replace what is 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

For fiscal 2023, the bank reported net profit of Rs 574 crore which translates to return on assets (RoA) of 1.8%. Improvement in profitability is primarily driven by net interest margin (NIMs), which was 7.9% for fiscal 2023 as compared to 7.7% in fiscal 2022 and, controlled credit cost which has reduced to 1.3% in fiscal 2023 against 1.9% in fiscal 2022. Profitability is also partly supported by other income which has improved on account of income from sale of NPAs to asset reconstruction companies (ARCs) of ~Rs.70 crores during the fourth quarter of fiscal 2023.

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 optimise operating expenses (which are still relatively high), remains a key monitorable. However, given the inherent risks of the asset segments in which the bank operates, any further provisioning requirements due to asset quality challenges would impose pressure on the profitability margin and may be a rating sensitivity factor.