MORE UPSIDE LIKELY FOR SMALL FINANCE BANKS

Transition to low-cost deposits will help improve margins, though some of this benefit might be offset by rise in expansion-related costs

Non-banking financial companies which have converted into small banks have got investor attention. The share prices of Ujjivan Financial Services, AU Small Finance Bank and Equitas Holdings have risen by 11-20 per cent in the past three months.

This reversal in sentiment is driven by a rebound in their March quarter performance and an improving outlook. Analysts believe there could be further gain in the share prices.

Till the December 2017 quarter, issues such as demonetisation, goods and services tax (GST) and loan waivers impacted many of the new Small Finance Banks (SFBs). Most of these did see marginal profit in FY18, thanks to the earnings rebound in the final (March) quarter. After this performance, these banks are expected to grow faster, reflecting in investor sentiment.

“With improvement in the rural economy, and now that demonetisation and GST pain is behind, small banks would focus more on acquisition of clients and cross-selling of products. This would help to increase their loan book, retail (from individuals) deposits and non-loan fee income,” says Manish Oswal, analyst at broking house Nirmal Bang.

Their loan book, for example, is expected to grow 25-38 per cent in FY19. A revival in the rural economy and improvement in semi-urban areas would provide an upward thrust here.

Importantly, the change in liability (deposit) mix will further propel earnings, at a time when other finance companies might get hit due to a rise in interest rates and high bond yields. After converting into banks, their low- cost deposits have increased sharply, reducing the share of costly sources of borrowings. At Ujjivan, for instance, the share of bank loans or debentures had reduced to 25 per cent by end-March, from 75 per cent a year before. Their average cost of borrowing came down from 10.5 per cent in FY17 to 9.4 per cent in the March 2018 quarter.

Beside, these banks are also aiming to grow their current and savings account ratio faster — these are the cheapest form of deposits. However, there is a flip side. “Access to low-cost retail deposits will help SFBs to boost their earnings. However, they have to control their cost to income ratio, likely to rise, owing to branch expansion or investment in banking infrastructure,” says Rajesh Gupta, assistant vice-president at SBICAP Securities.

Besides, while some believe diversification of the loan book to non-micro finance customers would be an advantage, others are not so excited, since microfinance loans generate higher yield as compared to business loans. It would be interesting to see how the asset mix plays on the margins, if these banks choose to increase the share of nonmicro loans.

The asset quality of these banks, after spiking in earlier quarters, is also improving. With more recoveries, due to a normal monsoon and improvement in cash flow of rural folk, this metric should look better in FY19.

With all these factors, many analysts are positive on the stocks of SFBs, expecting a 10-17 per cent rise. However, in select cases, their high valuation would restrict a sharp gain. AU Bank, for instance, is trading above seven times its FY19 book value. So, a fall in the share price could provide a better entry point to investors.