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Asset-quality slip overshadows strong show on liability front

* Despite strong NIMs/other income, Equitas reported a big miss on PAT at Rs0.1bn vs. estimate of Rs0.8bn, mainly due to higher opex/provisions. The GNPA ratio slipped 105bps qoq to 4.8%, while the restructured pool rose to 7.5% of loans from 2.6% in Q4 in the absence of the RBI-led moratorium like last year and the underlying Covid-led disruption in South India.

* The bank expects an improvement in collection efficiency, but the restructuring pool may rise to Rs14bn-17bn (10% of loans) in Q2 as customers need support to come out of stress. Even amid the deterioration in asset quality, the bank reached a historically high CASA of 40%, nearly closing the gap with best-in-class Bandhan Bank. This should support core NIMs/profitability.

* Equitas’ board has approved the reverse merger of holdco at a favorable share swap ratio of 226 shares of Equitas SFB for every 100 Equitas holdco shares, without any tax implications for shareholders, as per management. This deal should remove the overhang of promoter dilution in ESFB, subject to regulatory approval.

* We cut FY22/23/24E EPS by 23/14/6%, factoring in the moderation in growth/higher LLP. However, we continue to like the bank given the sharp improvement in its liability profile, asset diversification away from MFI and its ability to deliver higher return ratios. Retain Buy on ESFB and raise our TP from Rs74 to Rs78 (2x Sep’23E ABV) and holdco TP to Rs170 from Rs152, providing higher upside in the run-up to the deal.

Credit growth moderates but CASA reaches a historical high of 40%, supporting margins:

The bank posted moderate credit growth of 15% yoy/down 0.5% qoq to Rs178bn. Disbursements, which were higher at 125% yoy albeit on a lower base, were down 50% qoq due to the cautious stance in MFI and the slowdown in SBL/VF/LAP with stringent lockdowns in South India (mainly in TN). The MFI book now contributes 17.5% of the book, which management intends to reduce to 15% in order to diversify away from the volatile MFI. Deposit growth remained healthy at 45% yoy/5% qoq, mainly driven by 216% yoy/25% qoq growth in SA, stemming from the bank’s increased focus on retailization of deposits. Accordingly, the CASA ratio improved sharply by 549bps to 40%, resulting in a lower CoF, which supported a 30bps qoq increase in NIM to 7.9%. Management expects disbursements to return to 80% of Mar’21 levels in July with a sharp uptick in SBL/VF and MFI.

Covid 2.0 impairs collections, elevated restructuring pipeline in sight:

Gross slippages were higher at Rs3.7bn/10.4% of loans, leading to a 105bps qoq slip in GNPA to 4.8%. The restructured pool rose to 7.9% of loans from ~2.6% in Q4, and management expects another Rs8bn (5% of loans) in the pipeline, for which it carries a provision buffer of Rs1.4bn/0.8% of loans. Overall billing efficiency fell to 70% from 91% in Mar’21. Segment-wise efficiencies: MFI at 63%/SBL at 73% vs. 92% in Mar’21, VF at 69% vs. 87% in Mar’21, and MSME at 73% vs. 89% in Mar’21. The bank expects collections to improve meaningfully as the economy opens up, subject to no severe third Covid wave. It has guided for higher LLP at ~2.5%, factoring in elevated provisions on NPAs/restructured pool.

Outlook and valuation:

We cut FY22/23/24E EPS by 23/14/6%, factoring in the moderation in growth/higher LLP, but expect the bank to report a healthy improvement in RoE to 11-17% during the period. We believe that near-term asset quality performance will weigh on stock performance. However, the reverse merger of holdco with SFB should remove the overhang on promoter stake dilution. This, along with the subsequent conversion to a Universal Bank from a restrictive SFB, should be a long-term positive. Retain Buy with a revised TP of Rs78 (2x Sep’23E ABV) and a revised holdco TP of Rs170, providing higher upside in the run-up to the deal. Key risks: higher-than-expected NPA formation, loss of momentum in CASA flow, and management attrition.

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