Equitas Holdings Ltd will be the first so-called small finance bank (SFB) to hit the public markets. Being ahead of its peers will help. There are 10 companies that received approval to set up SFBs, and most have large foreign shareholding, which needs to be reduced to 49% to meet the central bank’s norms. Whether these companies tap the public markets or resort to private capital, the fact that they can’t sell shares to foreign investors will make the task challenging.

Besides the first-mover advantage, the company’s impressive growth and diversified portfolio are likely to attract investors. But because foreign investors can’t buy in the initial public offering (IPO), it remains to be seen whether there are enough takers for the approximately 2,170 crore issue. On the flip side, the fact that foreign investors can’t participate in the share sale means there may be some pent-up demand, which could help magnify the so-called listing pop.

The public issue is a combination of a fresh issue of shares worth 720 crore and an offer for sale worth 1,450 crore by overseas investors. Non-resident shareholders currently own 92.64% of the company’s equity capital, which will come down to 35% post the issue.

If the issue sails through, most of these investors will end up with handsome returns ranging from 14% to over 40% in annualized terms. The company’s loan book or assets under management has grown at an annual average rate of 50% in the past five years. Growth in the core microfinance book, which accounts for 53% of total assets, has been in the mid-40s, while the other businesses which were launched later have grown at a much faster pace. Equitas already has decent sized books in vehicle financing and loans to micro and small enterprises, besides a presence in housing finance.

Digant Haria, an analyst at Antique Stock Broking Ltd, pointed out in a note to clients that Equitas is present in segments that have traditionally been ignored by banks, which should result in strong loan growth going forward as well.

What’s more, gross non-performing assets (GNPAs) have been contained at around 1.1% of total assets. In the microfinance segment, GNPAs stood at 0.17% at the end of December 2015. Non-performing loans were relatively higher in the vehicle financing business, the second largest business segment for the company, which, according to Haria, needs watching. GNPA for vehicle loans overdue for more than 180 days stands at 3%. Says Haria, “While 3% GNPAs is not unusual for NBFCs operating in the used commercial vehicles space, we will monitor the NPA levels as the book gets seasoned."

Also, while Equitas has done well to grow outside its home state, Tamil Nadu still accounts for about three-fifths of total business. While the company’s conversion into a Reserve Bank of India (RBI)-regulated SFB will protect it from the vagaries of state laws, there are still other risks associated with high concentration. Of course, thus far, this hasn’t affected the company’s growth.

What about valuations? The IPO price band of between 109 and 110 per share results in a price-book multiple of around 2.3 times based on the company’s net worth in December. Last month, when Ujjivan Financial Services Ltd raised a little over 300 crore from domestic investors, it was valued at 2.1 times its end-December book value. Ritesh Chandra, executive director and head (consumer and financial services) at Avendus Capital Pvt. Ltd, says, “Any distinction in pricing could be because Equitas has a relatively more diversified product portfolio than that of Ujjivan. On the other hand, Ujjivan has a far more geographically diverse client base than Equitas."

Valuation multiples both companies are demanding this year are higher compared to when they last raised funds in end-2014. Equitas was valued at around 1.9 times its book on a pre-money basis back then, based on Mint calculations. But a point to note is that it didn’t have the SFB licence back then, and it’s understandable that valuations have risen since.

The RBI licence will enable these companies to take deposits and bring overall cost of funds down. Of course, the transition will have its share of costs and difficulties, and profit growth is likely to be depressed in the next two years. But from a long-term perspective, the development bodes well for companies such as Equitas and Ujjivan.

The only catch is that companies rarely hit public markets just ahead of times of uncertainty. But RBI’s pre-condition on foreign shareholding has left them with little choice. If Equitas is able to pull off the issue, it will end with a stronger balance sheet and position itself well for the transition ahead. Like existing investors, IPO investors may also end up with decent gains.

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