Utkarsh Small Finance Bank Limited IPO

About the company:

Utkarsh Small Finance Bank was incorporated in Varanasi on April 30, 2016, as Utkarsh Coreinvest Ltd. The promoter was granted the RBI In-Principle Approval to establish an SFB on October 7, 2015. Being a Small Finance Bank it caters especially to the unserved and underserved sections of the country. As of March 31, 2023, the Gross Loan Portfolio stood at INR 13,957 crore. Their Top three loan products consist of Micro Finance at 66% of their loan mix, followed by wholesale lending at 11% & Retail Assets (MSME) at 11%. The company has a presence in 26 states and Union Territories with a total of 830 banking outlets. However, their major business comes from Bihar and Uttar Pradesh which together constitute 57% of the company’s gross loan as of FY23.

IPO Details:

The Objectives of the Fresh Issue:

1. In terms of the RBI License and the SFB Licensing Guidelines, the bank was required to list its equity shares on the stock exchange within a period of three years from reaching a net worth of INR 500n crore.

2. The Bank intends to utilize the net proceeds from the issue towards augmenting its Tier 1 capital base to meet its future capital requirements.

3. Additionally, the Bank expects to receive the benefits of listing the Equity Shares on the Stock Exchanges.

Key Strengths:

1. Sound Understanding and Experience in an underpenetrated and fast-growing Micro Finance Industry

The Promoter company Utkarsh CoreInvest Ltd commenced its operations as an NBFC in FY2010 catering to micro finance segment in the states of Bihar and UP. The Bank, thus in total has an experience of more than 13 years in this industry. Microfinance as an industry is severely underpenetrated in our country. About 47% of India’s GDP comes from rural areas however their share in credit and deposits is low at 8% and 11% respectively. Further UP and Bihar which are the two biggest contributor for the company account for 17% and 9% of India’s overall population but their share in overall credit is only 5% & 1% respectively. 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.

2. The Growing Retail deposits to aid the cost of funds

The company has been gradually reducing its share of borrowings and focusing on Deposits. The company’s total deposits in FY23 have grown by 34% in FY22 and 36% in FY23, higher than the growth in its Gross loan portfolio in both years. Diving deeper into deposits, the management has stated that they would continue to grow their retail deposits at a faster pace. The company’s CASA ratio has increased to 20.89% in FY23 from 17.68% in FY21. Retail deposits offer greater opportunities for cross-selling and up-selling a variety of products which includes assets and third-party products, therefore meeting the life cycle of their customer requirements. The change in its liability mix has aided the bank in lowering its cost of funds. The cost of funds as of FY23 stands at 6.96% vs 8.27% in FY21.

3. 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 banks like Utkarsh SFB are able to generate higher yields and thus margins. As of FY23, the bank has a yield of 19.9% and Net Interest Margin of 10%. These higher operating numbers have led to the bank generating a higher ROAE of 22.8% as of FY23.

4. Strong Liquidity and Good Cost efficiencies

Utkarsh SFB has a comfortable liquidity profile that is backed by shorter tenure micro-banking lending and sufficient liquidity buffer. As of March 31, 2023, their Liquidity Coverage Ratio (“LCR”) was 375.82% as against the regulatory requirement of maintaining an LCR of 90%. They are well above the regulatory capital requirements, having an SLR, CRR, and CAR of 31.53%, 5.33%, and 20.64%, respectively, as of March 31, 2023. The Bank’s cost-to-income ratio was the lowest among SFBs with a Gross Loan Portfolio of more than INR 6,000 crore. Their cost-efficient operations are attributable to their automation and digitization of various processes including disbursements of loans in the micro-banking business.

Risks:

ØGeographic concentration – As of March 23, 57% of the bank’s business comes from two states – Bihar and Uttar Pradesh. Any natural or man-made calamity in these states can disrupt the bank’s financials.

ØDependences on Micro-Finance segment – As of March 2023, 66% of the bank’s loan mix consists of Micro-Banking loans. This segment is considered as a risky segment as in the occasion of any economic crisis these segments are the most impacted. Potentially leading to bad assets and poor profitability.

ØFinancial Risk - If they are unable to control the level of NPAs in their portfolio, their business, financial conditions, results of operations, and cash flows could be adversely affected. Their profit after tax declined from INR 111.8 crore in Fiscal 2021 to INR 61.5 crore in Fiscal 2022.

Conclusion:

Utkarsh SFB operates in a segment that is highly underpenetrated and has sufficient legroom to grow. This is evident from the fact that the industry has experienced an AUM CAGR of 29% in the past five years. The bank operates in a niche segment both geographically and in product category making it less prone to be disturbed by bigger banks. It generates handsome yields of 19.9% and NIM of 10% as of FY23 which is higher than its listed SFB peers. However, these higher yields are coming with extra risk leading to a higher GNPA of 3.23% as of FY23 which is also higher than its listed peers. On the bottom line, the ROAA of the bank stands at 2.4% which is on par with leading players.

At its upper price band, the bank demands a price to book of 1.37x. Considering the industry tailwinds, better macro conditions, high margins, and a fast-growing book the valuation appears fair. Considering these factors, we recommend a SUBSCRIBE rating for Utkasrh SFB IPO, as the company exhibits potential for sustained Value growth.