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Stress from microfinance segment far from over

Equitas Small Finance Bank (ESFBL) is the second-largest SFB in India in terms of total advances as of FY24. ESFBL, located across 18 states and UTs, serves through 987 banking outlets.

* Net Advances grew muted (18%YoY), driven by a 28% YoY increase in the Small Business Loan, 53% YoY increase in used car vehicle finance and 23%YoY increase in housing finance segments. Deposit growth advanced by 29.2% YoY, with CASA accounts growing by 17% YoY. The CASA ratio stood at 30.6%, a sequential decrease of 68bps.

* The bank is shifting its focus towards increasing disbursements in small business loans, vehicle finance, and affordable housing segments. This shift is evident as the microfinance segment experienced a 33% YoY decline in disbursements.

* Net Interest Income grew by 7.9% YoY in Q2FY25, impacted by falling yields on disbursements and rising costs of funds. Additionally, NIM contracted by 28 bps sequentially to 7.69%.

* Management has noted rising stress in the microfinance sector due to borrower overleveraging and an increase in the number of lenders. Despite increasing its PCR to 67.7%, the company continues to face asset quality challenges and high operating expenses, which are impacting its margins. GNPA and NNPA have deteriorated to 2.95% and 0.97%, respectively, from 2.12% and 0.91% in Q2 FY24.

* Other income grew 10%YoY, driven by an increase in treasury income and asset fee income. But a significant increase in provisions led PAT to degrow 94% YoY to Rs.12.9cr

Outlook & Valuation

The ongoing stress in the microfinance segment is expected to keep credit costs elevated for the next two quarters. The shift to lower-yielding assets compared to microfinance is also expected to reduce yields, further weighing on return ratios. The management remains focused on maintaining a robust and scalable banking model to enhance profitability and efficiency. Given the ongoing stress in the microfinance segment, we are downgrading our rating from Accumulate to Hold with a target price of Rs. 69 based on 1.2x FY26E BVPS

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