Equity Research INDIA July 8, 2021 BSE Sensex: 53055 Small Finance Banks ICICI Securities Limited is the author and distributor of this report Coming out of a transition; entering expansionary return ratio phase Sector Thematic India’s Small Finance Banks (SFBs) have carved a niche in small-ticket lending (~8% of systemic credit) in a short span of 4 years. They command 6% market FINANCIALS share in small loans and incremental market share of >20% pre-covid. Further, SFBs are improving their rural market share at an accelerated pace as seen in their ~2% market share in rural credit vs ~1% in systemic credit. We believe, SFBs are well positioned to seize the significant lending opportunity of Rs10trn (10x Equitas SFB cumulative SFB AUM as at Dec’20) for their future growth. End-to-end digital (Rs67 – BUY) onboarding of customers, higher interest rates and personalised services helped Target price Rs92 SFBs build stable source of funds via deposits, which helped lower the cost of funding, steadily. With the transition phase getting over for most SFBs and the Suryoday SFB huge lending opportunity in front of them, they are entering into an ‘expansionary (Rs212 – BUY) return ratio’ phase. Overall, we estimate SFBs (covered in this report) to deliver 18- Target price Rs310 20% AuM growth and sustainable RoE of 14-15% once the economy turns conducive. We initiate coverage on Equitas (BUY), Suryoday (BUY), and Ujjivan (ADD). Ujjivan SFB (Rs32 – ADD) ~Rs10trn lending opportunity to ensure industry-leading growth for SFBs. Target price Rs35 Accumulated AUM growth of 48% between FY18-Dec’20 for SFBs vs 7% systemic credit growth (13% for private sector banks) speaks of SFBs’ ability to carve a niche in small-ticket (mostly ‘new to formal credit’) lending space. Its market share in small loans remains as high as 6% vs 1% total credit market share as at Dec’20. Considering the government thrust on financial inclusion, huge untapped opportunity of ~Rs10trn and SFBs’ experience in underwriting loans based on unstructured data, we believe they will dominate the small-ticket lending space going ahead. SFBs’ incremental market share in such loans was at an average of 20% before covid onset in Mar’20. Fast-evolving liability franchise to provide sustainability. In a short span of 4 years in SFB operations, deposit market share of SFBs increased to 1% with incremental market share remaining much higher at 3%. End-to-end digital onboarding process, customised product offerings and relatively higher interest rates helped them gain share from incumbents at an accelerated pace. Strong 89% deposit CAGR between FY18-FY20 vs 9% systemic deposit growth also reflects increasing trust of depositors in parking their savings with SFBs and acceptance of SFBs as a new banking partner. Fast-evolving liability franchise would ensure sustainable source of funds at competitive rates and would further strengthen SFBs’ position in the lending space. Coming out from a long 4-year transition. Realigning their erstwhile NBFC operations as per the SFB model and build operations as per stipulated long-term strategy, was not only time consuming but also costly. During the transition phase, while different players have chosen different paths in terms of target markets and customers, the common theme was to build secured asset portfolios, limit unsecured exposure, and focus on retail deposits. Though covid has disrupted the journey, we believe, based on FY21 financial performance, SFBs are gradually coming out from the long transition phase and are set to improve profitability going forward.
We rank players on basis of retail liability and diversified asset mix. We believe Research Analysts: retail liability and diversified asset mix are two important pillars to build long-term Renish Bhuva sustainable business models, and we rank listed SFBs based on these two criteria. [email protected] While Suryoday and Ujjivan are steadily improving their retail deposits and secured +91 22 6637 7465 asset portfolios, Equitas ranks highest with the share of retail deposits and secured Kunal Shah asset products at >80% as at Mar’21. [email protected] Target Price P/BV (x) P/E (x) RoA (%) +91 22 6637 7572 Company Reco Chintan Shah Price (Rs) (Rs) FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E [email protected] Equitas SFB BUY 92 67 2.2 2.1 1.8 19.9 15.9 11.4 1.7 1.8 2.2 +91 22 6637 7658 Suryoday SFB BUY 310 212 1.4 1.4 1.3 189.7 44.9 15.7 0.2 0.7 1.8 Piyush Kherdikar Ujjivan SFB ADD 35 32 1.9 1.9 1.7 745.8 75.0 14.3 0.0 0.4 1.8 [email protected] Source: Company data, I-Sec research +91 22 6637 7465 Please refer to important disclosures at the end of this report
Small Finance Bank, July 8, 2021 ICICI Securities
TABLE OF CONTENTS
Financials snapshot ...... 3 Indian Small Finance Bank (SFB) Industry ...... 11 SFBs gaining credit market share at accelerated rate ...... 12 Cumulative credit opportunity of Rs~10trn to ensure sustainability of high growth over the medium term ...... 15 Robust digital platform, tailor-made customer service and differentiated interest rates to drive deposit growth for SFBs ...... 21 High-margin business model provides resilience during challenging credit events ..... 26 Productivity improvement and normalisation of credit cost to drive RoA (>2.0%) and RoE (>15%) over medium term ...... 26 Annexure: Index of tables and charts ...... 29
COMPANIES
Equitas Small Finance Bank ...... 31 Suryoday Small Finance Bank ...... 77 Ujjivan Small Finance Bank ...... 111
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Small Finance Bank, July 8, 2021 ICICI Securities
Financials snapshot
Table 1: SFBs comparison on key financial metrics NII (Rs mn) Equitas Ujjivan AU SS Opex (Rs mn) Equitas Ujjivan AU SS
FY18 8,605 8,610 9,405 1,638 FY18 8,811 6,529 7,526 1,314
FY19 11,517 11,064 13,423 3,389 FY19 10,085 10,034 10,824 1,935
FY20 14,953 16,336 19,094 4,905 FY20 11,801 13,186 14,179 2,722
FY21 17,980 17,286 23,654 4,101 FY21 13,294 12,301 16,584 3,286
FY22e 21,309 19,212 28,368 5,230 FY22e 15,107 13,306 21,663 3,855
FY23e 25,749 22,338 35,255 6,143 FY23e 18,509 15,608 26,517 4,392
FY18-21 CAGR (%) 28% 26% 36% 36% FY18-21 CAGR (%) 15% 24% 30% 36%
FY21-23 CAGR (%) 20% 14% 22% 22% FY18-21 CAGR (%) 18% 13% 26% 16%
PPoP (Rs mn) Equitas Ujjivan AU SS PAT (Rs mn) Equitas Ujjivan AU SS
FY18 2,206 3,196 5,759 704 FY18 318 69 2,920 101
FY19 4,261 3,090 7,219 2,123 FY19 2,106 1,992 3,818 867
FY20 5,976 6,372 11,977 3,058 FY20 2,436 3,499 6,753 1,109
FY21 8,866 8,093 21,586 1,813 FY21 3,842 83 11,707 119
FY22e 10,028 9,109 16,335 2,501 FY22e 4,797 825 8,506 501
FY23e 12,291 10,460 20,990 3,130 FY23e 6,682 4,338 11,738 1,430
FY18-21 CAGR (%) 59% 36% 55% 37% FY18-21 CAGR (%) 129% 7% 59% 6%
FY21-23 CAGR (%) 18% 14% -1% 31% FY21-23 CAGR (%) 32% 623% 0% 247%
AUM (Rs mn) Equitas Ujjivan AU SS Deposits (Rs mn) Equitas Ujjivan AU SS
FY18 82,390 75,600 1,33,121 15,690 FY18 56,040 37,725 79,055 7,500
FY19 1,17,042 1,10,490 2,28,187 26,800 FY19 90,067 73,794 1,94,224 15,934
FY20 1,53,660 1,41,530 2,69,924 35,319 FY20 1,07,884 1,07,805 2,61,630 28,487
FY21 1,79,270 1,51,400 3,46,089 42,060 FY21 1,63,920 1,31,358 3,59,790 32,557
FY22e 2,13,021 1,68,831 4,36,679 48,241 FY22e 1,93,930 1,53,534 4,43,684 39,072
FY23e 2,63,464 2,04,176 5,54,570 59,234 FY23e 2,48,214 1,81,041 5,55,818 48,840
FY18-21 CAGR (%) 30% 26% 38% 39% FY18-21 CAGR (%) 43% 52% 66% 63%
FY21-23 CAGR (%) 21% 16% 27% 19% FY21-23 CAGR (%) 23% 17% 24% 22%
EPS (Rs) Equitas Ujjivan AU SS BVPS (Rs) Equitas Ujjivan AU SS
FY18 0.3 0.0 10.2 1.5 FY18 19.2 10.0 78.2 78.0
FY19 2.1 1.0 13.1 10.6 FY19 20.6 9.4 103.3 107.9
FY20 2.3 1.8 22.1 12.8 FY20 23.7 16.5 142.9 123.1
FY21 3.4 0.0 37.5 1.1 FY21 29.8 16.7 201.0 150.5
FY22e 4.2 0.4 27.2 4.7 FY22e 32.4 17.1 225.8 155.2
FY23e 5.9 2.2 37.6 13.5 FY23e 36.7 19.4 261.0 168.7
FY18-21 CAGR (%) 120% 1% 54% -10% FY18-21 CAGR (%) 16% 18% 37% 24%
FY21-23 CAGR (%) 32% 623% 0% 250% FY21-23 CAGR (%) 11% 8% 14% 6%
RoA (%) Equitas Ujjivan AU SS RoE (%) Equitas Ujjivan AU SS
FY18 0.5 0.1 2.0 0.5 FY18 7.6 0.4 13.7 1.9
FY19 2.2 1.7 1.5 2.9 FY19 0.0 11.5 14.0 12.2
FY20 1.9 2.2 1.8 2.4 FY20 0.0 14.0 17.9 11.4
FY21 1.7 0.0 2.5 0.2 FY21 12.5 0.3 22.0 0.9
FY22e 1.8 0.4 1.5 0.7 FY22e 13.5 2.5 12.8 3.1
FY23e 2.2 1.8 1.7 1.8 FY23e 17.0 12.3 15.4 8.3
FY18-21 bps 128 -3 46 -30 FY18-21 bps 490 -16 830 -100 FY21-23 bps 41 172 -80 160 FY21-23 bps 445 1,207 -654 740
Cost/Income (%) Equitas Ujjivan AU SS Cost/Assets (%) Equitas Ujjivan AU SS
FY18 80.0 67.1 56.7 65.1 FY18 7.7 7.3 5.3 7.0
FY19 70.3 76.5 60.0 47.7 FY19 6.9 8.6 4.2 6.5
FY20 66.4 67.4 54.2 47.1 FY20 6.7 8.2 3.8 6.0
FY21 60.0 60.3 43.4 64.4 FY21 6.0 6.3 3.5 5.4
FY22e 60.1 59.4 57.0 60.7 FY22e 5.8 6.2 3.8 5.4
FY23e 60.1 59.9 55.8 58.4 FY23e 6.0 6.4 3.8 5.5
FY18-21 (%) -20% -7% -13% -70 FY18-21 bps -171 -95 -173 -160 FY21-23 (%) 0% 0% 12% -600 FY21-23 bps -7 1 30 10 Source: Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Table 2: Key metrics comparison of SFBs Key metrics Equitas Ujjivan Suryoday Loans (Rs mn) 1,79,250 1,51,400 42,060
State-wise break -up as per AUM Tamil Nadu 54% 16% 27% Kerala 2%
AP 2% WB 0% 13% Maharashtra 13% 10% 35% Karnataka 10% 14% 7% Rajasthan 4% 4% MP 3% 2% 6% Gujarat 4% 8% 8% Punjab 1% 2% Delhi 2% 3% 0% Haryana 2% 5% Telangana 2% Chattisgarh 1% 1% 1% UP 0% 4% 1% Bihar 6%
Odisha 3% 15%
Assam 2%
Others 1% 5% 0% *Suryoday loan break-up as on Dec'20
Deposit profile Total Deposits Rs mn 1,63,190 1,31,358 32,557 of which Retail deposit 55% 48% 65%* Bulk Deposit 45% 52% 20% CASA ratio (%) 34% 21% 15% CD ratio 110% 115% 129% Cost of Funds (%) 7.2 6.8 8.0 *Suryoday Retail deposit share is adjusted for CASA deposits
Asset quality (%) GNPL 3.7 7.1 9.4 MFI 3.4
SBL 3.3
Vehicle 3.8
MSE 2.8
Corporate
NNPL 1.6 2.9 4.7 Coverage 58% 59% 50% Credit cost 1.7% 5.5% 4.3%
Distribution Branches 861 575 556 Employee 16,556 16,571 5,131 Employee/per branch 19 29 9
Cost structure (Rs mn, p.a.) Staff cost (per employee) 0.5 0.5 0.4 Opex per Branch 6.2 8.4 2.6
Productivity (Rs mn) Loan per Employee 10.8 9.1 8.2 Deposits per employee 9.9 7.9 6.3 Source: Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Table 3: Valuation summary P/E (x) P/BV (x) P/ABV (x) Particulars CMP Rating TP FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E SFBs Equitas SFB 67 BUY 92 19.9 15.9 11.4 2.2 2.1 1.8 2.4 2.3 2.0 Ujjivan SFB 32 ADD 35 745.8 75.0 14.3 1.9 1.9 1.7 2.2 2.2 1.7 AU SFB 1,125 ADD 1,140 30.0 41.3 29.9 5.6 5.0 4.3 6.2 5.3 4.6 Suryoday SFB 212 BUY 310 189.7 44.9 15.7 1.4 1.4 1.3 N/A N/A N/A NBFC-MFIs CAGL 721 BUY 765 81.0 28.7 17.4 3.0 2.7 2.4 N/A N/A N/A Spandana 720 BUY 840 23.0 9.1 7.9 1.7 1.4 1.3 N/A N/A N/A
EPS (Rs) BV (Rs) RoAA (%) RoAE (%) Particulars FY21 FY22E FY23E FY21 FY22E FY23E FY20 FY21 FY22E FY23E FY20 FY21 FY22E FY23E SFBs Equitas SFB 3 4 6 30 32 37 1.4 1.7 1.8 2.2 9.7 12.5 13.5 17.0 Ujjivan SFB 0 0 2 17 17 19 2.2 0.0 0.4 1.8 14.0 0.3 2.5 12.3 AU SFB 37 27 38 201 226 261 1.8 2.5 1.5 1.7 17.9 22.0 12.8 15.4 Suryoday SFB 1 5 15 151 155 169 2.4 0.2 0.7 1.8 11.4 1.0 3.1 8.3 NBFC-MFIs CAGL 9 25 41 237 263 304 3.4 1.0 2.4 3.4 13.2 4.1 10.1 14.6 Spandana 31 79 91 434 497 570 6.3 2.7 5.7 5.6 15.6 7.4 17.0 17.1 Source: Company data, I-Sec research
Price charts AU SFB CreditAccess Gramin Spandana 1,600 1,350 600 1,400 1,200 500 1,050 1,200 400 900 1,000 300 (Rs) (Rs) 750 800 600 200 (Rs) 600 450 100 400 300 0 200 Jul-18 Jul-19 Jul-20 Jul-21 Jan-19 Jan-20 Jan-21 Jul-18 Jul-19 Jul-20 Jul-21 Jul-20 Jan-19 Jan-20 Jan-21 Jun-21 Mar-20 Mar-21 Aug-19 Dec-19 Nov-20 Source: Bloomberg
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Small Finance Bank, July 8, 2021 ICICI Securities
Key Charts Chart 1: Total lending opportunity of ~Rs10trn…
Cross-sell Market New to Total share gain* credit# Rs2,755bn Rs9,650bn Rs1,750bn Rs5,150bn Source: I-sec research *Assuming 7% market share in NBFC, we are taking clues from SFBs’ incremental market share in bank credit. #Assuming 25% market share in NTC, we are taking clues from SFBs’ incremental market share in small borrower banks’ credit. Chart 2: SFB’s dominant position in small-ticket Chart 3: SFBs’ incremental market share in small- lending (strong 5.6% market share) to help seize ticket loans fell to 7% as at Dec’20 but was average upon significant opportunity for their future 20% pre covid growth SFBs credit market share in small ticket loans SFB's incremental market share in small loans 35% 6.0% 5.6% 29% 29% 30% 5.0% 25% 22% 4.0% 19% 3.4% 20% 14% 3.0% 15% 14% 2.2% 10% 2.0% 10% 7% 7% 0.8% 1.0% 1.0% 0.6% 5% 0.4% 0.1% 0% 0.0% 1HFY18 FY18 FY19 Dec'20
Credit market share Small ticket credit market share Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Source: RBI, Company data, I-sec research Source: RBI, Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Chart 4: Players well positioned to grab the vast opportunity with adequate capital and deep distribution network…
50.0% Tier 1 (%) 1,200 Branch network
45.0% 47.2% 989 1,000 40.0% 861 35.0% 800
30.0% 575 600 556 25.0% 464 25.0% 20.0% 23.2% 400 15.0% 240 200 10.0%
5.0% 0 0.0% Equitas Ujjivan Suryoday Suryoday Ujjivan Equitas March'21 March'18
Source: Company data, I-sec research Source: Company data, I-sec research Chart 5: …to further support by evolving asset mix
Ujjivan - Incremental credit growth driver 151 Suryoday - Incremental credit growth driver 160 45 42 140 40 35 120 30 25 100 18 20 13 80 64 15 (Rs bn) (Rs 10 (Rs bn) (Rs 60 3 3 2 2 35 5 0 40 20 0 20 12 9 6 2 3 CV FY18 FY21
0 Others MFI loans MFI Agri FIG MSE FY17 FY21 Loans Others Housing Affordable Secured Secured Business Group Loans Group Affordable Housing Affordable Group loans Group Microfinance - Microfinance Microfinance - Microfinance Individual loans Individual Intermediary Financial Source: Company data, I-sec research
Chart 6: Eqitas, with already having diversified asset mix, likely to lead the credit growth
200 Equitas - Incremental credit growth driver (Rs bn) 175 180 160 140 120 100 72 80 (Rs bn) (Rs 60 47 40 13 11 20 9 8 8 7 1 1 1 0 -20 -1 FY17 FY21 Others New CV New Used CV Used Used Car Used Agri Loans Agri loans Gold Micro loans Micro Home loans Home MSE finance MSE Corporate loans Corporate
Small Business Loans Business Small Source: Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Chart 7: Deposit growth outpaced credit growth for all SFBs – Suryoday is leading on lower base AUM growth 95% Deposit growth 60% 100% 50% 90% 50% 80% 69% 70% 40% 37% 37% 60% 52% 30% 50% 39% 19%19% 20% 40% 20% 17% 14% 30% 22% 22%23% 17% 10% 7% 20% 14% 10% 0% 0% Suryoday Equitas Ujjivan Suryoday Ujjivan Equitas FY18-20 FY21 FY21-23E FY18-20 FY21 FY21-23E
Source: Company data, I-sec research Chart 8: Equitas stand out in terms of business mix; Suryoday is leading in cost effectiveness 100% 6.6 Cost ratios 70.0 89% 90% 83% 64.4 80% 6.4 80% 65.0 6.2 60.0 60.3 70% 6.0 60.0 60% 48% 5.8 50% 55.0 (%) 5.6
40% (%) 30% 27% 30% 5.4 50.0 20% 5.2 45.0 10% 5.0 5.4 6.0 6.3 0% 4.8 40.0 Equitas* Suryoday Ujjivan Suryoday Equitas Ujjivan Retail deposit share Secured loan book Cost to Assets Cost to Income
Source: Company data, I-sec research
Chart 9: Normalisation of credit cost to drive RoA for all SFBs Credit cost RoA 7.0% 3.0% 5.9% 2.4% 6.0% 2.5% 5.0% 2.2% 2.2% 5.0% 1.9% 4.3% 2.0% 4.0% 1.8% 1.7% 1.8% 4.0% 1.5% 3.0% 2.5% 2.3% 2.0% 1.0% 2.0% 1.4% 1.1% 0.5% 1.0% 0.2% 0.0% 0.0% 0.0% Equitas Ujjivan Suryoday Suryoday Equitas Ujjivan
FY21* FY22E FY23E FY20 FY21 FY23e
Source: Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Table 4: Evolving product offerings to support sustain high growth going ahead Equitas Ujjivan AU Suryoday Liability Products
Saving Account offering
Range of accounts 9 6 9 14 HNIs Elite Y Royale N NRI Y Y Y N 3 in 1 account (savings Y N Y N +trading+ demat) Paperless A/C opening Y Y Y Y Current Account offering Range of accounts 6 3 3 6 Escrow Y N (WIP) Y N Salary Accounts Y Y Y Y Term Deposits Recurring FD Y Y Y Y NRI FD Y Y Y Y Online FD Y Y Y Y
Assets Products Retail Home loan Y Y Y Y Gold loan Y Y Y N 2W N Y Y N 4W Y N Y N CV Y Y Y Y Used Vehicle Y Y Y N OD against FD Y Y Y Y LAP Y Y Y Credit Card N N Y N Personal Loan N Y Y N Business SME loans Y Y Y Y Avg ticket-size(Rs mn) 6.74 1.98 2 to 2.5 Corporate loans Y Y Y Y
Digital offering Whatsapp banking N N Y Y SMS & Missed call Banking N Y Y Y Debit card offers Y Y Y Y Paperless loans N 2W N N Y N PL N Y Y N Gold loan N N N QR based payment collection Y Y Y N UPI Y Y Y Y GST payment Y N Y N Bill Desk Y N Y Y Fastag Y N Y N
Third-Party HDFC Life Bajaj Future Generali India HDFC Life Life Insurance ICICI Pru Birla Sun life ICICI Kotak Life HDFC Life SBI Life Reliance ICICI General Bajaj Cholamandalam Lombard General Insurance Kotak Chola MS ICICI Lombard TATA AIG General Kotak General ACKO General SBI General Manipal HDFC Ergo Bajaj Aditya Birla Cigna Health ICICI Lombard TATA AIG Cholamandalam Care Health Source: Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Chart 10: Total NNPL + ECLGS + Restructuring as % of loans as at Mar’21 NNPL ECLGS Restructuring Write/offs 14.0%
12.0% 2.3% 10.0% 0.5% 3.3% 8.0% 6.7% 6.0% 2.3% 0.2% 1.0% 1.8% 4.0% 2.4% 0.4% 1.6% 2.0% 4.7% 2.9% 1.6% 2.2% 0.0% Equitas Ujjivan Suryoday AU
Source: Company data, I-sec research
Chart 11: Suryoday has written off ~2.3% of its loans in FY21 while Ujjivan and Equitas appear conservative
2.5% Write/offs
2.3% 2.0%
1.5%
1.0% 1.0%
0.5% 0.5%
0.0% Equitas Ujjivan Suryoday
Source: Company data, I-sec research
Chart 12: Suryoday appears most vulnerable with 20.7% ‘PAR 0’ portfolio as at Mar’21
25.0%
20.0% 20.7%
15.0% 15.0%
10.0% 10.0%
5.0% 5.9% 4.3% 2.3% 0.0% Equitas Ujjivan Suryoday
PAR 0 Total credit cost* Source: Company data, I-sec research Credit cost calculated as FY21 provision + Q4FY21 covid provision divided by FY21 AUM.
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Small Finance Bank, July 8, 2021 ICICI Securities
Indian Small Finance Bank (SFB) Industry
Despite banking liberalisation in 1991 and a series of new bank license issuance since then, financial penetration in India remained low. To improve the financial penetration and extend banking services to the underserved and unserved population of India, the RBI constituted a committee led by Dr. Nachiket Mor and sought its recommendations. The committee recommended differential licensing in the form of payment banks and small finance banks. In line with the recommendation, in 2014, the RBI released guidelines for a new class of banking entity called ‘Small Finance Banks’. On 16th
Sep’15, the RBI awarded 10 SFB licenses of which 8 were NBFCs.
Table 5: Evolution of SFB regulations since first issuance Licensing 1993 2001 2013 2014 SFB 2016 On tap 2019 On tap Guidelines Universal SFB Banks Licensed 10 2 2 10 None None Non-Operative No reference No reference Mandatory Not mandatory Not mandatory Not mandatory Financial Holding if promoter/ if promoter/ Company promoting entity promoting entity (NOFHC) does not have does not have Requirement other other group entities group entities Minimum initial Rs1bn Rs2bn to be raised to Rs5bn Rs1bn Rs5bn Rs2bn paid up capital / net Rs3bn within 3 years worth Minimum As determined 40% 40% 40% 40% 40% shareholding of by (raised to 49% in 2002 promoters (as % of RBI paid-up capital) Lock-in for No reference 5 year 5 year 5 year 5 year 5 year promoters’ above holding Dilution schedule After 1 year - Within 3 years - Within 5 years - Within 5 years - Within 5 years - for excess above 40% 40% 40% 40% 40% minimum required (raised to 49 % in 2002) capital (as % of (Bank to seek RBI paid-up voting approval if extra time equity capital) required) (from date of Within 10 years Within 10 years Within 10 years Within 10 years commencement of 20% 30% 30% 30% business) Within 12 years Within 12 years Within 15 years Within 15 years 15% 26% 15% 15% Listing To be governed Within Within Within 6 years Within requirements by regulations of 3 years 3 years of the 3 years SEBI regarding of the of net worth commencement of net worth public issues and commencement reaching to of reaching Rs5bn other guidelines of Rs5bn business by the applicable to listed business by the bank. banking companies bank Corporate/ No explicit ban Not allowed to be No bar on large Large PSUs Large industrial Large industrial Industrial Houses on setting up promoted by a large corporate/indust and industrial & houses were houses & as a Promoter banks by large industrial house, though rial houses to business not allowed to business groups industrial they were permitted to be promoters houses, promote a bank, not allowed to houses participate in the equity including but permitted to promote a bank up to a maximum of 10% NBFCs invest in the promoted by bank up to 10% them were not eligible Source: RBI, Company data, I-Sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
SFBs gaining credit market share at accelerated rate
With years of experience in servicing underserved rural / semi-urban populations (including individuals and small businesses) since their NBFC days, SFBs have carved a niche in financing the small-ticket self-employed segment. They are not only expanding the market size, but also eating away market share at accelerated pace from existing incumbents by offering tailor-made products and personalised services.
