Equitas Small Finance Bank: A Profitable lender to small businesses

Equitas Small Finance Bank: Navigating Challenges, Building for Recovery

Investment Thesis

Equitas Small Finance Bank faces short-term pressures stemming from elevated credit costs in its microfinance (MFI) portfolio. However, the bank’s proactive measures, strategic focus on secured lending, and improving operational dynamics set the stage for medium-term recovery.

Key Highlights Supporting the Investment Case:

1. Elevated Credit Costs and MFI Challenges

• Microfinance Pain Points: The MFI segment reported slippages of 8.7% in 2QFY25, driving overall gross slippages to 5.8%. Elevated provisions (up >400% YoY) kept credit costs high at ~4%.
• Provisioning Adjustments: The bank raised its Provision Coverage Ratio (PCR) to address stress in the MFI portfolio and meet regulatory requirements for universal banking eligibility.
• Shift in Lending Mix: MFI disbursements declined 33% YoY, while overall loan growth was impacted, with MFI now forming 16% of the portfolio.

2. Resilient Non-MFI Portfolio

• Strong Growth in Secured Lending: SBL (Small Business Loans) and Vehicle Finance grew at ~25% YoY and ~15% YoY, respectively, signaling resilience in the non-MFI book.
• Lower Loss Given Default (LGD): While delinquencies in the non-MFI portfolio rose slightly, the lower risk profile of secured loans mitigates significant credit cost concerns.

3. Operational and Financial Trends

• NII and Margin Pressure: NII growth of ~5% YoY lagged behind net advances growth (~18% YoY), as the loan mix shifted toward lower-yielding secured products. NIM contracted by ~35 bps QoQ.
• CASA Decline: CASA ratio dropped ~70 bps QoQ to ~31%, though deposit growth of ~29% YoY reflects a stronger funding position.
• CAR and Liquidity Strength: The bank maintains a comfortable Capital Adequacy Ratio (CAR) of 19.4% and a Loan-to-Deposit Ratio (LDR) of 87%.

4. Growth and Return Outlook

• Medium-Term Recovery in Returns: Despite near-term headwinds, management expects to achieve mid-teen RoE over the medium term, supported by operating leverage, improved MFI performance, and cost efficiency.

Monitorables and Risks

1. Asset Quality Trends: Progress in MFI collection efficiency and stabilization of credit costs, particularly in the non-MFI book.
2. Regulatory Compliance: Meeting universal bank eligibility requirements, including net NPL ratio below 1%.
3. Operational Efficiency: Successful execution of cost-reduction initiatives to enhance profitability.

Sources: Kotak Daily & Centrum