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IPO Analysis: ESAF Small Finance Bank Limited
IPO Analysis of ESAF Small Finance Bank Limited.
ESAF Small Finance Bank Limited is a small finance bank with a focus on unbanked and under-banked customer segments, especially in rural and semi urban centers. The Bank commenced their business as a small finance bank on March 10, 2017 and they were included in the second schedule to the RBI Act pursuant to a notification dated November 12, 2018 issued by the RBI. As at June 30, 2023, the Bank’s gross advances to their customers in rural and semi-urban centers (combined) accounted for 62.97% of their gross advances and 71.71% of the Banking outlets were located in rural and semi-urban centers (combined). The Bank’s primary products are their advances (asset products) and deposits (liability products). The Bank has a network of 700 banking outlets (including 59 business correspondent-operated banking outlets), 767 customer service centers (which are operated by their business correspondents), 22 business correspondents, 2,116 banking agents, 525 business facilitators and 559 ATMs spread across 21 states and two union territories, serving 7.15 million customers as at June 30, 2023. While the Bank’s operations are spread out across India, their business is concentrated in South India, particularly in the states of Kerala and Tamil Nadu. The Bank uses business correspondent entities to source and service customers for Micro Loans. Their business correspondents also source customers for mortgage loans, vehicle loans, MSME loans, agricultural loans and select deposit products. In addition, their business correspondents are responsible for sourcing and servicing the Banking agents.
Bank have a network of 700 banking outlets (including 59 business correspondent-operated banking outlets), 767 customer service centres (which are operated by our business correspondents), 22 business correspondents, 2,116 banking agents, 525 business facilitators and 559 ATMs spread across 21 states and two union territories, serving 7.15 million customers as at June 30, 2023. While our operations are spread out across India, their business is concentrated in South India, particularly in the states of Kerala and Tamil Nadu. As at June 30, 2023, 62.43% of banking outlets are located in South India (including 43.43% in Kerala and 13.86% in Tamil Nadu), 73.09% of gross advances are from customers in South India (including 43.45% from Kerala and 22.14% from Tamil Nadu) and 86.90% of deposits are from banking outlets in South India (including 80.04% from Kerala and 3.36% from Tamil Nadu). Bank commenced our business as a small finance bank on March 10, 2017 and were included in the second schedule to the RBI Act pursuant to a notification dated November 12, 2018 issued by the RBI. Bank does not have any subsidiaries, associates or joint ventures or a holding company.
Industry Research:
Over the past decade, banking credit growth lagged systemic credit growth for several years as NBFCs grew at a much faster pace. However, the NBFCs suffered a blow after IL&FS defaulted in September 2018. NBFCs, not having the advantage of size, rating and/or parentage, had to grapple with a liquidity crisis and as raising funding became difficult. Initially, post the IL&FS crisis, banks were expected to fill the space left out by NBFCs. However, with slower economic growth and muted private capex, banking credit growth remained low at ~6.8% in Fiscal 2020.
In the fourth quarter of Fiscal 2020 and the first quarter of Fiscal 2021, with the outbreak COVID-19 pandemic, challenges had intensified for both banks and NBFCs. NBFCs were hit harder in terms of demand, and they also turned cautious as they lend to borrowers with relatively weaker credit profile. In the second half of Fiscal 2021, the Indian economy showed signs of improvement, the effect of which was seen in the credit growth.
At the end of Fiscal 2021, the banking credit grew by ~5% on year while NBFCs witnessed a growth of 7.3% during the same period. In Fiscal 2022, the second wave of the COVID-19 pandemic led to weak demand for credit in the first quarter of the year. However, the pace of credit recovered, with overall credit growing by 8.4% and retail credit increasing by 11.6% year- on-year as of March 2022. Further, high frequency indicators point out that economic activity and consumer spending is returning to pre-COVID-19 levels. With the effect of COVID-19 waning, vaccination coverage progressively improving, the situation and growth improved further.