Chart 13: While universal banks command lion’s share of systemic credit, SFBs are slowly and firmly making strong inroads… Structural market share transition 60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0% SBI PSUs (ex SBI) Private FB SFB
FY05 FY10 FY15 Dec'20 Source: RBI, Company data, I-sec research Chart 14: …as reflects in their incremental share at 2.2% as at Dec’20 Incremental market share: >70% with private banks 80.0%
70.0%
60.0%
50.0%
40.0%
30.0% 20.0%
10.0%
0.0% SBI PSUs (ex SBI) Private FB SFB -10.0% FY05-10 FY10-15 FY15-Dec'20 Source: RBI, Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Chart 15: SFBs remained one of the fastest growing sub-segments between FY18-Dec’20 Loan CAGR 60%
48% 50%
40%
30%
20% 13%
10% 6% 3% 0% FY18-Dec'20 SFBs Private Foreign Banks PSBs Source: RBI, Company data, I-sec research
Chart 16: Equitas / Ujjivan / Suryoday driving SFBs’ credit market share; delivered significantly higher credit growth than other incumbents over past 3-4 years AUM growth 60% 50% 50%
40% 37% 37%
30% 24% 19% 20% 20% 17% 14%
10% 7%
0% Suryoday Equitas Ujjivan
FY18-20 FY21 FY21-23E
Source: Company data, I-sec research Chart 17: Incremental market share fell to 2.2% during 9MFY21 due to conservative approach adopted by most SFBs in expanding their MFI portfolio
2.2% Dec'20 1.0%
6.9% FY20 0.9%
2.6% FY19 0.6%
4.4% FY18 0.4%
3.2% FY17 0.1%
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 8.0%
Incremental market share (SFBs %) Outstanding market share (SFBs %) Source: RBI, Company data, I-sec research
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Small Finance Bank, July 8, 2021 ICICI Securities
Chart 18: Rural India driving incremental credit growth and the trend is likely to continue in the near term Credit growth trend 16% 13% 14% 13% 13% 12% 10% 10% 10%
8% 6% 6% 5%
4% 2% 2% 0% 0% FY19 FY20 FY21YTD (till Dec'20)
Total loans Rural+Semi urban Metro+Urban Source: RBI, Company data, I-sec research
Chart 19: SFBs enjoy strong position in rural lending market with 1.8% market share as at Dec’20 with incremental share much higher at 4%. Market share % 2.0% 1.8% 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% Sep'20 Dec'20 June'20 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20
Rural Urban Source: RBI, Company data, I-sec research Chart 20: SFBs command dominant position in small-ticket lending as seen in their strong 5.6% market share vs sub-1% in total systemic credit SFBs credit market share in small ticket loans 6.0% 5.6%
5.0%
4.0% 3.4%
3.0% 2.2% 2.0%
0.8% 1.0% 1.0% 0.6% 0.4% 0.1% 0.0% 1HFY18 FY18 FY19 Dec'20
Credit market share (%) Small ticket credit market share (%) Source: RBI, Company data, I-sec research ‘Small borrower accounts’ are accounts with credit limit of 14 Small Finance Bank, July 8, 2021 ICICI Securities Cumulative credit opportunity of Rs~10trn to ensure sustainability of high growth over the medium term While SFBs have already delivered Industry-leading loan CAGR over past 4 years, the important question here is how sustainable the current growth rates are. To answer this, we tried to look at the addressable credit opportunity by slicing it into three buckets: 1) cross-sell to existing MFI borrowers, 2) market share gain from banks and NBFCs given their expertise in financing borrowers with unstructured / informal income profile, and 3) ‘new to credit’ opportunity in MSME segment. We estimate a cumulative credit opportunity of ~Rs10trn spread over the above-mentioned sub-segments. Chart 21: Breakup of total lending opportunity of ~Rs10trn Cross-sell Market New to Total Rs2,755bn share gain* credit# Rs9,650bn Rs1,750bn Rs5,150bn *Assuming 7% market share in NBFC, we are taking clues from SFBs’ incremental market share in bank credit. #Assuming 25% market share in NTC, we are taking clues from SFBs’ incremental market share in small borrower banks’ credit. Source: Company data, I-sec research Increased government focus on financial inclusion, PMJDY and issuance of differentiated banking licenses like SFBs, Payment Banks, etc. has resulted in rapid formalisation of banking habits of Indian households over past 3-4 years. Most new-to credit customers (sourced over past 3 years) are now well versed in banking nitty- gritties and, more importantly, have understood the benefits of banking services. Over the years, SFBs have a carved a niche in underwriting small-ticket loans to self- employed borrowers with unstructured and informal data from the borrowers. Currently, unique MFI borrower base stands at 60mn as at March’21 and, assuming ~25% of existing customers would be eligible for higher loans (already in 3rd or 4th loan cycle) of up to Rs0.1mn, the immediate addressable market for SFB works out to Rs2.75trn, or 2.5x current AuM of all SFBs. 15 Small Finance Bank, July 8, 2021 ICICI Securities Chart 22: Unique MFI borrower base stands at Table 6: At 23% addressable market, immediate 55mn as at Sep’20; only ~2% of borrower base is lending opportunity would be Rs2.75trn, or 2.5x having ticket size of >Rs1,25,000 current SFB AuM Customer vintage as on Dec'18 Particulars Units 60% Unique customers (in mn) 59.9 Customers in >3rd cycle 23% 50% 54% Addressable market 13.8 Micro & Consumptions loans Small units (Including Gold, FD Target Market 40% against OD, Personal Loans etc.) Average ticket-size 1,50,000 50,000 30% Immediate Lending opportunity (Rs bn) 2,066 689 20% 24% Total opportunity (Rs bn) 2,755 Source: Industry, I-sec research 10% 11% 11% 0% Loan Cycle 1 Loan Cycle 2 Loan Cycle 3 Loan Cycle 4 Source: Industry, I-sec research Simultaneously, we have also looked at the competitive edge of SFBs – such as lower cost of funds vs NBFCs, cutting-edge digital platforms, familiarity in dealing with borrowers having unstructured / informal income profile, tailor-made product offerings, etc. – which are driving the current high growth rates. Chart 23: SFBs’ cost of funds is lower by average ~100bps than most NBFCs Cost of Funds % as on March'21 9.4 10.0 9.1 9.0 9.0 8.0 7.9 7.7 8.0 7.4 7.4 7.2 7.0 6.8 6.8 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 AU LTFH Chola Aavas MMFS Ujjivan Repco* Magma Equitas Shriram Suryoday Shriram City Shriram Repco CoF as at Dec’20 Source: Company data, I-sec research 16 Small Finance Bank, July 8, 2021 ICICI Securities Chart 24: Competitive pricing and niche in small ticket lending to help SFBs gain market share from NBFC… NBFC AuM (Rs trn) SFB's market share in small ticket credit 30 7.0% 24.6 25 23.7 6.0% 20.8 5.8% 5.0% 20 17.7 14.9 4.0% 15 12.5 3.4% 3.0% (Rs trn) (Rs 10 2.0% 2.2% 5 1.0% 0 0.0% FY15 FY16 FY17 FY18 FY19 FY20 Source: Crisil estimates, Company data, I-sec research Chart 25: …we estimate credit opportunity of Rs1,750bn for SFBs Banks / Development Banks /SFBs /NBFCs/ Micro Finance Institutions Co-op Banks Institutions Ticket-size Ticket-size Ticket-size More than 2.5mn Rs0.2mn to 2.5mn up to Rs0.2mn 1. Organised sectors 1. Unorganised sectors 1. No financials 2. Corporate entity 2. Cash basis accounting 2. General need of funds 3. Organised financials 3. Composite loan 4. Cash flow analysis requirements 5. Projects specific loans Source: I-sec research Chart 26: Total addressable credit gap in MSME space estimated at ~Rs26trn… 80 MSME credit gap (Rs trn) 69.3 70 60 50 40 36.7 (Rs bn) (Rs 30 25.8 20 10.9 10 0 Total Debt Demand Addressable Debt Total Formal Supply Total Credit Gap Demand of Debt Source: IFC estimate, Company data, I-sec research 17 Small Finance Bank, July 8, 2021 ICICI Securities Chart 27: Micro and small enterprises (SFBs’ target segment) offer biggest opportunity Medium enterprise, 1.0 tn Micro enterprise, 8.0 tn Small enterprise, 16.8 tn Source: IFC, Company data, I-sec research Chart 28: SFBs’ incremental market share in small-ticket loans fell to 7% as at Dec’20 but was average 20% pre covid SFB's incremental market share in small loans 35% 29% 29% 30% 25% 22% 19% 20% 14% 15% 14% 10% 10% 7% 7% 5% 0% Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Source: RBI, Company data, I-sec research We believe, considering the potential opportunity size of ~Rs10trn and SFBs’ niche in financing small-ticket borrowers in the self-employed segment, that SFBs are best positioned to sustain their industry-leading growth rates over the medium term. Within SFBs, industry leaders (e.g. AU, Equitas, and Ujjivan) are likely to lead the growth given their deep distribution networks, competitive rates on the back of lower cost of funds as compared to other SFBs, and wide range of products to cater to changing customer needs. 18 Small Finance Bank, July 8, 2021 ICICI Securities Chart 29: Top-3 players account for ~70% of SFB loans as at Mar’21 AuM as on March'21 (Rs bn) 400 377 350 300 250 200 179 (Rs bn) (Rs 151 150 100 42 50 0 AU Equitas Ujjivan Suryoday Source: Company data, I-sec research Chart 30: Evolving geographical presence and product mix to drive growth for SFB industry leaders Top-3 state's AUM contribution 90 80 81 78 77 80 72 70 70 60 50 43 44 40 30 20 10 0 Ujjivan AU Equitas Suryoday FY18 FY21 Source: Company data, I-sec research Chart 31: Ujjivan – Gradually building non-MFI Chart 32: Within secured lending, Ujjivan book incrementally focuses on formal segments Incremental credit growth driver (Rs bn) Loan mix changed in favour of secured assets 120% 160 151 98% 140 100% 120 100 80% 73% 80 64 60 60% 35 40 20 20 12 9 6 40% 2 3 27% 0 20% Agri FIG MSE FY17 FY21 2% Others 0% Housing Affordable FY17 FY21 Group loans Group Microfinance - Microfinance Microfinance - Microfinance Individual loans Individual Secured Unsecured Source: Company data, I-sec research Source: Company data, I-sec research 19 Small Finance Bank, July 8, 2021 ICICI Securities Chart 33: Equitas continues to strengthen its position in vehicle financing by foraying into new CV and used car segments 200 Incremental credit growth driver (Rs bn) 175 180 160 140 120 100 72 80 (Rs bn) (Rs 60 47 40 13 11 20 9 8 8 7 1 1 1 0 -20 -1 FY17 FY21 Others New CV New Used CV Used Used Car Used Agri Loans Agri loans Gold Micro loans Micro Home loans Home MSE finance MSE Corporate loans Corporate Small Business Loans Business Small Source: Company data, I-sec research Chart 34: AU is more focused on launching branch banking products, e.g. gold loans, business banking, OD against FD, etc. Incremental credit growth driver (Rs bn) 400 377 350 300 250 200 (Rs bn) (Rs 150 111 107 97 100 50 19 15 10 1 6 11 0 RE FY17 FY21 NBFC MSME Vehicle Finance Banking Business Agri SME Agri Home Loan Home OD against OD Gold Loan/ Gold FD & Others & FD Source: Company data, I-sec research Chart 35: Suryoday is scaling up its non-MFI portfolio in a calibrated manner Incremental credit growth driver (Rs bn) 45 42 40 35 30 25 20 18 13 15 10 3 3 2 5 0 2 0 CV FY18 FY21 Others Loans Secured Business Housing MFI loans MFI Affordable Financial Intermediary Group Loans Group Source: Company data, I-sec research 20 Small Finance Bank, July 8, 2021 ICICI Securities Robust digital platform, tailor-made customer service and differentiated interest rates to drive deposit growth for SFBs Building a granular deposit base has always been a challenging task for banking institutions. There are several examples of institutions carrying out banking operations for more than a decade and yet their deposit base is wholesale-heavy. SFBs, on the deposit front, made a promising start with deposit market share at 0.5% as at FY20 within 3 years of operations and retail deposits (including CASA) contributing more than 50% to total deposit base. Deposit base of SFBs has grown at a robust 89% CAGR between FY18-FY20 driven by higher deposit rates than private and public banks, and personalised service approach. Chart 36: Deposit market share of SFBs stands at ~0.6% as at FY20; incremental deposit share at 3% to ensure continuity of deposit accretion at accelerated pace Deposit market share 80% 70% 70% 66% 65% 60% 52% 50% 40% 36% 29% 30% 30% 26% 20% 9% 10% 4% 5% 5% 3% 0% 0% 1% 0% Incremental Market 2018 2019 2020 share in FY20 PSBs Pvt Banks FB SFBs Source: RBI, Company data, I-sec research Since the start of pandemic, our interactions with industry players suggest that customer acquisition via the digital mode has significantly outpaced the number of customers sourced via physical channels like branches. However, we still believe digital sourcing beyond metro and tiers-1/2/3 cities would be lower given the complexity involved in educating customers about deposit rates, reaching last mile customers, and inconsistent internet connectivity. Hence, we believe, customer acquisition level, especially on liability side, would still be much dependent on distribution networks and players’ ‘visibility’. Banks’ aggregate deposit market share nearly mirroring their respective branch market shares validate our thesis. Within banks, private and public banks’ deposit market share is at 29% and 62% as against their branch market share of 23% and 60% respectively suggest optimum utilisation of branch resources. Since SFBs’ distribution network is relatively new, its deposit market share at 1% is much lower than branch market share of 3% as at FY20. However, with likely improvement in productivity, we believe SFBs are well placed to accelerate liability customer acquisition over the medium term by sweating their existing branch networks. 21 Small Finance Bank, July 8, 2021 ICICI Securities Chart 37: Differentiated rates and state-of-art digital sourcing platforms to drive deposit market share in coming years SFBs Peak TD rates (<3 years) 8.0 Mid-sized Bank 6.8 6.8 7.0 6.5 6.3 6.3 6.0 Large Bank 5.5 5.5 5.5 6.0 5.4 5.2 5.3 5.3 5.0 4.0 (%) 3.0 2.0 1.0 0.0 AU SIB SBI Axis RBL PNB CUBK Ujjivan Equitas Federal HDFCB Suryoday IDFC First IDFC Source: Company data, I-sec research Chart 38: SFBs are offering higher SA rates than Banks Saving Rates 8.0 SFBs 7.0 Mid-sized Bank 6.0 5.0 Large Bank 4.0 (%) 3.0 2.0 1.0 0.0 AU SIB SBI Axis RBL PNB CUBK Ujjivan Equitas Federal HDFCB Suryoday IDFC First IDFC Peak Rate for >Rs1mn to 500 459 389 400 (Rs mn) (Rs 278 300 219 185 200 157 150 100 52 70 47 0 Federal SIB CUBK Suryoday Equitas Ujjivan Retail TD per branch CASA per Branch Source: Company data, I-sec research. Note - For Equitas and Suryoday we have taken only liability branches, while for Ujjivan we have taken total banking outlets. Retail TD is I-Sec estimates. 22 Small Finance Bank, July 8, 2021 ICICI Securities Chart 40: Deposit mobilisation for SFBs remain robust as reflect in increasing proportion of deposits in total liability mix 90% Deposit mobilisation 80% 70% 60% 42% 40% 50% 66% 64% 35% 49% 40% 30% 20% 41% 39% 33% 25% 10% 17% 16% 0% FY18 FY21 FY18 FY21 FY18 FY21 Equitas Ujjivan Suryoday Borrowing to total assets Deposits to total assets Source: Company data, I-sec research Chart 41: SFBs command 3% market share in branches; however, deposit market share remains lower at 1% unlike PSBs and private banks Market share in Branch & Deposits 70 60 62.4 62.4 50 59.8 40 28.9 28.9 (%) 30 22.8 18.5 18.5 20 27.5 27.5 7.1 7.1 6.2 6.2 6.0 4.8 4.8 4.7 4.7 10 3.4 18.9 18.9 0.9 0.9 2.7 2.7 0.5 0.5 8.0 0.0 1.1 0.1 0.7 0.1 0.5 0.2 16.2 16.2 12.1 12.1 14.7 12.6 0 Branch Deposits Branch Deposits Branch Deposits Branch Deposits Branch Deposits Total Rural Semi-urban Urban Metropolitan PSBs Pvt Banks SFBs Source: RBI, Company data, I-sec research Data as at Mar’20 23 Small Finance Bank, July 8, 2021 ICICI Securities Chart 42: In non-metro market, Ujjivan and Suryoday command higher market share in rural segment, while Equitas focuses semi-urban markets within SFB space Rural Branch market share as on Sep'20 Semi-urban Branch market share as on Sep'20 18% 16% 20% 17% 16% 15% 18% 17% 16% 14% 16% 12% 12% 14% 12% 11% 12% 12% 11% 10% 8% 8% 10% 9% 8% 7% 8% 6% 8% 6% 5% 6% 4% 3% 4% 4% 3% 2% 2% 0% 0% AU AU Ujjivan Ujjivan Equitas Equitas Player 1 Player 3 Player 6 Player 7 Player 9 Player Player 2 Player 3 Player 5 Player 8 Player 9 Player Suryoday 10 Player Suryoday 10 Player Source: RBI, Company data, I-Sec research Data as at Sep’20 Chart 43: In core market, Equitas / Ujjivan / AU are amongst top-5 players... Urban Branch market share as on Sep'20 30% 25% 25% 20% 15% 15% 13% 11% 10% 8% 10% 7% 7% 5% 3% 1% 0% AU Ujjivan Equitas Player 3 Player 4 Player 5 Player 7 Player 8 Player 9 Player Suryoday Source: RBI, Company data, I-sec research Chart 44: … while Suryoday is not far behind in the metro market. Metro branch market share as on Sep'20 25% 22% 21% 20% 14% 15% 13% 9% 10% 8% 6% 5% 5% 1% 0% 0% AU Ujjivan Equitas Player 2 Player 6 Player 7 Player 8 Player 9 Suryoday 10 Player Source: RBI, Company data, I-sec research 24 Small Finance Bank, July 8, 2021 ICICI Securities Chart 45: SFBs’ branch market share in top-100 deposit centres – Equitas / Ujjivan / AU amongst top-5 SFBs 450 0.6% 0.7% 400 0.6% 350 0.4% 0.4% 0.4% 0.5% 300 0.4% 0.3% 250 0.4% 0.3% 0.3% 200 0.3% 150 (nos) 0.2% 100 0.1% 50 0.1% 60 398 284 278 276 258 215 166 164 0 0.0% AU Ujjivan Equitas Player 2 Player 3 Player 7 Player 8 Player 9 Player Suryoday Total Branch network in Top-100 deposit centres (nos) Branch market share in Top 100 deposit centres (%) Data as at Sep’20. Above data is only representative and might vary from actual data. Source: RBI, Company data, I-sec research Table 7: State-wise branch distribution of SFBs in top-100 deposit centres Equitas Player 1 Player 2 Ujjivan AU Suryoday Player 3 Player 4 Player 5 Andhra Pradesh 12 1 23 Assam 1 4 9 1 Bihar 1 5 6 13 Chandigarh 1 1 2 1 2 1 1 2 3 Chhattisgarh 4 1 3 1 3 1 1 6 Goa 1 2 2 Gujarat 30 4 25 20 36 17 30 4 Haryana 5 1 9 2 8 4 6 1 Jammu & Kashmir 1 Jharkhand 2 7 9 14 Karnataka 44 9 36 43 2 18 25 Kerala 199 15 4 Madhya Pradesh 10 3 17 2 14 7 9 9 Maharashtra 77 13 40 37 46 113 19 21 NCT Of Delhi 16 6 13 9 21 3 4 19 5 Odisha 2 3 6 12 9 Punjab 14 5 6 18 4 51 Rajasthan 24 1 12 11 101 14 3 Tamil Nadu 146 34 59 17 30 26 Telangana 8 1 1 2 2 1 Uttar Pradesh 6 1 12 20 4 11 4 46 Uttarakhand 1 1 2 4 West Bengal 3 23 58 2 Total 398 284 278 276 258 215 166 164 60 Source: RBI, Company data, I-sec research. Data as on Sep’20. Note: We have highlighted the leaders in respective states 25 Small Finance Bank, July 8, 2021 ICICI Securities High-margin business model provides resilience during challenging credit events SFBs has shown strong resilience during recent challenging events such as demonetisation, economic slowdown, etc. as reflect in 5-year average credit cost for listed SFBs at half of NBFCs’ and at par with mid-sized banks. Further, their high- margin business, given focus on financial inclusion, provides much-needed resilience to absorb abnormal credit cost during any challenging credit events and yet generate good economic returns. Chart 46: SFBs high margin business model provides business resiliency Margins & Credit cost lender wise 12.0 10.1 10.0 8.6 8.0 6.0 (%) 4.0 3.3 2.3 1.6 2.0 1.1 0.0 NIMs Credit cost SFBs NBFC Mid Banks Note – Lender-wise data calculated as average of NIMs and credit cost for select lenders between FY15-FY20. NBFCs – Chola, Magma, SCUH, SHTF. Mid Banks – CUBK, KVB, DCB. SFBs – Equitas, Ujjivan, Suryoday Source: Company data, I-sec research Productivity improvement and normalisation of credit cost to drive RoA (>2.0%) and RoE (>15%) over medium term While profitability of SFBs is likely to remain subdued due to elevated credit costs linked to covid outbreak, strong margins and likely operating leverage would ensure they generate RoA of >2% and RoE of >15% over the medium term. Chart 47: Transition phase completed in terms of infrastructure building; cost ratio steadily moderating from FY18 onwards Cost / AuM 20.0% 18.0% 17.2% Pre - SFB Post - SFB 16.0% 14.0% 11.5% 10.9% 10.8% 12.0% 10.5% 10.4% 10.1% 10.1% 9.9% 9.4% 9.3% 8.8% 10.0% 8.7% 8.4% 8.4% 8.3% 8.3% 8.2% 8.2% 8.0% 7.8% 7.8% 7.6% 7.2% 7.1% 8.0% 7.1% 6.0% 4.0% 2.0% 0.0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 Suryoday equitas Ujjivan Source: Company data, I-sec research 26 Small Finance Bank, July 8, 2021 ICICI Securities Table 8: Player-wise cost break-up SSFB Equitas Ujjivan FY FY FY FY18 FY19 FY20 18-20 18-20 18-20 CAGR FY18 FY19 FY20 CAGR FY18 FY19 FY20 CAGR Cost break up Staff cost 872 1,267 1,714 40% 5,154 5,513 7,098 17% 3,604 5,188 7,185 41% Other exp. 442 641 1,008 51% 3,656 4,570 4,703 13% 2,924 4,846 6,000 43% Rent, Taxes and Lighting 74 124 222 73% 814 906 981 10% 476 915 1,425 73% Printing and Stationery 16 24 25 26% 110 97 103 -3% 138 237 254 36% Advertisement and Publicity 2 24 46 353% 107 162 182 30% 106 344 203 38% Depreciation on Bank's Property 47 56 98 45% 875 918 965 5% 414 606 726 32% Director's Fees, Allowances and Expenses 3 3 5 36% 8 9 19 54% 6 9 15 55% Auditors' fees and Expenses 4 5 6 16% 6 9 10 29% 5 7 9 30% Law Charges 4 18 24 147% 117 158 235 42% 16 40 63 99% Postages, Telegrams, Telephones etc. 20 24 25 13% 263 208 211 -10% 217 289 342 25% Repairs and Maintenance 123 170 227 36% 173 194 216 12% 504 714 749 22% Other Expenditure 133 167 283 46% 1,148 1,846 1,699 22% 1,027 1,644 2,145 44% Total operating cost 1,314 1,908 2,722 44% 8,810 10,083 11,801 16% 6,529 10,034 13,185 42% Branches 241 382 477 41% 989 991 854 -7% 464 524 575 11% Employees 2,883 3,931 4,695 28% 13,541 14,608 16,104 9% 11,242 14,752 17,841 26% Other Exp per Branch 1.8 1.7 2.1 3.7 4.6 5.5 6.3 9.2 10.4 Rent, Taxes and Lighting 0.31 0.33 0.47 0.82 0.91 1.15 1.03 1.75 2.48 Printing and Stationery 0.06 0.06 0.05 0.11 0.10 0.12 0.30 0.45 0.44 Advertisement and Publicity 0.01 0.06 0.10 0.11 0.16 0.21 0.23 0.66 0.35 % of revenue 0.1% 0.7% 0.9% 1.4% 1.2% 3.1% 1.2% Depreciation on Bank's Property 0.19 0.15 0.21 0.88 0.93 1.13 0.89 1.16 1.26 Director's Fees, Allowances and Expenses 0.01 0.01 0.01 0.01 0.01 0.02 0.01 0.02 0.03 Auditors' fees and Expenses 0.02 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.02 Law Charges 0.02 0.05 0.05 0.12 0.16 0.28 0.03 0.08 0.11 Postages, Telegrams, Telephones etc. 0.08 0.06 0.05 0.27 0.21 0.25 0.47 0.55 0.59 Repairs and Maintenance 0.51 0.45 0.47 0.17 0.20 0.25 1.09 1.36 1.30 Other Expenditure 0.55 0.44 0.59 1.16 1.86 1.99 2.21 3.14 3.73 % of total cost 30% 26% 28% 31% 40% 36% 35% 34% 36% Per employee cost 0.30 0.32 0.37 0.38 0.38 0.44 0.32 0.35 0.40 Source: Company data, I-sec research Table 9: RoA analysis (%) Equitas Ujjivan Suryoday FY19 FY20 FY21 FY19 FY20 FY21 FY19 FY20 FY21 Int income 13.4 13.7 12.9 13.3 14.7 13.8 14.1 14.3 11.6 Int exp 6.1 6.0 5.7 5.3 5.8 5.3 5.1 5.1 5.4 NII 7.3 7.7 7.3 8.1 8.9 8.5 9.0 9.1 6.1 Other Income 1.8 1.5 1.7 1.5 1.8 1.5 1.8 1.6 1.5 Net revenue 9.1 9.2 9.0 9.5 10.6 10.0 10.8 10.8 7.6 Staff 3.5 3.7 3.2 3.8 3.9 3.7 3.4 3.2 2.8 Other opex 2.9 2.4 2.2 3.5 3.3 2.4 1.8 1.9 2.1 Total cost 6.4 6.1 5.4 7.3 7.2 6.0 5.1 5.1 4.9 PPoP 2.7 3.1 3.6 2.2 3.5 4.0 5.6 5.7 2.7 Credit cost 0.6 1.3 1.5 0.3 0.9 3.9 2.0 2.8 2.5 PBT 2.1 1.8 2.1 2.0 2.5 0.1 3.7 2.9 0.2 Tax 0.7 0.6 0.5 0.5 0.6 0.0 1.4 0.8 0.0 RoA 1.3 1.3 1.6 1.4 1.9 0.0 2.3 2.1 0.2 Source: Company data, I-sec research SFBs’ return ratios were adversely impacted between FY17-FY20 largely due to surge in operating costs to realign systems and processes as per SFB model from their erstwhile NBFC avatar. However, our analysis suggests most transition-related costs are complete and operating leverage is likely to kick-in FY22E onwards. Per employee cost for SFBs is largely in line with top NBFCs, but productivity is much lower. 27 Small Finance Bank, July 8, 2021 ICICI Securities Table 10: Comparison of lending institutions on employee productivity and cost MFI Vehicle Financiers Banks (mid-sized) SFB As on FY21 CAGL Spandana Shriram Chola MMFS KVB CUBK DCB Equitas Ujjivan AU SFB Suryoday Employee 9,559 8,644 24,452 26,363 19,952 7,746 5,843 6,113 16,556 16,571 22,484 5,131 Loans 1,35,870 81,570 11,72,400 6,99,960 5,99,470 5,03,635 3,61,578 2,59,592 1,79,270 1,51,400 3,77,120 42,060 Loans per employee 14.2 9.4 47.9 26.6 30.0 65.0 61.9 42.5 10.8 9.1 16.8 8.2 Per Employee cost (FY21) 0.4 0.2 0.4 0.3 0.5 1.5 0.8 0.7 0.5 0.5 0.4 0.4 Employee cost as % Loans 2.8% 2.1% 0.8% 1.1% 1.7% 2.3% 1.3% 1.7% 4.4% 4.9% 2.6% 4.4% Employee cost 3,800 1,715 9,062 7,494 10,150 11,537 4,637 4,335 7,914 7,488 9,802 1,858 Note – Loans per employee is indicative range not adjusted for fleet on street. Data as on March’21 Source: Company data, I-sec research Chart 48: Significant scope to improve productivity Loans per employee 60 56 50 40 35 30 20 12 9 10 0 Banks Vehicle Financiers NBFC-MFIs SFBs (ex AU) Source: Company data, I-sec research. Average of players listed in Table 9. Chart 49: Loans per employee lender-wise Loans per employee 65.0 70.0 61.9 60.0 47.9 50.0 42.5 40.0 30.0 30.0 26.6 16.8 20.0 14.2 9.4 8.2 9.1 10.8 10.0 0.0 KVB DCB Chola CAGL CUBK MMFS Ujjivan Equitas Shriram AU SFB AU Suryoday Spandana Banks Vehicle Financiers NBFC-MFIs SFBs Source: Company data, I-sec research 28 Small Finance Bank, July 8, 2021 ICICI Securities Annexure: Index of tables and charts Tables Table 1: SFBs comparison on key financial metrics ...... 3 Table 2: Key metrics comparison of SFBs ...... 4 Table 3: Valuation summary ...... 5 Table 4: Evolving product offerings to support sustain high growth going ahead ...... 9 Table 5: Evolution of SFB regulations since first issuance ...... 11 Table 6: At 23% addressable market, immediate lending opportunity would be Rs2.75trn, or 2.5x current SFB AuM ...... 16 Table 7: State-wise branch distribution of SFBs in top-100 deposit centres ...... 25 Table 8: Player-wise cost break-up ...... 27 Table 9: RoA analysis ...... 27 Table 10: Comparison of lending institutions on employee productivity and cost ...... 28 Charts Chart 1: Total lending opportunity of ~Rs10trn… ...... 6 Chart 2: SFB’s dominant position in small-ticket lending (strong 5.6% market share) to help seize upon significant opportunity for their future growth ...... 6 Chart 3: SFBs’ incremental market share in small-ticket loans fell to 7% as at Dec’20 but was average 20% pre covid ...... 6 Chart 4: Players well positioned to grab the vast opportunity with adequate capital and deep distribution network… ...... 7 Chart 5: …to further support by evolving asset mix ...... 7 Chart 6: Eqitas, with already having diversified asset mix, likely to lead the credit growth .. 7 Chart 7: Deposit growth outpaced credit growth for all SFBs – Suryoday is leading on lower base ...... 8 Chart 8: Equitas stand out in terms of business mix; Suryoday is leading in cost effectiveness ...... 8 Chart 9: Normalisation of credit cost to drive RoA for all SFBs ...... 8 Chart 10: Total NNPL + ECLGS + Restructuring as % of loans as at Mar’21 ...... 10 Chart 11: Suryoday has written off ~2.3% of its loans in FY21 while Ujjivan and Equitas appear conservative ...... 10 Chart 12: Suryoday appears most vulnerable with 20.7% ‘PAR 0’ portfolio as at Mar’21 .. 10 Chart 13: While universal banks command lion’s share of systemic credit, SFBs are slowly and firmly making strong inroads… ...... 12 Chart 14: …as reflects in their incremental share at 2.2% as at Dec’20 ...... 12 Chart 15: SFBs remained one of the fastest growing sub-segments between FY18-Dec’20 ...... 13 Chart 16: Equitas / Ujjivan / Suryoday driving SFBs’ credit market share; delivered significantly higher credit growth than other incumbents over past 3-4 years ...... 13 Chart 17: Incremental market share fell to 2.2% during 9MFY21 due to conservative approach adopted by most SFBs in expanding their MFI portfolio ...... 13 Chart 18: Rural India driving incremental credit growth and the trend is likely to continue in the near term ...... 14 Chart 19: SFBs enjoy strong position in rural lending market with 1.8% market share as at Dec’20 with incremental share much higher at 4%...... 14 Chart 20: SFBs command dominant position in small-ticket lending as seen in their strong 5.6% market share vs sub-1% in total systemic credit ...... 14 Chart 21: Breakup of total lending opportunity of ~Rs10trn ...... 15 Chart 22: Unique MFI borrower base stands at 55mn as at Sep’20; only ~2% of borrower base is having ticket size of >Rs1,25,000 ...... 16 Chart 23: SFBs’ cost of funds is lower by average ~100bps than most NBFCs ...... 16 29 Small Finance Bank, July 8, 2021 ICICI Securities Chart 24: Competitive pricing and niche in small ticket lending to help SFBs gain market share from NBFC… ...... 17 Chart 25: …we estimate credit opportunity of Rs1,750bn for SFBs ...... 17 Chart 26: Total addressable credit gap in MSME space estimated at ~Rs26trn… ...... 17 Chart 27: Micro and small enterprises (SFBs’ target segment) offer biggest opportunity .. 18 Chart 28: SFBs’ incremental market share in small-ticket loans fell to 7% as at Dec’20 but was average 20% pre covid ...... 18 Chart 29: Top-3 players account for ~70% of SFB loans as at Mar’21 ...... 19 Chart 30: Evolving geographical presence and product mix to drive growth for SFB industry leaders ...... 19 Chart 31: Ujjivan – Gradually building non-MFI book ...... 19 Chart 32: Within secured lending, Ujjivan incrementally focuses on formal segments ...... 19 Chart 33: Equitas continues to strengthen its position in vehicle financing by foraying into new CV and used car segments ...... 20 Chart 34: AU is more focused on launching branch banking products, e.g. gold loans, business banking, OD against FD, etc...... 20 Chart 35: Suryoday is scaling up its non-MFI portfolio in a calibrated manner ...... 20 Chart 36: Deposit market share of SFBs stands at ~0.6% as at FY20; incremental deposit share at 3% to ensure continuity of deposit accretion at accelerated pace ...... 21 Chart 37: Differentiated rates and state-of-art digital sourcing platforms to drive deposit market share in coming years ...... 22 Chart 38: SFBs are offering higher SA rates than Banks ...... 22 Chart 39: Significant opportunity for SFBs to scale up deposits from existing network ..... 22 Chart 40: Deposit mobilisation for SFBs remain robust as reflect in increasing proportion of deposits in total liability mix ...... 23 Chart 41: SFBs command 3% market share in branches; however, deposit market share remains lower at 1% unlike PSBs and private banks ...... 23 Chart 42: In non-metro market, Ujjivan and Suryoday command higher market share in rural segment, while Equitas focuses semi-urban markets within SFB space ...... 24 Chart 43: In core market, Equitas / Ujjivan / AU are amongst top-5 players...... 24 Chart 44: … while Suryoday is not far behind in the metro market...... 24 Chart 45: SFBs’ branch market share in top-100 deposit centres – Equitas / Ujjivan / AU amongst top-5 SFBs ...... 25 Chart 46: SFBs high margin business model provides business resiliency ...... 26 Chart 47: Transition phase completed in terms of infrastructure building; cost ratio steadily moderating from FY18 onwards ...... 26 Chart 48: Significant scope to improve productivity ...... 28 Chart 49: Loans per employee lender-wise ...... 28 30 Equity Research INDIA July 8, 2021 BSE Sensex: 53055 Equitas Small Finance Bank BUY ICICI Securities Limited is the author and distributor of this report Granular balance sheet ensuring sustainability of return ratios Rs67 Equitas Small Finance Bank, with a well-diversified asset mix and steadily improving liability franchise (CASA ratio at 34%), is likely to emerge as a preferred player to play Initiating coverage on India’s financial inclusion story with economic formalisation as the key driver. We initiate with BUY rating and target price of Rs92, valuing the stock at 2.5 FY23E P/BV. FINANCIALS Journey from commencing CV financing in 2011 under its NBFC avatar to convert into SFB in 2017 has been encouraging and reflective of management’s ability to Target price Rs92 respond to market realties in a most effective manner. It trimmed unsecured lending to 17% in FY21 from 76% in FY13. Delivering its highest RoA (since commencement of SFB operations) at 1.7% and RoE at 12.5% in FY21 despite covid-related Shareholding pattern challenges speaks of its business resiliency. While near-term asset quality concerns Dec Mar persist amid resurgence of covid cases and its high exposure to self-employed ‘20 ‘21 segment, lower restructuring pool at ~2.4%, provision buffer at 90bps, and calibrated Promoters 82.0 82.0 lending (MFI book fell 11% YoY in FY21) reinforces our view that Equitas would Institutional investors 13.1 13.8 navigate the current cycle more effectively than peers. MFs and others 4.6 5.9 Carving out a niche in financing ‘underserved’ self-employed segment. An early FIs/Banks 2.4 2.0 FIIs 6.1 5.9 (2011) NBFC foray by entering into CV financing space provided a headstart in underwriting individual loans and with decade-plus experience, Equitas built a robust Others 4.9 4.2 proprietary credit model to underwrite ‘underserved’ small business owners mostly in tier 3-6 cities. Further, as a prudent lender, it preferred the organic way of doing business – right from sourcing (no DSA sourcing) to underwriting (including vehicle Price chart inspections, valuers, site visit for SBL loans) to collection. With >14% asset yields, average credit cost of ~150bps between FY13-FY21 speaks of its asset franchise. A 70 huge untapped market, adequate capital (tier-1 at 23%), and diversified asset mix, 60 underscore its ability to deliver industry-leading growth going forward. We estimate 19% / 24% AUM growth in FY22E/FY23E respectively. 50 . Differentiated ‘value for (Rs) CASA at 34% speaks for its strong liability franchise 40 money’ banking products and services, deep distribution and targeted approach 30 enabled Equitas to emerge as a strong alternative for customers banking with a traditional regional bank in their locality, and build strong retail liability franchise. Its C/D 20 ratio touching ~100% within 4 years of SFB operations reflects its successful execution of liability strategies. The early (FY17-FY18) capex on building liability-focused Apr-21 Jun-21 Feb-21 Nov-20 Dec-20 branches helped the company building trust in local communities, and the same helped it build strong 34% CASA by FY21-end, one of the highest within the SFB space. While it offers high SA rate at 7%, hence raises questions on stickiness of CASA deposits if it start cutting rates, our view is that CASA customers are less interest-rate sensitive if compensated by differentiated product offering. We have seen similar trend playing out for one of the large private sector banks. Operating leverage and normalisation of credit cost to remain key RoA driver. Equitas delivered its highest RoA since SFB conversion, at 1.7% and RoE at 12.5% despite elevated credit cost at 170bps (vs historical average of 120bps) due to covid challenges. However, benefits arising from operating leverage, cost/income ratio at lowest level of ~60%, enabled it to deliver highest profitability. Its continued focus on cost optimisation, no intent to expand branch network over next 2 years, and likely normalisation of credit cost from FY23E onwards is likely to drive RoA to >2% and RoE >18% going forward. Key risks: A) stress unfolding higher than anticipated, and B) delay in loan growth recovery. Market Cap Rs77bn/US$1bn Year to March 2020 2021 2022E 2023E Research Analysts: Bloomberg EQUITASB IN NII (Rs mn) 14,953 17,980 21,309 25,749 Shares Outstanding (mn) 1,142.4 Net Profit (Rs mn) 2,436 3,842 4,797 6,682 Renish Bhuva [email protected] 52-week Range (Rs) 67/33 EPS (Rs) 2.3 3.4 4.2 5.9 +91 22 6637 7465 Free Float (%) 18.0 % Chg YoY 10.5 45.8 24.8 39.3 Kunal Shah FII (%) 5.9 P/E (x) 26.1 19.9 15.9 11.4 [email protected] +91 22 6637 7572 Daily Volume (US$/'000) 1,158 P/BV (x) 2.6 2.2 2.1 1.8 Chintan Shah Absolute Return 3m (%) 17.9 Net NPA (%) 1.8 1.6 1.7 1.6 [email protected] Absolute Return 12m (%) NA BVPS (Rs) 26.1 29.8 32.4 36.7 +91 22 6637 7658 Piyush Kherdikar Sensex Return 3m (%) 7.3 RoA (%) 1.4 1.7 1.8 2.2 [email protected] Sensex Return 12m (%) 46.3 RoE (%) 9.7 12.5 13.5 17.0 +91 22 6637 7465 31 Equitas Small Finance Bank, July 8, 2021 ICICI Securities TABLE OF CONTENTS What stands out for Equitas SFB ...... 33 Strategic shift towards secured products and prudent lending approach driving lower LGDs than industry ...... 35 Prudent lending approach across products ...... 38 ‘Digital first’ approach – most banking services offered by Equitas are end-to-end digitally enabled ...... 43 Asset strategy – responsive to market realities ...... 45 Will asset-mix shift in favour of lower-yielding products to impact profitability? Not likely ...... 45 Asset product-wise strategy ...... 