When companies go public, they rarely seek pricing closer to the book value. One example is Utkarsh Small Finance Bank, whose IPO opened on Wednesday. Priced at just around FY23 book value and discounted for FY24 estimated earnings, the asking rate at a little less than 1.1x post-issue price to book makes Utkarsh SFB an attractive IPO for investors.

Although the issue was fully subscribed on the day of its opening, since allotment happens by draw of lots, investors can still consider subscribing to the issue. 

Business fundamentals

Like the existing listed SFBs, Utkarsh also received its licence to operate as a small finance bank in 2014 and thus migrated from NBFC-MFI to bank. The journey of Utkarsh is very similar to what most MFI-turned SFBs have witnessed in the last five years, including two cycles of elevated pain namely demonetisation and Covid, and sharp recoveries from each downturn

Consequently, for Utkarsh, the worst-case gross NPA ratio shot up to 6.1 per cent in FY22 and improved to 3.23 per cent in FY23, in line with the industry trend across SFBs. Being a micro finance institution that is now a bank, there isn’t much of a differential that Utkarsh SFBs offers. Over a third of the bank’s book was secured loans in FY23, such as loans against property, housing, commercial vehicles and construunction equipment. The rest (66 per cent)  is unsecured, of which microfinance is the major portion, though the bank has also forayed into personal small, small business loans etc. The bank‘s net interest margin was 9.3 per cent, and excluding the pandemic hit years, its profitability has been over nine per cent, which is the case with most SFBs. Its net NPA ratio in FY23 fell to 0.3 per cent, indicating that much of the Covid-related pain is behind the bank, and its total loan book size stood at Rs 13,068 crore.

Utkarsh SFB originated in Uttar Pradesh and was one of the early movers to explore the business in this state. Presently UP and Bihar accounted for 57 per cent of total loans in FY23. High regional concentration could be a risk to the bank, though it hasn’t encountered adversities due to political or business risks from the region so far.

Attractive valuations

Utkarsh SFB’s asking rate echoes the current sentiments around SFBs, considering that the latest fundraiser happened for a little below the book value. Even the listed players such as Equitas, Ujjivan and Suryoday are trading below the peak valuation which further justifies the pricing of Utkarsh SFB IPO.

The question is whether the market will quickly reward such undemanding valuations.

For one, the IPO is a fresh issue that is rare, especially for private equity backed companies in the financial services space. The IPO may help the bank increase its capital adequacy by around 500 basis points to 25 per cent. FY23 capital adequacy stood at 20.6 per cent. The purpose of the IPO is also to ensure that the regulatory requirements for listing as per the licensing norms are met.

Investors should note that the bank operates on a holding company structure. The capital that has come into the bank has been channelised through the holding company. There is a likelihood of collapsing this structure, which could be an overhang for the stock to re-rate in the near term. Much of the PE investments have flown into the bank through the holding company, and once the bank is listed, the investors may seek an exit through a reverse merger of the holding company and the SFB.

That said, while a potential reverse merger needs to be factored in, Utkarsh currently has a first mover advantage, given that at least three SFB IPOs are set to roll over the year. Further, with the cleanup of the loan book in FY23 and the macro trends for SFBs looking positive, the bank is well poised for structurally strong growth story. Therefore, investors with a long-term conviction in the SFB sector could consider the IPO.

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