Due to COVID-19 pandemic, demand for credit reduced drastically on account of economic activity coming down to standstill due to lockdown led sharp fall in disbursements. However, there was a pickup in disbursements since the second half of Fiscal 2022, a trend that continued in Fiscal 2023. The bank credit demand was broad based in Fiscal 2023 growing at 15% year on year. There was strong retail credit demand from segments like personal loans, consumer durables, credit card, vehicle loans etc.
Going forward, credit to the overall retail segment is expected to lead the growth of the banking sector, supported by healthy growth in housing, consumer durable, gold and other personal loans segments. CRISIL MI&A expects bank credit to grow at 12-14% CAGR between Fiscal 2023 and Fiscal 2025.
In Fiscal 2018, deposit growth rate fell to its lowest in over 55 years to ~7%, as the effect of demonetisation subsided, and households moved their savings from deposits to other lucrative instruments such as shares and debentures. However, in Fiscal 2019, deposit growth picked up and clocked 11%, in the wake of capital market volatility and higher deposit rates offered by the banks. In addition, inclusion of more people under the formal financial services channel improved deposit mobilisation as players continued to expand in the underbanked centres. Banking deposit growth was higher in semi-urban centres as compared to urban and rural centres, which witnessed similar growth.
In Fiscal 2020, with slowdown in the economy, deposits grew at a moderate ~9%. The banking sector witnessed movement of deposits from private sector banks to public sector banks as one of the private sector banks gross NPAs spiralled. Towards the end of Fiscal 2020, Yes Bank was put under moratorium for 30 days, wherein withdrawal of deposits was restricted before a management change was effected by the regulator and the central Government. Earlier, in 2019, the RBI had imposed operational restrictions and restrictions on withdrawals from Punjab and Maharashtra Co-operative Bank Limited after finding financial irregularities. Fiscal 2020 also saw deposit rates coming down with lending linked to an external benchmark and interest rate cycle on a downward scenario, resulting in banks reducing deposit rates to preserve their spread.
CRISIL MI&A expects deposits rate to inch up with increase in competition and to support the credit growth. However, the increase in Fiscal 2024 might be at a slower pace on account of new taxation rule that will come into effect from April 1, 2023, which will take away tax advantage from most debt mutual funds and will give edge to bank fixed deposits. Hence, the deposits are expected to grow by 11-12% in Fiscal 2024.
The pandemic resulted in one of the worst economic declines in decades. Airlines, hospitality, travel, gems and jewelry, auto dealers, and real estate were hit the hardest, given the discretionary nature of these sectors. Both collections and disbursements were impacted significantly in the first half of Fiscal 2021. However, with measures taken by the government and the RBI assisting in containing the deterioration in asset quality, overall GNPA ended Fiscal 2021 at 7.4%.
About 0.9% of the total credit outstanding was restructured by the RBI as of March 2021 under the one-time restructuring framework 1.0, which was significantly lower than earlier estimates. In the case of public banks, the majority of the restructurings come from the corporate sector. In the case of large and mid-size private sector banks, the proportion of retail assets in total restructuring (invoked + implemented) was relatively high.
On May 5, 2021, the RBI announced the restructuring framework 2.0 to protect individuals and MSMEs from the adverse impact of the second wave. The resolution facility was applicable for accounts classified as ‘Standard’ as at March 31, 2021, wherein individuals and MSMEs having an aggregate loan exposure of up to ₹250 million who have not availed restructuring under any of the earlier restructuring frameworks and who were classified as ‘Standard’ as on March 31, 2021 were allowed to restructure their loans. Restructuring under the proposed framework was able to be invoked up to September 30, 2021 and had to be finalised and implemented within 90 days after invocation of the resolution process (with the last date to implement the restructuring for banks being December 31, 2021). This framework saw better response from corporate borrowers. CRISIL MI&A estimates the overall restructuring (1.0 and 2.0) at ~1.4% of the loans outstanding as of March 2023. However, the stress on account of slippages from this portfolio remains to be monitored.