47 Micro banking: Technology-led redefined business model to roll out in FY22E ...... 47 Small business loans (including housing finance) would remain the key growth driver50 Vehicle financing: Strategically focused on new CV and used car ...... 54 Micro and Small Enterprise (MSE) and corporate finance – to serve the formal sector56 Liability strategy – more tilted towards deepening relationships and accelerating CASA mobilisation ...... 57 Operating leverage – key RoA improvement driver ...... 62 Valuations appear reasonable in relation to peers ...... 65 Financial outlook ...... 67 Summary financials ...... 71 Annexure: Index of Tables and Charts ...... 74 32 Equitas Small Finance Bank, July 8, 2021 ICICI Securities What stands out for Equitas SFB Deep ‘phygital’ distribution with one of the highest number of banking outlets within SFB space Equitas has one of the highest banking touch-points (861) within the SFB space across 17 states and Union Territories. Importantly, most of its liability outlets are operational for >4 years and – by being accessible anytime, anywhere across its target customers – it has established strong brand recall. While it expanded reach physically by accelerating branch additions in FY17, with changing Industry landscape it also built robust alternative non-branch delivery channel – which includes 322 ATMs, POS terminals, internet banking, tab-based assisted banking, phone banking, and mobile banking. Since it commenced operation as SFB, Equitas made significant investments in expanding branch network and building robust non-branch (digital) delivery support. It also strengthened its technology infrastructure and enhanced employee training activities to create awareness about its brand. This has enabled it to gain visibility in its key operating geographies, establish a trained employee base, and expand customer base. To promote its ‘phygital’ distribution approach, it has set up a digital banking team to focus on leveraging technology and develop products / services to acquire next- generation customers through providing mass personalisation. Its 861 banking outlets are comprise: 1) liability branches, which primarily focus on garnering and servicing depositors within ~3-5km, and 2) asset centres that conduct lending operations for the underbanked and unbanked in semi-urban locations within 30-40km. Additionally, it has 296 banking outlets that are operated by business correspondents to take banking into the hinterlands of the country. Chart 1: Highest outreach within listed SFB space Banking touchpoints 1050 991 1000 989 950 900 858 854 861 850 800 750 FY17 FY18 FY19 FY20 FY21 Source: Company, I-Sec research 33 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 2: State-wise advance and deposit mix Andhra Chattisgarh, Advances Deposit Punjab, 1% Pradesh, 2% 1% Chandigarh, Chattisgarh, Chandigarh, 0.3% Andhra 4% 5% Delhi, 2% Telangana, UP, 0.1% Pradesh, 2% UP, 2% 2% Pondicherry Pondicherry Haryana, Punjab, 9% , 0% 2% , 0.3% Madhya Tamil Nadu, 25% pradesh, Delhi, 6% 3% Gujarat, 4% Telangana, Rajasthan, Tamil Nadu, 2% 4% 54% Haryana, Karnataka, 6% 10% Madhya Maharashtr pradesh, a, 17% 4% Maharashtr Gujarat, 4% Rajasthan, Karnataka, a, 13% 5% 9% Source: Company, I-Sec research Niche business model enabling industry-leading profitability and growth Over the years, with unwavering focus on maintaining the highest asset quality and risk management, Equitas laid a strong foundation that not only seamlessly navigates economic cycles, but also comes out stronger with every passing cycle. In testimony, Equitas delivered strong PPoP growth of 59% CAGR over FY18-FY21 vs an AuM CAGR of 30%. Over the years, it has successfully diversified its asset portfolio as reflected in its wide range of retail loan product offerings. Most importantly, however, the core focus remained intact – servicing unserved and underserved segments. Over >14 years of experience in underwriting self-employed informal segment (ticket-size: 50% 39% 40% 37% 36% 38% 36% 30% 30% 26% 30% 24% 20% 15% 10% 0% PPoP Loan Opex Equitas AU Suryoday Ujjivan Source: Company, I-Sec research 34 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Strategic shift towards secured products and prudent lending approach driving lower LGDs than industry Right from its NBFC days, Equitas has always maintained right mix of secured and unsecured loans: it operated as an NBFC-AFC carrying out vehicle financing, MSE finance and home loans through its wholly-owned subsidiaries. Post commencing operations as SFB, with enhanced product portfolio and bandwidth to service a vast customer base, it strategically focused on expanding secured loans faster than MFI. In MFI, it focused on deepening existing relationships, cross-sell other loan products and judiciously grow a new-to-bank MFI customer base. Chart 4: Strategically, Equitas reduced the share of unsecured loans Share of unsecured loans 76% 200 179 80% 180 60% 154 70% 160 53% 54% 60% 140 47% 118 120 50% 33% 100 82 30% 40% 72 80 61 25% 30% 60 17% 40 20% 40 25 15 20 10% 0 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 AUM (Rs bn) % Unsecured Lending Source: Company, I-Sec research Across cycles, Equitas’ asset quality clearly stands out as reflected in lower credit cost at 1.5% / 0.7% in FY18/FY19 respectively vs industry average of 2.1% / 0.9% during the same period (chart 5). Over the years, it has strategically trimmed down unsecured exposure (MFI) and focused on secured lending with quality underlying collaterals. Chart 5: Secured and diversified asset mix helped it manage credit cost at lower level than Industry Asset quality metric 3.0 2.7 2.5 2.5 2.1 2.2 2.0 1.5 1.6 1.5 0.9 1.0 0.7 0.5 0.0 FY18 FY19 FY18 FY19 Credit cost (%) GNPL (%) Equitas SFBs Source: Company, I-Sec research 35 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 6: Write-offs as percentage of 2-year rolling book Write / offs 3000 100% 90% 2500 80% 2000 70% 60% 1500 50% 40% 1000 30% 500 20% 10% 0 0% FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 W/offs LGD Average LGD Note: LGD is calculated as amount written off / average of previous two years GNPL. Source: Company, I-Sec research Collection: Equitas Chart 7: Robust risk management framework is investing heavily in Structured portfolio quality monitoring framework strengthening its Procedures like Account Monitoring Scoring (AMS) framework, Branch collection process Credit Risk Scoring (BCRS), daily overdue and collections management and team. During the Concentration risk analysis, stress testing and effective use of bureau last 2 years, ~90% of services newly recruited staff Effective collection mechanism are employed in In-house collections team targeting delinquency cohorts sales and collection Microfinance: Repayments collected in cash, passbooks are issued, pre- as no new vertical or printed stickers for each Microfinance Loan account evidencing cash receipt, SMS-based process also followed to track collections product has been Other segments: All accounts reviewed periodically, especially larger loans launched. and delinquent customers accounts Customised credit assessment procedures in place Next plan is to set Entire process is initiated with telephonic checks followed by in-person up Bucket wise meetings (to understand business, cash flows among other parameters) collection team in A proprietary discounted cash flow model is also applied in addition to development of worthiness potential borrowers FY22. FrameworkManagementRisk Board and management oversight Several Board-level and Management-level committees constituted to overlook and mitigate risks, which ESFB may be subject to These committees oversee and monitor different issues for example interest rate risk, ALM mismatch, identification of willful defaulters, credit risk, cyber security, technology risk, material risk, operational risk, monitoring of high-value frauds Source: Company data, I-Sec research 36 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 8: Equitas Chakravyuh – robust risk management system comprising multiple risk filters Physical Verification - Sales Officer Internal Audit Random Verification - Branch Manager Field Risk Equitas Audit Chakravyuh De-duplication Check of Customers - Back Office Random Disbursement Validation - Risk Tele KYC Health Calling from Check - Back HO Office Source: Company data, I-Sec research Chart 9: Small Business Loans – assessment and risk control system Sales Team Prepare Online Auto Factoring Decision CAM Engine • Business Income Factoring Triggering Process Policy • Random Sampling by Credit Deviation Report Real salary Factoring Intel Team • Daily Wages Factoring • Collateral Assessment Tool Risk Property Assessment Assessment Variance Analysis (RPA) Executed Source: Company data, I-Sec research 37 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Prudent lending approach across products Vehicle Financing: Equitas entered vehicle financing with the launch of used CV financing in CY11 and has since followed a conservative and prudent approach while scaling up the vertical. Notably, it built in-house capabilities for all major functions like sourcing, underwriting and valuers. It does not rely on DSAs for growth and follows a proprietary credit approval process and underwriting policy. It follows a 3-layer underwriting process – starting with initial underwriting by credit team, second level of underwriting by a concurrent risk team, and a random sampling of approved loans. This institutional knowledge to build a proprietary process and policy has been built/gained over the years of doing business. Small Business Loans (SBLs): Equitas entered the Small Business Loan (SBL) segment in CY13, mainly to cater to informal small business establishments. Since <10% of their income is documented or runs through the bank account, it is very crucial to understand the business and build a credit model. Over the last 7-8 years, Equitas has built a proprietary underwriting model and has a template for a number of businesses (e.g. kirana store, milk vendor, tailor, barber shop, etc.) to assess cashflow in different geographies (metro, urban, semi-urban, rural). As a prudent lender, it operates at very low LTV in SBL. Well-diversified advances portfolio provides stability and derisks growth Equitas has come a long way by successfully transforming itself from a single product company. It started its journey way back in CY07 by launching microfinance loans, and now offers tailor-made customised loan products to underserved populations. Asset products like MFI, new & old CVs, used cars, gold loans, small business loans, home loans, etc. address the financial needs of ‘bottom of the pyramid’ households. It also offers NBFC loans and MSME loans to cater to medium enterprises. In its pre-SFB avatar, the businesses were conducted through three separate subsidiaries, each dedicated to a single vertical: Equitas Microfinance Ltd (EMFL), which consisted of the microfinance business. Equitas Finance Ltd (EFL), which consisted of used commercial vehicle finance, and micro and small enterprise (MSE) finance business. Equitas Housing Finance Limited (EHFL), which focused on providing micro- housing and affordable-housing loans to self-employed individuals whose access to bank loans is limited. At the point of conversion into a Small Finance Bank (SFB), all the above three subsidiaries were merged into a single entity (SFB) christened Equitas Bank, 100% owned by Equitas Holdings (listed entity). Chart 10: Evolution of retail and secured product offerings CY11 CY13 CY17 CY18 Used Small New MSE Commercial Business Commercial Finance Vehicle Loans Vehicle Source: Company data, I-Sec research 38 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 11: Loan products Loan Product Small Business Microfinance Vehicle Finance MSE Finance Corporate Loans Others Loans Loans • Secured Business • Group loansLoans to to • Used Commercial • Working Capital • Loans to Financial • Loans against Loans microMicroentrepreneur entrepreneurs Vehicle Loan Institutions Gold • LAP (Self ial loans • New Commercial • Fund-based • Loans to • OD facilities employed and Vehicle (Cash Credit, Corporates against Fixed salaried) • Used Passengers Overdraft etc) Deposits • Agri Loans Cars • Non-fund Based • Unsecured • Housing Loans (Bank Guarantee, Business Loans Letter of Credit) Source: Company data, I-sec research Chart 12: Asset mix – one of most diversified product portfolios Asset mix 100% 4% 2% 3% 2% 3% 13% 5% 19% 22% 80% 4% 29% 30% 25% 31% 33% 60% 27% 35% 40% 27% 25% 24% 25% 53% 54% 20% 46% 28% 26% 24% 18% 0% FY15 FY16 FY17 FY18 FY19 FY20 FY21 MFI Vehicle Finance Small Business Loans MSE Finance Agri loans Housing Finance Corporate loans Others Source: Company, I-Sec research Chart 13: More than 80% of AuM has average ticket-size of Average Ticket size 7,00,000 35% 40% 6,00,000 35% 5,00,000 25% 30% 25% 4,00,000 18% 20% 3,00,000 5,74,000 15% 4,10,000 2,00,000 10% 1,00,000 5% 18,000 30,000 3,41,000 3,33,000 0 0% MFI SBL Vehicle Portfolio Disbursements % of total AuM Source: Company, I-Sec research 39 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Over the years, Equitas has successfully diversified its asset portfolio as reflected in its wide range of retail loan product offerings but, most importantly, the core focus has remained intact, i.e. servicing the unserved and underserved segments. Over >14 years of experience in underwriting the self-employed informal segment (ticket-size Chart 14: Within SBL and vehicle loans (combined Chart 15: …loans with >Rs1mn ticket-size are only share of 57%)… ~14% of total AuM SBL Vehicle finance >Rs10mn, >Rs10mn, 3% 11% Rs5-10 mn, 10% Source: Company, I-Sec research Source: Company, I-Sec research Chart 16: Steady AuM Growth across cycles – FY21 growth remained robust at 17% YoY AuM (Rs bn) 200 179 180 154 160 140 117 120 100 82 71 80 61 60 40 40 25 15 20 8 0 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 Source: Company, I-Sec research Best-in-class liability franchise; one of the highest CASA ratios Since commencement of SFB operations in FY17, Equitas has built one of the best ‘retail liability’ franchises within a short span of 4 years. Differentiated ‘value for money’ banking products and services, deep distribution and targeted approach enabled it to emerge as a strong alternative for customers banking with a traditional regional bank in their locality. Further, Equitas strategically focused on leveraging its strong asset franchise by offering liability products to all asset customers. Its deposit base grew by robust 51% CAGR during FY18-FY21. 40 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 17: Equitas delivered >50% deposit CAGR over FY18-FY21 4,00,000 80% 3,50,000 72% 70% 63% 3,00,000 60% 2,50,000 51% 50% 46% 2,00,000 40% 3,43,320 1,50,000 30% 1,00,000 20% 1,63,190 50,000 1,16,969 10% 32,557 0 0% AU SFB Equitas Ujjivan Suryoday Deposits as on March'21 Deposit CAGR (FY18-21) Source: Company, I-Sec research Company primarily focuses on the mass and mass-affluent segment for deposits, and offers 9 products for SA, 6 for CA and 4 for TD customers. Along with traditional deposit products, Equitas also offers services such as wealth management for facilitating mutual fund investments, Insurance, FASTag, etc. to deepen customer relationships and generate cross-sell / up-sell opportunities. Chart 18: CASA ratio at 34%, within 4 years of SFB operations, is one of the highest in the SFB industry CASA ratio (%) 40% 34% 34% 34% 35% 30% 27% 25% 23% 23% 20% 20% 16% 15% 10% 5% 0% Equitas AU Ujjivan Suryoday Federal KVB CUBK DCB bank Source: Company, I-Sec research 41 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 19: Retail + CASA share is highest at >80% Deposit mix 100% 11% 90% 80% 33% 48% 46% 70% 34% 60% 23% 50% 11% 16% 40% 30% 55% 44% 20% 36% 43% 10% 0% AU SFB Equitas Ujjivan Player 1 Retail TD CASA Bulk Deposits Source: Company, I-Sec research Chart 20: Deposit accretion at competitive rates resulted in steady decline in cost of funds 70% 8.2 8.3 8.4 8.1 8.1 8.1 8.0 8.0 8.2 60% 7.9 7.8 8.0 50% 7.6 7.8 40% 7.4 7.6 7.3 30% 7.2 7.4 7.2 20% 7.0 10% 36% 39% 40% 45% 51% 53% 56% 52% 53% 55% 55% 62% 66% 6.8 0% 6.6 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Deposit (ex CD) / Assets Cost of Funds Source: Company, I-Sec research 42 Equitas Small Finance Bank, July 8, 2021 ICICI Securities ‘Digital first’ approach – most banking services offered by Equitas are end-to-end digitally enabled Over the past 3 years, Equitas has achieved significant scale through prudent deployment of technology to provide superior experiences and building efficiency through automation. Digital technologies have helped it widen its reach and grow at a faster pace without increasing operating costs. With the same branch network, it clocked 31% / 26% growth in advances and deposits (excluding certificate of deposits) respectively during FY20. Similarly, its cost-to-income ratio improved by 390bps to 66% in FY20. As a modern, technology-enabled bank, Equitas has built cutting-edge digital capabilities for all stakeholders including employees, customers, regulators and management. It plans to leverage its front-end technology platforms to further improve customer acquisition and transaction management. This will also make it easier and bring in convenience for customers to manage their transactions, while facilitating significant cross-selling opportunities for the company. Table 1: Key digital capabilities of Equitas Digital platform Features Selfe platform A customer can open a savings account or a fixed deposit account in under 5 minutes using their Aadhar and PAN numbers. Tab-based banking Customer onboarding digitally in minutes Business correspondent assisted onboarding and transactions Opening up API kit To enable Banking as a Service (BaaS) and facilitate partnership with emerging fintech companies. BankOpen became first partner to drive new SMB (Small & Medium Business) customer acquisition. It is currently live with 5 partners. Live on NPCI Offering services like micro ATM (AePS/Card+PIN enabled), and UPI / IMPS / eNACH prepaid cards and ETC-enabled through API plugins for partners and clients to avail of payment services through direct (host to host) integration. Groww - Fintech partnership Wealth management platform. Open - Fintech partnership Neobanking player – Creating a digital platform for NRI segment. Video-enabled KYC To elevate delivery experience with customer lifecycle management. Virtual RM Data Mart Centralised MIS reporting and analytics. Upgraded internet and mobile banking platforms For better customer experience. Facial authentication for login and transaction Developed a CRM in-house FRM Real -time transactions’ fraud monitoring and automated NPA identification. Pre-paid cards Live with one major partner. Source: Company, I-Sec research Equitas has set up a separate ‘digital office’ for driving innovation and has adequately trained its people on technology-enabled agile delivery. It is developing digital-only products, specifically designed for the younger and technology-savvy customer base. Its endeavour is to empower customers to access various products and services on their own, reduce operating costs and increase efficiencies. 43 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Digital 2.0 is built on following focus areas Partnering with neo banks Collaboration via fintech programmes Strengthening of digital channel Building up of digital assets Digital payments, acquiring and prepaid Digital financial inclusion through business correspondents Developing digital transaction banking Apart from these, the bank focuses on digital transformation & digital garages (internal digitisation projects, digital journey, process enhancements, etc). 44 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Asset strategy – responsive to market realities Key asset strategy elements Equitas is likely to follow going ahead, are: MFI share to further reduce to 15% over next 3-5 years from 20% currently – reimagining the entire micro-lending business. Small business loan, affordable housing (5% share) and MSE finance (6% share) segments are likely grow faster. Within vehicle financing, used car and new CV financing to grow faster than the used CV book – but overall vehicle book share is likely to remain static at the current level of 25%. Other segments like agri loan and corporate loan would broadly mirror blended growth. Will asset-mix shift in favour of lower-yielding products to impact profitability? Not likely Management is well aware about likely yield compression with further decline in share of MFI (~23% yields) going forward. During the first phase of building stability and sustainability – the period CY15-CY21 – when Equitas tapered off its high-yielding unsecured book from 54% to 19%, it successfully offset the drop in yields arising out of change in product mix with an improvement in cost of funds and operating cost. Deriving comfort from the first phase experience, the company believes shrinking the high-yielding MFI portfolio is not likely to impact profitability. Overall RoA would continue to improve as the blended yield, though lower, will be offset by better operating leverage, lower cross-cycle credit cost, and reducing cost of funds, given that MFI is a high-cost and relatively higher cross-cycle credit cost model. As per management, Equitas’ asset mix is not likely change materially; only a shift will happen between MFI and affordable housing. Equitas has been in the non-MFI, traditional NBFC/HFC lending business since CY11. In its pre-SFB avatar, its businesses were conducted through 3 separate subsidiaries, each dedicated to a single vertical: Equitas Microfinance Ltd (EMFL), which consisted of the microfinance business. Equitas Finance Ltd (EFL), which consisted of used commercial vehicle finance, and micro and small enterprise (MSE) finance business. Equitas Housing Finance Limited (EHFL), which focused on providing micro- housing and affordable-housing loans to self-employed individuals whose access to bank loans is limited. At the point of conversion into a Small Finance Bank (SFB), all the above three subsidiaries were merged into a single entity (SFB) christened Equitas Bank, 100% owned by Equitas Holdings (listed entity). 45 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 21: MFI lending continues to decline; affordable home loans and MSE financing to grow at faster clip Asset mix 100% 4% 2% 3% 2% 3% 13% 5% 19% 22% 80% 4% 29% 30% 25% 31% 33% 60% 27% 35% 40% 27% 25% 24% 25% 53% 54% 20% 46% 28% 26% 24% 18% 0% FY15 FY16 FY17 FY18 FY19 FY20 FY21 MFI Vehicle Finance Small Business Loans MSE Finance Agri loans Housing Finance Corporate loans Others Source: Company data, I-Sec research Table 2: Product highlights Agriculture LAP (Agri General Business Housing Segments Micro LAP Salaried LAP Loans) LAP LAP Finance Salaried Small Business 30% existing MFI customers individuals from Small Service Owners (informal and 70% ‘new to bank’ informal sectors Farmers Business Providers segment) in semi- customers; like trading, textiles Owners urban location Customer profile and retail Average Average Average Typically, below Sourcing same MFI locations Indicative yield (%) ~22-24% ~12-15% ~19-21% ~14-18% ~15-18% ~11-13% Source: Company data, I-Sec research 46 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Asset product-wise strategy Micro banking: Technology-led redefined business model to roll out in FY22E After spending more than a decade (in MFI business since CY07) in serving micro entrepreneurs under the traditional JLG model mainly in urban locations, Equitas now plans to leverage its strong expertise and holistic relationships with MFI customers. It is in advance stages of finalising new technology-led MFI business model, which would help sweat existing microfinance assets. To bring in more seriousness and from a brand-building perceptive, it renamed its MFI business as ‘Micro Banking’ and put out a detailed roadmap to launch the redefined business model in FY22E. Chart 22: Geographic split: Predominantly urban-focused Based on Banking outlet classification Rural, 3% Metro, 15% Semi-urban, 52% Urban, 30% Source: Company data, I-Sec research Table 3: More than 50% of customers are engaged in essential services (animal husbandry + agri + food) business as at Jun’20 Customer profile % of customers Animal husbandry 44% Tailoring 20% Agriculture 10% Trading 7% Shopkeeper 6% Food products 5% Handicrafts 2% Others 7% Source: Company data, I-Sec research Key features of micro banking: To implement and push digital collections at centre meetings to improve productivity. Equitas has already collaborated with Airtel Payments Bank and is in early stages of onboarding a few more partners to facilitate digital collections. Segregation of sourcing and customer servicing. Under the new model, sales team will be responsible for sourcing while relationship managers will handle collections and build relationships. To deepen relationship with customers, Equitas proposes to increase the Centre meeting time to 60 minutes from 30 minutes currently. 47 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Cost ratios are not likely to be adversely impacted given that digital collection is likely to save a couple of hours for relationship officers as they don’t need to go back to branch to hand over cash and could now spend the saved hours at centres to cross-sell products. Prudent lending approach to continue – no exposure in Assam and West Bengal Equitas’ loan outstanding per borrower is much lower at ~Rs19,000 as against ~Rs37,000 in Tamil Nadu. It strictly follows the norm of maximum three lenders and does not encourage offering 2-3 loans to same borrower. Loan ticket-size for new-to-bank customers is restricted at Rs30,000. Company will continue to follow the traditional monthly collection model. Chart 23: Conservative approach reflects in ticket-size being half of state averages… Average loan O/S per Unique Borrower 37,177 40,000 36,906 36,787 35,330 35,000 30,000 25,000 19,260 20,000 15,314 15,802 16,491 15,000 10,000 5,000 0 Karnataka Tamil Nadu Maharashtra Madhya Pradesh States Equitas SFB Source: Company data, I-Sec research Chart 24: …similar trend is visible in lower disbursement value vs industry average Average Ticket Size at Disbursement 40,000 35,652 33,245 35,000 30,000 30,000 26,000 25,000 20,000 20,000 15,000 10,000 5,000 0 Q2FY21 Q3FY21 Q4FY21 Industry Equitas SFB Source: Company data, I-Sec research 48 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 25: Share of MFI loans in total AuM to settle at 15% vs 20% currently MFI loans (Rs bn) % of total AuM 40 53% 54% 60% 35 46% 50% 30 40% 25 28% 26% 20 24% 30% 15 18% 20% 10 10% 5 21 33 33 23 31 36 32 0 0% FY15 FY16 FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Chart 26: Prudent lending driving better collections in MFI Trend in collection 120% 98% 100% 92% 91% 91% 93%92% 77% 80% 61% 60% 42% 40% 20% 7% 0% 0% March'20 April'20 May'20 June'20 July'20 Oct'20 Dec'20 March'21 Collection efficiency Billing efficiency Source: Company data, I-Sec research Note – Collection efficiency represents total collections during the month as a percentage of December’s total EMIs due. Billing efficiency represents only the EMIs of December alone collected as a percentage December the month’s total EMIs due. Chart 27: X bucket collection efficiency reaching pre-covid level in March’21 X Bucket Collection Efficiency 100% 98.7% 99% 98.5% 98.4% 98.3% 98% 97% 96% 95% 94% 93% 92% 91% 90% Feb'19 Dec'19 Dec'20 March'21 Source: Company data, I-Sec research 49 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 28: GNPL in current cycle is better than past cycle GNPA (%) - MFI 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 For Q3FY21, we have considered proforma GNPL Source: Company data, I-Sec research Chart 29: Steady decline in PAR portfolio across buckets PAR movement 14.0% 12.9% 12.0% 9.7% 10.0% 8.3% 8.0% 7.0% 6.5% 6.0% 4.9%5.2% 4.8% 3.4% 4.0% 2.0% 0.0% PAR>30 PAR>60 PAR>90 PAR>30 PAR>60 PAR>90 Dec'20 March'21 Industry Equitas SFB Source: Company data, I-Sec research Small business loans (including housing finance) would remain the key growth driver The pan-India addressable credit gap of ~Rs8trn in micro and small businesses, as per IFC 2018 report, provides ample opportunities to players like Equitas who have built expertise in underwriting loans for borrowers not having formal income papers and quite often having cyclical / volatile business cashflows. Further, with improving adoption of the Goods and Services Tax (GST) and digital payments, credit penetration in the micro and small business segment ( 50 Equitas Small Finance Bank, July 8, 2021 ICICI Securities the company subsequently launched differentiated LAP products to cater to wider borrower groups. From FY20 onwards, by leveraging its credit assessment skills, deep distribution network and strong community presence, Equitas has been growing SBLs at a faster clip and mainly from new-to-bank customers. It mostly operates in Based on Banking outlet classification Rural, 3% Metro, 15% Semi-urban, 52% Urban, 30% Source: Company data, I-Sec research Table 4: Lending approach is extremely prudent as reflected in conservative LTVs, stringent underwriting process, and high portfolio yield at ~18.8% Ticket Size < Rs0.5mn Rs0.5mn to Rs1mn >Rs1mn Share of loans 40% 29% 31% Avg LTV at origination 38% 43% 51% ~40% cases go through 100% cases go through personal discussion apart personal discussion apart from detailed ground-level from detailed ground-level Underwriting Similar to MFI customer due-diligence due-diligence Source: Company data, I-Sec research Table 5: Small business loans (SBLs) mainly cater to micro entrepreneurs Customer profile % of SBLs Essential services 31% Non-essential services 24% Agri-related 8% Livestock 9% Salaried 27% Source: Company data, I-Sec research 51 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 31: Small business loans’ (SBLs) share in overall AUM to remain at current level, but would continue to be the key growth driver SBL loans (Rs bn) % of total AuM 90 44% 50% 41% 80 39% 45% 70 36% 40% 35% 60 30% 50 25% 22% 25% 40 20% 30 15% 20 10% 10 5% 13 17 29 46 63 80 0 0% FY16 FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Affordable housing Chart 32: Affordable housing to witness strong traction and should see steady segment has a up-tick in its share volatile past (FY12- FY16), but Equitas Affordable housing loans (Rs bn) % of total AuM is now focusing on 12 5% 6% scaling up aggressively over 10 5% next 3-5 years. We 4% 8 4% have already seen 3% good traction since 3% FY19. Although the 6 2% 2% 3% business was 4 2% started in CY12 in the erstwhile 2 1% Equitas Housing 1 2 2 4 6 10 Finance Limited 0 0% (later merged with FY16 FY17 FY18 FY19 FY20 FY21 SFB), its share in Source: Company data, I-Sec research total AuM is still in infancy. Equitas is sourcing most SBL (via LAP) customers by upscaling well-behaving MFI customers with an established history and non-MFI customers from same geographies To bring in where it has prior asset experience. This strategy we believe could be a key concentered differentiator when it comes to credit behaviour. efforts and focus, Equitas is planning to carve out affordable housing loans as a separate vertical. 52 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 33: Collections continued to trend well in SBL Collection trend 120% 103% 105% 107% 91% 100% 88% 91% 80% 73% 66% 61% 60% 40% 17% 16% 20% 0% March'20 April'20 May'20 June'20 July'20 Oct'20 Dec'20 March'21 Collection efficiency Billing efficiency Source: Company data, I-Sec research Chart 34: GNPL contained at pre-covid level despite disruption due to pandemic speaks of the quality of SBL portfolio GNPA (%) - SBL 4.0% 3.5% 3.3% 3.0% 3.0% 2.7% 2.6% 2.7% 2.5% 2.0% 1.5% 1.0% 0.9% 0.5% 0.0% FY19 FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Source: Company data, I-Sec research Chart 35: Customer acquisition remained key focus area as reflected in 30% AUM CAGR vs 20% CAGR in ticket-size between FY19-FY21 AuM (Rs bn) Average tikcet size (Rs mn) 90 80 80 70 63 60 47 50 40 0.35mn 0.34mn 30 0.24 mn 20 10 0 FY19 FY20 FY21 Source: Company data, I-Sec research 53 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Vehicle financing: Strategically focused on new CV and used car Equitas entered the vehicle financing space in FY11 (after spending 4 years as a pure MFI lender) to cater to ‘driver-cum-owner’ and ‘new to credit’ borrower categories. It has now specialised in small-ticket used CV financing space. Further, to support entrepreneurial aspirations of the mid-income segment, it started with financing of used CVs. Typically, these customers would have limited access to formal financing (banks, NBFCs, etc.) and having mostly limited or no credit history. However, with a view to build the customer’s secured asset book, to avail of used CV loans, Equitas made it mandatory for the borrower to own assets, e.g. a house / property or vehicle. Starting from CY18, to support existing customers who have grown over time from driver-cum-owner category to small fleet operator category and want to replace used vehicles with new vehicles to drive efficiency, Equitas ventured into offering new vehicle financing loans by leveraging existing team, but will mostly target LCVs initially. New vehicle financing: Unlike used vehicle financing wherein bulk of customer sourcing is done at marketplace or by referral (no dealer involvement), to build sustainable long-term new vehicle financing business building strong dealer network is key. Taking cognizance of that, in its first year (FY19) as new vehicle financier it carried out business from existing 200-300 banking outlets that source business through dealer network of vehicle manufacturers such as Tata Motors, Mahindra and Mahindra, etc. In the second year (FY20), Equitas became a preferred financier with vehicle manufacturers and enjoyed a pan-India market share. Turnaround time (TAT) for sanctioning loans is very critical to get dealer business. To fast-track this process, Equitas has implemented a real-time SMS-based credit screening to provide an immediate feedback on loan eligibility. It is also revamping its loan origination and management systems to improve TAT. Used car financing – to diversify and enhance product offerings Its 10+ years of experience in used CV financing helped Equitas build a robust credit model for used car financing. As a precautionary lender, it prefers sourcing used car customers at organised dealer points to ensure quality of customers and better quality vehicles. Further, it includes the service package for used cars to ensure quality of vehicle is maintained. Formalisation of used car financing market beyond tier-1 cities with players like Car Dekho, Maruti Truvalue, and Mahindra First coming into the segment, is likely to help players like Equitas who already enjoy strong used vehicle financing (used CV) infrastructure and dealer relationships. Further, covid outbreak has pushed preference for personal mobility, which will further help the used car market to grow at a faster clip. In-house capabilities of underwriting, vehicle inspection, and collection. Yields in used car financing is largely market-driven and currently ranges between 14% to 17%. 