The initial public offer (IPO) by Equitas Holdings will take the company a step closer to becoming a small finance bank.
The company, one among the eight micro-finance institutions (MFIs) that were granted small finance bank licence, will have to bring down its foreign holding to below 49 per cent by April 2017.
Post-issue, the foreign holding will come down to 35 per cent from 92.6 per cent currently.
Equitas Holdings that operates across four segments — microfinance, used vehicle finance, micro and small enterprises (MSE) finance and housing finance — has delivered a strong 50 per cent annual growth in its loan book and 39 per cent in its earnings in the last four years.
While transitioning into a small bank will impact earnings in the next two to three years, a strong team of professionals, with extensive experience in the financial services space, offers comfort.
The asking price for the issue is also reasonable and appears to factor in the concerns of a negative impact on profitability, when Equitas becomes a bank.
At the upper band of the issue price of ₹110, the valuation works out to about 1.7 times the FY17 book value (post-issue). While a like-to-like comparison is not possible, the valuation looks reasonable when compared with MFI player SKS Microfinance that trades at about four times FY17 book value and commercial vehicles financier Shriram Transport Finance that quotes at about two times its book value.
Investors looking for opportunities beyond the traditional banking or NBFC space and willing to bet on the long-term prospects of the ‘small bank’ can subscribe to the issue.
Business segmentsEquitas is a holding company and operates through its three subsidiaries — Equitas Microfinance, Equitas Finance (engaged in vehicle and MSE lending) and Equitas Housing Finance. Currently, micro-finance constitutes about 53 per cent of the company’s loan book. Equitas is now the fourth largest MFI in the country, after Bandhan got converted into a bank last year. In the latest December quarter, loan growth was a healthy 49 per cent year-on-year.
Strong risk management systems in place have also ensured stable asset quality in an otherwise risky business. The gross non-performing assets (GNPA), based on the 30-day norm, are 0.2 per cent of loans as of December 2015.
The used commercial vehicle business, on the other hand, has a higher delinquency rate. The business, about 26 per cent of the overall loan book, had a GNPA of 3.8 per cent as of December 2015. Equitas follows a 150-day norm to classify bad loans, which will have to be brought down to 90 days when it becomes a small bank.
This may impact asset quality. The pace of growth is likely to fall due to the overall sluggishness in the industry and more demand for new vehicles over the next two years. The MSE finance business (17 per cent of loans) and housing finance (4 per cent of loans), though, should continue to grow at a healthy pace.
While Equitas has expanded operations to other states, the overall business of Equitas is highly dependent on Tamil Nadu, which accounts for 63 per cent of the loan accounts. This pegs up its geographical risk.
A game changerThe central idea behind a small finance bank is to provide basic banking activities to small businesses and low-income households.
Equitas, given its existing customer base and products, can transition smoothly into a small finance bank. The company is well placed to meet the norm of extending 75 per cent of loans to the priority sector and have at least 50 per cent of loans up to ₹25 lakh. The average ticket size of loans for its micro-finance business is about ₹10,500.
On the assets side, the company has already diversified its loan book — a key positive.
The real challenge lies in being able to manage profitability in the near term, which will be impacted on account of costs involved in meeting the statutory requirements of a bank and branch expansion.
Small finance banks will have to comply with the requirements relating to cash reserve ratio (CRR) and statutory liquidity ratio (SLR) from day one of conversion to a bank.
Banks do not earn any interest on the CRR balance kept with the RBI, while SLR can earn interest of 7-8 per cent compared with the current loan yield of 20.3 per cent for Equitas. The healthy return on assets of about 3 per cent can hence, fall to about 2 per cent in the next two to three years.
Incremental benefits of low-cost deposits can help cushion the erosion in profitability. But garnering these deposits will be a challenge.
Currently, about 57 per cent of the total borrowings are in the form of bank borrowings, which will have to be replaced with deposits from customers.
It is still early days to gauge the success of the new differentiated banking model. But those willing to take the risk can find comfort in the reasonable valuation.
Use of fundsThe IPO is a combination of fresh issue of shares worth ₹720 crore and an offer-for-sale (OFS) for 13.2 crore equity shares.
Of the ₹720 crore raised, the company plans to use ₹616 crore (net proceeds) towards investment in its subsidiaries to shore up the capital base.