GNPA of both private and public banks improved in Fiscal 2022 on account of reduction in fresh slippages and improvement in upgrades and recoveries. GNPA of scheduled commercial banks stood at a six-year low of ~5.9% as of March 2022. CRISIL MI&A estimates the GNPA of scheduled commercial banks to have declined further in Fiscal 2023 on account of lower slippages, higher recoveries and expectation of recoveries via the NCLT and National Asset Reconstruction Company Ltd (NARCL) route.
In order to promote financial inclusion, the Indian banking industry has seen several changes in recent years. NBFCs, such as Bandhan and IDFC, received permission to set up universal banks. Also, a few microfinance companies, a local area banks and an NBFC as well as one urban co-operating bank have received permission to set up small finance banks (SFBs). The RBI awarded SFB licences to 12 players keeping in with the government’s focus on financial inclusion and inclusive banking.
Growth drivers for small finance banks:
• Customized products aided by technology and information availability
Greater use of technology is enabling lenders to provide customised products, that too at much lower turnaround time. Multiple data points are available for lenders that is facilitating quick decision making. In fact, they can take lending decisions within minutes using data-driven automated models. These models would help in supply of credit to small business units and the unorganised sector at low cost. Technology also helps these players expand their reach to under penetrated population in remote centres at a lower operating cost.
• Availability of funds at cheaper rates
CASA and other retail deposits are a cheap source of funds for SFBs, which help them expand their product portfolio. They can provide lower rates in the market to compete with NBFCs. With SFBs expanding in the underserved regions further, their deposit base is expected to further widen. The CASA deposits for SFBs is estimated to have grown at 66% CAGR from Fiscal 2018 to Fiscal 2023. This will give them an advantage over NBFCs and help expand their asset book.
The small finance banks’ advances under management (which is gross advances plus off-balance sheet advances (“AUM”) is estimated to have clocked 29% CAGR from March 31, 2018 to June 30, 2023. CRISIL MI&A estimates that the top three SFBs accounted for ~60% of the aggregate AUM as of June 30, 2023, up from 55% as of March 31, 2017 indicating the rising concentration and expansion of players within the SFBs. CRISIL MI&A also estimates that the top six players accounted for ~85% of the market share as of June 30, 2023. In Fiscals 2021 and 2022, new loan origination remained low as SFBs turned cautious and selective in disbursals due to the pandemic. However, as economy revived and business operations normalised, SFBs’ AUM witnessed strong growth post pandemic. As of June 30, 2023, SFB AUM is estimated to have crossed ₹1,900 billion. CRISIL MI&A expects SFB’s AUM to grow at ~22-24% CAGR between June 30, 2023 and March 31, 2025, as most of the SFBs have completed the transition phase and are likely to benefit from their operating leverage.
Investment Rationale:
Their understanding of the micro loan segment has enabled them to grow their business outside of Kerala, their home state:
As at June 30, 2023, the Bank had over 3.25 million customers with Micro Loans, the majority of whom were women. Their understanding of the micro loan segment has enabled them to successfully expand their business outside of Kerala. As at June 30, 2023, their products and services were offered in 21 states and two union territories. Their gross Micro Loans to customers outside of Kerala were ₹43,305.24 million, representing 42.30% of their total gross Micro Loans, as at June 30, 2023. As at June 30, 2023, their top five states outside Kerala for gross Micro Loans were Tamil Nadu, Maharashtra, Madhya Pradesh, Karnataka and Chhattisgarh, with gross Micro Loans in those states (combined) being ₹50,437.31 million, which represented 49.27% of their total gross Micro Loans.
Main focus on their rural and semi-urban banking franchise:
The Bank’s main focus is on providing loans to customers in rural and semi-urban centres. Their customers in rural and semi-urban centres (combined) have increased from 3.00 million as at March 31, 2021 to 3.93 million as at March 31, 2023 and further increased to 4.07 million as at June 30, 2023. As at June 30, 2023, their gross advances to customers in rural and semi-urban centres (combined) were ₹90,951.76 million, representing 62.97% of their gross advances. As at June 30, 2023, 4.07 million of their customers were in rural and semi-urban centres (combined), representing 56.92% of their total customers, and the number of banking outlets in rural and semi-urban centres (combined) was 502, representing 71.71% of their total banking outlets.