54 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 36: New CV financing expanding at a faster clip – grew at 83% CAGR vs 14% CAGR in used CV during FY18-FY21 Used CV (Rs bn) New CV (Rs bn) Vehicle finance (Rs bn) 100 90 80 70 45 60 38 50 30 40 16 23 30 11 7 20 3 30 23 26 10 15 19 20 8 12 0 1 3 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Chart 37: Asset quality in CV lending has deteriorated, but GNPLs are still not materially higher than pre-covid peak GNPL (%) - Vehicle financing 6.0% 5.5% 4.9% 5.0% 4.0% 4.0% 4.0% 3.8% 3.8% 3.0% 3.0% 2.0% 1.0% 0.0% FY18 FY19 FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Source: Company data, I-Sec research Chart 38: Collections continued to improve Trend in collection 120% 114% 108% 100% 88% 88% 82% 81% 78% 80% 60% 47% 42% 40% 20% 13% 14% 0% March'20 April'20 May'20 June'20 July'20 Oct'20 Dec'20 March'21 Collection efficiency Billing efficiency Source: Company data, I-Sec research 55 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Micro and Small Enterprise (MSE) and corporate finance – to serve the formal sector Equitas, to widen the scope of MSME financing, was providing MSE finance (targeted towards formal sector) as part of its SBL product segment. Later, it carved out MSE finance as separate vertical aimed at providing loans to micro and small enterprises for business expansion and modernisation with investments in fixed assets and technology with differentiated product offerings based on customer profile. Key feature of MSE finance: Targeted at formal sector enterprises with annual turnover of Rs100mn-150mn. It offers wide range of products and customised services including overdraft facility and corporate internet banking to suit the specific requirements of MSE customers. To build holistic customer relationship with MSE entrepreneurs, Equitas is leveraging its technology platform (including virtual relationship manager) – for funds and portfolio management and has also set up a MSME RM team to provide personalised service. Average ticket-size stands at Rs6.3mn with asset yield ranging between 10.5% to 12%. Chart 39: Best-performing segment with lowest GNPL ratio as at Mar’21 MSE loans (Rs bn) GNPL (%) 14.0 4.0% 12.0 3.5% 10.0 2.8% 3.0% 8.0 2.5% 6.0 1.8% 2.0% 4.0 2.0 1.2% 1.5% 0.6 4.1 5.3 6.7 11.8 0.0 1.0% FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Being an NBFC for over 10 years primarily focusing on financing informal sector, Equitas has developed a good understanding of this sector. It largely provides term loans to NBFCs, which are further lending to similar customer segments like MFI, vehicle finance, housing finance, etc. During FY20, it accelerated funding to this segment given the risk averse approach (triggered by IL&FS crisis) adopted by many traditional NBFC funding providers and an opportunity to cherry pick good customers. It would continue to scale up funding to NBFCs given better profitability and strong relationship with NBFCs. Key feature of corporate & NBFC lending (currently contributes ~5% of AuM) Minimum BBB grade rating from a recognised credit rating agency. Average ticket-size for these loans range between Rs150mn-500mn. Average yield around 11-12%. 56 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Liability strategy – more tilted towards deepening relationships and accelerating CASA mobilisation Key liability strategy Equitas is likely to follow in near term: Calibrated branch expansion as it believes existing branch infrastructure is capable of nearly doubling the deposit base to Rs300bn-350bn from currently Rs164bn. Key focus market would continue to remain tiers 2-4 cities (~375 branches in these locations) though the company would gradually tap tier-1 and metro markets. With sizeable liability customer base of ~1.2mn (FY20), incremental focus would be on deepening relationships, and cross-sell and upsell. A strong MIS is in place to leverage customer base, strengthen digital offerings and payment solutions. Equitas would continue to roll out differentiated liability products based on market and customer requirements; in FY20 it launched ~7-8 new liability products. Focus would be on household penetration with differentiated approach: a) it plans to leverage its strong relationship with senior citizens (~25% of liability customers) by offering liability products to other family members of the same household; b) it launched a women-centric liability product (added benefits) in FY20 to further deepen relationship with existing customers. It is true that a retail liability franchise is one of the prime motivators of bank license aspiration. Equitas, under its SFB avatar, has not only done well in scaling up liability better than peers, but has also built a granular liability franchise. Its CASA ratio at 34% as at Mar’21 is highest within the SFB space. The strategy of waiving average monthly balance (AMB) charges and offering higher deposit rates enabled Equitas to accelerate growth in FY21. Equitas’ liability profile is fairly granular with Retail+CASA deposits commanding 72% share in the total deposits as at Mar’21. Though the corporate/bulk deposits contribute to 35% of the bank’s total deposits, 80% of them are non-callable, providing further comfort in managing the asset liability profile. Chart 40: Equitas offers one of the highest TD rates enabling higher deposit mobilisation SFBs Peak TD rates (<3 years) 8.0 Mid-sized Bank 6.8 6.8 7.0 6.5 6.3 6.3 6.0 Large Bank 5.5 5.5 5.5 6.0 5.4 5.2 5.3 5.3 5.0 4.0 (%) 3.0 2.0 1.0 0.0 AU SIB SBI Axis RBL PNB CUBK Ujjivan Equitas Federal HDFCB Suryoday IDFC First IDFC Source: Company data, I-Sec research 57 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 41: Strategically offering higher SA rate Saving Rates 8.0 SFBs 7.0 Mid-sized Bank 6.0 5.0 Large Bank 4.0 (%) 3.0 2.0 1.0 0.0 AU SIB SBI Axis RBL PNB CUBK Ujjivan Equitas Federal HDFCB Suryoday IDFC First IDFC Peak Rate for >Rs1mn to Table 6: Comprehensive liability product offerings to deepen customer relationships… Customer profile Digital (young Affluent & HNIs Mass affluent Women NRIs population) Equitas Elite Regular Savings Eva Savings NRE Rupee Selfe Savings Savings Accounts Account Account Savings Account Account Wings Savings Eva Elite Savings NRO Rupee My Savings Account Account Account Savings Account Basic and Small Savings Account Source: Company Data, I-Sec Research Table 7: …and improve stickiness Current Accounts Term Deposits Wings Current Account Fixed Deposits Business Account Recurring Deposits Business Prime Current Account Selfe FD Advance Current Account Institutional Products Trade-In Current Account My Business Account Source: Company data, I-Sec research Currently, it operates its liability vertical from ~375 branches primarily located in tier 2- 4 cities. Its strength lies in launching differentiated products keeping in mind the constantly changing customer needs and preferences. 58 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 42: Deposit growth revived in FY21 sharply led by concentrated efforts on scaling up liability Deposits (Rs bn) YoY growth (%) 180 70.0% 61% 160 52% 60.0% 140 50.0% 120 100 40.0% 80 30.0% 20% 60 20.0% 40 10.0% 20 56 90 108 164 0 0.0% FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Table 8: Focus on relationship building Relationship Sourcing RM model building strategy Set up team of 40 virtual relationship managers (VRMs); initial progress is Mass market Digital encouraging as the VRM team added Rs3.5bn value to existing business. Strengthening RM team (for accounts with balance of >Rs0.4mn); plan is to Affluent Branch increase RM team to 220 from 140 currently. Strengthening personal banker team (for accounts with balance between HNIs RM Rs0.1mn-0.4mn); plan is to increase RM team to 350 from 250 currently. Digital / Branch Strengthening NR relationship manager team (for NRIs); plan is to increase NRIs / NRM NR-RM team to 45 from 25 currently. Source: Company data, I-Sec research Table 9: Key strategic initiatives to help sustain current customer acquisition momentum Key Initiatives Insights 3-in-1 account In partnership with It launched 3-in-1 account in Nov'20 to offer value-added service to Aditya Birla Securities Ltd existing customers and tap customers aspiring to invest surplus savings. Currently live; it offers value-added services to existing customers and taps Dion – Platform for MF investments customers aspiring to invest surplus savings. Wealth management platform offering FD as an investment option to Partnership with Groww customers Prepaid Cards Live with one major partner Leveraging its strong MIS system; MIS tracks whether SA is opened for all incremental asset customers or not; company has made it compulsory to disburse loan amount in Equitas’ SA account, so it tracks balance Liability account analysis movement month on month basis, etc. Target top-100 deposit centres Incrementally focuses on tapping dense deposit markets. Offering differentiated products (like EVA saving accounts for women) to Improve household level penetration improve penetration. Source: Company data, I-Sec research 59 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 43: Retail+CASA scale-up is a function of strategic initiatives and would continue Retail TD + CASA trend 100 90 80 70 34 25 60 21 21 25 50 40 30 53 55 20 47 48 47 10 0 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Retail TD (%) CASA (%) Source: Company data, I-Sec research Chart 44: Focus on building granular deposits March'19 March'21 16,00,000 14,00,000 13,36,327 12,00,000 10,00,000 8,00,000 7,33,521 6,00,000 4,00,000 1,13,408 2,00,000 94,188 50,164 75,144 0 Average TD balance Average CA balance Average SA balance Source: Company data, I-Sec research Chart 45: Making strong inroads into high-end deposit segment Contribution of HNIs in total deposits (Rs mn) Contribution of HNIs in total deposits (%) 60,000 33% 35% 27% 27% 50,000 30% 23% 22% 25% 40,000 20% 30,000 15% 20,000 10% 10,000 5% 23,220 27,140 34,890 42,840 53,690 0 0% Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Source: Company data, I-Sec research 60 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 46: Steady decline in cost of funds – SA cost has broadly peaked out at current level Trend in cost of fund 10.0% 8.2% 8.3% 8.4% 9.0% 8.0% 8.2% 8.0% 8.0% 7.8% 6.4% 6.5% 6.5% 7.0% 6.2% 6.2% 6.0% 6.0% 5.9% 7.8% 6.0% 7.6% 7.6% 5.0% 7.4% 7.3% 7.4% 8.6% 8.6% 8.4% 8.2% 7.2% 4.0% 8.1% 7.9% 7.6% 7.4% 3.0% 7.2% 2.0% 7.0% 1.0% 6.8% 0.0% 6.6% Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 SA cost TD cost Cost of Funds Source: Company data, I-Sec research 61 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Operating leverage – key RoA improvement driver Equitas is at an inflection point with the build-out phase now behind, hence operating leverage is likely to drive profitability in the near term. With the same branch network, it delivered 24% CAGR in advances and 35% CAGR in deposits between FY19-FY21, while its cost-to-income ratio improved by 10% to 60% in FY21 from 70% in FY19. The same resulted in ~150 branches breaking even in FY21 from only 18 branches in FY20. Equitas realised that opening of 375 liability branches in its first year of SFB operations was a mistake in hurry, as stabilising branch operations and tracking performance / productivity was operationally challenging. However, early acceleration of branch expansion helped it cover a catchment area and provide an edge over competitors in terms of reach. With the current focus on improving productivity of the existing branch network, Equitas does not intend to add new branches over next 2 years as well. It will take a relook at its branch expansion strategy once cost/income ratio stabilises at 50% vs the current 60%. Chart 47: Equitas consolidated its branch network… Banking touchpoints 1050 991 1000 989 950 900 858 854 861 850 800 750 FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Chart 48: …without impacting business growth, which remains robust Business growth 70% 61% 60% 50% 52% 50% 40% 30% 23% 19% 20% 20% 10% 0% FY19 FY20 FY21 Advance growth (%) Deposit growth (%) Source: Company data, I-Sec research 62 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Key initiatives taken to drive operating efficiency higher Going forward, Equitas will open asset branches closer to liability branches (mostly at the upper floor of liability branches) for better coordination and cross- leverage. Gradually, it has also initiated relocating of old asset centres, closer or same to as liability branches once the lease comes up for renewal. Company launched gold loans and used car loans to improve cross-selling. Gold loans are performing well and is being extended to more and more branches; audit process is settling and, by Sep’21 it expects all branches to be equipped to offer gold loans. Increased focus on cross-selling: Liability products per customer is two, but asset- liability product per customer is low. o Of total 0.1mn liability customers, ~25% have >750 CIBIL score. o Liability team is sourcing 35-40% MSE loans and this should increase in coming quarters o Focus on digital sourcing: Breakeven AMB for digitally sourced accounts is much lower at Rs1,000-1,500 vs Rs5,000-8,000 for accounts sourced physically at branch. o Equitas has tied-up with HDFC Bank to offer co-branded credit card to the former’s existing liability customer base. No DSA at all: Most business is sourced directly; strong brand name helps it source customers through referrals. For example, since it caters to mostly new-to- bank customers, their banking with Equitas becomes news and they refer it to their family members and friends. Chart 49: Trend in cost/asset and cost/income ratios Cost / Assets ratio Cost / Income ratio (RHS) 9.0 80.0 85.0 8.0 80.0 7.0 70.3 75.0 6.0 66.4 70.0 5.0 60.0 60.1 60.1 65.0 (%) 4.0 60.0 (%) 3.0 55.0 2.0 50.0 1.0 45.0 7.7 6.9 6.7 6.0 5.8 6.0 - 40.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research 63 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 50: Deposit per branch / employee trending well on back of series of strategic liability focused initiatives Deposit per branch (Rs mn) Deposit per employee 500 12 450 10 10 400 350 7 8 300 6 250 6 4 200 4 150 100 2 50 143 229 288 437 0 0 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Chart 51: Advance per branch / employee steadily improving driven by niche position in small-ticket self-employed segment and timely product launch Loans per branch (Rs mn) Loans per employee 500 12 10 450 10 400 9 8 350 8 300 6 250 6 200 4 150 100 2 50 197 295 367 449 0 0 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research 64 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Valuations appear reasonable in relation to peers We understand that the transition phase from NBFC to SFB (FY17-FY20) was challenging and we believe Equitas has done reasonably well as reflected in: 1) CASA ratio reaching 34% within 4 years of SFB operations, 2) steady decline in cost / income ratio to 60% in FY21 with further room for improvement, 3) delivering 26% AuM CAGR over FY17-FY21 with successfully scaling down unsecured share to 17% in Mar’21 from 47% in Mar’17, and 4) exiting FY21 with highest RoE at 12.5% since commencement of SFB operations. We believe Equitas reached an inflection point in FY21 in terms of building a sustainable business model and, hereon, profitability is likely to show consistent improvement driven by operating leverage and lower credit cost than the FY21 level. Stock witnessed steady rerating over past 6 months due to its improved financial performance and improving visibility on it touching 17% RoE by FY23E. However, resurgence of covid in Apr’21 poses near-term asset quality risk. We initiate coverage on Equitas with a BUY rating and target price of Rs92, valuing the stock at 2.5x FY23E P/ABV. Our target multiple of 2.5x FY23E P/ABV is dictated by a likely RoE of 17% in FY23E and >21% AuM growth over FY21-FY23E. Margin expansion on the back improving retail liability franchise is key upside risk. Table 10: Peer valuations P/E (x) P/BV (x) P/ABV (x) Particulars CMP Rating TP FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E SFBs Equitas SFB 67 BUY 92 19.9 15.9 11.4 2.2 2.1 1.8 2.4 2.3 2.0 Ujjivan SFB 32 ADD 35 745.8 75.0 14.3 1.9 1.9 1.7 2.2 2.2 1.7 AU SFB 1,125 ADD 1,140 30.0 41.3 29.9 5.6 5.0 4.3 6.2 5.3 4.6 Suryoday SFB 212 BUY 310 189.7 44.9 15.7 1.4 1.4 1.3 N/A N/A N/A NBFC-MFIs CAGL 721 BUY 765 81.0 28.7 17.4 3.0 2.7 2.4 N/A N/A N/A Spandana 720 BUY 840 23.0 9.1 7.9 1.7 1.4 1.3 N/A N/A N/A EPS (Rs) BV (Rs) RoAA (%) RoAE (%) Particulars FY21 FY22E FY23E FY21 FY22E FY23E FY20 FY21 FY22E FY23E FY20 FY21 FY22E FY23E SFBs Equitas SFB 3 4 6 30 32 37 1.4 1.7 1.8 2.2 9.7 12.5 13.5 17.0 Ujjivan SFB 0 0 2 17 17 19 2.2 0.0 0.4 1.8 14.0 0.3 2.5 12.3 AU SFB 37 27 38 201 226 261 1.8 2.5 1.5 1.7 17.9 22.0 12.8 15.4 Suryoday SFB 1 5 15 151 155 169 2.4 0.2 0.7 1.8 11.4 1.0 3.1 8.3 NBFC-MFIs CAGL 9 25 41 237 263 304 3.4 1.0 2.4 3.4 13.2 4.1 10.1 14.6 Spandana 31 79 91 434 497 570 6.3 2.7 5.7 5.6 15.6 7.4 17.0 17.1 Source: Company data, I-Sec research 65 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 52: Trend in P/BV PBV 6M avg avg. + 1 SD avg. - 1 SD 2.1 1.9 1.7 1.5 1.3 1.1 0.9 0.7 0.5 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Source: Company data, I-Sec research 66 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Financial outlook Comprehensive product offerings, deep distribution and vast untapped opportunity to drive 20%+ AUM CAGR over FY21-FY23E Equitas demonstrated superior execution of strategies between FY18-FY21, even while transiting from NBFC to SFB and realigning its product mix in favour of secured assets, as reflected in 30% AuM CAGR and average 1.5% RoA during the period. Strategically, it trimmed down MFI exposure and built one of the most diversified asset portfolios capable of serving a diverse range of customers in tiers 2-6 cities. Further, its distribution network (861 banking outlets) is one of the highest within SFB space and would ensure it reaching the last mile customer more effectively than peers. Considering the vast untapped opportunity at ~Rs10trn in small-ticket lending, its niche in small-ticket financing coupled with diversified product mix would ensure Equitas continues with its industry-leading growth going forward. We estimate 21% AUM CAGR over FY21-FY23E, lower than the historical average given that H1FY22E is likely to remain subdued due to resurgence of covid. Chart 53: AUM CAGR likely to remain at 21% over FY21-FY23E; H1FY22E to remain subdued AUM (Rs bn) YoY growth (RHS) 300 42% 45% 40% 250 31% 35% 200 30% 24% 25% 150 19% 17% 20% (%) (Rs bn) (Rs 16% 100 15% 10% 50 5% 82 117 154 179 213 263 0 0% FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research Stable asset mix with improving liability profile to ensure NIM stability at current levels Equitas has successfully built retail liability with CASA reaching 34%, one of the highest within SFB space, and retail TD now contributing 55% of total term deposits. Increasing proportion of sticky retail deposits enabled it to gradually realign its deposits rates with that of market leaders. The same helped it reduce its borrowing cost to 7.2% in Q4FY21 from 8.1% in Q4FY19 and we see room for further improvement considering its deposit rates are still >100bps higher than market leaders. Also, we believe consolidation in the high-yielding MFI book (contributing only 18% to total loans) is near to end and asset mix is likely to remain at current levels. The same would ensure asset yield not falling much from current level. 67 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Combination of stable asset mix and improving liability profile would ensure NIMs stabilise at current levels. However, in the near future, NIMs are likely to remain under pressure given looming concern over asset quality due to resurgence of covid. Chart 54: NIMs to settle at 8.5% in the medium term 8.6 NIMs 8.4 8.5 8.2 8.3 8.2 8.1 8.0 7.8 7.9 (%) 7.6 7.6 7.4 7.2 7.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research Productivity improvement and enhanced digital platform to drive cost efficiency Equitas is at an inflection point with the build-out phase now behind, hence operating leverage is likely to drive profitability in the near term. With the same branch network, it delivered 24% CAGR in advances and 35% CAGR in deposits between FY19-FY21, while its cost-to-income ratio improved by 10% to 60% in FY21 from 70% in FY19. The same resulted in ~150 branches breaking even in FY21 from only 18 branches in FY20. With current focus on improving productivity of existing branch network (Equitas does not intent to add new branches over next 2 years as well), the bank will take a relook at its branch expansion strategy once cost/income ratio stabiles at 50% vs the current 60%. Chart 55: Focus on cost optimisation to continue Cost / Assets ratio Cost / Income ratio (RHS) 9.0 80.0 85.0 8.0 80.0 7.0 70.3 75.0 6.0 66.4 70.0 5.0 60.0 60.1 60.1 65.0 (%) 4.0 60.0 (%) 3.0 55.0 2.0 50.0 1.0 45.0 7.7 6.9 6.7 6.0 5.8 6.0 - 40.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research 68 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Near-term asset quality concern persists, but demonstrated business resiliency to rescue Equitas, since converting into SFB avatar, has strategically focused on expanding secured assets like SBLs, home loans, vehicle loans, etc. As a result, unsecured loans share fell to 17% of total loans as at Mar’21. Higher proportion of secured assets coupled with stringent underwriting and risk management is likely to help it contain incremental slippages at lower than FY21 levels. Further, we derive comfort from its historical record of containing credit cost at average 120bps between FY13-FY21, which was an outcome of its conservative lending (lower LTVs), stringent credit monitoring and focus on collections. While resurgence of covid cases poses near-term asset quality risk, we believe credit cost in FY22E is likely to be higher than the historical average and in FY23E should normalise. Chart 56: Credit cost as percentage of loans to normalise by FY23E 1.8 Credit cost 1.6 1.7 1.4 1.6 1.5 1.4 1.4 1.2 1.3 1.0 1.1 1.1 (%) 0.8 0.9 0.8 0.6 0.7 0.4 0.2 - FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research RoE is likely to reach 17%+ and sustain We believe Equitas’ transformation journey broadly concluded in FY21 in terms of upfront SFB-related transition cost, investments towards building branch distribution and workforce, and realignment of loan mix to capture the vast untapped lending opportunity. With the process stabilising in FY21, we expect operating leverage to play out from FY22E onwards and drive profitability. Further, the way it managed covid first wave – delivering its all-time RoA at 1.7% since commencing SFB operations despite elevated credit cost of 1.7% due to covid – speaks of its business resiliency. The same gives us confidence that FY22E/FY23E credit cost is likely to be lower than in FY21 and should not adversely impact profitability. We estimate RoA to breach the 2% mark and RoE to settle at 17%+ in FY23E. 69 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 57: Improving trajectory in return ratios to continue 18.0 RoA (%) RoE (%) 17.0 16.0 13.3 13.5 14.0 12.2 12.5 11.1 12.0 9.8 9.7 10.0 8.9 (%) 8.0 6.0 4.4 3.8 3.9 2.9 4.0 2.2 1.5 1.4 1.4 1.7 1.8 2.0 0.3 - FY14 FY15 FY16 FY17 FY18 FY19 Source: Company data, I-Sec research 70 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Summary financials Table 11: Profit and Loss Statement (Rs mn, year ending March 31) FY19 FY20 FY21 FY22E FY23E Interest earned 21,119 26,454 31,944 36,615 43,942 Interest expended 9,602 11,501 13,965 15,306 18,193 Net interest income 11,517 14,953 17,980 21,309 25,749 Other income 2,829 2,824 4,181 3,827 5,050 Staff cost 5,513 7,098 7,914 8,846 10,605 Depreciation - - - - - Other operating expenses 4,572 4,703 5,380 6,261 7,903 Total operating cost 10,085 11,801 13,294 15,107 18,509 Pre-provisioning op profit 4,261 5,976 8,866 10,028 12,291 Provisions & contingencies 1,024 2,466 3,753 3,680 3,449 Profit before tax & exceptional items 3,237 3,509 5,113 6,348 8,842 Exceptional items - - - - - Profit before tax & exceptional items 3,237 3,509 5,113 6,348 8,842 Income taxes 1,132 1,073 1,270 1,551 2,160 PAT 2,106 2,436 3,842 4,797 6,682 Source: Company data, I-Sec research Table 12: Balance Sheet (Rs mn, year ending March 31) FY19 FY20 FY21 FY22E FY23E Capital 10,059 10,534 11,393 11,393 11,393 Reserves & surplus 12,484 16,907 22,571 25,557 30,428 Net worth 22,543 27,441 33,963 36,950 41,821 Borrowings 39,730 51,349 41,653 36,091 42,302 Deposits 90,067 1,07,884 1,63,920 1,93,930 2,48,214 Other Liabilities 5,286 6,471 7,616 9,257 11,252 Total liabilities & stockholders' equity 1,57,627 1,93,145 2,47,152 2,76,228 3,43,589 Loans & advances 1,15,950 1,37,472 1,68,479 2,02,370 2,52,925 Investments 23,445 23,425 37,052 43,634 55,848 Cash and Balance 12,606 25,368 33,787 20,702 23,241 Fixed Assets 2,373 2,128 1,851 2,255 2,739 Current & other assets 3,253 4,752 5,983 7,268 8,835 Total Assets 1,57,627 1,93,145 2,47,152 2,76,228 3,43,589 Source: Company data, I-Sec research 71 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Table 13: Key ratios (Year ending March 31) FY19 FY20 FY21 FY22E FY23E Growth (%) AUM 42.1 31.3 16.7 18.8 23.7 Loan book (on balance sheet) 46.9 19.9 22.6 20.1 25.0 Total Assets 18.5 22.5 28.0 11.8 24.4 Total Deposits 69.8 28.5 58.4 18.8 28.0 Total NDTL (23.3) 29.2 (18.9) (13.4) 17.2 Total Investments (39.2) (0.1) 58.2 17.8 28.0 Interest Income 37.9 25.3 20.8 14.6 20.0 Interest Expenses 43.1 19.8 21.4 9.6 18.9 Net Interest Income (NII) 33.8 29.8 20.2 18.5 20.8 Non-interest income 17.3 (0.2) 48.1 (8.5) 32.0 Net Income 30.2 23.9 24.7 13.4 22.5 Total Non-Interest Expenses 14.5 17.0 12.7 13.6 22.5 Pre provisioning operating profits (PPoP) 93.1 40.2 48.4 13.1 22.6 PAT 561.5 15.7 57.7 24.8 39.3 EPS 561.5 15.7 57.7 24.8 39.3 CA 25.7 (27.2) 48.7 18.1 22.7 SA 43.2 3.7 174.1 18.1 33.5 Time deposits 86.1 40.9 32.3 19.2 25.7 Yields, interest costs and spreads (%) NIM on AUM 7.9 8.5 8.2 8.1 8.3 Yield on loan assets 14.5 15.1 14.5 14.0 14.2 Average cost of funds 8.1 8.0 7.7 7.0 7.0 Interest Spread on loan assets 6.5 7.1 6.9 7.0 7.2 Operating efficiencies Non-interest income as % of net income 19.7 15.9 18.9 15.2 16.4 Cost to income ratio (%) 70.3 66.4 60.0 60.1 60.1 Op.costs/avg AUM (%) 6.9 6.7 6.0 5.8 6.0 No of employees 14,608.0 16,104.0 16,556.0 17,919.0 19,394.0 Average annual salary (Rs '000) 377.4 440.8 478.0 493.7 546.8 Salaries as % of non-int.costs (%) 54.7 60.1 59.5 58.6 57.3 AUM/employee(Rs mn) 8.0 9.5 10.8 11.9 13.6 Balance Sheet Structure Loans/ deposits (%) 128.7 127.4 102.8 104.4 101.9 Loans/ Total assets 73.6 71.2 68.2 73.3 73.6 Loans/NDTL 89.3 86.3 82.0 88.0 87.1 CA% of NDTL 3.7 2.2 2.5 2.7 2.6 SA% of NDTL 13.8 11.7 24.8 26.1 27.6 CASA% of NDTL 17.5 13.9 27.3 28.8 30.2 Total deposits as % of NDTL 61.8 64.7 79.4 84.3 85.4 Capital Structure Leverage (x) 7.0 7.0 7.3 7.5 8.2 CAR (%) 22.4 23.6 24.2 22.4 20.6 Tier 1 CAR (%) 20.9 22.4 23.2 21.5 19.7 Tier 2 CAR (%) 1.5 1.2 1.0 1.0 1.0 Tier 1 Capital (Rs mn) 20,761.0 25,260.0 33,963.4 36,949.6 41,821.0 Tier 2 Capital (Rs mn) 1,503.7 1,315.0 1,502.9 1,634.0 2,019.6 RWA (Rs mn) 99,204.9 1,12,574.0 1,58,199.1 1,72,000.7 2,12,593.7 Asset quality and provisioning GNPA (%) 2.5 2.7 3.7 4.2 3.8 NNPA (%) 1.6 1.8 1.6 1.7 1.6 GNPA (Rs mn) 2,960.0 4,173.2 6,427.8 8,499.5 9,611.2 NNPA (Rs mn) 1,860.0 2,476.1 2,661.7 3,484.8 3,940.6 Coverage ratio (%) 37.2 40.7 58.6 59.0 59.0 Credit costs as % of average AUM 0.7 1.4 1.7 1.4 1.1 Return ratios RoAA (%) 1.4 1.4 1.7 1.8 2.2 RoAE (%) 9.8 9.7 12.5 13.5 17.0 72 Equitas Small Finance Bank, July 8, 2021 ICICI Securities FY19 FY20 FY21 FY22E FY23E Valuation Ratios EPS (Rs) 2.1 2.3 3.4 4.2 5.9 EPS fully diluted (Rs) 2.1 2.3 3.4 4.2 5.9 Price to Earnings 28.0 25.4 19.9 15.9 11.4 Price to Earnings (fully diluted) 28.0 25.4 19.9 15.9 11.4 Book Value (fully diluted) 22.4 26.1 29.8 32.4 36.7 Adjusted book value (fully diluted) 20.6 23.7 27.5 29.4 33.2 Price to Book 3.0 2.6 2.2 2.1 1.8 Price to Adjusted Book 3.3 2.8 2.4 2.3 2.0 Source: Company data, I-Sec research Table 14: Du Pont analysis (% Year ending March 31) FY19 FY20 FY21 FY22E FY23E Interest earned 14.5 15.1 14.5 14.0 14.2 Interest expended 6.6 6.6 6.3 5.8 5.9 Gross Interest Spread 7.9 8.5 8.2 8.1 8.3 Credit cost 0.7 1.4 1.7 1.4 1.1 Net Interest Spread 7.2 7.1 6.5 6.7 7.2 Operating cost 6.9 6.7 6.0 5.8 6.0 Lending spread 0.3 0.4 0.4 1.0 1.2 Non-interest income 1.9 1.6 1.9 1.5 1.6 Operating spread 2.2 2.0 2.3 2.4 2.9 Exceptional items 0.0 0.0 0.0 0.0 0.0 Final Spread 2.2 2.0 2.3 2.4 2.9 Tax rate (%) 0.8 0.6 0.6 0.6 0.7 ROAAUM 1.4 1.4 1.7 1.8 2.2 Effective leverage (AAUM/ AE) 6.8 7.0 7.2 7.4 7.9 RoAE 9.8 9.7 12.5 13.5 17.0 Source: Company data, I-Sec research 73 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Annexure: Index of Tables and Charts Tables Table 1: Key digital capabilities of Equitas ...... 43 Table 2: Product highlights ...... 46 Table 3: More than 50% of customers are engaged in essential services (animal husbandry + agri + food) business as at Jun’20 ...... 47 Table 4: Lending approach is extremely prudent as reflected in conservative LTVs, stringent underwriting process, and high portfolio yield at ~18.8% ...... 51 Table 5: Small business loans (SBLs) mainly cater to micro entrepreneurs ...... 51 Table 6: Comprehensive liability product offerings to deepen customer relationships… ... 58 Table 7: …and improve stickiness ...... 58 Table 8: Focus on relationship building ...... 59 Table 9: Key strategic initiatives to help sustain current customer acquisition momentum 59 Table 10: Peer valuations ...... 65 Table 11: Profit and Loss Statement ...... 71 Table 12: Balance Sheet ...... 71 Table 13: Key ratios ...... 72 Table 14: Du Pont analysis ...... 73 Charts Chart 1: Highest outreach within listed SFB space ...... 33 Chart 2: State-wise advance and deposit mix ...... 34 Chart 3: Leading operating profit growth vs peers ...... 34 Chart 4: Strategically, Equitas reduced the share of unsecured loans ...... 35 Chart 5: Secured and diversified asset mix helped it manage credit cost at lower level than Industry ...... 35 Chart 6: Write-offs as percentage of 2-year rolling book ...... 36 Chart 7: Robust risk management framework ...... 36 Chart 8: Equitas Chakravyuh – robust risk management system comprising multiple risk filters ...... 37 Chart 9: Small Business Loans – assessment and risk control system ...... 37 Chart 10: Evolution of retail and secured product offerings ...... 38 Chart 11: Loan products ...... 39 Chart 12: Asset mix – one of most diversified product portfolios ...... 39 Chart 13: More than 80% of AuM has average ticket-size of 74 Equitas Small Finance Bank, July 8, 2021 ICICI Securities Chart 28: GNPL in current cycle is better than past cycle ...... 50 Chart 29: Steady decline in PAR portfolio across buckets ...... 50 Chart 30: Semi-urban segment remains key target market ...... 51 Chart 31: Small business loans’ (SBLs) share in overall AUM to remain at current level, but would continue to be the key growth driver ...... 52 Chart 32: Affordable housing to witness strong traction and should see steady up-tick in its share ...... 52 Chart 33: Collections continued to trend well in SBL ...... 53 Chart 34: GNPL contained at pre-covid level despite disruption due to pandemic speaks of the quality of SBL portfolio ...... 53 Chart 35: Customer acquisition remained key focus area as reflected in 30% AUM CAGR vs 20% CAGR in ticket-size between FY19-FY21 ...... 53 Chart 36: New CV financing expanding at a faster clip – grew at 83% CAGR vs 14% CAGR in used CV during FY18-FY21 ...... 55 Chart 37: Asset quality in CV lending has deteriorated, but GNPLs are still not materially higher than pre-covid peak ...... 55 Chart 38: Collections continued to improve ...... 55 Chart 39: Best-performing segment with lowest GNPL ratio as at Mar’21 ...... 56 Chart 40: Equitas offers one of the highest TD rates enabling higher deposit mobilisation 57 Chart 41: Strategically offering higher SA rate ...... 58 Chart 42: Deposit growth revived in FY21 sharply led by concentrated efforts on scaling up liability ...... 59 Chart 43: Retail+CASA scale-up is a function of strategic initiatives and would continue 60 Chart 44: Focus on building granular deposits ...... 60 Chart 45: Making strong inroads into high-end deposit segment ...... 60 Chart 46: Steady decline in cost of funds – SA cost has broadly peaked out at current level ...... 61 Chart 47: Equitas consolidated its branch network… ...... 62 Chart 48: …without impacting business growth, which remains robust ...... 62 Chart 49: Trend in cost/asset and cost/income ratios ...... 63 Chart 50: Deposit per branch / employee trending well on back of series of strategic liability focused initiatives ...... 64 Chart 51: Advance per branch / employee steadily improving driven by niche position in small-ticket self-employed segment and timely product launch ...... 64 Chart 52: Trend in P/BV ...... 66 Chart 53: AUM CAGR likely to remain at 21% over FY21-FY23E; H1FY22E to remain subdued ...... 67 Chart 54: NIMs to settle at 8.5% in the medium term ...... 68 Chart 55: Focus on cost optimisation to continue ...... 68 Chart 56: Credit cost as percentage of loans to normalise by FY23E ...... 69 Chart 57: Improving trajectory in return ratios to continue ...... 70 75 Equitas Small Finance Bank, July 8, 2021 ICICI Securities This page has been intentionally left blank 76 Equity Research INDIA July 8, 2021 BSE Sensex: 53055 Suryoday Small Finance Bank BUY ICICI Securities Limited is the author and Cost leadership with increasing share of secured distributor of this report assets to drive profitability Rs212 Suryoday Small Finance Bank (Suryoday) is among the leading SFBs in India in FINANCIALS terms of profitability – delivering >2% RoA in FY19-FY20, supported by cost efficiency (cost / assets at <5.5% in FY21) and higher NIMs. Strong business growth with advances / deposits delivering 39% / 63% CAGR between FY18-FY21, even during the transition phase, and ~80% retail deposits as at Mar’21 speaks of superior Target price Rs310 execution. Though Suryoday’s retail asset journey has gone through its learning curve, better-quality growth is likely in the foreseeable future, driven by: 1) revamped business architecture with separate collection team, 2) stringent credit underwriting, Shareholding pattern and 4) focus on small-ticket secured loans in segments like SCV, affordable housing, Mar etc. While Suryoday’s near-term asset quality concerns persist amid covid ‘21 Promoters 28.0 resurgence, and its high exposure to MFI segment, we expect better and sustainable Institutional profitability in the longer term on the back of: 1) incremental focus on secured investors 34.6 assets, 2) cost leadership, 3) adequate capital (CAR: 51%), and 4) conservative MFs and others 16.7 FIs/Banks 1.1 provision (bank is amongst the very few having a floating provision policy). We Insurance 10.1 initiate with a BUY rating and target price of Rs310, valuing the stock at 1.8 FY23E FIIs 6.7 book value. Others 37.4 Cost leadership to ensure better profitability than peers. The most critical factor for most SFBs post getting license in FY16-FY17, was to expand geographical reach to build a liability franchise, sustain high asset growth, and invest towards brand building, digital offerings, new business lines, etc. with minimal impact on profitability. However, very few, like Suryoday, Price chart succeeded in lowering total costs (by >150bps between FY18-FY21), yet expand their 350 distribution network by 32% and workforce by 21% during the same period. Optimal size of each bank branch, thus relatively lower opex per branch, end-to-end digitisation of many 300 operations including loan sourcing and higher proportion of variable compensation like 250 ESOPs, are the key cost drivers. Suryoday contained its non-staff costs at <2% even during (Rs) the expansion of its branch network from 241 in FY18 to 556 in FY21. 200 Fast-evolving granular deposit franchise. Post commencing SFB operations in CY17, 150 Suryoday focused on building long-term sustainable sourcing, i.e. granular retail deposit base. Comprehensive product offerings, strategic presence in deposit-rich centres like metro and 5-Jul tier-1 cities, personalised customer service, and higher interest rates helped it increase the 1-Jun 11-Apr 28-Apr 18-Jun 25-Mar 15-May share of retail deposits to 80% by Mar’21 with CASA ratio at 15%. Given its low base, it delivered 63% CAGR in deposits between FY18-FY21 with much higher retail deposit growth. We believe, its fast-evolving granular deposit franchise will not only provide stable source of funding to grow AUM, but would also cushion margins from likely moderation in asset yields as it incrementally focuses on growing secured assets faster than MFI loans. Credit cost normalisation and sustained cost leadership to drive profitability. While Suryoday delivered industry-leading profitability in FY19-FY20 (RoA >2%) supported by cost efficiency, its credit cost remained elevated at an average of >2% vs <1% for peers during the same timeframe. Covid-led disruption is likely to keep credit cost higher in FY22E, but we expect profitability in FY23E and beyond to be driven by: increasing share of retail secured assets, resiliency of MFI borrowers, and cost leadership. We estimate RoA to reach 1.8% and RoE >8% by FY23E. Key risks: A) higher MFI exposure in Maharashtra could result in lower collections than anticipated, and B) incremental growth coming at higher cost could result in higher cost / assets. Market Cap Rs22.5bn/US$301mn Year to March 2020 2021 2022E 2023E Research Analysts: Bloomberg SURYODAY IN NII (Rs mn) 4,905 4,101 5,230 6,143 Shares Outstanding (mn) 106.1 Net Profit (Rs mn) 1,109 119 501 1,430 Renish Bhuva 52-week Range (Rs) 305/212 EPS (Rs) 12.8 1.1 4.7 13.5 [email protected] +91 22 6637 7465 Free Float (%) 72.0 % Chg YoY 20.6 -91.3 322.7 185.2 Kunal Shah FII (%) 6.7 P/E (x) 16.5 189.7 44.9 15.7 [email protected] Daily Volume (US$/'000) NA P/BV (x) 1.7 1.4 1.4 1.3 +91 22 6637 7572 Absolute Return 3m (%) Chintan Shah (20.0) Net NPA (%) 1.7 4.7 2.9 2.7 [email protected] Absolute Return 12m (%) NA BVPS (Rs) 123.1 150.5 155.2 168.7 +91 22 6637 7658 Sensex Return 3m (%) 7.3 RoA (%) 2.4 0.2 0.7 1.8 Piyush Kherdikar Sensex Return 12m (%) 46.3 RoE (%) 11.4 0.9 3.1 8.3 [email protected] +91 22 6637 7465 77 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities TABLE OF CONTENTS What stands out for Suryoday SFB ...... 