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In the September Quarter, small finance banks reported a record percentage of microfinance institution (MFI) loans that had remained unpaid for 30-180 days.
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According to Sadaf Sayeed, CEO of Muthoot Microfin, there could be a few reasons why. First, the average ticket size of SFBs is higher than those of NBFCs and NBFC-MFIs. Second, SFBs’ MFI portfolios could be slightly more concentrated in states that are showing signs of stress. Third, small finance banks are moving away from unsecured micro loans and focusing more on building secured loan books, so their MFI book base is not growing while NPAs are.
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Regardless of the type of lender – banks, small finance banks or NBFCs – the fact remains that microfinance lenders are in trouble.
But why is Equitas SFB, which only has 16% of its total loan book exposed to microloans, down 40% over the past year? It’s down by as much as Ujjivan Small Finance Bank, which has almost 50% exposure to MFI loans. And why is Equitas trading below its median three-year price-to-book? Is the market overestimating the negative impact of the MFI segment on it?
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We believe there are three primary reasons why Equitas is currently out of favour.
Small business loans
One possible explanation is that the customer profile for small business loans (SBL), which constitute about 41% of the portfolio, is not considered materially different from that of microloans. According to management, there is some overlap, meaning the top layer of MFI customers and bottom layer of SBL customers are the same.
This is especially the case in the micro-LAP segment (within SBL), which comprises secured loans of around ₹7 lakh. Management acknowledged that this segment has a higher nonperforming asset (NPA) ratio than SBL, but because the loans are secured, the eventual credit loss is less than that of micro-loans.
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Since NPAs for SBL are within acceptable limits (at 2.19%, up from 2.03% in the June quarter), it would be unfair to say, at least at this point, that SBL NPAs are likely similar to those of micro-loans.
Net interest margin compression
Equitas has said it aims to keep its unsecured portfolio to 20% of the total loan book. In line with this, it has been increasing the share of housing, vehicle and secured business loans, all of which offer a lower yield than MFI loans.
At the same time, the cost of funds has inched higher owing to the MFI trouble and the bank’s strategy to increase the share of retail deposits, for which it is offering higher interest rates. The net effect of these trends is a compression of the net interest margin (NIM), a key ratio similar to gross profit margin for non-banks.
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Since there is no near-term visibility on when these metrics are likely to improve, it’s likely that the market is factoring this uncertainty into the price.
Profitability hit due to upfront provisioning
The provision coverage ratio (PCR) of Equitas bank has been lower historically, and it is taking steps to remedy this situation. Accordingly, provisioning norms for microfinance loans overdue by 90 to 180 days has been increased from a standard 50% to 75%. Additionally, while a 100% provision was previously applied to loans overdue by more than 360 days, this threshold has now been lowered to 180 days.
This has resulted in improved PCR but lower profitability.
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It also appears that the MFI portfolio is adequately provisioned for now. With a gross NPA of 4.83%, and 3.75% of loans 31-90 days past due (DPD), the bank holds a total provision of 5.4%. This is just about sufficient but likely to be higher in the coming two quarters, according to an Axis Securities report.
The net effect of increased provisioning over the past two quarters is that return on equity (RoE) numbers are down significantly.
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We believe the changing portfolio mix, higher provisioning, and uncertainty regarding when the margins and profitability are likely to stabilise is what’s causing the stock to take a beating. We also believe it is unlikely that Equitas will continue to trade at similar valuations once the MFI issue is out of the way. The larger context supporting this view is that the banking sector itself seems to be trading at the lower end of historical valuations.
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As and when the banking sector’s outlook and valuations are re-rated, Equitas is a potential candidate for a re-rating.
For more such analysis, read Profit Pulse.
Note: We have relied on data from Screener.in and Tijorifinance.com throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information.
The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only.
Rahul Rao has been Investing since 2014 and has helped conduct financial literacy programmes for more than 1,50,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an alternative investment fund, focusing on small- and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.
Disclosure: The writer and his dependants do not hold the stocks/commodities/cryptos/any other asset discussed in this article.