Growing Retail Deposits portfolio:
The Bank’s total deposits increased from ₹89,994.26 million as at March 31 2021 to ₹146,656.25 million as at March 31, 2023, representing a CAGR of 27.66%, and further increased to ₹156,558.54 million as at June 30, 2023, an increase of 6.75%. They have placed an emphasis on increasing their Retail Deposits. Their Retail Deposits increased from ₹87,963.84 million as at March 31, 2021 to ₹133,230.03 million as at March 31, 2023, representing a CAGR of 23.07%, and further increased to ₹139,772.67 million as at June 30, 2023, an increase of 4.91%. CASA tends to provide a stable and low-cost source of deposits compared to term deposits. Their CASA increased from ₹17,476.45 million as at March 31, 2021 to ₹31,374.47 million as at March 31, 2023, representing a CAGR of 33.99%, and decreased to ₹28,519.70 million as at June 30, 2023, a decrease of 9.10%.
Customer connections driven by their customer-centric products and processes and other non-financial services for Micro Loan customers:
The Bank aims to provide the best-in-class banking services to their customers, as they believe their customers are the most important stakeholders in their business. Their products and services are designed to meet the various lifecycle needs of their customers, such as home loans, clean energy product loans, loans for agricultural activities, loans against property, personal loans, education loans, gold loans and vehicle loans. An example of their customer-centric approach is that their Micro Loans can be repaid on a weekly, fortnightly or monthly basis based on their customers’ preferences. As at June 30, 2023, 55.31% of their Micro Loan customers repaid their loans on a weekly basis. Their business correspondents collect cash repayments on their behalf and through regularly meeting with their Micro Loan customers, their business correspondents are better able to understand those customers’ requirements. They believe their business correspondents’ constant engagement with their Micro Loan customers helps to keep delinquencies in check.
Technology-driven model with a digital technology platform:
The Bank offers their customers various digital platforms, including an internet banking portal, a mobile banking platform, SMS alerts, bill payments and RuPay branded ATM cum debit cards. All banking and payment transactions, such as remittances and utility payments, can be completed through these platforms. Their customers are also able to register their savings accounts on a unified payment interface based mobile applications. Their account opening and loan underwriting processes have been digitalised by using tablets, which enabled them to reduce their turnaround time and offer better service to customers. They have a digitalised central credit-processing unit for their micro loans. Their customer on-boarding process has been predominantly digitalised for their micro loans.
Experienced Board and Key Managerial Personnel and Senior Management Personnel:
The Bank has an experienced Board comprising members with diverse business experience, many of whom have held senior positions in well-known financial services institutions. Mr. Kadambelil Paul Thomas, their Managing Director and Chief Executive Officer and one of their Promoters, was previously a senior field representative at Indian Farmers Fertilizers Cooperative Limited and since 2013 he has been the president of the Kerala Association of Micro Institutional Entrepreneurs. Members of their Senior Management Personnel and Key Managerial Personnel have been working in the banking and financial services sector for more than 27 years. The members of their Senior Management Personnel have expertise in scaling up financial services organizations and collectively they have all the relevant experience in credit evaluation, risk management, treasury and technology.
Expanding deeper penetration: As at June 30, 2023, the Bank had 700 banking outlets (including 59 business correspondent-operated banking outlets), 767 customer service centres (which are operated by business correspondents), 22 business correspondents, 2,116 banking agents, 525 business facilitators and 559 ATMs. As at June 30, 2023, they served over 7.15 million customers in 21 states and two union territories. Since April 2020, they have considerably expanded the number of states and territories they operate in. In Fiscal 2021, they expanded their operations to Meghalaya, Uttar Pradesh, Haryana, Tripura and Chandigarh, by opening banking outlets and/or appointing business correspondents for these states/union territory. In Fiscal 2022, they expanded their operations to Uttarakhand by appointing a business correspondent for that state. In Fiscal 2023, they opened Branches in Tripura and Uttarakhand for the first time.