79 Digitisation – a key strategic focus ...... 89 Asset strategy – Secured loans to outpace unsecured loan growth ...... 92 Strengthening liability muscle by building granular retail and CASA deposit base...... 97 Current valuation not adequately factoring-in profitability normalcy in FY23E .... 100 Financial outlook ...... 101 Niche in small-ticket lending, comprehensive product offerings, and vast untapped opportunity to drive 19% AUM CAGR over FY21-FY23E ...... 101 Changing asset mix in favour of secured products to weigh on NIMs; improving liability profile to partially offset adverse impact ...... 101 Cost-efficient operations to drive profitability ...... 102 Near-term asset quality concerns persist, but increasing share of secured assets to help lower credit cost in FY23E ...... 103 RoA likely to reach ~1.8% by FY23E ...... 103 Summary Financials ...... 105 Annexure: Index of Tables and Charts ...... 108 78 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities What stands out for Suryoday SFB Conservative lending approach since inception; diversification and healthy balance sheet have always been top priorities Suryoday started its journey as a micro finance lender in CY09 as an MFI organisation, and has since remained focused on scaling up the business at a stable and sustainable pace. This is reflected in its minimum CAR at >25% across cycles (average 36% between FY13-FY21) and leverage not exceeding 4x (average 3.3x between FY13-FY21) in any of the years. Post commencing SFB operations in CY17, with access to stable source of funds via deposits and increasing pie of secured loans (~31% of total loans as at Mar’21), leverage gradually increased to 3.5x by FY20 from 1.7x in FY17. Fund-raising via IPO in FY21 led to a healthy CAR of 51.5%, which resulted in leverage falling to 2.6x. However, in its SFB avatar, we see leverage structurally settling higher at 6x-7x going forward. Table 1: Prudent approach in lending… AUM (Rs mn) Equity (Rs mn) Leverage (x) CAR (%) FY13 1,524 641 2.4 41.0 FY14 3,266 875 3.7 28.0 FY15 5,820 1,320 4.4 25.9 FY16 9,830 1,975 5.0 22.4 FY17 8,340 5,006 1.7 53.6 FY18 17,600 5,398 3.3 37.9 FY19 29,700 8,806 3.4 35.0 FY20 37,110 10,670 3.5 29.6 FY21 42,060 15,970 2.6 51.5 Average 3.3 36.1 Source: Company data, I-Sec research Chart 1: …as reflected in leverage not exceeding 4x, except in FY15 and FY16, in last 9 years AuM growth Leverage (RHS) Average leverage (RHS) 140% 6.0 120% 114% 5.0 4.4 5.0 100% 111% 3.7 80% 3.5 4.0 3.3 3.4 60% 78% 69% 69% 2.6 3.0 (x) 40% 20% 1.7 2.0 25% 13% 0% 1.0 -20% -15% -40% 0.0 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Further, taking cognisance of the nature of loans (unsecured) and vulnerability of the MFI customer segment to external events like farm loan waivers, elections, natural calamities, etc., Suryoday is amongst the very few SFBs having a floating provision policy within MFI space. As at Mar’21, total floating provision pool stood at Rs0.9bn or 3.5% of standard MFI loans; however it was utilised fully towards covid stress. 79 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Table 2: Amongst the very few having floating provision policy within MFI space Movement in floating provision (Rs mn) FY17 FY18 FY19 FY20 FY21 Opening provision 0 63 63 323 532 Addition during the year 63 0 261 209 375 Drawdown during the year 0 0 0 0 0 Closing provision 63 63 323 532 907 % of loans 0.8% 0.4% 1.1% 1.4% 2.2% Source: Company data, I-Sec research Suryoday’s prudent approach in micro finance over the years also reflects in its focus on expanding the market by accelerated new customer acquisition and constant check on customer leverage. This reflects in the 32% growth in borrower base vs 47% growth in AUM over FY12-FY21; all these years’ average outstanding per borrower remained well below at ~Rs21,000 vs the industry average of >Rs30,000. Further, the share of ‘new to credit’ customers remained well above ~30% vs the industry average of ~25%. Chart 2: Prudent lending approach with focus on Chart 3: One of the lowest borrower outstanding penetration as at Mar’21… 50% CAGR (FY12-21) Average outstading per borrower (March'21) 45,000 45% 38,963 47% 40,000 38,463 40% 35,000 33,294 35% 30,000 30% 32% 25,000 22,313 25% 20,000 17,616 20% 15% 15,000 10% 10,000 11% 5% 5,000 0% 0 AUM Borrower Ticket-size CAGL Ujjivan Spandana Suryoday Equitas Source: Company data, I-Sec research Source: Company data, I-Sec research Chart 4: …even while disbursing incrementally during covid, Suryoday continued to fund lower borrowing buckets Disbursement tikcet size between Oct'20-Mar'21 60% 50% 50% 40% 43% 39% 30% 20% 23% 18% 10% 13% 14% 0% 0% 0-10k 10-25k 25-50k 50k+ Industry Suryoday Source: Company data, I-Sec research 80 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Cost leadership: A key competitive edge, also driving industry-leading profitability Our analysis of various SFB players’ transition journey over past 4 years, realigning their erstwhile NBFC avatar to SFB, suggests that it is a costly affair and takes time before one starts reaping benefits from operating leverage. However, Suryoday stands out with one of the lowest cost-to-income and cost-to-asset ratios within India’s SFB space. Since commencing SFB operations in CY17, its strength has been in operating in a cost-efficient and cost-effective manner without compromising on the quality of service. Its cost-to-income ratio reduced from 73% in FY17 to 47% in FY20, while it increased to 64% in FY21 due to: 1) higher interest reversal and negative carry on account of excess liquidity, and 2) Rs0.2bn one-off expenses towards technology enhancement. Key strategy leading to best operating metrics Digitisation of operations: Suryoday moved to TAB-based banking in FY18-19 overhauling the infrastructure across all banking outlets. Employee compensation structure include stock options across various levels – and led to cost control in the overall compensation cost and resulted in employee stickiness over the years. Customer-centric business operations has resulted in ~80% customer retention ratio, thereby saving customer acquisition cost. Relatively moderate size of its banking outlets has led to reduction in the overall capital expenditure and operating expenditure per outlet. Suryoday does not compromise on branch locations, mainly high-stress branches, but branch size is relatively smaller than peer SFBs as it believes branch is only one of the many banking channels like mobile, internet, neo-banking, etc. Focus on customer acquisition via word of mouth (~50% of customer acquisition) leading to limited expenditure on advertising and publicity. Suryoday believes in low infra model – most branches are equipped with movable furniture. Cost efficiency coupled with better margins due to higher share of microfinance portfolio enabled Suryoday to sustain industry-leading profitability since demonetisation. Notably, delivering one of the highest RoAs at >2% in FY19 / FY20 within the SFB space, despite higher credit cost than peers, speaks of its operational excellence. Table 3: Suryoday has been steadily maintaining ~5% cost-to-assets ratio since commencement of SFB operations… Equitas Suryoday Ujjivan RoA analysis FY19 FY20 FY21 FY19 FY20 FY21 FY19 FY20 FY21 Int income 13.4% 13.7% 12.9% 14.1% 14.3% 11.6% 13.3% 14.7% 13.8% Int exp 6.1% 6.0% 5.7% 5.1% 5.1% 5.4% 5.3% 5.8% 5.3% NII 7.3% 7.7% 7.3% 9.0% 9.1% 6.1% 8.1% 8.9% 8.5% Other Income 1.8% 1.5% 1.7% 1.8% 1.6% 1.5% 1.5% 1.8% 1.5% Net revenue 9.1% 9.2% 9.0% 10.8% 10.8% 7.6% 9.5% 10.6% 10.0% Staff 3.5% 3.7% 3.2% 3.4% 3.2% 2.8% 3.8% 3.9% 3.7% Other opex 2.9% 2.4% 2.2% 1.8% 1.9% 2.1% 3.5% 3.3% 2.4% Total cost 6.4% 6.1% 5.4% 5.1% 5.1% 4.9% 7.3% 7.2% 6.0% PPoP 2.7% 3.1% 3.6% 5.6% 5.7% 2.7% 2.2% 3.5% 4.0% Credit cost 0.6% 1.3% 1.5% 2.0% 2.8% 2.5% 0.3% 0.9% 3.9% PBT 2.1% 1.8% 2.1% 3.7% 2.9% 0.2% 2.0% 2.5% 0.1% Tax 0.7% 0.6% 0.5% 1.4% 0.8% 0.0% 0.5% 0.6% 0.0% RoA 1.3% 1.3% 1.6% 2.3% 2.1% 0.2% 1.4% 1.9% 0.0% Source: Company data, I-Sec research 81 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 5: …and even while adding infrastructure at Chart 6: Sustaining business productivity even accelerated pace vs peers during expansion phase suggesting improved business from legacy infrastructure Productivity trend 2% 1% 90 78 78 76 0% 80 -2% -2% 70 -2% 60 59 -2% 60 -4% 50 42 -5% 40 -6% 30 -8% 20 8 8 8 6 6 -10% -11% 10 4 0 -12% AUM per AUM per Deposit per Deposit per Suryoday Ujjivan Equitas employee branch employee branch Branches (CAGR FY19-21) Employee (CAGR FY19-21) FY19 FY20 FY21 Source: Company data, I-Sec research Source: Company data, I-Sec research Chart 7: Asset-light unique distribution strategy Hub Branch Poi nt 1 Branch with 5 to 7 ROs + 20 Self Credit Appraisal Point Customer Service Points + 50 API Provides the Raw Material Customer Service Points + 1 Support like Cash, KYC, Card Unconventional Partner Branch - Unit 'Ecosystem' IF/URC/RB Inner Circle - Less Outer Circle - than 5km radius of Greater than 5km Exclusive Business Correspondents radius of the API Customer Service Points the Branch (FINO, Airtel, Spice Money (Self Customer Service Points) Branch' Consume Cash and the like) Customer Transaction Points Acquire Customers (Loan Withdrawal, Smile Cash in Cash KYC and Loan Withdrawal, Smile Out - AePS/ATM) Account Cash In Cash Out ROs Cash Deposits Source: Company data, I-Sec research 82 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Table 4: Digitisation of processes reflects in lower printing, stationery, postage, etc. while lower business overheads per branch at Rs0.59mn vs Rs2mn-3.7mn for peers suggests efficient cost management SSFB Equitas Ujjivan FY FY FY FY18 FY19 FY20 18-20 18-20 18-20 CAGR FY18 FY19 FY20 CAGR FY18 FY19 FY20 CAGR Cost break up Staff cost 872 1,267 1,714 40% 5,154 5,513 7,098 17% 3,604 5,188 7,185 41% Other exp. 442 641 1,008 51% 3,656 4,570 4,703 13% 2,924 4,846 6,000 43% Rent, Taxes and Lighting 74 124 222 73% 814 906 981 10% 476 915 1,425 73% Printing and Stationery 16 24 25 26% 110 97 103 -3% 138 237 254 36% Advertisement and Publicity 2 24 46 353% 107 162 182 30% 106 344 203 38% Depreciation on Bank's Property 47 56 98 45% 875 918 965 5% 414 606 726 32% Director's Fees, Allowances and Expenses 3 3 5 36% 8 9 19 54% 6 9 15 55% Auditors' fees and Expenses 4 5 6 16% 6 9 10 29% 5 7 9 30% Law Charges 4 18 24 147% 117 158 235 42% 16 40 63 99% Postages, Telegrams, Telephones etc. 20 24 25 13% 263 208 211 -10% 217 289 342 25% Repairs and Maintenance 123 170 227 36% 173 194 216 12% 504 714 749 22% Other Expenditure 133 167 283 46% 1,148 1,846 1,699 22% 1,027 1,644 2,145 44% Total operating cost 1,314 1,908 2,722 44% 8,810 10,083 11,801 16% 6,529 10,034 13,185 42% Branches 241 382 477 41% 989 991 854 -7% 464 524 575 11% Employees 2,883 3,931 4,695 28% 13,541 14,608 16,104 9% 11,242 14,752 17,841 26% Other Exp per Branch 1.8 1.7 2.1 3.7 4.6 5.5 6.3 9.2 10.4 Rent, Taxes and Lighting 0.31 0.33 0.47 0.82 0.91 1.15 1.03 1.75 2.48 Printing and Stationery 0.06 0.06 0.05 0.11 0.10 0.12 0.30 0.45 0.44 Advertisement and Publicity 0.01 0.06 0.10 0.11 0.16 0.21 0.23 0.66 0.35 % of revenue 0.1% 0.7% 0.9% 1.4% 1.2% 3.1% 1.2% Depreciation on Bank's Property 0.19 0.15 0.21 0.88 0.93 1.13 0.89 1.16 1.26 Director's Fees, Allowances and Expenses 0.01 0.01 0.01 0.01 0.01 0.02 0.01 0.02 0.03 Auditors' fees and Expenses 0.02 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.02 Law Charges 0.02 0.05 0.05 0.12 0.16 0.28 0.03 0.08 0.11 Postages, Telegrams, Telephones etc. 0.08 0.06 0.05 0.27 0.21 0.25 0.47 0.55 0.59 Repairs and Maintenance 0.51 0.45 0.47 0.17 0.20 0.25 1.09 1.36 1.30 Other Expenditure 0.55 0.44 0.59 1.16 1.86 1.99 2.21 3.14 3.73 % of total cost 30% 26% 28% 31% 40% 36% 35% 34% 36% Per employee cost 0.30 0.32 0.37 0.38 0.38 0.44 0.32 0.35 0.40 Source: Company data, I-Sec research Retail deposits – one of the best while CASA ratio is gradually increasing In the 4 years of SFB operations, Suryoday established a strong deposit franchise with granular deposit base as reflected in share of its retail deposits at 80% -- one of the highest within SFB space as at Mar’21. CASA ratio increased to 15.4% in FY21 from 11.4% in FY20, but still remained lower than peers. Bank’s focus on productivity (separate liability vertical), better customer experience and customer acquisition along with expanding its operations has led to significant growth in retail deposits. Diversified product offerings with a host of value-added services like such as debit card, bill pay, UPI-based money transfer, safe deposit, locker facilities, etc. enabled strong acquisition in liability customer and improved customer stickiness. Further, clear focus on targeting metro markets (key deposit centres) for garnering deposits instead of targeting tier 2-6 cities also helped build a sticky retail deposit base. Apart from setting up liability focused branches (96 branches as at Mar’21), Suryoday also expanded its reach by tying up business correspondents and payment banks to expand the horizons of customer acquisition beyond its own reach. As at Mar’21, it has tied up with 3 payment banks to manage sweep accounts. 83 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Further, Suryoday has set up a dedicated liability team to reach out to individual depositors across regions, and a product development team to enhance the features of existing products and develop new products that would appeal to them. Key highlights Share of retail deposits increased to 80% in FY21 from 54% in FY20. CASA ratio stood at 15.4% in FY21 vs 11.4% in FY20. Share of non-callable bulk deposits stands at ~91% as at FY21. Bank had a total of 96 liability-focused branches as at 31st Mar’21. Total deposits through partnerships for sweep-in stood at Rs599mn as at Mar’21. Chart 8: Retail deposit share is one of the highest Chart 9: …driven by strategic focus on metro at 80% vs <60% for peers… market, diversified product offerings, and dedicated liability team Retail Deposits share Region-w ise deposits 90% 80% Rural, 3% 80% 70% 60% 55% 55% Urban, 27% Metro, 70% 48% 50% 40% 30% 20% 10% 0% Suryoday Equitas* AU Ujjivan Source: Company data, I-Sec research Source: Company data, I-Sec research Holding structure – one of the only 3 SFBs without holding company structure Suryoday’s organisation structure is most simplified with no holding company, unlike most SFBs (7 out of 10) having multi-layer organisation structure. In most cases, SFBs owned by non-operative holding companies face risk of dilution, while in the case of Suryoday there is no mandatory requirement of bringing down promoter holding in the near term. Chart 10: Ujjivan group structure Chart 11: Equitas group structure Domestic Shareholders Foreign Shareholders Equitas Holdings Limited Ujjivan Financial Services Limited Equitas Small Finance Equitas Technological Bank Private Limited Ujjivan Small Finance Bank Source: Ujjivan SFB data, I-Sec research Source: Equitas SFB data, I-Sec research 84 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 12: No mandatory requirement for Suryoday to bring down promoter holding in the near term 90% 83% 82% Shareholding 80% 72% 72% 70% 60% 50% 40% 28% 28% 30% 18% 20% 17% 10% 0% Ujjivan Equitas AU Suryoday Promoter Public & Others Source: Company data, I-Sec research. Data as on March’21 Asset quality – higher share of MFI portfolio poses risk of near-term asset quality deterioration Suryoday’s asset quality has been volatile in the recent past as reflected in its average GNPL, since demonetisation, remaining at ~5% between FY17-FY21 and, similarly, credit cost settling much higher at an average of ~3.5% during the same period. However, cost efficiency enabled it to sustain industry-leading profitability despite elevated credit cost. Chart 13: Steady improvement in GNPL was witnessed post demonetisation, but covid-led disruption resulted in GNPL increasing to 9.4% in FY21 Asset quality 10.0% 9.0% 8.0% 9.4% 7.0% 6.0% 5.0% 4.7% 6.2% 4.0% 3.8% 3.0% 1.9% 2.0% 3.5% 2.8% 0.6% 1.0% 0.4% 0.0% 0.0% 0.1% 0.2% 1.8% 0.0% FY15 FY16 FY17 FY18 FY19 FY20 FY21 GNPL NNPL Source: Company data, I-Sec research Key challenges 1. Demonetisation: Higher share of unsecured loans (share of MFI loans was ~99% in FY17) with ~40% exposure in one of the worst impacted states, Maharashtra. Suryoday wrote-off ~Rs0.85bn, or ~8% of FY17 AUM, due to demonetisation. 2. Scaling up unsecured MSME portfolio without adequate infrastructure: Post commencement of SFB operations in CY17, in order to diversify its asset mix, Suryoday aggressively pursued scaling up of retail assets, namely unsecured 85 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities MSE, SBL, CV and micro individual loans. Combined share of non-MFI book increased to 17% by FY20 from <1% in FY17. However, without setting up adequate infrastructure, in terms of collections, credit underwriting and risk management framework, the strategy backfired as each of these businesses showed sign of stress between FY18-FY20. o Unsecured business loans: Entered unsecured business loan space in CY18 with an average ticket-size between Rs0.3mn-0.5mn. Economic downturn in CY19 coupled with lack of adequate infrastructure impacted asset quality. o Commercial vehicle (CV) financing: Entered new CV financing business in CY18 with primary focus on large fleet owners. However, with the economic downturn in CY19, the CV portfolio touched 5% GNPL in FY20 due to MHCV portfolio and Mumbai region (~70% NPAs from Mumbai). o Small business loans: Suryoday was engaged in providing small-ticket business loans (old LAP) until Mar’18 primarily to customers engaged in the informal segment without significant credit history, and such lending has since been defocused. NPAs are predominantly from old LAP while new LAP delinquency is insignificant. Chart 14: Segment-wise NPLs Segment-wise asset quality 25.0% 19.8% 20.0% 13.9% 15.0% 12.8% 10.6% 10.1% 10.0% 8.9% 7.4% 4.2% 5.0% 1.0% 1.1% 1.2% 0.8% 0.0% Unsecured CV Others JLG SBL HL business loans FY19 FY21 Source: Company data, I-Sec research Corrective measures 1. Set up a separate credit team and collection team for retail assets. 2. Revamped credit and underwriting process headed by Chief Credit Officer, Mr. Vaman Kamat (earlier with HDFC Bank and Cholamandalam). 3. Strategic realignment of portfolio towards formal segments: o Discontinued small-ticket LAP product in CY19, which was targeted towards informal segments. o Shifted focus to small fleet owners from large fleet owners. o Defocused unsecured SME loans from Jun’19. 86 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 15: Revamped credit processes and robust risk management framework Revamped credit process Credit function team Data analytics for decision Quality assurance officer making Fraud verification Separate team for PIN-code Bank has a quality tools/processes on customer analysis, customer leverage, assurance officer at each of profile and documentation etc. its banking outlets that offer Its credit underwriting Business insights based on inclusive finance loans. The practices include score-card proprietary customer data & officer’s role is independent of the reporting structure at based assessment for its credit bureaus data. retail asset products, Its analytics capabilities the banking outlet and is segment-based and include determining customer responsible for geography-based repayment behaviour over the implementation of policies assessment policies. lifecycle of a loan, estimating and processes for inclusive Partnership with third-party & customer repayment capacity finance loans, customer fintechs to implement based on monthly obligation visits and control over cash compliance & risk payable to various lenders, at the banking outlet. PIN code based analysis of management tools. market to identify potential growth markets, customer behaviour, customer’s leverage, delinquency analytics based on statistical methods including static pool, cohort analysis and repayment behaviour. Source: Company data, I-Sec research While the corrective measures are likely to help build better quality portfolio going ahead and sustain improved asset quality, we believe, with the advent of covid second wave, towards the fag end of Apr’21 and imposition of the lockdowns across multiple states, the collection efficiency will remain volatile in the near term. Chart 16: Steady improvement in collection efficiency since Jun’20; resurgence of covid derailed the momentum Collection Efficiency (CE) – Restricted to 1 EMI 100% 87% 90% 82% 82% 80% 70% 70% 60% 50% 46% 40% 30% 20% 10% 0% Jun'20 Sep'20 Dec'20 Mar'21 Apr'21 Source: Company data, I-Sec research 87 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Table 5: State-wise collection trend – Karnataka and Odisha leading while Maharashtra and Madhya Pradesh lagging Collection Efficiency (CE) – Restricted to 1 EMI Jun'20 Sep'20 Dec'20 Mar'21 Apr'21 Tamil Nadu 44% 71% 83% 88% 83% Maharashtra 35% 61% 74% 82% 72% Odisha 48% 67% 85% 88% 88% Karnataka 56% 79% 88% 90% 87% Madhya Pradesh 50% 75% 84% 87% 78% Source: Company data, I-Sec research Table 6: Product-wise collections – affordable housing and secured loans are showing resiliency, while CV and MFI appear most vulnerable Collection Efficiency (CE) – Restricted to 1 EMI Jun'20 Sep'20 Dec'20 Mar'21 Apr'21 Inclusive Finance 46% 69% 81% 85% 81% Commercial Vehicle 34% 77% 89% 93% 84% FIG 83% 100% 100% 100% 100% Affordable Housing 57% 84% 94% 96% 92% Secured Business – New 38% 80% 96% 95% 89% Secured Business – Old 34% 62% 66% 66% 56% Source: Company data, I-Sec research Table 7: Product-wise provision coverage – total provision coverage (including floating provision) stands at 52% on GNPL portfolio and 84% on 90+ GNPA GNPL (after Floating 90+ Rs mn Provisions NNPA PCR w/offs) provision GNPA JLG 2,929 685 910 1,332 65% 1,829 HL 130 25 0 105 19% 77 SBL 118 69 0 49 58% 87 CV 456 245 0 211 62% 279 FIG 0 0 0 0 0% 0 Unsecured business loans 97 64 0 33 92% 79 Other 207 56 0 152 27% 92 Total 3,937 1,144 910 1,882 64% 2,443 Source: Company data, I-Sec research Table 8: Total NNPL + w/offs + ECLGS + restructuring stands at 12.6% as at Mar’21 GNPL NNPL ECLGS Restructuring Write/offs Total (%) (%) % of loans % of loans % of loans (ex GNPL) As at March'21 9.4% 4.7% 2.3% 3.3% 2.3% 12.6% Source: Company data, I-Sec research Chart 17: Movement in PAR portfolio – PAR1+ at 21% as at Mar’21 is broadly at Jun’20 level PAR 1+ PAR 30+ PAR 60+ PAR 90+ 35.0% 31.1% 28.5% 30.0% 25.0% 20.7% 19.0% 19.7% 20.0% 12.8% 15.0% 13.5% 10.0% 5.2% 8.4% 4.1% 4.1% 9.1% 5.0% 4.2% 3.0% 3.3% 6.4% 3.2% 2.8% 3.5% 2.9% 0.0% Mar'20 Jun'20 Sep'20 Dec'20 Mar'21 Source: Company data, I-Sec research 88 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Digitisation – a key strategic focus Suryoday’s strategic focus is to build itself as a ‘data driven agile SFB’ by extensive use of technology. Use of advanced, cost-effective technologies has been a significant factor contributing to its industry-leading growth and profitability since commencement of SFB operations in CY17. It has implemented various digital technology solutions for the entire customer lifecycle – from acquisition, sanction, disbursement to repayments and closure. It has equipped its frontline staff with tablets/mobile devices in order to be able to provide the entire gamut of services – leading to better efficiencies and customer service. This would also enable Suryoday to sustain best-in-class profitability. As part of the digital roadmap, the bank is also leveraging its partnerships with technology service providers and fintechs to improve productivity of field force, accuracy and quality of data captured, and reduce turnaround time. Suryoday also leverages technologies such as process automation to drive greater operational efficiencies and improve customer service through fewer errors. In addition, it has made investments to strengthen the security infrastructure given the paramount importance of information security. Chart 18: Turnaround time reduced to 5 days from 11 for MFI loans 12 TAT (IF loans) in days 10 11 8 6 4 5 2 0 FY18 FY20 Source: Company data, I-Sec research Suryoday has built an enterprise integration layer that facilitates integration with partner entities through APIs. It is in the process of implementing a new Business Origination System (BOS) by engaging with multiple fintech partners. The BOS will be interfaced with a number of APIs to automate aspects of loan processing, including disbursement. Key strategic initiatives 1. Further enhanced its internet banking and mobile banking platforms. 2. Set up integration with payment gateways, which has enabled the digital collection process from borrowers. 3. Commenced the creation of an API layer that facilitates easy integration with third parties and empowers the open banking platform. 4. Joined hands with multiple payments banks for real-time integration to garner deposits: 89 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities o First-of-its-kind initiative by an SFB to collaborate with Paytm for end-to-end digital MSME lending programme up to Rs100,000. The partnership started in Apr’21. o Tech-enabled and real-time opening of bank account, OD account, and ECLGS account. Digital strategy helps Suryoday provide its customers a seamless, secured and convenient user experience. It also helps the bank know its customers better in terms of their preferences, requirements or concerns, and serve them accordingly. Digitisation is enabling the bank to achieve higher efficiencies across all its processes and become a leaner, future-ready organisation. Chart 19: Share of customers having both, asset and liability products, jumped to 33% by Mar’21 35% Customer leverage 30% 33% 25% 20% 15% 10% 5% 0% 0% 3% 0% FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Chart 20: Increasing penetration of debit card Chart 21: Debit card transactions steadily issuances improving 1,80,000 Debit Card Transactions 1,60,000 Value of Debit Card Transactions (RHS) 4,00,000 400 1,40,000 3,50,000 324 321 350 1,20,000 1,58,488 1,02,704 3,00,000 300 1,00,000 2,50,000 250 80,000 (nos) 2,00,000 200 60,000 mn) (Rs 1,50,000 106 111 150 34,217 40,000 1,00,000 100 13,596 11,098 20,000 53,972 50,000 50 0 0 27,544 1,27,292 3,60,398 3,50,330 0 0 0 FY18 FY19 FY20 FY21 - Dec'20 FY18 FY19 FY20 FY21 - Dec'20 Total Debit Cards Issued Active users Source: Company data, I-Sec research Source: Company data, I-Sec research 90 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 22: Increasing internet banking transactions Chart 23: Steady improvement in mobile banking platform adoption Internet Banking Transactions Mobile Banking Transactions Value of Internet Banking Transactions (RHS) Value of Mobile Banking Transactions (RHS) 1,20,000 6,343 7,000 4,50,000 9,000 7,821 4,00,000 8,000 1,00,000 6,000 4,704 3,50,000 7,000 5,000 80,000 3,00,000 5,352 6,000 4,000 2,50,000 5,000 (nos) 60,000 (nos) 2,00,000 4,000 (Rs mn) (Rs 3,000 mn) (Rs 40,000 1,50,000 3,000 1,455 2,000 1,891 1,00,000 2,000 20,000 477 480 1,000 50,000 1,000 8,241 40,417 1,01,820 87,685 17,911 1,43,280 3,38,368 3,93,260 0 0 0 0 FY18 FY19 FY20 FY21 - FY18 FY19 FY20 FY21 - Dec'20 Dec'20 Source: Company data, I-Sec research Source: Company data, I-Sec research Table 9: Key digital capabilities Segment Digital solution Key feature A solution for liability account opening to enable customer acquisition Video KYC Liability through video calls Whatsapp receipt FD receipts on Whatsapp Sumeru (retail App to enable repayment collections including mobility-based Collections collection App) collections Assets BOS HL New origination system and workflow for processing housing loans BC Novopay Phase 2 BC solution to onboard and manage corporate and individual BCs Service Call centre / IVR Implementation of own IVR and call centre infrastructure Fraud Risk FRM solution Implementation of Clarify, an enterprise FRM solution. Management Source: Company data, I-Sec research 91 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Asset strategy – Secured loans to outpace unsecured loan growth Asset diversification has been one of the key strategies post commencing SFB operation in FY17. During the past 4 years, Suryoday has launched a series of new asset products, mainly secured, to deepen its relationship with existing customers and acquire new customers in the unbanked and underbanked segments of India. Incrementally, it is also focused on getting into lending to formal segments in order to diversify its customer profile and to improve product offerings for branch banking business in metro and tier-1&2 cities. Further, Suryoday is driving its asset diversification strategy differently by focusing on product-led growth rather than blanket growth in secured loans and scale-down in MFI loans, unlike peers. Considering the current market realities, it laid down the following asset strategy to pursue in FY22/FY23: 1. Secured loan book to outpace unsecured loan growth, but would be product- specific 2. Affordable housing to drive incremental growth in FY22 while the bank will continue to have cautious approach in growing CV and SBL till the market becomes conducive. 3. Within the CV segment, focus would be more on small fleet operators and LCVs, and to create niche in CV financing by offering differentiated products like Transport Sathi (CV OD), which provide small working capital limits to transporters. Suryoday set up 798 set up with 68% utilisation in FY21. It aims at deepening its relationship with these customers and capitalise on the same once the business environment stabilises. 4. Small business loans (SBL): Focus would be more on lending to formal segments with ticket-size of ~Rs5mn and above. Secured lending outpaced unsecured loan growth since FY17-18; trend to continue going ahead With the commencement of SFB operations in FY17, Suryoday has focused on diversifying its asset mix by improving the share of secured lending. It has successfully trimmed the share of unsecured loans by 5-9% per annum since CY17 and this trend will most likely continue in the near term. It expects growth in the secured portfolio, on a low base, to continue to outpace growth in unsecured loans (mainly MFI) in the near term and incremental growth to be largely driven by affordable housing, CV and SBL in FY22/FY23. 92 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 24: Affordable housing and SBL have been Chart 25: …CV and affordable housing have been key credit growth drivers in the recent past… key growth drivers Inclusive Finance CV Affordable Housing SBL FIG Others FY18-FY21 Loan CAGR 250% 100% 246% 90% 200% 80% 187% 70% 150% 60% 142% 50% 90 100% 40% 81 76 69 30% 50% 65% 20% 35% 24% 10% 0% 0% CV FIG Affordable SBL Others Inclusive FY18 FY19 FY20 FY21 Housing Finance Source: Company data, I-Sec research Source: Company data, I-Sec research Asset mix: Comprehensive asset product mix to help sustain industry-leading growth going ahead Suryoday started its lending journey as a single-product company by venturing into providing microfinance loans to underserved and underbanked segments in CY08. It has since come a long way by successfully diversifying its asset mix to comprise MFI loans, CV financing, affordable housing loans, secured business loans, unsecured MSME, micro individual loans, staff loans, ODs, etc. by FY21. Its focus will continue to be on the inclusive finance segment in line with industry growth. It also intends to grow its secured portfolio at a faster pace compared to the inclusive finance portfolio due to its comparatively small base currently. Amongst retail asset products, key growth drivers are likely to be home loans, secured business loans, and micro business loans. Table 10: Product description Segment Description Group loans for business purposes to women customers under JLG 1 Joint Liability Group (JLG) Loans model. Funding primarily new medium and heavy commercial vehicles (MHCV), construction equipment (CE), buses, among others. 2 CV Loans Primary focus on high-quality retail customers and fleet operators, and gradual expansion into used CV. Funding primarily for affordable housing segment to salaried / self- 3 Affordable Housing Loans employed customer segment. Unsecured working capital loans to small businesses such as kirana 4 Micro Business Loans (T-NAGAR) shops, medical stores, small manufacturing / service units. Term loans to financial institutions, primarily NBFCs, NBFC-MFIs and 5 Financial Intermediary Group (FIG) housing finance companies. Secured business loans to SME / MSME / corporate entities for growth / 6 Secured Business Loans expansion, capital expenditure, and working capital. Unsecured business loans to MSMEs / SMEs for working capital, 7 Unsecured MSME/SME Loans capacity expansion and more. Source: Company data, I-Sec research 93 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities 1. Inclusive financing – focus on improving household penetration of JLG customers. While Suryoday’s business model has transitioned over the years, initially operating as an NBFC-MFI before commencing SFB operations in CY17, its core focus has been to serve the unbanked and underbanked customer segments. With deep understanding of these segments and rich experience in serving the informal segment, it plans to leverage the existing MFI borrower base through inclusive financing. The vertical is designed to cross-sell and upsell an entire range of banking products in existing locations by improving household penetration (targeting other family members of MFI borrowers) and expanding geographical presence in a calibrated manner. Key initiatives Launched recurring deposit product to help JLG customers and their families save on regular basis and make them a part of the formal banking channel. Launched OD product (Smile) in FY21 for JLG customers to meet their working capital needs with credit limits of Rs5,000 to Rs20,000. T-Nagar loans – these are unsecured micro business loans offered to customers with identifiable small businesses. Table 11: Key features of inclusive finance vertical Asset product (as on Mar'21) Inclusive finance AUM (Rs bn) 29.2 AUM (%) 69% Yield (%) 20% GNPA (%) 10.1% ATS Rs35,000 Average Tenure 21 months Customer Sourcing Through relationship officers (ROs) RO establishes groups of >5 customers (known to each other and requiring credit) Customer Assessment RO conducts their credit assessment through KYC checks and credit history An independent credit verification is also carried out by Quality Assurance Officer Repayments are collected in cash at centre meetings held monthly Amount collected is entered into a loan card and signed by the relationship Collection Process manager as an acknowledgment Supervisory team (branch and area managers) is involved promptly if the customers / centres default in repaying dues Source: Industry data, I-Sec research 2. Commercial vehicle loans. Suryoday commenced commercial vehicle financing in FY18 with primary focus on secured lending to new CV segment. After testing the market, it recently entered the used CV financing market too. Initially, it targeted large fleet operators, but post economic downturn in FY19/FY20 and subsequently higher NPAs in its CV portfolio, it shifted focus to small fleet owners and used CV financing. Further, to deepen the relationship with existing customers, it launched (in FY21) one-of-its-kind OD facility for small and medium fleet owners to meet their working capital requirements. 