New Delhi, August 29, 2016: We initiate coverage on two listed small finance bank (SFB) licencees — Equitas Holdings (EQUITAS) and Ujjivan Financial Services (UJJIVAN) with Buy ratings. Our interactions with some of the SFB licencees and our branch visits make us believe that the short-term challenges in the transition to a bank will be offset by long-term opportunities in under-served retail credit and liabilities markets. Going forward, we expect a far more fundamentally robust business model, aided by sustainable AUM growth, predictable earnings and stable asset quality, given regulatory supervision and government support. Hence, we expect these entities to gradually evolve from microfinance juggernauts to stable banking franchises.
Regulatory and government support bode well for the business model: It is apparent from the PMJDY and PMMY schemes that the government is clearly focused on financial inclusion, particularly on financial products for small entrepreneurs and businesses. With SFBs expected to cater to this borrower segment, there is likely to be generous support from the government towards the former to foster their business growth. In addition, RBI has often advocated the addition of new banking entities to strengthen financial inclusion in India. Hence, the government support and RBI’s conservative and prudent regulations give the SFB framework and its operating environment considerable strength and visibility in the future.
Multiple benefits for MFIs who have received SFB licences: Out of the 10 applicants who received a SFB licence, eight are micro-finance institutions (MFIs). While these entities cater to a strong-niche borrower segment, the switch to a bank is likely to entail execution risks as well as significant competition from large established banks. However, there are benefits for MFIs to transform to a SFB, which include (1) political risk mitigation, (2) product diversification, (3) customer diversification, (4) ability to build a meaningful retail liability base, (5) leverage low-cost operating structures better for business growth and (6) ability to achieve goals set at inception.
Long-term opportunities outweigh the short-term challenges: We expect the licencees to face challenges in the transition to a SFB, as it entails changes in the business model, organisational structure, capital structure, product suite, IT/MIS and others. Adhering to RBI’s foreign shareholding limit of 74%, high initial promoter contribution, high capital adequacy requirements, elevated costs of transformation, human resource management and retail deposit mobilisation are the immediate hurdles to contend with. However, there are numerous opportunities, both in the underserved credit markets of micro lending (business/consumption/mortgages) and retail financial savings, as evident in India’s low penetration of financial services. If executed well, these long-term opportunities would compensate for the short-term challenges and result in a more stable and economically viable business model.
Initiate with Buy ratings on EQUITAS and UJJIVAN: We like both EQUITAS and UJJIVAN, given their strong profitability (32% CAGR in PAT over FY16-19e), healthy asset quality and capitalisation. Going forwad, we expect a far more fundamentally robust business model, aided by sustainable AUM growth, predictable earnings and stable asset quality, given regulatory supervision and government support. In the current fragile economic environment, we also expect SFBs to fare much better than most of their universal banking peers. Hence, we initiate coverage with Buy ratings on both. Our target prices, based on the Residual Income Model, are Rs220 for EQUITAS (2.7x FY18e BV) and Rs630 for UJJIVAN (3.6x FY18e BV); the target prices are. Risks: Rampant borrower overleverage in microfinance, irrational competition from large commercial banks/NBFCs, adverse change in management, delays or inability to successfully execute the SFB transformation.
Corporate Comm India(CCI Newswire)