Increasing their deposits and in particularly their Retail Deposits: The Bank plans to continue to increase their deposits, in particular their Retail Deposits, in order to help grow their business and reduce their Cost of Funds. Their total deposits increased from ₹89,994.26 million as at March 31 2021 to ₹146,656.25 million as at March 31, 2023, representing a CAGR of 27.66%, and further increased to ₹156,558.54 million as at June 30, 2023, an increase of 6.75%. Their Retail Deposits increased from ₹87,963.84 million as at March 31, 2021 to ₹133,230.03 million as at March 31, 2023, representing a CAGR of 23.07%, and further increased to ₹139,772.67 million as at June 30, 2023, an increase of 4.91%. To increase their deposits, the Banking outlets and business correspondents will continue to target new and existing customers to source deposits in the form of CASA, fixed deposits and recurring deposits by focusing on customer service and offering competitive pricing.
Continue to grow their Micro Loans while increasing their other categories of advances both in absolute terms and as a percentage of their total AUM:
Continue to grow their Micro Loan business: Their AUM of Micro Loans increased from ₹71,452.80 million as at March 31, 2021 to ₹122,548.83 million as at March 31, 2023, representing a CAGR of 30.96%, and further increased to ₹128,511.97 million as at June 30, 2023, an increase of 4.87%. CRISIL MI&A expects small finance banks’ AUM to grow at approximately 22-24% CAGR between June 30, 2023 and March 31, 2025.
Expand their retail loan business: In Fiscal 2018, they began offering retail loans and since then they have been expanding their portfolio of retail loan products, including offering gold loans in Fiscal 2019. Gold loans in particular have contributed to the growth of their retail loans.
Increase their MSME loans: Their AUM of MSME Loans increased from ₹483.57 million as at March 31, 2021 to ₹1,600.61 million as at March 31, 2023, representing a CAGR of 81.93%, and decreased to ₹1,531.69 million as at June 30, 2023, a decrease of 4.31%. They plan to increase their MSME loans both in terms of amount and as a percentage of their AUM by having their relationship managers in the Banking outlets reach out to MSMEs and offer them working capital and term loans.
Grow their agricultural loan business: They set up their agricultural (agri) loan business department in Fiscal 2020. In Fiscals 2023, 2022 and 2021, they introduced two, two and three new agricultural loan products, respectively, resulting in them having seven agricultural loan products as at June 30, 2023. Their AUM of agricultural loans increased from ₹90.30 million as at March 31, 2021 to ₹6,878.24 million as at March 31, 2023, representing a CAGR of 772.76%, and increased to ₹7,838.51 million as at June 30, 2023, an increase of 13.96%.
Increase fee-based income by cross-selling, expanding third-party products and service offerings and expanding their feebased offerings: The Bank intends to increase their fee-based income by cross-selling third-party products and service offerings to their customers and expanding third-party products and service offerings. In Fiscal 2019, they began distributing the National Pension System, Atal Pension Yojna and third-party general insurance products. In Fiscal 2020, they began distributing third-party life insurance products. In Fiscal 2023, they began distributing third-party mutual funds and offering third-party depositary services. In addition, they plan to offer bank guarantees and letters of credit to MSMEs.
Continue to leverage technology and customer data analytics: The Bank believes their use of technology has significantly improved the efficiency of their operations. They plan to further enhance their technology platforms, such as internet banking, mobile banking, ATMs, cash deposits machines, customer service applications and payment interfaces, which they believe will increase the adoption of their service delivery mechanisms. This will also enable them to perform more reliable data analytics, resulting in more efficient risk management processes, targeted customer profiling and offer customised products to suit their customers’ diverse requirements.
Management Profile:
Ravimohan Periyakavil Ramakrishnan is the Part-Time Chairman and Non-Executive Independent Director of the Bank. He is a certified associate of the Indian Institute of Bankers. He was previously employed as a chief general manager in the department of banking supervision of the RBI. He was previously a resident advisor, financial sector supervision, International Monetary Fund, AFRITAC South, Mauritius.