94 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Table 12: Key features of commercial vehicle loans Asset Product (as on Mar'21) CV AUM (Rs bn) 3.6 AUM (%) 8% Yield (%) 10% GNPA (%) 12.8% ATS Rs1.6mn Average Tenure 39 months Customer Sourcing Through sales executives and existing customer relationships Customers with some credit history, business experience and stability of office/ Customer Assessment residence Customers with prior vehicle ownership and a valid driving license Collections carried out through the bank’s personnel; collections monitored daily Repayments in the form of cash, post-dated cheques, demand drafts and through various online portals Collection Process Collections through approved external vendors in case of sale of repossessed vehicles, once the customer fails to make payments by the due date Repayments overdue by 30 days and 60 days are each managed through different processes Source: Industry data, I-Sec research 3. Affordable housing – A key growth driver going forward. Suryoday commenced affordable housing loans in FY18, in line with its strategy to build a sustainable secured asset portfolio. It primarily offers affordable home loans from its banking outlets located in urban / semi-urban areas. Loans are provided for purchase of house, construction of house, improvement / restoration of home, as well as for refinancing construction, balance transfers and as top-ups of existing loans. Its housing loan offerings are aimed at self-employed / salaried applicants for purchase of apartments, or self-construction of their property, with focus on non-agricultural town planning approved properties (NATP). Affordable housing portfolio showed strong resiliency as reflected in its robust 72% YoY growth in AUM in FY21 with pristine asset quality (GNPL at 4% as at Mar’21). It expects affordable home loans to sustain their high growth trajectory going forward. Table 13: Key features of affordable housing loans Asset Product (as on Mar'21) HL AUM (Rs bn) 3.1 AUM (%) 7% Yield (%) 11% GNPA (%) 4.2% ATS Rs0.9mn Average Tenure 202 months (~16.5 years) Field-based credit assessment by credit team members personally and, if Customer Sourcing required, liaising with external vendors for detailed credit assessment Eligibility based on cashflows, business performance if self-employed, salary details including job stability, past banking conduct and repayment track-record Customer Assessment Legal and technical assessment regarding property title and valuations are done through external parties and is also verified by internal teams Collections carried out through the bank’s personnel; collections monitored daily Repayments are in the form of post-dated cheques, demand drafts and through Collection Process various online portals Repayments overdue by 30 days and 60 days are each managed through different processes Source: Industry data, I-Sec research 4. Secured Business Loans – cautious stance in the near term, but to remain focus segment once economic environment turns conducive. Entering into MSME lending was a natural and obvious move once Suryoday commenced SFB operations in FY17. However, it entered the MSME/SME lending space via 95 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities unsecured loans in FY17 targeted towards entities / individuals engaged in small business activities without adequate documentation and credit histories. However, within a couple of years, unsecured MSME portfolio started showing signs of stress. As a corrective measure in FY19, the bank focused on developing its internal credit team, which led to a shift in target customers towards customers with adequate documentation and credit history. Suryoday has since reduced its focus on unsecured MSME / SME loans and increased focus on secured loans in the formal MSME / SME segment. Table 14: Key features of Secured Business Loans (SBLs) Asset Product (as on Mar'21) SBL AUM (Rs bn) 1.6 AUM (%) 4% Yield (%) 13% GNPA (%) 7.4% ATS Rs1.8mn Average Tenure 119 months (~10 years) Through Direct Channel – RO conducts field activities to engage with potential Customer Sourcing customers Customer sourcing through referral model – Banking outlets to source or refer customers Customer Assessment Eligibility based on cashflows, viability of end use, past banking conduct and repayment track record Also assesses the actual deployment of funds made by the customer Collections carried out through the bank’s personnel; collections monitored daily Repayments in the form of post-dated cheques, demand drafts and through various online portals Collection Process Collections are through approved external vendors, once the customer fails to make payments by the due date Repayments overdue by 30 days, 60 days and 90 days are each managed through different processes Source: Industry data, I-Sec research 5. Financial Intermediary Group Loans (FIGL). Suryoday offers term loans (for onward lending) to investment grade financial intermediaries such as NBFCs, MFIs and HFCs serving retail segments like housing finance, loans against property, microfinance, vehicle finance and other similar sectors. It leverages on their distribution, technology and appraisal expertise to build a strategic alliance for the ultimate motive of increasing financial inclusion of underserved people. Table 15: Key features of FIG loans Asset Product (as on Mar'21) FIG AUM (Rs bn) 2.1 AUM (%) 5% Yield (%) 11% GNPA (%) 0.0% ATS Rs11mn Average Tenure 29 months Through internal referrals, existing industry relationships and conferences / Customer Sourcing seminars. Preliminary assessment – business model, credit ratings, reputation, size and vintage of the company Analysis of audited financial statements, balance sheet strength, asset quality, Customer Assessment quality of earnings, capital adequacy Assessment of liquidity positions – ALM, capital structure, repayment track- record, ability to raise funds RO and head of FIG responsible for collections till 60 days overdue; post this, account handed over to collections team Loans secured against booked debts and receivables as charge being created Collection Process against these book debts and receivables Repayments overdue by 30 days, 60 days and 90 days are each managed through different processes Source: Industry data, I-Sec research 96 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Strengthening liability muscle by building granular retail and CASA deposit base Access to stable sources of fund to build a long-term sustainable business model, is of utmost important and was one of the key elements for players applying for SFB license. However, building a sticky and granular deposit base is not an easy task, but Suryoday fared well as compared to peers. This is reflected in its retail deposit share at 80% - one of the highest in SFB space. More importantly, while building liability franchise, Suryoday remains focused on value proposition rather than volumes. The same reflects in the 63% deposit CAGR between FY18-FY21 with steady decline in cost/assets to 5.4% by FY21 from 7% in FY18. Similarly, CASA ratio too improved to 15.4% in Mar’21, but is still lower than that for most SFBs. Strategically, Suryoday focused on building its deposit base by targeting key industry deposit markets (top-100 deposit centres comprising mainly metro and urban cities) during the initial phase. Later, it started gradually entering rural and semi-urban markets by leveraging its rich inclusive finance distribution network and working on creating saving habits amongst the rural population. As per the committed intent of inclusive financing for rural people, the bank has started recurring the deposit product for MFI customers in FY19, with the intention to create banking habits amongst customers located in rural and semi-urban areas. Key initiatives A dedicated team to reach out to individual depositors across regions. A product development team to enhance the features of existing products and develop new products that would appeal to new customers and improve stickiness of existing customers. Enhanced mobile and internet banking platform for better customer experience. End-to-end digital onboarding process. Strategic focus on tapping senior citizens by providing personalised services. The share of deposits from senior citizens stands at ~40% of total retail deposits. Building relationships NRIs, educational institutions, NBFCs, corporates and cooperative banks. Further, Suryoday has set a near-term milestone to build a deposit base that can at least fund the entire loan book. Currently, the ‘deposit to credit’ ratio stands at 82%, which it plans to scale up to 100% in the near term. As per the stated strategy, deposit growth has steadily outpaced credit growth between FY18-FY21. 97 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 26: Deposits outpaced AUM growth in Chart 27: …with increasing share of retail recent past… deposits at 80% as at Mar’21 45 Retail deposit % of total deposits Deposit CAGR (FY18-21) -63% 90 40 Loans CAGR (FY18-21) -36% 40 80 35 80 35 70 30 33 60 28 25 27 50 54 (Rs bn) (Rs 20 40 43 15 41 16 16 30 10 20 5 8 10 0 FY18 FY19 FY20 FY21 0 FY18 FY19 FY20 FY21 Advances Deposits Source: Company data, I-Sec research Source: Company data, I-Sec research Chart 28: CASA share sharply increased to 15.4% Chart 29: Deposit mix as of Mar’21 in Mar’21 18.0 CASA ratio Deposit Mix as at March' 21 16.0 CA , 3.3% 15.4 Bulk TD, 14.0 20.0% SA, 12.1% 12.0 10.0 11.0 11.3 11.5 (%) 8.0 6.0 4.0 2.0 Retail TD, 0.0 64.6% FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Source: Company data, I-Sec research Cost of funds witnessed steady decline since FY18 with increasing share of retail deposits and gradually improving CASA ratio. CoF fell >250bps over the past 4 years. 98 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 30: Steady improvement in cost of funds (CoF) led by changing funding mix in favour of deposits 12.0 Cost of Funds 10.0 10.7 9.0 8.0 8.6 8.0 6.0 (%) 4.0 2.0 0.0 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research 99 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Current valuation not adequately factoring-in profitability normalcy in FY23E Suryoday’s recent underperformance was attributable to: a) higher exposure to vulnerable segment (MFI) and, within it, ~45% of loans were in Maharashtra during covid second wave; b) fear of 10% margin cap on SFBs due to regulation harmonisation; and c) business growth moderation amid the pandemic-led disruption and lack of clarity about business normalcy due to resurgence of covid cases. However, with gradual reopening of economy, the proposal to remove margin cap and likely improvement in collection subsides some of the above discussed challenges. With an improving business outlook and subsiding asset quality woes would ensure credit cost not stretching beyond FY22E, hence Suryoday’s cost leadership and adequate capital (CAR >50%) would help sharply improve profitability in FY23E. Suryoday has significantly underperformed the broader indices in past 3 months and, at 1.3x FY23E P/BV, the current valuation is not adequately factoring-in likely return to normal profitability led by: 1) fast-evolving deposit franchise (80% retail deposits at Mar’21), 2) cost leadership (cost / assets at <5.5%), and 3) gradual decline in credit cost. Further, Suryoday’s simple organisation structure (without a holding company) would also command scarcity premium in the SFB space. We initiate coverage with a BUY rating and target price of Rs310, valuing the stock at 1.8x FY23E P/ABV. Our target multiple is dictated by a likely RoA improvement to 1.8%% in FY23E and 19% AuM growth over FY21-FY23E vs 13% growth in FY21. Key risks: a) Sharper margin deterioration due to stiff competition in formal segment lending, and b) higher than expected credit cost. Table 16: Relative peer valuations P/E (x) P/BV (x) P/ABV (x) Particulars CMP Rating TP FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E SFBs Equitas SFB 67 BUY 92 19.9 15.9 11.4 2.2 2.1 1.8 2.4 2.3 2.0 Ujjivan SFB 32 ADD 35 745.8 75.0 14.3 1.9 1.9 1.7 2.2 2.2 1.7 AU SFB 1,125 ADD 1,140 30.0 41.3 29.9 5.6 5.0 4.3 6.2 5.3 4.6 Suryoday SFB 212 BUY 310 189.7 44.9 15.7 1.4 1.4 1.3 N/A N/A N/A NBFC-MFIs CAGL 721 BUY 765 81.0 28.7 17.4 3.0 2.7 2.4 N/A N/A N/A Spandana 720 BUY 840 23.0 9.1 7.9 1.7 1.4 1.3 N/A N/A N/A EPS (Rs) BV (Rs) RoAA (%) RoAE (%) Particulars FY21 FY22E FY23E FY21 FY22E FY23E FY20 FY21 FY22E FY23E FY20 FY21 FY22E FY23E SFBs Equitas SFB 3 4 6 30 32 37 1.4 1.7 1.8 2.2 9.7 12.5 13.5 17.0 Ujjivan SFB 0 0 2 17 17 19 2.2 0.0 0.4 1.8 14.0 0.3 2.5 12.3 AU SFB 37 27 38 201 226 261 1.8 2.5 1.5 1.7 17.9 22.0 12.8 15.4 Suryoday SFB 1 5 15 151 155 169 2.4 0.2 0.7 1.8 11.4 1.0 3.1 8.3 NBFC-MFIs CAGL 9 25 41 237 263 304 3.4 1.0 2.4 3.4 13.2 4.1 10.1 14.6 Spandana 31 79 91 434 497 570 6.3 2.7 5.7 5.6 15.6 7.4 17.0 17.1 Source: Company data, I-Sec research 100 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Financial outlook Niche in small-ticket lending, comprehensive product offerings, and vast untapped opportunity to drive 19% AUM CAGR over FY21-FY23E Key differentiation for Suryoday was its undisrupted business growth (AUM CAGR at 35% over FY18-FY21) even during the transition phase of FY18-FY20 and the most recent covid-led slowdown in FY21. While continuing its strategy to build a retail secured asset portfolio, it delivered 19% YoY AUM growth in a most challenging year FY21, driven by <50% growth in retail loans and calibrated growth (flat YoY) in MFI portfolio in FY21. Retail operation stabilization, revamped business processes, expanded reach and adequate capital (CAR >50%) is likely to ensure industry-leading AUM growth over FY21-FY23E. Considering the vast untapped opportunity at ~Rs10trn in small-ticket lending, its niche in this segment of financing coupled with diversified product mix would ensure Suryoday sustaining high growth going ahead. We estimate 19% AUM CAGR over FY21-FY23E, lower than the historical average given that H1FY22E is likely to remain subdued due to resurgence of covid cases. Chart 31: AUM CAGR likely to remain at 19% over FY21-FY23E; H1FY22E to remain subdued AUM YoY growth (RHS) 70 100% 86% 60 73% 80% 50 60% 40 40% (%) 30 25% 23% (Rs bn) (Rs 15% 13% 20% 20 10 0% 10 9 -11% 17 30 37 42 48 59 0 -20% FY16 FY17 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research Changing asset mix in favour of secured products to weigh on NIMs; improving liability profile to partially offset adverse impact Suroday’s focus on expanding its retail secured assets at an accelerated pace, once the economic environment turns conducive, is likely to impact asset yields adversely in the near term. Asset yield fell from 21.4% in Mar’18 to 19.7% in Dec’20 and 17.8% in Mar’21 (due to higher interest reversals) given that share of secured assets increased to 30% in FY21 from ~10% in FY18. While its liability profile is improving as reflected in its retail deposit share increasing to 80% in FY21, Suryoday’s relatively younger franchise would limit its ability to cut deposit rates in the near future. However, change in borrowing mix towards deposits would reduce cost of funds and thus partially offset 101 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities the adverse impact of lower asset yields on NIMs. Cost of borrowing steadily fell to 8% by Mar’21 from 8.6% in Mar’20. Chart 32: NIMs to settle at ~8% in the medium term 14.0 NIMs 12.0 11.9 10.0 11.1 10.2 8.0 9.0 7.7 8.0 (%) 6.0 7.1 4.0 2.0 0.0 FY17 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research Cost-efficient operations to drive profitability Calibrated branch expansion with focus on providing cost-effective banking services to the underserved population backed by strong digital platforms, higher component of variable pay to employees and undisrupted AUM growth since commencement of SFB operations have been key differentiators for Suryoday’s industry-leading profitability. Cost/Assets ratio steadily declined to 5.4% in FY21 from 7.3% in FY17. Cost/Income ratio too remained at <50% in FY19/FY20 and spiked to 64% in FY21 largely due to lower revenues on higher interest reversals. We believe, the cost/assets ratio is likely to sustain at current level, or improve marginally, given the bank’s demonstrated track- record of containing costs at manageable levels by balancing investments in technology and distribution reach, with productivity improvement from existing assets. Chart 33: Focus on sweating existing assets Cost / Assets ratio Cost / Income ratio (RHS) 8.0 70.0 65.1 7.0 64.4 65.0 6.0 60.7 58.4 60.0 5.0 (%) 4.0 55.0 (%) 3.0 47.7 47.1 50.0 2.0 45.0 1.0 7.0 6.5 6.0 5.4 5.4 5.5 0.0 40.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research 102 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Near-term asset quality concerns persist, but increasing share of secured assets to help lower credit cost in FY23E Suryoday, post commencing SFB operations, has been incrementally focusing on building secured assets and increasing lending to formal segments. As a result, the share of secured assets increased to 30% in FY21 from sub-10% in FY18 and the trend is likely to continue going forward. Strategic shift towards secured and formal segment lending would help it gradually change its customer risk profile in favour of better-quality customers. While higher proportion of unsecured assets (~70% in FY21) resulted in higher credit cost in FY21 at 4.3%, increasing share of retail secured assets and stringent underwriting and risk management is likely to help it contain incremental slippages at a lower level than in FY22E/FY23E than in FY21. PAR 0+ at ~20%, NPL coverage ratio at 52% and restructured assets at 3.3% as at Mar’21 poses upside risk to our credit cost assumption. Chart 34: Credit cost likely to moderate, but would yet be higher than the historical average 5.0 Credit cost 4.5 4.5 4.0 4.3 4.1 4.0 3.5 3.0 3.2 2.5 (%) 2.0 2.1 1.5 1.0 0.5 0.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research RoA likely to reach ~1.8% by FY23E Suryoday’s SFB journey was evolving well until FY20, with RoA remaining >2% between FY19-FY20, secured asset share increasing to 30%, retail deposit share increasing to 80% and cost ratios steadily declining since FY17. Though covid-led disruption impacted financial performance significantly, the business evolution journey continued with increasing share of retail deposits (~80% of total deposits) and advances (30% of loans) even in FY21. Further, over the past of couple of years, it built robust digital capabilities enabling lower cost of acquisition, better customer experience and improved cross-sell ratio. Combination of improving productivity and gradual normalisation of credit cost would offset the likely margin compression due to higher share of better-quality assets going forward. Overall, we expect RoA to improve to 1.8% and RoE to >8% by FY23E. 103 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 35: Return ratios to gradually improve RoA RoE (RHS) 3.5 14.0 12.2 11.4 3.0 12.0 2.5 10.0 8.3 2.0 8.0 (%) (%) 1.5 6.0 1.0 3.1 4.0 1.9 0.5 1.0 2.0 0.5 2.9 2.4 0.2 0.7 1.8 - - FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research 104 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Summary Financials Table 17: Profit and Loss statement (Rs mn, year ending March 31) FY19 FY20 FY21E FY22E FY23E Interest earned 5,301 7,667 7,758 9,284 10,612 Interest expended 1,912 2,762 3,657 4,054 4,469 Net interest income 3,389 4,905 4,101 5,230 6,143 Other income 669 875 999 1,126 1,379 Staff cost 1,267 1,714 1,858 2,230 2,565 Other operating expenses 668 1,008 1,428 1,625 1,827 Total operating cost 1,935 2,722 3,286 3,855 4,392 Pre-provisioning op profit 2,123 3,058 1,813 2,501 3,130 Provisions & contingencies 738 1,519 1,692 1,804 1,144 Profit before tax & exceptional items 1,384 1,540 121 696 1,986 Exceptional items Profit before tax & exceptional items 1,384 1,540 121 696 1,986 Income taxes 518 430 2 195 556 PAT 867 1,109 119 501 1,430 Source: Company data, I-Sec research Table 18: Balance sheet (Rs mn, year ending March 31) FY19 FY20 FY21E FY22E FY23E Capital 816 866 1,061 1,061 1,061 Reserves & surplus 7,990 9,796 14,908 15,409 16,839 Networth 8,806 10,662 15,969 16,470 17,900 Total borrowings 11,242 12,646 16,666 15,767 15,781 Term Deposits & CASA 15,934 28,487 32,557 39,072 48,840 Other Liabilities and Provisions 1,634 1,850 1,928 3,107 3,728 Total liabilities & stockholders' equity 37,616 53,645 67,120 74,416 86,249 Loans & advances 26,800 35,319 39,828 48,241 59,234 Investments 6,644 8,081 18,737 16,372 15,525 Cash and Balance 2,762 8,380 5,966 6,697 7,762 Other assets 1,410 1,865 2,589 3,107 3,728 Total Assets 37,616 53,645 67,120 74,416 86,249 Source: Company data, I-Sec research 105 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Table 19: Key ratios (Year ending March 31) Growth (%): FY19 FY20 FY21E FY22E FY23E AUM 72.7 25.1 13.3 14.7 22.8 Disbursements 66.9 8.4 -28.3 95.5 34.7 Loan book (on balance sheet) 70.8 31.8 19.1 14.7 22.8 Total Assets 74.5 42.6 25.1 10.9 15.9 Total Deposits 112.4 78.8 14.3 20.0 25.0 Total NDTL 85.1 51.4 19.7 11.4 17.8 Total Investments 113.6 21.6 131.9 -12.6 -5.2 Interest Income 84.8 44.6 1.2 19.7 14.3 Interest Expenses 55.4 44.4 32.4 10.9 10.2 Net Interest Income (NII) 106.9 44.8 -16.4 27.5 17.5 Non-interest income 76.05 30.82 14.10 12.78 22.42 Net Income 101.09 42.45 -11.77 24.63 18.34 Total Non-Interest Expenses 47.26 40.67 20.73 17.31 13.91 Pre provisioning operating profits (PPoP) 201.58 44.08 -40.71 37.89 25.16 PAT 756.67 28.01 -89.31 322.71 185.16 Yields, interest costs and spreads (%) Average earning assets 36,206 51,780 64,531 71,310 82,521 Total Funds 27,176 41,133 49,223 54,839 64,621 NIM on AUM 11.9 11.1 7.1 7.7 8.0 Yield on loan assets 22.6 23.0 19.6 20.6 19.7 Average cost of funds 9.1 8.1 8.1 7.8 7.5 Interest Spread on loan assets 13.5 14.9 11.5 12.8 12.3 Operating efficiencies Non interest income as % of net income 16.5 15.1 19.6 17.7 18.3 Cost to income ratio (%) 47.69 47.09 64.44 60.66 58.39 Op.costs/avg AUM (%) 8.26 8.15 8.30 8.54 8.17 Salaries as % of non-int.costs (%) 65.5 63.0 56.5 57.8 58.4 Balance Sheet Structure Loans/ deposits (%) 168.2 124.0 122.3 123.5 121.3 Loans/ Total assets 71.2 65.8 59.3 64.8 68.7 Loans/NDTL 98.6 85.9 80.9 88.0 91.7 CA% of NDTL 1.7 1.4 2.2 2.5 2.7 SA% of NDTL 4.9 6.5 8.0 10.8 15.1 CASA% of NDTL 6.6 7.9 10.2 13.3 17.8 Total deposits as % of NDTL 58.6 69.3 66.1 71.2 75.6 Capital Structure Leverage (x) 4.27 5.03 4.20 4.52 4.82 CAR (%) 36.0 29.6 44.4 37.1 33.8 Tier 1 CAR (%) 33.7 28.6 42.7 37.1 33.8 Tier 2 CAR (%) 2.3 1.0 1.7 1.5 1.2 Asset quality and provisioning GNPA (%) 1.9 2.9 9.4 11.6 6.9 NNPA (%) 0.8 1.7 4.7 2.9 2.7 GNPA (Rsmn) 496 1,013 3,937 5,619 4,066 NNPA (Rsmn) 209 600 1,881 1,405 1,626 Coverage ratio (%) 57.9 40.7 52.2 75.0 60.0 Credit costs as % of average AUM 3.2 4.5 4.3 4.0 2.1 Return ratios RoAA (%) 2.9 2.4 0.2 0.7 1.8 RoAE (%) 12.2 11.4 0.9 3.1 8.3 Valuation Ratios EPS (Rs) 10.6 12.8 1.1 4.7 13.5 EPS fully diluted (Rs) 10.6 12.8 1.1 4.7 13.5 Price to Earnings 20.0 16.5 189.7 44.9 15.7 Price to Earnings (fully diluted) 20.0 16.5 189.7 44.9 15.7 Book Value (fully diluted) 107.9 123.1 150.5 155.2 168.7 Adjusted book value (fully diluted) 107.9 123.1 150.5 155.2 168.7 Price to Book 2.0 1.7 1.4 1.4 1.3 Price to Adjusted Book 2.0 1.7 1.4 1.4 1.3 Source: Company data, I-Sec research 106 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Table 20: DuPont analysis (%) FY19 FY20 FY21E FY22E FY23E Interest earned 17.9 16.8 12.8 13.1 13.2 Interest expended 6.5 6.1 6.1 5.7 5.6 Gross Interest Spread 11.5 10.7 6.8 7.4 7.6 Credit cost 2.50 3.33 2.80 2.55 1.42 Net Interest Spread 9.0 7.4 4.0 4.8 6.2 Operating cost 6.5 6.0 5.4 5.4 5.5 Lending spread 2.4 1.5 -1.5 -0.6 0.8 Non-interest income 2.3 1.9 1.7 1.6 1.7 Operating spread 4.7 3.4 0.2 1.0 2.5 Exceptional items 0.0 0.0 0.0 0.0 0.0 Final Spread 4.7 3.4 0.2 1.0 2.5 Tax rate (%) 1.8 0.9 0.0 0.3 0.7 ROAAUM 2.9 2.4 0.2 0.7 1.8 Effective leverage (AAUM/ AE) 4.2 4.7 4.5 4.4 4.7 RoAE 12.2 11.4 0.9 3.1 8.3 Source: Company data, I-Sec research 107 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Annexure: Index of Tables and Charts Tables Table 1: Prudent approach in lending… ...... 79 Table 2: Amongst the very few having floating provision policy within MFI space ...... 80 Table 3: Suryoday has been steadily maintaining ~5% cost-to-assets ratio since commencement of SFB operations… ...... 81 Table 4: Digitisation of processes reflects in lower printing, stationery, postage, etc. while lower business overheads per branch at Rs0.59mn vs Rs2mn-3.7mn for peers suggests efficient cost management ...... 83 Table 5: State-wise collection trend – Karnataka and Odisha leading while Maharashtra and Madhya Pradesh lagging ...... 88 Table 6: Product-wise collections – affordable housing and secured loans are showing resiliency, while CV and MFI appear most vulnerable ...... 88 Table 7: Product-wise provision coverage – total provision coverage (including floating provision) stands at 52% on GNPL portfolio and 84% on 90+ GNPA ...... 88 Table 8: Total NNPL + w/offs + ECLGS + restructuring stands at 12.6% as at Mar’21 .... 88 Table 9: Key digital capabilities...... 91 Table 10: Product description ...... 93 Table 11: Key features of inclusive finance vertical ...... 94 Table 12: Key features of commercial vehicle loans ...... 95 Table 13: Key features of affordable housing loans ...... 95 Table 14: Key features of Secured Business Loans (SBLs) ...... 96 Table 15: Key features of FIG loans ...... 96 Table 16: Relative peer valuations ...... 100 Table 17: Profit and Loss statement ...... 105 Table 18: Balance sheet ...... 105 Table 19: Key ratios ...... 106 Table 20: DuPont analysis ...... 107 Charts Chart 1: …as reflected in leverage not exceeding 4x, except in FY15 and FY16, in last 9 years ...... 79 Chart 2: Prudent lending approach with focus on penetration ...... 80 Chart 3: One of the lowest borrower outstanding as at Mar’21… ...... 80 Chart 4: …even while disbursing incrementally during covid, Suryoday continued to fund lower borrowing buckets ...... 80 Chart 5: …and even while adding infrastructure at accelerated pace vs peers ...... 82 Chart 6: Sustaining business productivity even during expansion phase suggesting improved business from legacy infrastructure ...... 82 Chart 7: Asset-light unique distribution strategy ...... 82 Chart 8: Retail deposit share is one of the highest at 80% vs <60% for peers… ...... 84 Chart 9: …driven by strategic focus on metro market, diversified product offerings, and dedicated liability team ...... 84 Chart 10: Ujjivan group structure ...... 84 Chart 11: Equitas group structure ...... 84 Chart 12: No mandatory requirement for Suryoday to bring down promoter holding in the near term ...... 85 Chart 13: Steady improvement in GNPL was witnessed post demonetisation, but covid-led disruption resulted in GNPL increasing to 9.4% in FY21 ...... 85 Chart 14: Segment-wise NPLs...... 86 Chart 15: Revamped credit processes and robust risk management framework ...... 87 Chart 16: Steady improvement in collection efficiency since Jun’20; resurgence of covid derailed the momentum ...... 87 108 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities Chart 17: Movement in PAR portfolio – PAR1+ at 21% as at Mar’21 is broadly at Jun’20 level ...... 88 Chart 18: Turnaround time reduced to 5 days from 11 for MFI loans...... 89 Chart 19: Share of customers having both, asset and liability products, jumped to 33% by Mar’21 ...... 90 Chart 20: Increasing penetration of debit card issuances ...... 90 Chart 21: Debit card transactions steadily improving ...... 90 Chart 22: Increasing internet banking transactions ...... 91 Chart 23: Steady improvement in mobile banking platform adoption ...... 91 Chart 24: Affordable housing and SBL have been key credit growth drivers in the recent past… ...... 93 Chart 25: …CV and affordable housing have been key growth drivers ...... 93 Chart 26: Deposits outpaced AUM growth in recent past… ...... 98 Chart 27: …with increasing share of retail deposits at 80% as at Mar’21 ...... 98 Chart 28: CASA share sharply increased to 15.4% in Mar’21 ...... 98 Chart 29: Deposit mix as of Mar’21 ...... 98 Chart 30: Steady improvement in cost of funds (CoF) led by changing funding mix in favour of deposits ...... 99 Chart 31: AUM CAGR likely to remain at 19% over FY21-FY23E; H1FY22E to remain subdued ...... 101 Chart 32: NIMs to settle at ~8% in the medium term ...... 102 Chart 33: Focus on sweating existing assets ...... 102 Chart 34: Credit cost likely to moderate, but would yet be higher than the historical average ...... 103 Chart 35: Return ratios to gradually improve ...... 104 109 Suryoday Small Finance Bank, July 8, 2021 ICICI Securities This page has been intentionally left blank 110 Equity Research INDIA July 8, 2021 BSE Sensex: 53055 Ujjivan Small Finance Bank ADD ICICI Securities Limited is the author and Most diversified presence; asset mix shifting towards distributor of this report more stable secured loans in retail Rs32 Ujjivan Small Finance Bank’s (Ujjivan) core philosophy of driving business by FINANCIALS focus on digital capabilities, customer-centricity, and financial inclusion harmonises well with India’s increasing financial penetration, especially in rural areas. Its pan-India presence with no single state contributing >20% of AUM as at Mar’21, coupled with an evolving product portfolio, would enable it to outpace Target price Rs35 systemic credit growth once the macro turns conducive. While Ujjivan’s journey towards building secured assets is progressing well, its liability franchise is still Shareholding pattern evolving with retail deposits at 48% of total deposits and CASA ratio at 15%. Sep Dec Mar Subdued RoA in FY21 was an outcome of the bank recognising stress and ‘20 ‘20 ‘21 provisioning for it upfront – ~10% coverage on restructured book and 59% on Promoters 83.3 83.3 83.3 NPAs. While near-term asset quality concerns persist given it’s high exposure to Institutional investors 9.3 9.4 7.5 MFI segment, incremental focus on secured assets, healthy coverage on the MFs and others 0.8 1.1 0.7 existing stress pool, and provision buffer at 1% reinforces our view that Ujjivan FIs/Banks 0.0 0.0 0.0 FIIs 8.5 8.3 6.8 would deliver normalised RoA by FY23E. We initiate coverage with an ADD rating Others 7.4 7.3 9.2 and target price of Rs35, valuing the stock at 1.8 FY23E BV. Pan-India presence with no single state contributing >20% of AUM. Ujjivan, being in an unsecured lending business (predominately MFI) and taking cognisance of the segment’s vulnerabilities to external events like natural calamities, elections, Price chart etc. has built a most diversified presence with no single state contributing >20% of 70 AUM. Its pan-India operations with presence in 24 states/UTs and 248 districts 60 would help navigate credit cycles more effectively than peers. Further, its exposure 50 to diverse geographies much earlier in the journey should help it build a proprietary 40 credit model on the back of its rich and relatively longer experience of working in (Rs) different regions. The same blends well with its long-term goal of providing banking 30 services to the underserved rural market across India in a cost-effective manner. 20 Focus on ‘digital banking’. Under the new leadership team, headed by Mr. Nitin 10 Chugh (took charge as MD & CEO in Dec’19), Ujjivan focused on building robust digital capabilities targeted towards improving efficiencies and better customer Jul-20 Apr-20 Jun-21 Feb-21 Dec-19 Nov-20 experience. End-to-end digital liability account opening, ~99% of borrower origination on handheld and paperless mode, reduction in TAT, improvement in productivity (steady decline in cost/income ratio) and increasing adoption of alternative channels, e.g. mobile banking, internet banking, etc. speaks of its digital transformation. Additionally, Ujjivan has implemented Open Banking, an API gateway to empower customers to meet all their business requirements on a single platform and develop new business opportunities by integration. Margin moderation to be offset by normalisation of credit cost and operating leverage. Changing asset mix in favour of the formal segment and secured products is likely to result in lower NIMs going forward. However, continuity of improving operational efficiency (C/I ratio fell to 60% in FY21 vs 67% in FY18) and gradual normalisation of credit cost from 5.5% in FY21 to 2.5% in FY23E, is likely to drive RoA to 1.8% by the end of the next fiscal. Key risks: A) higher slippages from restructured book, and B) delay in loan growth recovery. Market Cap Rs54.6bn/US$731mn Year to March 2020 2021 2022E 2023E Research Analysts: Bloomberg UJJIVANS IN NII (Rs mn) 16,336 17,286 19,212 22,338 Shares Outstanding (mn) 1,728.3 Net Profit (Rs mn) 3,499 83 825 4,338 Renish Bhuva 52-week Range (Rs) 43/27 EPS (Rs) 1.8 0.0 0.4 2.2 [email protected] +91 22 6637 7465 Free Float (%) 16.7 % Chg YoY 75.6 -97.6 894.3 425.7 Kunal Shah FII (%) 6.8 P/E (x) 17.7 745.8 75.0 14.3 [email protected] Daily Volume (US$/'000) 1,916 P/BV (x) 1.9 1.9 1.9 1.7 +91 22 6637 7572 Absolute Return 3m (%) Chintan Shah 2.3 BVPS (Rs) 16.5 16.7 17.1 19.4 [email protected] Absolute Return 12m (%) (14.5) Net NPA (%) 0.2 2.9 3.3 0.8 +91 22 6637 7658 Sensex Return 3m (%) 7.3 RoA (%) 2.2 0.0 0.4 1.8 Piyush Kherdikar Sensex Return 12m (%) 46.3 RoE (%) 14.0 0.3 2.5 12.3 [email protected] +91 22 6637 7465 111 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities TABLE OF CONTENTS What stands out for Ujjivan SFB ...... 113 Asset strategy – Gradually focuses on formal segment ...... 129 Key initiatives ...... 137 Valuations appear reasonable in relation to peers ...... 138 Financial outlook ...... 140 Pan-India presence, comprehensive product offerings, and vast untapped opportunity to drive >15% AUM CAGR over FY21-23E ...... 140 Changing asset mix in favour of secured products will weigh on NIMs; improving liability profile to partially offset adverse impact ...... 140 Enhanced digital capabilities to drive productivity improvement...... 141 Near-term asset quality concerns persist, but increasing share of secured assets to help lower credit cost in FY23E ...... 142 RoA likely to cross 1.5% threshold by FY23E ...... 142 Summary financials ...... 144 Annexure: Index of Tables and Charts ...... 