With new RBI norms, investors need to be cautious about small finance arms

Overhang for Equitas and Ujjivan is listing of small finance arms

With the Reserve Bank of India set to open up the small finance banking space for more players soon, investors will be flooded with more options, thanks to the mandatory listing norms for SFBs. 

Among the current entities, Equitas and Ujjivan are required to list their SFBs by September 2019 and February 2020, respectively. While this will not only amount to a dual listing, but also be a litmus test to gauge investors’ interest in these stocks and the valuations they are willing to pay for this sector. 

Brokerages such as UBS and Nomura have turned positive on SFBs ahead of the event. However, given the overhang on these stocks, investors may be required to exercise caution, especially those planning to take fresh positions in these stocks. 

A lot of the concern emanates from the potential valuations that these SFBs will get when they spilt from their holding companies. A key factor will be the loan book composition. Equitas draws over 75 per cent of its loan book outside the microfinance lending business, while Ujjivan continues to rely significantly on microfinance business, accounting for 75 per cent of loans.

While both banks are making reasonable headways in expanding into new lending opportunities, a large part of these gains will be more pronounced in FY21 when new branches start fully functioning. A pullback by certain non-banking finance companies in semi-urban and rural places will be a blessing in disguise for SFBs. 

Analysts at UBS Securities say Equitas and Ujjivan have the potential to grow their revenues by 28–32 per cent in FY21. But, all this is at least three to six months after the listing of the SFB in FY20. Thus, while the long-term potential remains strong, the question is that of timing so that investors aren’t caught on the wrong foot. A wait and watch approach may be more rewarding not withstanding their attractive valuations at 1.7 times FY20 book. 

As for AU SFB, which does not have to contend with regulatory issues, steep valuations at 4.3 times its FY20 book (almost like that of retail banks) could be a deterrent. Analysts at Nomura said at these levels, there was little room for error. “We think the Street’s expectations are too optimistic on operating leverage and can be a reason for disappointment,” they added.

Thus, until investors get a better picture of the sector, SFBs are best avoided.