By Jindal Haria

India Ratings and Research (Ind-Ra) has upgraded Equitas Finance Limited’s (EFL) Long-Term Issuer Rating to ‘IND A+’ from ‘IND A-’. The Outlook is Stable. The agency has also upgraded the Short-term rating on EFL’s INR0.25bn commercial paper (CP) programme to ‘IND A1+’ from ‘IND A1’. A full list of EFL’s rating actions is given at the end of this commentary.

EFL is one of the operating non-banking financial company subsidiaries of Equitas Holdings Limited, which received in-principle approval from the Reserve Bank of India to operate a small finance bank (SFB) in FY16. Equitas Microfinance Limited and Equitas Housing Finance Limited will be merged into EFL to form Equitas SFB (ESFB). ESFB is slated to commence operations in 2QFY17.

KEY RATING DRIVERS

The upgrade takes into account the agency’s expectation of strengthening in EFL’s funding profile as well as the stronger liquidity on its balance sheet and enhanced systems, processes and supervision on account of its transition into ESFB. The ratings also factor in the immediate diversification in loan assets due to the merger as well as the opportunity to further diversify its loan assets and operational geographies. ESFB plans to sustain leverage at around 6x after transitioning to the banking business, which in Ind-Ra’s opinion, is critical in view of its product mix. The agency also considers idiosyncratic risks that its unsecured microfinance portfolio (over 50% of its consolidated loan portfolio in FY16) could be subject to and geographic concentration in Tamil Nadu, which could remain as-is in the medium term. Additionally, EFL’s ability to compete in new segments where some banks could already be present as well as its ability to develop a liability franchise that materially includes low-cost retail deposits needs to be established.

In FY16, the consolidated entity had INR61.2bn of loans under management and its small finance bank (SFB) operations with over INR19bn of equity (IPO in 1QFY17 led to a fresh issue of INR7bn of equity) would start in 2QFY17. While microfinance constitutes about 53% of ESFB’s portfolio, the micro SME loans that are provided to entrepreneurial clients among its microfinance customers constitute 14%. The micro SME loans segment has limited competition and the agency expects its share to increase over the next three to four years, since penetration of this product among microfinance customers is around 3%. Vehicle finance accounts for 25% of loans; the company has shown improvements in delinquencies in FY16 compared with
 FY15 (150 dpd portfolio declined to 3% from 3.9% and 90 dpd has declined to 5% in FY16 from 7.5%) mainly due to its focus on early delinquencies and the recovery model that it began to implement in FY15. The housing and loan against property segments account for the remaining 8%. In 1QFY17, ESFB’s gross NPAs increased to 1.61% from 1.34% in FY16 (mainly on account of moving from 150 dpd to 120 dpd NPA recognition) and the agency expects this to be marginally higher after SFB operations commence. 

ESFB would open about 400 branches in the first year of operations; the company has estimated INR1bn of additional expenses for banking operations annually and about INR2bn of one-time capital expenditure in FY17. Also, as it will expand its product suite and compete with banks in some segments over the next three to four years, it could face pressure on yields, which could be partly offset by declining cost of funds. In Ind-Ra’s opinion, its RoAs could settle at 2%-2.5% over the medium-to-long term.

ESFB is slated to start banking operations in September-October 2016 with equity of about INR19bn. The leverage of the consolidated entity (after adjusting for fresh equity) was 2.3x in FY16. In Ind-Ra’s assessment, the high exposure of the SFB to joint liability group (microfinance) loans as well as its concentration in a single state exposes the company to idiosyncratic risks and hence warrants lower leverage than some of its peers that have lower microfinance exposure. This will also be a key monitorable.
 

Ind-Ra expects ESFB to secure low-cost market funding (before starting SFB operations) and institutional deposits as compared with its current average cost of funds (11.3% in FY16; 12.1% in FY15). It could also replace high-cost bank loans with low-cost loans and refinancing lines. It also targets 20% of loans under management to be securitised on a continuous basis, which Ind-Ra believes is manageable. On the liquidity front, EFL benefits from a shorter asset tenor in microfinance and could raise certificates of deposits with matching tenors and derive pricing benefits from the interest rate curve. In its banking form, it also has access to the Reserve Bank of India as lender of the last resort.


RATING SENSITIVITIES

Positive: A sustained increase in operating scale, portfolio size, franchise and share of secured loans without significant deterioration in asset quality, along with successful execution of SFB operations, ability to raise longer tenor debt and deposits (especially low-cost retail deposits) while maintaining adequate short-term liquidity and robust equity and capital buffers, which in Ind-Ra’s opinion increases the company’s tolerance for asset quality deterioration, could lead to a positive rating action.

Negative:
An unsustained increase in NPAs, failure to mobilise sufficient deposits, capitalisation falling below or close to minimum regulatory requirements or deterioration of leverage relative to the product mix, could lead to a negative rating action.


COMPANY PROFILE

EFL is a Chennai-based non-deposit taking non-banking financial company, operating in the high-yield used vehicle finance, micro enterprise finance and loan against property businesses. The company started operations in June 2011 and currently operates 136 branches as at FYE16, 52% of which are in south India. The consolidated loans under management of EFL, Equitas Microfinance and Equitas Housing Finance were about INR61.2bn in FY16.

EFL’s ratings:
- Long-Term Issuer Rating: upgraded to ‘IND A+’/Stable from ‘IND A-’/Stable
- INR11bn bank loans (increased from INR6bn):  upgraded to ‘IND A+’/Stable from ‘IND A-’/Stable
- INR3.7bn non-convertible debentures (NCDs): upgraded to ‘IND A+’/Stable from ‘IND A-’/Stable
- INR400m subordinate debt: upgraded to ‘IND A+’/Stable from ‘IND A-’/Stable
- INR0.25bn CP programme: upgraded to ‘IND A1+’ from ‘IND A1’
- INR1.5bn senior unsecured NCDs: assigned ‘IND A+’/Stable 



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Additional information is available at www.indiaratings.co.in.The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings.

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

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Analyst Names

  • Primary Analyst

    Jindal Haria

    Director
    India Ratings and Research Pvt Ltd Wockhardt Towers, 4th floor, West Wing Plot C-2, G Block. Bandra Kurla Complex Bandra (East), Mumbai 400051
    +91 22 40001750

    Secondary Analyst

    Prakash Agarwal

    Director and Head Financial Institutions
    +91 22 40001753

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121