147 112 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities What stands out for Ujjivan SFB Most diversified geographical presence enabled Ujjivan to navigate MFI-related challenges resulting from the covid-induced disruption better than peers. Historical events and its implication on MFI business, both in terms of asset quality and growth, suggests that building a diversified portfolio and presence is of utmost importance. Most players, having higher exposure in their respective home states, have understood this and are in the process of diversifying operations. Ujjivan is way ahead in building a diversified portfolio and, since the inception of MFI business in 2005, it has successfully built the most diversified portfolio within SFB space as at Mar’21. It serves >5mn customers with 575 branches (including 144 URCs) spread across 24 states / Union Territories covering 244 districts. Within the four listed SFBs, Ujjivan has the most diversified operations (geographically) and portfolio. Its top-3 states’ contribution in total AUM stands at the lowest for Ujjivan at <50%, while that of top-3 states in total AUM is much higher at >70% for other SFBs. Table 1: Ujjivan has the geographically most diversified portfolio… As of Mar'21 Ujjivan Equitas AU Suryoday Top-3 state contribution 43.5 78.0 70.0 72.0 Tamil Nadu 15.8 54.0 22.8 West Bengal 13.3 Karnataka 14.4 11.0 7.2 Maharashtra 9.7 13.0 13.0 34.2 Gujarat 8.3 4.0 10.0 8.8 Rajasthan 4.2 4.0 40.0 Odisha 2.7 15.0 MP 1.5 3.0 17.0 6.4 Bihar 6.1 Haryana 4.8 2.0 Assam 2.3 Uttar Pradesh 4.4 Punjab 2.4 5.0 Jharkhand 2.1 Kerala 1.6 Delhi 3.0 8.0 Tripura 1.1 Others 2.3 3.0 5.6 Source: Company data, I-Sec research Chart 1: …with share of its top-3 states in total AUM lowest at <45% Top-3 state's share in AUM as at March'21 80.0 78.0 70.0 72.0 70.0 60.0 50.0 40.0 43.5 30.0 20.0 10.0 0.0 Equitas Suryoday AU Ujjivan Source: Company data, I-Sec research 113 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Table 2: Pan-India focus with higher share from loans from South at 33% and deposits from North at 35%… As at Mar'21 South North East West Total Loans (Rs bn) 49 33 42 27 151 % of total loans 33% 21% 28% 18% Deposits (Rs bn) 35 46 20 30 131 % of total loans 27% 35% 15% 23% Employees 4,788 3,844 5,331 2,608 16,571 Loans per employee (Rs mn) 10.3 8.5 7.9 10.4 Deposits per employee (Rs mn) 7.4 12.0 3.7 11.6 Source: Company data, I-Sec research Deep penetration via its distribution network across 24 states / UTs covering 248 districts has enabled Ujjivan to develop expertise to understand and differentiate customers on the basis of their specific requirements. Its established distribution network and relationships with customers helped it offer customised products that include a wide range of asset and liability products. It also distributes third-party insurance products from various insurance companies to customers. We believe Ujjivan’s diversified operations and understanding of customer requirements would help it establish a strong liability franchise and navigate challenging events (in any state-specific disruptions in MFI collections) better than peers. Chart 2: …with equal focus on ex-rural markets Rural, 7% Metro, 31% Semi-urban, 28% Urban, 34% Source: Company data, I-Sec research Chart 3: Ujjivan successfully navigated state-specific issues – diversified operations came to rescue 8.0 Asset quality Ratios 7.1 7.0 6.2 6.0 5.0 5.0 4.2 3.7 4.0 3.6 (%) Kerala flood Odisha flood Assam bill 2.9 2.7 3.0 2.3 1.9 1.4 2.0 1.4 1.0 1.0 1.0 1.0 1.0 0.9 0.9 0.9 0.8 0.7 0.4 1.0 0.3 0.3 0.3 0.3 0.3 0.3 0.2 0.2 0.1 0.1 0.0 0.0 Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 GNPL NNPL Source: Company data, I-Sec research 114 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Incrementally focuses on digital channels and partnerships to expand reach Ujjivan, under the new leadership of Mr. Nitin Chugh, in FY20 laid down its detailed strategy to build robust alternative delivery channels to cater to the underserved population in a most efficient and effective manner. Hence, by the time covid hit came, it was ready to combat the business challenges with digital services. Adoption of alternative delivery channels at a broader customer base remained untested and was increasing at a meagre pace. Lack of internet connectivity, limited alternative delivery channel options, lack of customer intent to switch to alternate channels were key reasons behind the lower adoption. However, with an increased adoption of the digital platform for various banking transactions due to the covid- induced nationwide lockdown, we believe that this is a good opportunity for Ujjivan to expand its digital initiatives and increase adoption of the digital channels. Chart 4: Robust alternative channel platforms Multiple delivery channels Personal & Business ATMs Web/ Tablet Based Phone Mobile App Internet banking 491 ATMs including 53 Origination 24x7 phone banking High customer rating of Web-based, can be ACR* machines Liability customer helpline 4.4/5 on Google accessed from any Customer alerts for acquisition from Loan on Phone for Playstore as of Mar’21 system each incorrect PIN anywhere using repeat GL customers – Highest among SFBs High volume bulk entry website Ability to service Nine languages option upload facility Green PIN facility 24/7 Tablet-based customer customers in 13 – English, Hindi, Customizable client for OIN change acquisition for loan Languages Kannada, Tamil, centric approval matrix Empowering products Missed call and SMS Bengali, Marathi, customers to Chatbot Aria to banking services Gujarati, Punjabi and block/unblock debit improve user Odiya card & set transaction experience Working on voice and limits through ATMs Door-step service; video enabled 12 regional languages faster, easier, better customer interface TAT Active users exceed 0.68mn as of Mar’21. Source: Company data, I-Sec research The covid crisis has forced incumbents to reimagine their business model in light of changing customer behaviour. Since the onset of the pandemic, the pace of digital service adoption suggests that digital banking will be a key driver of business in the post-covid era. Ujjivan has already initiated a series of strategic initiatives to remain ahead of the curve in the digital journey. It has developed contactless lending products, completely digital processes for better efficiencies and greater customer convenience. Ujjivan’s end-to-end digital processes for loans and deposits, robust mobile and internet banking platform, digital loan repayments, UPI QR code and fintech partnerships, will help it cater to the underserved population in a remote area most efficiently. Strategic initiative to improve adoption of alternative channels to expand reach and deliver value to customers To promote alternative delivery channels, and encourage cashless transactions and adoption of digital platforms, Ujjivan intends to set up a network of e-kiosks that would provide 24x7 access to its customers in their own neighborhoods. 115 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Upscale and improve the digital offerings to attract target ‘new-to-bank’ customers. Intend to explore strategic partnerships with fintechs to increase customer acquisition, reduce processing and onboarding costs, reduce turnaround time, and improve overall customer experience. Chart 5: The number of transactions increased 2x since the covid-led disruption; share of digital transactions stands at 57% as in Mar’21 Total transactions Digital transactions (RHS) 30 70% 59% 56% 56% 57% 25 60% 50% 20 35% 32% 33% 40% 15 27% (%) (mn) 30% 10 20% 5 10% 14.3 9.1 14.5 19.9 26.0 0 0% Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Source: Company data, I-Sec research Increasing share of retail (secured) portfolio to ensure long-term sustainable loan growth with better asset quality Ujjivan’s transformation from erstwhile NBFC to its current SFB avatar, was relatively more challenging operationally as well as execution-wise. Post commencing SFB operations in CY17, unlike Equitas and AU (who were already having diversified asset mix), Ujjivan had to focus on building its secured book simultaneously with liability franchise and managing costs. The share of secured loans improving to 27% by Mar’21 from almost nil in Mar’17, complemented by pristine asset quality (~90% collections in vehicle, affordable housing, secured MSE and institutional lending in Apr’21), speaks of Ujjivan’s superior execution of asset diversification strategy. Chart 6: The share of secured loans increased to 27% by Mar’21… Secured loans % of total loans 30% 25% 27% 20% 22% 15% 14% 10% 5% 5% 0% FY18 FY19 FY20 FY21 Source: Company data, I-Sec research 116 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Ujjivan started its lending business as a single product company in CY05 – with the focus to provide a full range of financial services to the financially unserved and underserved segments in India, not having access to formal financing and other banking services. While it forayed into MSE financing (unsecured) to leverage MFI customer base prior to SFB conversion, it began asset transformation journey immediately after getting SFB license in CY17. Since CY17, with a customer-centric approach and ability to offer multi-products under its SFB avatar, Ujjivan has been incrementally focusing on diversifying its asset mix in favour of secured loans. Strategically, to leverage its deep geographical reach with presence in 248 districts across India, expertise in underwriting small-ticket loans in remote areas and existing customer base, it focused on building tailor-made secured loan products suitable to its catchment areas. Over the past 4 years, Ujjivan launched a series of secured products, e.g. SME loans, affordable housing, vehicle loans – two-wheeler (2W) and E-3-wheeler (E-3W), etc. – complementing its product offering to mass underserved market. While it continued to grow the MFI book, it adopted a calibrated approach in incremental growth and stayed away from geographies where stress was building up. Most of its secured products are end-to-end digitally enabled, which makes its product offerings more competitive and easily accessible in remote areas. Chart 7: Evolution of asset products – focus on building a secured asset portfolio Microfinance Agri MSE Personal Gold loan - Group loans loans 2005 2005 2005 2012 2015-16 Aug’18 Sep’18 Oct’18 Oct’20 Microfinance Housing Financial Vehicle - Individual Institutions Financing loans Group Source: Company data, I-Sec research Chart 8: Since FY18, Ujjivan incrementally focused on building non-MFI biz Microfinance - Group loans Microfinance - Individual loans MSE Housing Agri FIG Gold loan Personal loans Vehicle Financing Others 100% 120 40 0 01 1 13 3 8 9 5 11 14 80% 8 7 8 10 11 60% 85 84 40% 76 66 59 20% 0% FY17 FY18 FY19 FY20 FY21 Source: Company data, I-Sec research 117 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 9: Over past 3 years, incremental growth Chart 10: …disbursement trend suggests strong was largely driven by secured loans… traction in secured loans is likely to continue 250% FY19-21 loan cagr 100% Disbursement trend 200% 210% 80% 92% 150% 87% 84% 83% 83% 81% 80% 78% 76% 76% 140% 60% 74% 100% 50% 70% 40% 17% 57% 48% 38% 3% 0% 20% 13% FIG 8% Agri MSE 26% 24% 24% 17% 19% 22% 17% 16% 20% Housing 0% Total AuM Total loans Microfinance - Microfinance Individual loans Individual Personal Loan, Personal Q4FY18 Q3FY19 Q4FY19 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Vehicle loan, Staff… loan, Vehicle Microfinance - Group Microfinance Microbanking disbursements Non - Microbanking disbursements Source: Industry data, I-Sec research Source: Industry data, I-Sec research *Microbanking includes group loans and Individual loans – mostly unsecured. *Non-microbanking includes MSE, gold loans, vehicle, affordable housing, agri loans, FIG etc. – mostly secured. Digital transformation – Key driver to efficiency and productivity improvement going forward Ujjivan reimagined its entire business model (right from customer onboarding to transaction) under the new leadership of Mr. Nitin Chugh (took charge as MD & CEO in Dec’19). It penned down a detailed strategy to emerge as a complete digitally enabled ‘new-age SFB’. In the process of building robust digital banking and analytics platform, it focuses on the optimal use of advanced, cost-effective technology in every banking process and further intends to strategically invest in technology to offer a convenient and secured banking experience to its customers. To make the partnership model more effective and cost-efficient, Ujjivan has set up an innovation centre, to explore potential tie-ups with new-age fintechs. All potential collaborations undergo an evaluation through a PoC (Proof of Concept). The collaboration becomes live only after successful completion of the PoC and necessary clearances. We believe, the PoC model will help the bank emerge as a leading partner for fintechs, thereby ensuring steady growth for both. Key strategies: To build a user-friendly digital interface to extend the bank’s reach and offer a strong banking platform and focus on user adoption with programs like Digibuddies-led digitisation initiatives at branches, which are helping customers embrace various digital platforms. Invest in API platform, innovations, and fintech partnerships to widen and deepen product offerings / banking services to the mass market. Invest strategically to integrate technology into operations to empower customers, reduce costs and increase efficiencies. Adopt robotic processes to automate operational processes to the extent possible. Data analytics to be used to offer customised solutions and improve cross-sell / upsell. Establish Ujjivan as a modern technology-enabled bank. 118 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Table 3: Highlights of key digital initiatives Segment Digital capabilities Collaborated with Rupee Power — a leading credit origination platform (CreditOn) —which will enable end- Assets to-end digital customer acquisition, credit assessment, KYC and loan processing across its products. I. Microbanking Tie-up with Airtel Payments Bank and PayNearby to facilitate cashless repayments. Digital on-boarding system live across branches II. Affordable Housing Digital & Hub based disbursements – adapting to the new normal assuring business continuity; 30% reduction in disbursal TAT III. MSE LOS Mobile sourcing solution piloted in Q4 across 5 locations, with full-fledged launch planned for Q1-FY22 Fintech tie-up went live in Mar’21 and May’21 IV. Personal loans End-to-end digital product: Using tech service provider, focus on making whole flow digital and contactless V. Vehicle Launched digital LOS for two-wheeler products; FY22 to see increased adoption Liability Launched digital SA / FD – providing an end-to-end un-assisted digital journey to onboard new customers. Third-Party Digital Insurance distribution project in final phase of IT development for 1st phase plan. I. Insurance Revamped Hospi-Cash product in Aug’20 – complete digital product – onboarding, payment and policy delivery. Proposal accepted by IRDA to digitise Hospi-Cash claims. Deployment in progress. II. Mutual Funds Evaluating tech vendors in progress for digitising solutions for mutual funds and Atal Pension Yojana. Process & Customer service Digital collections remain stable contributing an average of 18% of microbanking and rural banking collections for FY21 Expansion of collection points through fintechs (PayNearby, SETU) and payments bank (Airtel) has contributed I. Collections to 40% of overall collections in Q4FY21; >10,000 fintech partner outlets activated pan-India. Self-repayment modes like BBPS* have seen substantial uptick with MoM growth of 15% overtaking direct cash deposits at collection points. Ujjivan offers 159 API’s, which cover most of banking transactions and requirements such as customer onboarding for liabilities & assets, service requests, and all types of payment services II. API Banking & Seven APIs listed on NPCI’s API Aggregator portal – nfinite.in (among the first 2 banks whose APIs are listed Fintech here). partnership Six fintech partnerships live – 3 for loan repayments and 3 for digital lending to personal loans and MSE customers. Q4-FY21: Twelve processes across business verticals are completely automated, leading to substantial savings. As per internal analysis, 99% accuracy has been achieved for most processes. III. Robotic Process Automation Fifteen processes to be automated by Q1FY22, with targeted automation of 15 processes every quarter. Limited human contact in loan processing (repeat microbanking loans via phone, mobile app and ATM among others, remodelling housing/MSE processes and prioritising video KYC programme). For ‘Existing to Bank’ customers, Automated Customer Engagement (ACE) platform has been implemented for IV. Enhancing improved customer engagement and enriching Customer Life-Time Value (CLTV). customer Machine learning based customer segmentation models have helped identify and target potential customers for life cycle value cross-sell and upsell opportunities Source: Company data, I-Sec research Process automations: Ujjivan intends to automate most operational processes for better efficiency by adopting robotic inputs and limiting human intervention to the extent possible. It plans to leverage data analytics for customer segmentation and targeted offerings tailored to customer needs, targeted marketing, faster and better credit decisions and proactive risk management. It also intends to shift from providing personalised services to more self-assisted services using handheld devices and phone / internet banking services. Bank is now live with an end-to-end digital account opening solution for all customers. A dedicated team for Robotic Process Automation (RPA) has been created for a focused approach towards exploring areas where technology can help reduce TAT, resource consumption, etc. Reconciliation is one of the activities currently enjoying the benefits of RPA. Ujjivan has enabled paperless and handheld device-based loan origination and cashless disbursements with remittances directly credited to customers’ accounts. 119 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities It collaborated with Rupee Power — a leading credit origination platform (CreditOn) — which will enable end-to-end digital process for customer acquisition, credit assessment, KYC and loan processing across products. The platform helps in real-time credit decision-making, fraud detection and digital KYC with sales underwriting workflows, while exposing these services to lenders’ sales, digital and banking channels through APIs, mobile apps and microsites. The loan origination system (LOS) comes with various features such as data entry of customers, eligibility check, real-time credit decisioning, disbursements and tracking case documents. It offers its relationship officers an easier way of doing business. Ujjivan implemented Open Banking, an API gateway that provides its partners with an opportunity to collaborate with Ujjivan. This empowers customers to meet all their business requirements on a single platform and develop new business opportunities by integration. Chart 11: Improved turnaround time (TAT) since the implementation of tablet- based loan origination system TAT in days 25.0 24.0 22.5 20.0 21.5 19.5 15.0 10.0 5.0 6.9 4.2 4.9 2.9 0.0 Group loan Individual loans MSE loan Affordable Housing 2018-19 2019-20 Source: Company data, I-Sec research Improved adoption of digital services All branches of Ujjivan are optimally equipped in terms of personnel, infrastructure and products. It intends to offer a standardised experience across all branches to its customers. It encourages and empowers customers via Digibuddy at branches, who assist customers in conducting banking operations through secure digital channels, including internet, phone and mobile banking. Further, to enhance adoption of digital channels among the underserved segment, it has undertaken measures to improve mobile application by activating voice-enabled and gesture-enabled interfaces in regional languages. Concentrated efforts on customer awareness about its enhanced digital platform, and covid accelerated the pace of digital banking adoption. 120 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 12: Increasing share of digital transactions Total transactions Digital transactions (RHS) 30 70% 59% 56% 56% 57% 25 60% 50% 20 35% 32% 33% 40% 15 27% (%) (mn) 30% 10 20% 5 10% 14.3 9.1 14.5 19.9 26.0 0 0% Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Source: Company data, I-Sec research Chart 13: Active customer base using internet & Chart 14: Enhanced net banking platform resulted mobile banking platform jumped 1.6x over past in high adoption by SMEs one year Trend in active users Business Net Banking 800 2,500 16.0 14.6 774 700 14.0 685 2,000 600 10.3 12.0 603 500 1,500 10.0 532 7.4 400 474 8.0 5.6 bn) (Rs 1,000 6.0 300 3.5 4.0 200 500 2.0 72 78 100 48 59 66 1,164 1,416 1,638 1,775 2,045 0 0.0 0 Mar'20 June'20 Sep'20 Dec'20 Mar'21 Internet Banking active users ('000) Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Mobile Banking active users ('000) Active customers Value (RHS) Source: Industry data, I-Sec research Source: Industry data, I-Sec research Chart 15: UPI transaction value jumped 3.5x over Chart 16: Increasing customer engagement as past one year reflected in 30% YoY growth in average ticket-size since covid onset UPI transaction 2.5 POS transaction trend 1,500 8,00,000 25.0 1,338 1,325 6,80,321 1,266 7,00,000 2.0 1,300 20.0 6,00,000 5,57,743 21.1 1,020 4,59,097 1.5 986 1,100 5,00,000 15.0 3,77,162 16.6 4,00,000 3,12,165 1.0 900 (Rs) 3,00,000 10.0 bn) (Rs 10.9 2,00,000 bn) (Rs 0.5 700 5.0 1,00,000 6.1 5.2 1.4 1.4 1.0 1.0 1.2 1.6 1.4 1.8 1.5 2.0 0.0 500 0 0.0 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 POS Transactions (nos mn) Values Active customers Value (RHS) Average ticket size (RHS) Source: Industry data, I-Sec research Source: Industry data, I-Sec research 121 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Asset quality – Managed well but ‘high touch’ model poses risk of higher stress in near term Redefined business model with higher focus on secured loans and calibrated approach in growing MFI book, post demonetisation, complemented with diversified operations helped Ujjivan maintain best-in-class asset quality in recent years. Since CY17, GNPL has steadily declined and normalised to sub-1% between FY19-FY20 and, similarly, credit cost too remained sub-1% during the same period. Robust repayment rate and stable asset quality pre-covid is also an outcome of its stringent credit risk monitoring policies like account monitoring designed to identify and facilitate corrective action for weak accounts, portfolio monitoring aimed at identifying credit stress in specific sectors and geographies ahead of industry, etc. Key learnings from demonetisation: Focus on customer services rather than on collections in crisis time. Stand with customers in challenging times and, if needed, extend small credit line to help them come out of the crisis. Most likely, customers will settle all repayments once they start generating cashflow from business. Ujjivan recovered Rs1bn during past 4 years from demonetisation-related total written- off portfolio of Rs3bn. Calibrated and prudent lending: When times are good, don’t rush for growth, but first test the market, understand the customer’s need and credit behavior, and then expand AUM in a calibrated manner. Chart 17: There was steady improvement in asset quality post-demonetisation, but covid onset resulted in GNPL reaching historical peak 8.0 Asset quality 7.1 7.0 Post Demonetisation Covid impact 6.0 4.8 5.0 4.0 3.7 3.6 (%) 2.9 3.0 2.1 2.0 1.0 1.0 1.2 0.7 0.9 1.0 0.3 0.3 0.20.0 0.0 0.2 0.2 0.0 FY16 FY17 FY18 FY19 FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 GNPL NNPL Q2FY21 & Q3FY21 asset quality ratios are on proforma basis. Source: Industry data, I-Sec research 122 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 18: MSE segment appears most vulnerable; unsecured MSE loans contributed to asset quality woes 7 Segment-wise NNPL 6 6.4 5 4 3 2.8 2 2.2 1.7 1 0.6 0.5 0.1 0.2 0.3 0.9 0.4 0.1 0.1 1.1 0.4 0 FY18 FY19 FY20 FY21 Group Loan Micro Individual Loan MSE Housing In FY21, NNPL is reported on consolidated basis for Group Loan & Micro Individual Loan Source: Industry data, I-Sec research Chart 19: Maharashtra and Assam witnessing lowest collections at 74% and 66% respectively in Apr’21 MicroBanking collection trend 100% 90% 80% 94% 92% 92% 90% 89% 89% 88% 87% 87% 87% 87% 87% 85% 70% 84% 80% 78% 60% 74% 74% 72% 50% 66% 40% 30% 20% 10% 0% West Bengal Punjab Maharashtra Assam Dec'20 Jan'21 Feb'21 Mar'21 Apr'21 Source: Industry data, I-Sec research Covid onset in early FY21 impacted asset quality, specifically in MFI portfolio given its ‘high touch’ collection model. Considering the highly uncertainty around cashflow generation and inability to meet customers due to nationwide lockdown, MFI borrowers were granted a complete payment holiday (morat 1.0) for almost 3 months. Ujjivan adopted a differentiated approach during the pandemic to improve collections once moratorium is lifted, which includes: Focused approach on collections with a strengthened collection team. Continued touch with regular and non-paying customers. Remodelling processes to suit post-covid business arena: limited human contact in loan processing, prioritising video KYC program in housing / MSE loans. Repeat microbanking loans via phone, mobile app, ATM MSE pre-qualified loan program based on track record ‘Loan against rent receivables’ is being launched to target Ujjivan premise owners. 123 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Partnering with fintechs and startups operating in payments, collections, lead generation, lending, etc. to expand reach inorganically. Redefining internal workflow, identifying areas and piloting projects for automation and productivity improvement. Rolled-out moratorium 2.0 on an ‘Opt-in’ basis and focus plan for customers for who have availed of moratorium. Tie-up with Airtel Payments Bank and business correspondents to increase reach; to give flexible and multiple modes of collections apart from traditional centre meetings / door-to-door collections. Renewed thrust on enabling EMI repayments through online payment platforms like ECS, e-wallets, UPI / QR, etc. and drive higher usage. Chart 20: PAR peaked out at 16.8% in Q2FY21, but Chart 21: ‘Portfolio at risk’ is highest in MSE book, near-term concerns persist due to resurgence of but it contributes only 8% of AuM as at Mar’21 covid Portfolio At Risk 18 25.0 23.3 72.0 80.0 16 16.8 16.2 70.0 14 20.0 14.9 60.0 12 15.8 50.0 10 15.0 8 10.3 40.0 6 10.0 8.4 30.0 4 14.0 20.0 5.0 8.0 2 4.0 1.8 1.6 2.1 2.0 1.8 2.0 10.0 0 0.7 0.0 0.0 MSE MR & RB Housing FIG Others Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Portfolio At Risk (segment wise) % of AUM Source: Industry data, I-Sec research Source: Industry data, I-Sec research Covid resurgence derailed the collection trend as reflected in Apr’21 collections falling to 89%, similar to Oct’20 collections and further expected to decline in May’21 considering 15% portfolio at risk as at Mar’21. We believe increasing share of secured loans and calibrated approach in MFI book would help Ujjivan improve its asset quality on sustainable basis in the long term. However, near-term asset quality concerns persist given NNPL at 2.9% (~59% PCR) and restructured pool of 6.8% as at Mar’21. Table 4: Trend in collections – Apr’21 collections fell 89% due to lower collections in unsecured MSE segment and microbanking Mar'20 Apr'20 May'20 Jun'20 July'20 Aug'20 Sep'20 Oct'20 Nov'20 Dec'20 Jan'21 Feb'21 Mar'21 Apr'21 Total collections 93% 5% 16% 54% 61% 69% 84% 88% 89% 94% 92% 92% 94% 89% Microbanking 93% 2% 14% 53% 60% 68% 83% 88% 89% 94% 92% 92% 94% 88% MSE 82% 19% 17% 46% Secured 57% 64% 64% 81% 86% 88% 90% 90% 89% 90% 87% Unsecured 30% 48% 44% 62% 67% 67% 69% 66% 62% 63% 48% Affordable Housing 94% 32% 33% 53% 67% 71% 92% 93% 94% 94% 94% 94% 96% 91% Personal Loans 91% 44% 38% 63% 62% 62% 79% 88% 88% 89% 91% 90% 91% 88% Vehicle loans 95% 33% 23% 71% 72% 68% 92% 91% 96% 97% 97% 88% 99% 96% FIG 100% 77% 67% 86% 100% 100% 100% 100% 100% 99% 98% 98% 98% 98% Source: Industry data, I-Sec research 124 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Business operations stabilizing; steady improvement in efficiency and productivity led by optimum use of technology Post getting the in-principle approval to set up as an SFB, the most challenging task was to realign the erstwhile NBFC model to an SFB compliant model, which was not only time consuming but also costly. However, Ujjivan approached the transition in a most effective manner by expanding footprints initially to capture the market and then focus on driving efficiency and productivity. In past 4 years, it focused on equipping branches with adequate manpower (~29 employees per branch), full range of banking products and latest digital banking platforms. Further, with most back-end operations being digitised, physical branches mostly act as customer acquisition, retention and brand building tools. Since the commencement of SFB operations in CY17, total branch network grew at 6% CAGR and employees grew at 13% CAGR between FY17-FY21. Ujjivan has achieved strong growth in advances and deposits by providing user- friendly end-to-end digital banking services through the optimal use of advanced, cost- effective technology and analytical tools. These digital platforms and analytical tools has also helped Ujjivan in the process and cost optimisations, as reflected in improved cost-to-income ratio and operating expenses/average assets of 60% and 6.3% in FY2021 vs 67% and 8.2% in FY20 respectively. As a modern, technology-enabled bank, Ujjivan has built cutting-edge digital capabilities for all stakeholders including employees, customers, regulators and management. It plans to leverage its front-end technology platforms to further improve customer acquisition and transaction management. This, coupled with neo-banking services, will also make it easier for customers to manage their transactions, while facilitating significant cross-selling opportunities for Ujjivan. Front-end technology: Company’s full range of alternate banking channels like mobile banking, internet banking, missed call services, SMS banking, ATMs and ACRs is allowing the customers to access banking services round the clock from the convenience of their homes and neighbourhoods. It has empowered its relationship officers and branches with multi-functional handheld devices and various software solutions (such as customer relationship management, loan origination systems and collection management systems) to deliver products and services to customers at their doorstep. Back-end technology: At the back-end, Ujjivan has put in place an array of solutions such as loan management system, core banking solutions, customer relationship management solutions, credit decision rule engine and enterprise risk management solution to provide timely delivery of products and services to customers as well as create a secure banking environment. Key initiatives to improve productivity and efficiency: Ujjivan intends to automate the operational processes by adopting robotic processes in order to become faster and efficient. In phase-I, >100 processes are being automated, which will lead to improved efficiency and cost benefits. Fully digitised onboarding for all asset and liability products – onboarding processes like statement analysis, document verification, e-agreements, e- 125 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities mandates – are now operational. TAT for various processes in the onboarding journey reduced by 70-90% and processing capacity increased by 30-70%. In order to enhance adoption of digital channels among the underserved segment, the bank has undertaken measures to improve its mobile application by activating voice-enabled and gesture-enabled interfaces in regional languages. Use of data analytics to do better customer segmentation and understand their evolving requirements leading to new product development, faster and better credit decisions and proactive risk management. To move from person-to-person services to providing technology-assisted services using handheld devices and phone banking services to the entirely self-service model through the use of internet and mobile banking. Chart 22: Initial transition phase utilised to build Chart 23: …incrementally focuses on productivity infrastructure… and cost optimisation Branches Employees (RHS) Cost / Assets Cost / Income (RHS) 700 20,000 10.0 120.0 17,841 16,571 18,000 9.0 95.3 600 100.0 14,757 16,000 8.0 500 14,000 7.0 76.5 80.0 11,242 67.1 67.4 12,000 6.0 400 10,167 60.3 10,000 5.0 60.0 300 8,000 4.0 40.0 200 6,000 3.0 4,000 2.0 100 20.0 2,000 1.0 457 464 524 575 575 1.5 7.3 8.6 8.2 6.3 0 0 0.0 0.0 FY17 FY18 FY19 FY20 FY21 FY17 FY18 FY19 FY20 FY21 Source: Industry data, I-Sec research Source: Industry data, I-Sec research Chart 24: Improvement in employee productivity... Chart 25:... as well as branch productivity 10.0 Employee productivity 300.0 Branch Productivity 9.0 250.0 8.0 8.7 7.9 7.0 7.9 252.1 200.0 244.2 7.2 6.0 228.4 6.5 201.4 5.0 6.0 150.0 5.8 187.5 4.0 5.0 100.0 158.1 3.0 140.8 128.3 3.4 2.0 50.0 81.3 1.0 4.5 0.2 0.0 0.0 FY17 FY18 FY19 FY20 FY21 FY17 FY18 FY19 FY20 FY21 Deposits per employee Advances per employee Deposits per Branch Advances per Branch Source: Industry data, I-Sec research Source: Industry data, I-Sec research We believe that greater adoption of its digital service delivery mechanisms is likely to drive cost-efficiency and data analytics to ensure better target customer profiling, customised and tailor-made products to suit the diverse requirements of underserved mass populations. 126 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Comprehensive product offering – complementing its deep distribution reach Ujjivan’s vision is to become a ‘new-age digital bank’, a one-stop-shop for financial services, delivering quality products and solutions, along with a personalised customer experience to a diversified customer base. It constantly conducts qualitative and quantitative research to understand the changing requirements and expectations of its target customers and the same reflects in its comprehensive suite of 103 asset and liability products. In FY20, 63% of the customers were using 3 or more banking products (from Ujjivan). Incremental focus on formal segment for expanding liabilities and asset products: With the availability of funds at cheaper costs due to strong deposits mobilisation post SFB conversion, Ujjivan incrementally focuses on tapping formal segments to bring quality into liabilities and asset products. While it continues to focus on informal segments like small traders, etc., incrementally it focusses on getting into more formal segments like manufacturing, large service units, etc. by offering MSE, housing, personal and vehicle loans, and expecting these segments to be major contributors in credit growth in near-to-medium term. Ujjivan is also focusing on developing products and services designed for rural and urban mass retail customers, specifically digital savings products for younger customers who have just entered or are entering into banking channels, and salaried savings accounts with organisational tie-ups. Chart 26: Comprehensive banking product and service offerings Loan Products Microbanking MSE Loans Affordable Housing Vehicle Loans Personal Loans FIG Group Loans Secured Loans 2W loans Loans to salaried Term loans to Individual Loans Enterprise and Construction and MMCV Loan customers NBFCs and MFIs Business Loans Purchase Top-up Loans – Electric 3W Self-employed CC/OD and group loan Business Edge Home Small commercial professional loans WCDL to NBFCs Agriculture & Loans and Improvement vehicle(SCV) Small-ticket and MFIs allied loans Overdrafts Composite Home 3W - ICE personal loan with Gold loans LARR* Home Equity Used Car loan# fintech Street vendor Overdraft with Loans partnership loans fintech Commercial partnership Purchase Loans Top-up Loans – individual loans# Loan against Micro – LAP# property Deposit Products Third-Party Products Retail Products Institutional Products Fee-based Products Current Account Fixed Deposit Insurance Savings Account Term Money APY Term Deposit Current Account Aadhar enrolment services Goal-based Savings Certificate of Deposit CMS Digital Savings & FD Collection/Escrow Account# Mutual Fund# Call money products# G-Sec trading# Source: Company data, I-Sec research *Loan against rent receivables #Work in progress 127 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 27: Comprehensive product offering coupled with data analytics resulted in improving ‘products per customer’ ratio Customer penetration 7.0 1.9 2.0 1.6 1.8 6.0 1.6 5.0 1.3 1.4 1.0 4.0 1.2 1.0 3.0 0.7 0.8 0.6 2.0 0.5 0.6 0.3 0.4 1.0 0.2 4.6 4.9 5.1 5.3 5.5 5.5 5.7 5.9 0.0 0.0 Q4FY19 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Total Active Customers Active Asset Only Source: Company data, I-Sec research 128 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Asset strategy – Gradually focuses on formal segment Key asset strategy Ujjivan is likely to follow going ahead: Realign AUM mix with micro and non-microbanking shares at 50%-50% over next 3 years from currently 72%-28% respectively. Improve share of secured portfolio to 40% within next 3 years from currently 27%. Affordable housing and MSE segments to remain key non-microbanking growth drivers in the medium term with focus on the formal segment. . Ujjivan has improved its internal processes by way of digitisation and the focus on productivity resulted in an-time high disbursement in Jan’21. . MSE marked Ujjivan’s entry into the formal segment. To expand its target market and shift product mix to bring in a better quality of book, it plans to deal with more formal segments rather than only the informal and the semiformal. In Q3FY21, it had tied up with fintechs for supply chain finance and it believes partnerships like these are going to strongly supplement its growth, will come through these alternate channels. Personal and vehicle loans in the early stages, but Ujjivan plans scale them up in next 2-3 years. . Disbursement in personal loans and vehicle loans has shown strong traction in FY21 and, most importantly, the growth came from Ujjivan’s own channels rather than any high-cost third-party channel. Bank is also trying to partner with many fintechs for alternate distribution. Most importantly, most of its branches are now enabled to cross-sell vehicle loans and personal loans to branch customers. Gold loans: Ujjivan entered the gold loan space in Q3F21 and expects it to remain a focus product in FY22. Credit cards in FY22: Company also plans to introduce credit cards for its customers in FY22 and is already in discussion with credit card issuers. It is also exploring the opportunity to go down the path of the white labeled cards and then effectively learn the business to see if it is feasible to do it on its own. 129 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 28: Since FY18, incrementally it focuses on building non-MFI biz Microfinance - Group loans Microfinance - Individual loans MSE Housing Agri FIG Gold loan Personal loans Vehicle Financing Others 100% 120 40 0 01 1 13 3 8 9 5 11 14 80% 8 7 8 10 11 60% 85 84 40% 76 66 59 20% 0% FY17 FY18 FY19 FY20 FY21 Source: Industry data, I-Sec research Chart 29: Over past 3 years, incremental growth was largely driven by secured loans… FY19-FY21 loan cagr Microfinance - Group loans 3% Microfinance - Individual loans 38% MSE 48% Housing 57% FIG 70% Personal Loan, Vehicle loan, Staff Loan & 140% others Agri 210% Total AuM 17% 0% 50% 100% 150% 200% 250% Source: Industry data, I-Sec research Microbanking: Ujjivan focuses on improving household penetration. Currently, its microbanking customer base largely comprises women. It intends to offer MSE loans, vehicle finance and micro-loans against property to family members of Joint Liability Group (JLG) customers. It has also developed need-based products for small and marginal farmers and intends to develop more products to finance agriculture and allied activities. In microbanking, Ujjivan caters to over 4.7mn customers classified into 4 categories, viz. group loans, individual loans, rural banking, and Sampoorna Family Banking. 