Kadambelil Paul Thomas is the Managing Director and Chief Executive Officer of the Bank. He was previously the chairman and managing director of ESAF Financial Holdings Private Limited. He has also served as the founder secretary cum honorary executive director of Evangelical Social Action Forum for over 25 years. He was also previously a director on the boards of Sanma Garments Private Limited, Rhema Dairy Products India Private Limited, Rhema Milk Producer Company Limited, Lahanti Homes and Infrastructure Private Limited, ESAF Health Care Services Private Limited, ESAF Swasraya Producers Company Limited, CEDAR Retail Private Limited, ESAF Enterprise Development Finance Limited and CEDAR Livelihood Services Private Limited (Formerly Cedar Agri Solutions Private Limited). Presently, he is the president of Kerala Association of Microfinance Institutions Entrepreneurs. He was previously the chairman of Sa-Dhan, and the chairman of Confederation of Indian Industry – Kerala. During Fiscal 2022, he received the Marketing Meister award, the Business Leader of the Year award, FE Pillar of the BFSI Industry award, the APY Big Believers (ABB) 3.0 award from PFRDA for the best performing MD & CEO, the India Banking Summit CEO of the Year Award, the Exemplary Diamond award from PFRDA, the CEO with HR orientation award at world HRD congress, the APY Big Believers Exemplary Award of Par Excellence from PFRDA, and the APY Big Believers Award of Excellence from PFRDA. He is on the board of directors of Thrissur Startup Incubation Council.
Thomas Jacob Kalappila is a Non-Executive Independent Director on the Board of the Bank. He is an associate member of the Institute of Chartered Accountants of India and holds a diploma in information and systems audit from the Institute of Chartered Accountants of India. He is a partner of Thomas Jacob & Co., a partnership firm and has 35 years of experience in statutory audit, internal and forensic audit of banks. He has previously served as an independent director on the board of directors of South Indian Bank Limited and Malabar Cements Limited.
Vinod Vijayalekshmi Vasudevan is a Non-Executive Independent Director on the Board of the Bank. He is the group CEO of FLYTXT, Dubai and Amsterdam. He is currently on the board of directors of Flytxt Mobile Solutions International, Z3P Tech Fund and Z3P Global, Mauritius.
Ravi Venkatraman is a Non-Executive Independent Director on the Board of the Bank. He was the former Executive Director and Chief Financial Officer of Mahindra and Mahindra Financial Services Limited. He is currently on the board of directors of Bajaj Finserv Mutual Fund Trustee Limited, Kotak Mahindra General Insurance Company Limited, Avanse Financial Services Limited, Kotak Mahindra Prime Limited, Sarvagram Solutions Private Limited, Aditya Birla AMC Limited.
Kolasseril Chandramohanan Ranjani is a Non-Executive Independent Director on the Board of the Bank. She has held senior management positions with SIDBI, and has more than 21 years of experience in Micro, Small and Medium Enterprises in India. She is currently on the board of directors of SM Swasthman Foundation.
Biju Varkkey is an Additional Non-Executive Independent Director on the Board of the Bank. He is also a faculty member at IIM Ahmedabad. He was on the board of directors of Bank of Baroda.
John Samuel is a Non-Executive Nominee Director on the Board of the Bank. He is an associate of the Institute of Chartered Accountants of India. He was previously a Member of the Postal Services Board and held the position of Chief Post Master General.
Ajayan Mangalath Gopalakrishnan Nair is a Non-Executive Nominee Director on the Board of the Bank. He is a certified associate of the Indian Institute of Bankers. He was previously employed as the Executive Vice President of the Bank. He was previously the General Manager of IT and CIO, General Manager of retail assets, General Manager of transaction banking, General Manager of Pune Circle, Chief Compliance Officer and Deputy General Manager of Calicut Circle in Canara Bank. He is currently an additional director on the board of directors of ESAF Financial Holdings Private Limited.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Stocx Research Club). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI Registered individual/entity and the above research article is only for educational purpose and is never intended as trading/investment advice.
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