Equitas SFB has all things in place for a performance-based rerating

Representative image.

Shares of Equitas Small Finance Bank Ltd have returned a stellar 57 percent in the past six months, outperforming the small-cap space and most of its peers in the market.

The BSE Small Cap index gained 16 percent during this period and the broader index, the Nifty50, rose 14 percent.

The rise in Equitas share price comes even as the bank went through a leadership flux that eventually ended on a positive note when managing director PN Vasudevan decided to continue at the helm, seven months after announcing he is stepping down.

Reverse merger with parent

Investors also had to digest the implications of the impending reverse merger of the bank with its parent Equitas Holdings Ltd during this period.

The bank announced the reverse merger with the parent with a revised share swap ratio of 100:231 in March 2022.

Domestic funds, like SBI MF and DSP MF, hold about 63 percent in Equitas Holdings, and, after the merger, the stake of the fund houses will sharply increase on a consolidated basis.

Banking rules require institutions to seek approval from the Reserve Bank of India (RBI) to hold more than 5 percent of any bank’s paid-up capital. SBI Mutual Fund is the latest to seek such approval to hold 9.9 percent in the bank, following similar moves by DSP Mutual Fund and Franklin Templeton Mutual Fund as their holdings will breach the 5 percent threshold.

Analysts said that the move by domestic fund houses to stick with their investments is a positive for the bank.

The swap ratio of 100:231 means shareholders of Equitas Holdings will get 231 shares of the bank for every 100 they hold. The swap ratio was seen as benefiting holding company shareholders although the bank’s assets outstrip the parent’s. Indeed, Equitas SFB’s share price was under pressure after the swap ratio announcement.

Rerating candidate

Now, with the reverse merger zooming towards a conclusion and leadership issues resolved for the next three years, analysts believe the bank has everything in place for a rerating.

“Things are getting better with asset quality. Their collection efficiencies, which they diligently report, are also showing improvement. Overall, we project ROA (return on assets) of 1.9 by FY24,” said Nitin Aggarwal, banking analyst with Motilal Oswal Financial Services Ltd.

Meanwhile, the bank has been making progress on bringing down its delinquencies, boosting its liability franchise and improving its overall operating performance. Gross bad loans, as a percentage of loan book, have inched lower in the past two quarters while provisions have been beefed up.

As of September 2022 quarter, the bank had a provision coverage ratio of 50 percent. Gross bad loans were just 3.9 percent of its book, down from 4.2 percent, as of March. What’s more, the bank’s restructured book is also down to 3.2 percent of loans from 5.9 percent during the same period.

The upshot is that incremental stress is seen lower which would reduce provisioning needs and boost bottom line.

Besides, the bank is also gearing up for a faster loan growth now and a rising interest rate cycle will add to the margins.

The loan book of the bank has expanded close to 20 percent for the first six months of FY23. Close to 80 percent of its book is secured. “Improvement in asset quality is driving a stronger and broad-based credit growth for the bank. The flagship SBL book will grow with a shift in mix towards better quality customers and, hence, higher ticket segments of business loans and salaried LAP (loan against property),” analysts at Kotak Institutional Equities pointed out in a note.

Kotak analysts expect slippages to gradually come down to 3.3 percent in FY24 from the current 5.5 percent. This, coupled with improving credit costs, would ensure operating profit grows at a faster clip. For investors, the clouds on leadership and reverse merger have now cleared and the share price is likely to reflect the performance of the bank, hereon.