130 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Table 5: Key features of microbanking loans Segment Microbanking Agri Group Kisan Suvidha Kisan Pragati Asset Product Group Loan Individual Loan Loan Loan Card Type Unsecured Secured Rs2,000 to Rs30,000 to Rs60,000 to Rs50,000 to Ticket-Size Rs51,000 to Rs200,000 Rs60,000 Rs60,000 Rs200,000 Rs100,000 Tenure 1 to 2 Years Up to 2 Years 6 Months to 3 Years Up to 2 Years Up to 5 Years Loan book Rs108.7bn Customer Base 4.7mn+ ATS (Q4FY21) Rs38,463 Rs113,909 (trending up) Source: Company data, I-Sec research Group loans: Delivered through the JLG model. Company launched top-up loan (for short-term needs), which is disbursed within a day, one of the fastest services in the industry. Individual Loans: Targeted towards long-term group loan customers with a repayment track history who can become individual customers. Agri loans: Launched a new agri secure product, Kisan Pragati Card, to cover farmers’ credit requirement for agricultural and allied needs. Also, initiated Kisan Pragati Club, comprising 15-20 volunteer-farmers across 35 branches to promote customer engagement, disseminate the principles of development through credit and inculcate better repayment ethics (in short, to encourage good banking practices). Rural Banking: Agri group loans and Kisan Suvidha loans are offered in Ujjivan’s existing markets (Karnataka, Tamil Nadu, West Bengal, Odisha, Gujarat) as well as newer markets (Rajasthan and Uttar Pradesh). Sampoorna Banking: Company launched Sampoorna Banking to step forward in its motto of ‘building banking behavior’ among its microfinance customers and their families. This helped scale up individual lending via introducing goal-based savings to meet the family’s short- and long-term goals. The deposit base stood at Rs8.07bn as on March’20. More than 80,000 family members were covered through the Sampoorna Banking initiative. MSE segment – Incrementally focuses on formal segment. Ujjivan is widening its product portfolio to meet the diverse need of SMEs. It offers a range of loan and overdraft facilities to customers in this segment and intends to introduce bill discounting and non-fund based credit facilities too. Table 6: Key features of Micro and Small Enterprises (MSE) loans Segment Micro and Small Enterprises (MSE) OD against Business Edge Term Business Loan LAP Asset product Property Loan and Overdraft Type Secured Rs1mn to Rs0.3mn to Rs1mn to Rs2.5mn Rs2.5mn to Rs20mn Ticket-size Rs10mn Rs1mn Tenure 3 to 10 years Up to 1 year 3 to 7 years Loan book Rs12.9bn Customer base 14,500+ ATS (Q4FY21) Rs1.98mn (trending upwards sharply) Source: Company data, I-Sec research Ujjivan strategically tweaked its MSE business model in CY19 by: a) shifting focus on financing the formal MSE segment with 100% security, and b) discontinuing unsecured MSE lending from Sep’19. Higher stress from legacy unsecured MSE loans was the primary reason behind Ujjivan’s redefined SME strategy. Subsequently, it 131 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities hired a vertical head Mr. Rajiv Kumar Pathak (ex-HDFCB) a year ago and revamped the credit and underwriting process to ensure better quality growth in coming years. As per the renewed strategy, Ujjivan incrementally focuses on tapping formal segment customers with 100% security. The share of secured MSE lending book increases to 90% in the overall MSE book as at Mar’21. This formal segment of customers are largely onboarded on the basis of balance sheet or financials, GST details, etc., and they could be traders, small & medium scale manufacturers, etc. Ujjivan sources 70- 72% of customers in the MSE segment via its own channel and the rest via DSAs and connectors. To address stress in the residual unsecured portfolio, Ujjivan set up a dedicated collection team for recovery. It also activated branch sourcing of MSE customers, with their share reaching 14% as at 31st Mar’20 (4% a year ago). Chart 30: Strategic shift towards lending to formal Chart 31: …resulted in increase in MSE ticket-size MSE segment… ('000) Average Ticket size FY19-21 CAGR in Average Ticket size 45% 2,500 40% 1,980 40% 2,000 35% 30% 1,500 25% 1,110 1,010 940 1,000 20% 15% 500 10% 14% 88 114 11% 31 38 5% 9% 0 MSE Affordable Micro Group Loans 0% Housing Individual Loan MSE Micro Individual Group Loans Affordable Loan Housing March'19 March'21 Source: Industry data, I-Sec research Source: Industry data, I-Sec research Affordable housing – plans to scale it up to 18-20% of the AUM in medium term Ujjivan plans to scale up its business in the affordable housing segment in a calibrated manner by testing the new market with small ticket-size of Ujjivan offers an array of products ranging from small ticket-size home improvement loans to larger loans for purchase of ready housing units to help customers to meet their housing needs. It intends to collaborate with state housing boards for properties built by them for providing housing loans to the beneficiaries of such housing projects, as well as online aggregators to reach out to a larger potential customer base. With the introduction of credit-linked subsidiary scheme under the Pradhan Mantri Awas Yojana, Ujjivan finds significant opportunities to offer affordable housing finance products to existing and prospective customers. Given diverse regulatory regimes 132 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities across states regarding real estate and customer preferences, it worked on developing region-specific policies in FY21. Sourcing: 70% internal and 30% via DSAs, connectors, etc. Yields: 13-14% LTV: 50-55%. Table 7: Key features of Ujjivan’s affordable housing loans Segment Affordable Housing Construction and purchase, home improvement, composite home, home Asset product equity, commercial purchase Type Secured Ticket-size Rs0.2mn to Rs7.5mn Tenure 3 to 20 years Loan book Rs20.5bn Customer base 19,000+ ATS (Q4FY21) Rs1.11mn (trending upwards) Source: Company data, I-Sec research Vehicle loans. It focuses on secured lending towards 2-W and 3-W segments. Currently, 57% of the vehicle financing book comprises women customers and 74% are self-employed. In this segment, Ujjivan has entered into memoranda of understanding with select OEMs to provide customers with financing facilities for electric vehicles. It intends to expand its offerings to finance purchase of two-wheelers, three-wheelers, small commercial vehicles, and used cars. Table 8: Key features of Ujjivan’s vehicle loans Segment Vehicle Loans Asset product Electric 3W and 2W, MMCV and Used Cars Loans Type Secured Ticket-size Rs26,000 to Rs0.25mn (LTV - up to 95%) Tenure 1 to 3 years Loan book Rs0.12bn Customer base >1,800 ATS (Q4FY21) Source: Company data, I-Sec research Personal Loans: Ujjivan’s personal loan products and their delivery structure is specially aligned with needs of the salaried segment and we believe it will be a key enabler in scaling up the salary account program. Table 9: Key features of Ujjivan’s personal loans Segment Personal Loans Asset product Loans to Salaried Customers, self-employed professionals Type Unsecured Ticket-size Rs50,000 to Rs1.5mn Tenure 1 to 5 Years Loan book Rs0.79bn Customer base 5,300+ ATS (Q4FY21) Source: Company data, I-Sec research 133 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Strengthening liability franchise with granular retail and CASA deposits Ujjivan’s key focus, post SFB conversion, has always remained towards strengthening the liability franchise, primarily retail and CASA deposits, which put forth a stable, low-cost source of funding. Its diversified geographical presence, coupled with deep distribution ‘phygital’ network and customer-suited product offerings, enabled the company in building a sticky deposit base. Its deposit base expanded at a robust 52% CAGR during FY18-FY21, while contribution of retail and CASA deposits also increased from 11% in FY18 to 48% in FY21. Its CASA ratio improved to 21% in FY21 from 4% in FY18. Key actions taken: End-to-end digital account opening, Selfie account opening and other value-added digital offerings. Introduced simpler and user-friendly mobile app, with specific focus to on microbanking customers. Revamped Business Edge current account product, ‘RuPay Platinum’ debit card with lifestyle benefits, increase in cash deposit limits and Cash Management Services (CMS) proposition to address the needs of medium and large businesses. Privilege savings account: This offers superior banking services, such as unlimited free ATM transactions, higher transaction limits, complimentary RuPay platinum debit card with lifestyle benefits. New acquisitions in Privilege savings contributed Rs1.4bn in FY20 with an average ticket-size of Rs0.1mn. Garima savings account: This is targeted at women as the product has been named; it offers multiple customised benefits to women, including a maximum of 7% rate of interest on the savings account. Chart 32: Deposit growth continues to outpace Chart 33: …with increasing share of retail AUM growth… deposits Deposits YoY growth (RHS) Deposit mix as at March'21 140 120% CD, 3% 120 100% Saving a/c, 96% 17% 100 80% 80 Current a/c, 3% 60% Bulk TD, (Rs bn) (Rs 46% 60 46% 40% 40 22% 20% 20 Retail TD, 38 74 108 131 30% 0 0% FY18 FY19 FY20 FY21 Source: Company data, I-Sec research Source: Company data, I-Sec research 134 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 34: Retail deposit share increases to 48% as Chart 35: … similarly, CASA ratio witnssed steady at Mar’21… growth Retail deposits % of total deposits CASA ratio (%) 50 25 48 49 20 48 48 21 46 18 15 16 44 45 14 14 44 10 12 12 42 43 43 10 42 5 40 38 0 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Q1FY20 Q2FY20 Q3FY20 Q4FY20 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Source: Company data, I-Sec research Source: Company data, I-Sec research Chart 36: Sharp improvement in customer Chart 37: …with digital engine contributing ~15% acquisition in FY21… of new account openings 3,50,000 Customer acquisition 549 600 Liability customers sourced digitally 15% 3,00,000 500 15% 2,50,000 15% 400 2,00,000 277 293 300 14% 1,50,000 209 200 14% 1,00,000 14% 50,000 100 13% 1,20,128 1,59,029 1,68,344 3,15,827 13% 0 0 Q1FY21 Q2FY21 Q3FY21 Q4FY21 Liability customer acquisition 13% Customer acquisition per branch Q1FY21 Q2FY21 Q3FY21 Source: Company data, I-Sec research Source: Company data, I-Sec research Diversify Revenue Streams An important strategic focus of Ujjivan is to diversify the revenue stream by improving the non-interest income stream. Over a medium term, it expects to build a sustainable revenue stream comprising of fee and commission-based income by leveraging on its strong ‘phygital’ network, increasingly diversified product and service portfolio, and robust digital platform. Further, it plans to extensively use data analytics to improve cross-sell and upsell, and is also pursuing strategic relationships with corporate entities, the GoI and state governments, to expand the customer base. The inherent nature of its assets business gives Ujjivan an opportunity to build priority sector advances in surplus of the targets mandated by the RBI. Trading of priority sector lending certificates would continue to be an important source of fee income. 135 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 38: Diversifying revenue mix with focus on building sustainable non- interest income stream PSLC Income Third-party Products Rs0.29bn in Q4FY21 and Rs0.58bn in FY21 Rs0.1bn in Q4FY21 and Focused approach to maximise PSLC Rs0.2bn in FY21 income by way of automated tagging Current line of products – to be ramped and better timing up over medium-term Majority of portfolio is PSL-compliant Insurance: Life, General, Health vs the regulatory requirement of insurance maintaining 75% o Relevant benefits for target segment o Simple and easy process Other o Sold through branches and field staff Income Products under evaluation Fee-based and Others Mutual Funds National Pension Scheme Rs0.79bn in Q4FY21 and Rs2.33bn in FY21 Process improvement Automation and IT integration Processing fees Tick-based products AMC/NACH/ CMS fee Treasury Income Bad debt recovery and others Source: Company data, I-Sec research Chart 39: Processing fees and PSLC income contributed >75% of total core fees Core fee income break up as at FY21 Misc. Income, 31% Processing fees, 53% Insurance income, 10% Bad debts recovery, 5% PSLC income, 29% Source: Company data, I-Sec research 136 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Key initiatives Insurance Tying up with an InsurTech Riskcovry for digital distribution of insurance business through its API integration and the whole process of onboarding insurance customers will also get digitised. Amongst the very few players who would have digitised the whole end-to-end insurance workflow as an insurance distributor and not necessarily as a manufacturer. IRDA-certified professionals staff 95% of branches Revamped Hospi-Cash product in Aug’20: This is now a complete digital product including onboarding, payment and policy delivery. Proposal to digitise Hospi- Cash claims has also been accepted by the IRDA. Chart 40: Sharp uptick in retail insurance premium Chart 41: Retail insurance is driving fee income 1400 Insurance Premium 100 Fee income 90 1200 80 244 1000 70 40 800 147 60 50 25 (Rs mn) (Rs 600 mn) (Rs 40 924 400 30 727 50 20 35 200 10 0 0 Q4FY20 Q4FY21 Q4FY20 Q4FY21 Credit Life Retail Credit Life Retail Source: Industry data, I-Sec research Source: Industry data, I-Sec research Mutual funds Collaboration with BSE-Star to launch mutual fund distribution Ujjivan is evaluating tech vendors in progress for digitising solutions for mutual funds and Atal Pension Yojana. 137 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Valuations appear reasonable in relation to peers We understand that the transition phase from an NBFC to SFB (FY17-FY20) was challenging for Ujjivan and we believe it has done reasonably well as reflected in: 1) delivering 26% AuM CAGR over FY18-FY21 with successfully scaling down unsecured share to 73% in Mar’21 from >90% in Mar’17; 2) steady decline in cost/income ratio to 60% in FY21, with scope of further improvement; and 3) robust digital capabilities, which will ensure higher efficiency and better customer experience. Ujjivan’s higher exposure to vulnerable segments (MFI), hence higher credit cost at 5.5% (higher than credit cost post-demonetisation) in FY21 led to stock valuation settling much lower at ~2x vs >3x during the IPO. However, the company remained focused on pursuing its long-term asset strategy of building secured retail assets even during the pandemic as reflected in the strong 32% YoY growth in non-MFI assets during FY21. Further, the increasing share of retail deposits to 48% in FY21 from 44% in FY20, speaks of its better execution on building a granular liability base. While near- term asset quality concerns persist due to economic disruption led by resurgence of covid, we believe its accelerated stress recognition in FY21 would ensure credit cost not spilling over beyond FY22E. We initiate coverage on Ujjivan with an ADD rating and target price of Rs35, valuing it at 1.8x FY23E P/ABV. Our target multiple of 1.8x FY23E P/ABV is dictated by a likely RoA improvement to 1.8% in FY23E and >15% AuM growth over FY21-FY23E vs 7% in FY21. Key risks: i) Sharper margin deterioration due to stiff competition in formal segment lending, and ii) higher than expected credit cost. Table 10: Relative peer valuations P/E (x) P/BV (x) P/ABV (x) Particulars CMP Rating TP FY21 FY22E FY23E FY21 FY22E FY23E FY21 FY22E FY23E SFBs Equitas SFB 67 BUY 92 19.9 15.9 11.4 2.2 2.1 1.8 2.4 2.3 2.0 Ujjivan SFB 32 ADD 35 745.8 75.0 14.3 1.9 1.9 1.7 2.2 2.2 1.7 AU SFB 1,125 ADD 1,140 30.0 41.3 29.9 5.6 5.0 4.3 6.2 5.3 4.6 Suryoday SFB 212 BUY 310 189.7 44.9 15.7 1.4 1.4 1.3 N/A N/A N/A NBFC-MFIs CAGL 721 BUY 765 81.0 28.7 17.4 3.0 2.7 2.4 N/A N/A N/A Spandana 720 BUY 840 23.0 9.1 7.9 1.7 1.4 1.3 N/A N/A N/A EPS (Rs) BV (Rs) RoAA (%) RoAE (%) Particulars FY21 FY22E FY23E FY21 FY22E FY23E FY20 FY21 FY22E FY23E FY20 FY21 FY22E FY23E SFBs Equitas SFB 3 4 6 30 32 37 1.4 1.7 1.8 2.2 9.7 12.5 13.5 17.0 Ujjivan SFB 0 0 2 17 17 19 2.2 0.0 0.4 1.8 14.0 0.3 2.5 12.3 AU SFB 37 27 38 201 226 261 1.8 2.5 1.5 1.7 17.9 22.0 12.8 15.4 Suryoday SFB 1 5 15 151 155 169 2.4 0.2 0.7 1.8 11.4 1.0 3.1 8.3 NBFC-MFIs CAGL 9 25 41 237 263 304 3.4 1.0 2.4 3.4 13.2 4.1 10.1 14.6 Spandana 31 79 91 434 497 570 6.3 2.7 5.7 5.6 15.6 7.4 17.0 17.1 Source: Company data, I-Sec research 138 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 42: Trend in Ujjivan’s P/BV PBV 2.5 yr avg avg. + 1 SD avg. - 1 SD 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 Dec-19 Feb-20 Apr-20 Jun-20 Aug-20 Oct-20 Dec-20 Feb-21 Apr-21 Jun-21 Source: Company data, I-Sec research 139 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Financial outlook Pan-India presence, comprehensive product offerings, and vast untapped opportunity to drive >15% AUM CAGR over FY21-23E Transition from its erstwhile NBFC avatar to the SFB model resulted in a volatile AUM trajectory for Ujjivan. During the first couple of years, post commencing SFB operations, AUM growth fell to sub-18% between FY17-FY18 and it rebound to average 35% between FY19-FY20 given gradual operational stability. While covid-led disruption resulted in lowest (in past 7 years) growth in advances to 7% YoY in FY21, notably, the non-MFI portfolio reported strong 32% YoY growth during the same period. Further, Ujjivan’s pan-India distribution network (575 banking outlets), increasing share of high-growth segments like MSE, affordable housing, etc. and adequate capital with tier-1 at 25% would ensure it reaching normalcy quicker than peers. Considering the vast untapped opportunity at ~Rs10trn in small-ticket lending Ujjivan’s niche in small-ticket financing coupled with a diversified product mix would ensure it continues its industry-leading growth going forward. We estimate 16% AUM CAGR over FY21-FY23E, lower than the historical average given that H1FY22E is likely to remain subdued due to resurgence of covid cases. Chart 43: AUM CAGR likely to remain at 16% over FY21-FY23E; H1FY22E to remain subdued due to covid resurgence AUM YoY growth (RHS) 250 65% 70% 60% 200 46% 50% 150 40% 28% (%) 30% (Rs bn) (Rs 100 21% 19% 20% 18% 12% 50 7% 10% 54 64 76 110 142 151 169 204 0 0% FY16 FY17 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research Changing asset mix in favour of secured products will weigh on NIMs; improving liability profile to partially offset adverse impact Ujjivan’s focus on increasing its secured asset mix and accelerating lending to formal segment customers, and relatively higher competition, is likely to impact asset yields adversely in near term. Asset yield fell from 22% in Mar’18 to 20% in Dec’20 and 17% in Mar’21 (due to higher interest reversals) given that share of secured assets increased to 27% in FY21 from ~7% in FY18. While its liability profile is improving as reflected in retail deposits’ share increasing to 48% in FY21 from 44% in FY20, the relatively younger franchise would limit its ability to cut deposit rates in near future. However, change in borrowing mix towards deposits would drive lower cost of funds 140 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities and thus partially offset the adverse impact of lower asset yields on NIMs. Cost of borrowing steadily fell to 6.8% by Mar’21 from 9% in Mar’18. Chart 44: NIMs to settle at ~9% in medium term 14.0 NIMs 12.0 12.4 10.0 11.2 10.8 10.5 10.4 9.5 9.5 9.4 8.0 (%) 6.0 4.0 2.0 0.0 FY15 FY16 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research Enhanced digital capabilities to drive productivity improvement After expanding its reach (added 60 branches) and workforce (added ~3,500 employees) in FY19, Ujjivan focused on sweating its existing assets and building digital capabilities in subsequent years. It has enabled paperless and handheld device-based loan origination and cashless disbursements for its customers with remittances credited to their accounts. Since the commencement of its banking operations, ~99.5% of advances have originated through handheld devices. Further, it has developed an end-to-end digital account opening process for all liability customers. With the same branch network of 575, it delivered cumulative 35% advance growth in FY20-FY21 and delivered 33% deposit CAGR between FY19- FY21, while its cost-to-income ratio improved by >15% to 60% in FY21 from 77% in FY19. Most of its secured businesses are now breakeven at operating level. Chart 45: Focus on sweating existing assets Cost / Assets ratio Cost / Income ratio (RHS) 10.0 80.0 76.5 9.0 75.0 8.0 7.0 67.1 67.4 70.0 6.0 (%) 5.0 65.0 (%) 60.3 4.0 59.4 59.9 60.0 3.0 2.0 55.0 1.0 7.3 8.6 8.2 6.3 6.2 6.4 0.0 50.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research 141 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Near-term asset quality concerns persist, but increasing share of secured assets to help lower credit cost in FY23E Ujjivan, post commencing SFB operations, incrementally focuses on building secured assets and higher lending to formal segments. As a result, the share of secured assets increased to 27% in FY21 from sub-5% in FY18 and the trend is likely to continue going forward. Strategic shift towards secured and formal segment lending would help it gradually change its customer risk profile in favour of better quality. While higher proportion of unsecured assets (~73% in FY21) resulted in higher credit cost in FY21 at 5.5%, increasing share of retail secured assets and stringent underwriting & risk management is likely to help it contain incremental slippages lower in FY22E/FY23E than in FY21. PAR 0+ at ~20%, NPL coverage ratio at 59%, and restructured assets at 6.8% as at Mar’21 poses an upside risk to our credit cost assumption. Chart 46: Credit cost likely to moderate, but would yet be higher than the historical average 6.0 Credit cost 5.0 5.5 5.0 4.0 4.5 3.0 (%) 2.0 2.5 1.0 1.4 0.4 0.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research RoA likely to cross 1.5% threshold by FY23E Ujjivan’s SFB journey has been evolving well until FY20, with RoA crossing 2% and secured asset share increasing to 22% during the year. Retail deposit share has increased to 44% and there has been a steady decline in cost ratios since FY18. While covid-led disruption impacted financial performance significantly, business evolution continues with increasing share of retail deposits (~44% of total deposits) and retail advances (27% of loans) even in FY21. Further, over the past of couple of years, it built robust digital capabilities enabling lower cost of acquisition, better customer experience and improved cross-sell ratio. Combination of improving productivity and gradual normalisation of credit cost would offset the likely margin compression due to higher share of better quality assets going forward. Overall, we expect RoA to improve to 1.8% and RoE to >12% by FY23E. 142 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 47: Return ratios to improve gradually RoA RoE (RHS) 2.5 16.0 14.0 12.3 14.0 11.5 2.0 12.0 10.0 1.5 8.0 (%) 6.0 (%) 1.0 2.5 4.0 0.5 0.4 0.3 2.0 - 0.1 1.7 2.2 0.0 0.4 1.8 - -2.0 FY18 FY19 FY20 FY21 FY22E FY23E Source: Company data, I-Sec research 143 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Summary financials Table 11: Profit and Loss Statement (Rs mn, year ending March 31) FY19 FY20 FY21 FY22E FY23E Interest earned 18,316 27,036 28,061 30,993 35,580 Interest expended 7,252 10,700 10,775 11,782 13,241 Net interest income 11,064 16,336 17,286 19,212 22,338 Other income 2,060 3,222 3,108 3,202 3,730 Staff cost 5,188 7,185 7,488 7,862 9,435 Other operating expenses 4,846 6,001 4,813 5,443 6,174 Total operating cost 10,034 13,186 12,301 13,306 15,608 Pre-provisioning op profit 3,090 6,372 8,093 9,109 10,460 Provisions & contingencies 406 1,710 7,991 8,006 4,663 Profit before tax & exceptional items 2,684 4,662 102 1,103 5,797 Exceptional items Profit before tax & exceptional items 2,684 4,662 102 1,103 5,797 Income taxes 692 1,163 19 278 1,459 PAT 1,992 3,499 83 825 4,338 Source: Company data, I-Sec research Table 12: Balance Sheet (Rs mn, year ending March 31) FY19 FY20 FY21 FY22E FY23E Capital 16,400 19,282 19,283 19,283 19,283 Reserves & surplus 1,796 12,595 12,904 13,730 18,068 Networth 18,196 31,877 32,187 33,013 37,351 Total borrowings 41,661 39,533 32,473 30,278 35,589 Term Deposits & CASA 73,794 1,07,805 1,31,358 1,53,534 1,81,041 Provisions 1,335 - - - - Other Liabilities 2,436 4,898 7,786 9,343 11,212 Total liabilities & stockholders' equity 1,37,422 1,84,112 2,03,805 2,26,168 2,65,193 Loans & advances 1,05,525 1,40,436 1,44,940 1,68,831 2,04,176 Investments 15,266 23,961 25,165 35,313 38,924 Cash and Balance 10,945 13,433 25,775 13,818 13,578 Fixed Assets 2,844 3,005 2,807 3,088 3,397 Current & other assets 2,842 3,277 5,118 5,118 5,118 Total Assets 1,37,422 1,84,112 2,03,805 2,26,168 2,65,193 Source: Company data, I-Sec research 144 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Table 13: Key ratios (Year ending March 31) FY19 FY20 FY21 FY22E FY23E Growth (%) AUM 46.2 28.1 7.0 11.5 20.9 Loan book (on balance sheet) 40.5 33.2 7.0 11.5 20.9 Total Assets 45.1 34.0 10.7 11.0 17.3 Total Deposits 95.6 46.1 21.8 16.9 17.9 Total NDTL 51.4 27.6 11.2 12.2 17.9 Total Investments 23.9 57.0 5.0 40.3 10.2 Interest Income 24.8 47.6 3.8 10.5 14.8 Interest Expenses 19.5 47.5 0.7 9.3 12.4 Net Interest Income (NII) 28.5 47.6 5.8 11.1 16.3 Non-interest income 84.8 56.4 -3.5 3.0 16.5 Net Income 34.9 49.0 4.3 9.9 16.3 Total Non-Interest Expenses 53.7 31.4 -6.7 8.2 17.3 Pre provisioning operating profits (PPoP) -3.3 106.2 27.0 12.5 14.8 PAT 2803.3 75.6 -97.6 894.3 425.7 EPS 2803.3 75.6 -97.6 894.3 425.7 CA 183.9 93.5 40.0 40.0 SA 75.0 83.3 40.0 40.0 Time deposits 41.3 12.0 10.9 10.7 Yields, interest costs and spreads (%) NIM on AUM 10.4 10.8 9.5 9.5 9.4 Yield on loan assets 18.6 20.3 17.8 17.8 17.5 Average cost of funds 7.6 8.1 6.9 6.8 6.6 Interest Spread on loan assets 11.0 12.1 10.8 11.0 10.9 Operating efficiencies Non-interest income as % of net income 15.7 16.5 15.2 14.3 14.3 Cost to income ratio (%) 76.5 67.4 60.3 59.4 59.9 Op.costs/avg AUM (%) 8.6 8.2 6.3 6.2 6.4 No of employees 14,752 17,841 16,571 19,057 21,915 Average annual salary (Rs '000) 351.7 402.7 451.9 412.6 430.5 Salaries as % of non-int.costs (%) 9.7 14.5 12.2 -8.7 4.3 AUM/employee(Rs mn) 7.5 7.9 9.1 8.9 9.3 Number of asset branches 524.0 575.0 575.0 625.0 675.0 AUM/asset branch(Rs mn) 210.9 246.1 263.3 270.1 302.5 Balance Sheet Structure Loans/ deposits (%) 143.0 130.3 110.3 110.0 112.8 Loans/ Total assets 76.8 76.3 71.1 74.6 77.0 Loans/NDTL 91.4 95.3 88.5 91.8 94.3 CA% of NDTL 0.7 1.6 2.7 3.4 4.0 SA% of NDTL 6.1 8.4 13.8 17.2 20.4 CASA% of NDTL 6.8 9.9 16.5 20.6 24.4 Total deposits as % of NDTL 63.9 73.2 80.2 83.5 83.6 Capital Structure Leverage (x) 7.6 5.8 6.3 6.9 7.1 CAR (%) 18.9 28.8 26.4 24.3 24.0 Tier 1 CAR (%) 18.4 28.0 25.1 23.1 23.0 Tier 2 CAR (%) 0.6 0.8 1.4 1.2 1.0 Tier 1 Capital (Rs mn) 16,530 30,180 28,630 31,362 35,483 Tier 2 Capital (Rs mn) 500 870 1,570 1,570 1,570 RWA (Rs mn) 89,900 1,07,750 1,14,200 1,35,684 1,54,299 Asset quality and provisioning GNPA (%) 0.9 1.0 7.1 9.4 4.8 NNPA (%) 0.3 0.2 2.9 3.3 0.8 GNPA (Rs mn) 979 1,371 10,689 14,985 8,877 NNPA (Rs mn) 275 275 4,286 5,251 1,407 Coverage ratio (%) 71.8 80.0 59.9 65.0 84.1 Credit costs as % of average AUM 0.4 1.4 5.5 5.0 2.5 Return ratios RoAA (%) 1.7 2.2 0.0 0.4 1.8 RoAE (%) 11.5 14.0 0.3 2.5 12.3 145 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities FY19 FY20 FY21 FY22E FY23E Valuation Ratios EPS (Rs) 1.0 1.8 0.0 0.4 2.2 EPS fully diluted (Rs) 1.0 1.8 0.0 0.4 2.2 Price to Earnings 31.1 17.7 745.8 75.0 14.3 Price to Earnings (fully diluted) 31.1 17.7 745.8 75.0 14.3 Book Value (fully diluted) 9 17 17 17 19 Adjusted book value (fully diluted) 9 16 14 14 19 Price to Book 3.4 1.9 1.9 1.9 1.7 Price to Adjusted Book 3.5 2.0 2.2 2.2 1.7 Source: Company data, I-Sec research Table 14: DuPont analysis (%) FY19 FY20 FY21 FY22E FY23E Interest earned 15.8 16.8 14.5 14.4 14.5 Interest expended 6.2 6.7 5.6 5.5 5.4 Gross Interest Spread 9.5 10.2 8.9 8.9 9.1 Credit cost 0.3 1.1 4.1 3.7 1.9 Net Interest Spread 9.2 9.1 4.8 5.2 7.2 Operating cost 8.6 8.2 6.3 6.2 6.4 Lending spread 0.5 0.9 -1.5 -1.0 0.8 Non-interest income 1.8 2.0 1.6 1.5 1.5 Operating spread 2.3 2.9 0.1 0.5 2.4 Exceptional items 0.0 0.0 0.0 0.0 0.0 Final Spread 2.3 2.9 0.1 0.5 2.4 Tax rate (%) 0.6 0.7 0.0 0.1 0.6 ROAAUM 1.7 2.2 0.0 0.4 1.8 Effective leverage (AAUM/ AE) 6.7 6.4 6.1 6.6 7.0 RoAE 11.5 14.0 0.3 2.5 12.3 Source: Company data, I-Sec research 146 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Annexure: Index of Tables and Charts Tables Table 1: Ujjivan has the geographically most diversified portfolio… ...... 113 Table 2: Pan-India focus with higher share from loans from South at 33% and deposits from North at 35%… ...... 114 Table 3: Highlights of key digital initiatives ...... 119 Table 4: Trend in collections – Apr’21 collections fell 89% due to lower collections in unsecured MSE segment and microbanking ...... 124 Table 5: Key features of microbanking loans ...... 131 Table 6: Key features of Micro and Small Enterprises (MSE) loans ...... 131 Table 7: Key features of Ujjivan’s affordable housing loans ...... 133 Table 8: Key features of Ujjivan’s vehicle loans ...... 133 Table 9: Key features of Ujjivan’s personal loans ...... 133 Table 10: Relative peer valuations ...... 138 Table 11: Profit and Loss Statement ...... 144 Table 12: Balance Sheet ...... 144 Table 13: Key ratios ...... 145 Table 14: DuPont analysis ...... 146 Charts Chart 1: …with share of its top-3 states in total AUM lowest at <45% ...... 113 Chart 2: …with equal focus on ex-rural markets ...... 114 Chart 3: Ujjivan successfully navigated state-specific issues – diversified operations came to rescue ...... 114 Chart 4: Robust alternative channel platforms ...... 115 Chart 5: The number of transactions increased 2x since the covid-led disruption; share of digital transactions stands at 57% as in Mar’21 ...... 116 Chart 6: The share of secured loans increased to 27% by Mar’21… ...... 116 Chart 7: Evolution of asset products – focus on building a secured asset portfolio ...... 117 Chart 8: Since FY18, Ujjivan incrementally focused on building non-MFI biz ...... 117 Chart 9: Over past 3 years, incremental growth was largely driven by secured loans… . 118 Chart 10: …disbursement trend suggests strong traction in secured loans is likely to continue ...... 118 Chart 11: Improved turnaround time (TAT) since the implementation of tablet-based loan origination system ...... 120 Chart 12: Increasing share of digital transactions...... 121 Chart 13: Active customer base using internet & mobile banking platform jumped 1.6x over past one year ...... 121 Chart 14: Enhanced net banking platform resulted in high adoption by SMEs ...... 121 Chart 15: UPI transaction value jumped 3.5x over past one year ...... 121 Chart 16: Increasing customer engagement as reflected in 30% YoY growth in average ticket-size since covid onset ...... 121 Chart 17: There was steady improvement in asset quality post-demonetisation, but covid onset resulted in GNPL reaching historical peak ...... 122 Chart 18: MSE segment appears most vulnerable; unsecured MSE loans contributed to asset quality woes ...... 123 Chart 19: Maharashtra and Assam witnessing lowest collections at 74% and 66% respectively in Apr’21 ...... 123 Chart 20: PAR peaked out at 16.8% in Q2FY21, but near-term concerns persist due to resurgence of covid ...... 124 Chart 21: ‘Portfolio at risk’ is highest in MSE book, but it contributes only 8% of AuM as at Mar’21 ...... 124 Chart 22: Initial transition phase utilised to build infrastructure… ...... 126 Chart 23: …incrementally focuses on productivity and cost optimisation ...... 126 147 Ujjivan Small Finance Bank, July 8, 2021 ICICI Securities Chart 24: Improvement in employee productivity...... 126 Chart 25:... as well as branch productivity ...... 126 Chart 26: Comprehensive banking product and service offerings ...... 127 Chart 27: Comprehensive product offering coupled with data analytics resulted in improving ‘products per customer’ ratio ...... 128 Chart 28: Since FY18, incrementally it focuses on building non-MFI biz ...... 130 Chart 29: Over past 3 years, incremental growth was largely driven by secured loans… 130 Chart 30: Strategic shift towards lending to formal MSE segment…...... 132 Chart 31: …resulted in increase in MSE ticket-size...... 132 Chart 32: Deposit growth continues to outpace AUM growth… ...... 134 Chart 33: …with increasing share of retail deposits ...... 134 Chart 34: Retail deposit share increases to 48% as at Mar’21… ...... 135 Chart 35: … similarly, CASA ratio witnssed steady growth ...... 135 Chart 36: Sharp improvement in customer acquisition in FY21… ...... 135 Chart 37: …with digital engine contributing ~15% of new account openings ...... 135 Chart 38: Diversifying revenue mix with focus on building sustainable non-interest income stream ...... 136 Chart 39: Processing fees and PSLC income contributed >75% of total core fees ...... 136 Chart 40: Sharp uptick in retail insurance premium ...... 137 Chart 41: Retail insurance is driving fee income ...... 137 Chart 42: Trend in Ujjivan’s P/BV ...... 139 Chart 43: AUM CAGR likely to remain at 16% over FY21-FY23E; H1FY22E to remain subdued due to covid resurgence ...... 140 Chart 44: NIMs to settle at ~9% in medium term ...... 141 Chart 45: Focus on sweating existing assets ...... 141 Chart 46: Credit cost likely to moderate, but would yet be higher than the historical average ...... 142 Chart 47: Return ratios to improve gradually ...... 143 148 Small Finance Bank, July 8, 2021 ICICI 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