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Asset quality stress and upfront provisioning impact RoA

Substantial flows/slippages and credit cost in MFI portfolio impacts profitability

Equitas SFB’s credit cost (3.7% annualized) was higher than even Q1 FY25 (3.5% - which included Rs1.8bn of additional floating provision) due to 1) significantly increased flows/slippages in MFI portfolio, 2) moderate incremental deterioration in vehicle finance, affordable housing and MSE finance asset quality and 3) additional provisioning of ~Rs1.5bn made on MFI portfolio (Rs0.5bn for upfronting provionsing policy on NPLs and Rs1bn for buffering provisions to 50% on the increased 30-90 dpd bucket). Slippages for the bank materially rose to 5.8% annualized (4.5% in Q1 FY25) and the SMA pool also witnessed a significant increase of 17% qoq (rising from 7.4% to 8.5%).

Banks’ gross advances grew by 3.4% qoq/15.4% yoy driven by sustained strong traction in SBL (incl. M-LAP), Used CVs & Cars and MSE Finance. Disbursements in MFI further declined and originations in affordable housing lacked the earlier momentum. Lending Spread was largely stable with increase in CoD offset by improvement in portfolio yield. PPOP was slightly better than our estimate, despite higher manpower cost (augmentation of collection/recovery team in MFI & VF), on account of substantially higher treasury income.

Key monitorables for H2 - 1) movement in X-Bucket CE in MFI and VF, 2) recoveries/rollbacks in VF, 3) disbursement improvement in Affordable Housing and 4) reduction in CoD

Q3 FY25 has started on a better note for the bank with disbursements of Rs19bn+ (highest in the year) and X-Bucket CE in VF inching above 97% and X-Bucket CE in MFI stabilizing near 98% (did not deteriorate further). The bank has augmented manpower in VF business with focus on improving collections in early buckets and recoveries of NPLs, and generally asset quality trends are better in this business in the second half of a fiscal. Similarly in MFI, the bank has strengthened manpower in many branches for better customer engagement and dpd resolutions and is driving better behaviour by offering interest rate reductions. In our estimate, if the X-Bucket CE gradually improves in MFI and VF portfolios, then credit cost run-rate would be significantly lower in H2 FY25.

Notwithstanding further reduction in MFI share in coming quarters, the gross yield on advances is likely to remain stable aided by stronger growth in higher yielding products like Used CV/Cars financing and Micro-LAP and origination yield being better than portfolio yield in some of the products. The CoD is expected to come down over the coming quarters with 1) downward revision in SA rate (from 3.5% to 3%) for up to Rs1 lac deposits (this benefit will fully come in Q3 FY25) and 2) rate reduction of 25 bps on the flagship 444-day RTD (55% of overall TD) (this benefit will gradually reflect over ensuing 4-5 quarters). Bank’s lending spread is expected to remain steady in the near term.

Significantly cut earnings once again; inexpensive valuation and likely lesser incremental downgrades underpins our ADD rating

Factoring credit cost and growth adjustments in MFI, while also moderating growth and raising credit cost in non-MFI portfolio (particularly VF), we cut earnings estimates for FY25/26 by 36%/13% respectively. However, we expect an improvement in RoA/RoE performance in H2 FY25 with somewhat better collections/recoveries, slight pick-up in loan book growth and steady lending spread/NIM. As soon as the cyclical asset quality pressure abates meaningfully, we expect the bank to revert to 1.5% RoA/14% RoE. The stock trades at 1x P/BV and 6x P/E on FY27 estimates. We retain ADD rating with a view of limited downside in price in near-term and possibility of material upside in the medium term.

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