ESAF Small Finance Bank Limited IPO

About the company:

ESAF Small Finance Bank (“ESAF SFB”) was incorporated on May 5, 2016. The Bank was granted the RBI’s Final Approval to carry on business as an SFB, on November 18, 2016. ESAF SFB has focus on unbanked and under-banked customer segments, especially in rural and semi-urban centres. As at June 30, 2023, their gross advances to their customers in rural and semi-urban centres (combined) accounted for 62.97% of the gross advances and 71.71% of the banking outlets were located in rural and semi-urban centres (combined). As of June’30 2023 the bank’s Assets under management (AUM) stood at INR 17,203.97 crore. Out of their total AUM Micro Finance Loans constitute 75%, Gold Loans 13%, Agriculture 5%, Mortgage 2% and others 5%. While their operations are spread out across India as at June 30, 2023, 73.09% of their gross advances are from customers in South India (including 43.45% from Kerala and 22.14% from Tamil Nadu) and 86.90% of their deposits are from banking outlets in South India (including 80.04% from Kerala and 3.36% from Tamil Nadu).

The Objectives of the Fresh Issue:

- To augmenting the Bank’s Tier – 1 capital base to meet the future capital requirements.
- General Corporate Purposes

Key Strengths:

Deep understanding of the microfinance segment

ESAF Small Finance Bank commenced its operations as an NBFC catering to micro finance segment catering primarily in the state of Kerela. The Bank thus has a significant experience in the micro-finance industry. Microfinance as an industry is severely underpenetrated in our country. As at June 30, 2023, ESAF SFB had over 0.33 crore customers with Micro Loans, the majority of whom were women. As at June 30, 2023, their products and services were offered in 21 states and 2 union territories. Their gross Micro Loans to customers outside of Kerala were ?4,330.52 crore, representing 42.30% of the total gross Micro Loans, as at June 30, 2023. Demonstrating its ability to expand its business beyond its home state. The AUM of the Small finance industry has been growing at a CAGR of 29% in the past five years and the under-penetration will continue to aid the industry’s growth.

The Growing Retail deposits to aid the cost of funds

Bank’s total deposits increased from INR 8,999.43 crore as at March 31 2021 to INR 14,665.63 crore as at March 31, 2023, representing a CAGR of 27.66%, and further increased to INR 15,655.85 crore as at June 30, 2023, an increase of 6.75%. They have placed an emphasis on increasing their Retail Deposits. The Retail deposits have witnessed a CAGR growth of 23.07% from March 2021 to March 2023. The CASA increased from INR 1,747.65 crore as at March 31, 2021 to INR 3,137.45 crore as at March 31, 2023, representing a CAGR of 33.99%. The bank’s cost of funds has declined to 6.19% in FY2023 from 7.56% in FY21.

Presence in a Niche market with high-yielding products

Being a Small Finance Bank, it caters especially to the unserved and underserved sections of the country. It has its primary focus on unsecured segments in the rural and semi-urban regions. These are the section of people who are largely unserved by the mainstream banks and thus there is a supply issue. Thus, ESAF SFB is able to generate higher yields of 20.23% on its loan book as of FY23.

Technology driven model with an advanced digital technology platform

The Bank continuously works towards improving their customers’ experience through the use of technology. All banking and payment transactions, such as remittances and utility payments, can be completed through their digital platforms. Their customer on-boarding process has been predominantly digitalised for their micro loans. They leverage technology for underwriting and credit sanctioning for their loan products based on inputs from credit bureaus and/or their customer data analytics. They have implemented technology solutions that enable them to ensure cashless disbursement of loans and implemented electronic signing for micro loans, both of which have reduced paperwork.

Risks

Dependence on Micro Finance Makes the book cyclical in nature
Their business is significantly dependent on the micro loan segment, which comprises our Microfinance Loans and Other Micro Loans (together, “Micro Loans”). Their Microfinance Loans and Other Micro Loans are provided to individuals without being secured by collateral. Therefore, in the times of economic stress the credit costs of the bank would see a significant spike and vice-versa in the case of a good economic environment.

Geographic Concentration

Their business is concentrated in South India, particularly in the states of Kerala and Tamil Nadu. While their operations are spread out across India, a significant number of their banking outlets are located in South India, especially Kerala and Tamil Nadu, and a majority of their gross advances and deposits are from customers in South India, especially Kerala and Tamil Nadu. Therefore, any risk or slowdown arising in these key states would have a direct impact on the bank’s business.

Conclusion:

ESAF Small Finance Bank (SFB) operates in a relatively untapped market segment, providing ample room for expansion. This is evident from the industry's impressive 29% Compound Annual Growth Rate (CAGR) in Assets Under Management (AUM) over the past five years. The bank's focus on a niche market, both in terms of geography and product offerings, reduces its vulnerability to disruption by larger banks. It has been able to generate impressive yields of 20.23% and a Net Interest Margin (NIM) of 10.67% as of FY23, which surpasses those of its listed SFB peers. However, it's worth noting that these higher returns come with added risk, leading to a Gross Non-Performing Asset (GNPA) ratio of 2.49% as of FY23.
At the upper end of its price range, the bank is valued at a Price-to-Book (P/B) ratio of 1.67x. Taking into account the favourable industry trends, improved macroeconomic conditions, robust profit margins, and a rapidly expanding customer base, this valuation appears reasonable. Given these factors, we recommend a "SUBSCRIBE" rating for the ESAF SFB IPO, as the company demonstrates the potential for sustained value growth.