Small finance banks turn tricky bet amid mounting NPA woes

Catch them young was one of the key selling propositions in the initial public offerings (IPOS) of Ujjivan Small Finance Bank (SFB) and Equitas SFB.

While Ujjivan was listed in December 2019, Equitas hit the market in October last year. The pandemic was not reckoned on when Ujjivan SFB was listed, while in Equitas’ case, the effect of the pandemic wasn’t anticipated to be very strong as it turned out to be.

It was in the December 2020 quarter (Q3) results that it became obvious that both banks would take a while to heal. Ujjivan’s proforma gross non-performing assets (without considering the Supreme Court’s stay on asset classification) stood at 4.8 per cent, and Equitas’ at 4.24 per cent. Reported gross NPAS were much lower (see table). According to analysts, Ujjivan’s FY21 estimated credit cost is about 5 per cent, while Equitas’ is at 2.5 per cent — the highest both banks have seen after demonetisation.

Provisioning costs, which shot up from ~30 crore a year earlier to ~583 crore in Q3, flipped Ujjivan’s operating profit of ~204 crore to a net loss of ~279 crore in Q3 — the first quarter of massive losses after demonetisation. In the case of Equitas, ~275 crore of operating profit shrank to ~110 crore of net profit, thanks to three times’ increase in provisions (~126 crore). The microfinance (MF) segment in particular was the most painful for both. While Ujjivan’s problem with its MF portfolio came from Assam, Equitas saw pressure building up in Maharashtra and Punjab, pushing the bank’s MF segment’s gross NPAS to 5.22 per cent in Q3.

For now, both have adequately provided stress and have guided for normalising credit costs in the March quarter. However, as they strive to diversify their businesses, credit costs may remain elevated in the coming years too, as new products are added.

“Ujjivan SFB’S long-term prospects hinge on ramping up its liability pool and assetside product diversification away from MFI, which remains vulnerable to shocks such as Covid-19, waivers and natural calamities,” say analysts at Emkay Global Financial. Vidhi Shah of Antique Stock Broking has noted that Equitas can scale up its business in secured products by leveraging its branch network, leading to better operating performance.

“However, one needs to be watchful about the unseasoned non-mf book, which, along with added stress in the MF book, can lead to asset quality issues and thus impact profitability,” she said.

In terms of valuation, at 1x its FY22 estimated book, Equitas SFB scores better than Ujjivan’s 1.8x. However, given the asset quality uncertainties of both banks, investors may be better off being on the sidelines.