Price Band: INR Financials snapshot: Equitas Holdings Consolidated

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1 BSE SENSEX S&P CNX 25,270 7,713 Issue Summary Period April 5-7, 2016 Price band (INR) Size (INR m) INR b INR14.5offer for sale and INR7.2b fresh issue No. of shares (m) 130.8m offer for sale and 65.5m fresh issue MCap post issue 36.8 (INR b) Founder and MD : MR. P N Vasudevan Book running lead managers: Axis Capital, HSBC and Edelweiss Registrars: Link Intime Amount Objects of the issue (INR b) Investment into subsidiaries to augment capital base for growth requirements [6.16] Share holding pattern Pre-issue Post issue FIIs Public and Others 7 65 Price Band: INR April 2016 IPO Note Sector: Financials Equitas Holdings First IPO of a small finance bank: Incorporated in 2007, Equitas Holdings is an NBFC focused on individuals and micro and small enterprises (MSEs) that are underserved by formal financing channels. The company is one of the 10 recipients of small finance bank (SFB) licenses by the RBI and is the India s first small finance bank recipient to come up with an IPO. Target segment: Equitas target customers are low income and economically weaker individuals operating small businesses, as well as MSEs with limited access to formal financing channels. Equitas is a holding company and operates through its three subsidiaries. Equitas Microfinance (EMFL) is engaged in microfinance lending, Equitas Finance (EFL) in vehicle and MSE lending, and Equitas Housing Finance (EHFL) is in affordable housing finance. About the issue: Total IPO size is INR21.7b, of which INR14.5b is offer for sale from existing foreign investors. Post IPO, foreign shareholding will decline from the current 93% to 35%. Founder and Managing Director: Equitas founder, Mr PN Vasudevan has over two decades of experience in financial services. He started his career with the Chola Group, where he was instrumental in starting the vehicle finance business. Post that, he had also worked as Head of Consumer Finance at DCB Bank. Mr. Vasudevan holds 3% stake in the company. Investment view Equitas is a well-established player and has a strong management team that can deliver business scalability. RoE (sub-10%) is likely to be subdued in initial years due to dilution and initial cost of setting up banking operations. However it has strong growth potential and can deliver +2% RoA. At INR110 stock is valued at 1.88x trailing post money book. Sunesh Khanna (Sunesh.Khanna@MotilalOswal.com); Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com); Financials snapshot: Equitas Holdings Consolidated INRm FY11 FY12 FY13 FY14 FY15 9MFY16 AUM 7,939 8,239 14,838 24,856 40,099 55,052 AUM Growth (%) NA 3.8% 80.1% 67.5% 61.3% 37.3 Net Profit ,066 1,204 Yield (%) Spread (%) NIMs (%) Opex / AUM Gross NPA (%) RoA (%) RoE (%) Leverage (x) Earnings Per Share Book Value Per Share Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 Company background Incorporated in 2007, Equitas Holdings is an NBFC focused on individuals and micro and small enterprises (MSEs) that are underserved by formal financing channels. The company is one of the 10 recipients of small finance bank (SFB) licenses by the RBI and is the India s first small finance bank to come up with an IPO. Equitas target customers are low income and economically weaker individuals operating small businesses, as well as MSEs with limited access to formal financing channels. Equitas is a holding company and operates through its three subsidiaries. Equitas Microfinance (EMFL) is engaged in microfinance lending, Equitas Finance (EFL) in vehicle and MSE lending, and Equitas Housing Finance (EHFL) is in affordable housing finance. Equitas is headquartered in Chennai and has its operations spread across 11 states through 539 branches, 8,067 employees and 2.88m customers as on 31 December On a consolidated level, it has AUMs of INR55b and a net worth of INR12.3b. While the company started as an MFI, after four years of successful operations, it diversified into other secured loan products, with different subsidiaries offering vehicle finance, MSE finance, and housing finance. MFI contributes 53% of the loan book, followed by vehicle finance (25.5%), MSE finance (17%), and housing finance (4%). Exhibit 1: Key financials INRm FY11 FY12 FY13 FY14 FY15 9MFY16 AUM 7,939 8,239 14,838 24,856 40,099 55,052 AUM Growth (%) NA 3. 8% 80.1% 67.5% 61.3% 37.3% On-Book AUM 6,268 6,160 12,135 21,232 34,646 50,139 Off-Book AUM 1,671 2,079 2,703 3,625 5,453 4,913 Disbursements 9,024 7,682 14,879 23,844 36,063 36,698 Net Interest Income 1,532 1,169 1,470 2,460 3,921 4,149 Operating Expense 986 1,187 1,260 1,618 2,472 2,547 Net Profit Yield (%) Spread (%) NIMs (%) Opex / AUM Gross NPA (%) No of branches No of employees 2,492 2,716 3,148 4,477 6,275 8,067 No of loan accounts (mn) RoA (%) RoE (%) Leverage (x) Earnings Per Share Book Value Per Share April

3 Key charts Exhibit 2: AUM Mix: MFI loans form 53% of AUM MSE 17% Housing 5% Exhibit 3: On-book loans over 90% On Book (%) Off Book (%) Vehicle Finance 25% Microfinance 53% FY11 FY12 FY13 FY14 FY15 9MFY16 Exhibit 4: Disbursements have grown +50% CAGR Disbursements (INRb) Exhibit 5: AUM has grown over 6x in last 4 years AUM (INRb) Growth (%) FY11 FY12 FY13 FY14 FY15 9MFY16 Exhibit 6: Strong customer base with 2.88m loans a/c 3.8 FY11 FY12 FY13 FY14 FY15 9MFY16 Exhibit 7: Geographical mix: 77% of loans in TN & Maha. (%) Total Loan Accounts (mn) FY11 FY12 FY13 FY14 FY15 9MFY16 Gujarat Karnataka Madhya Pradesh Maharashtra Pondicherry Rajasthan Tamil Nadu 1 April

4 Exhibit 8: Spreads have been coming down Exhibit 9: Borrowing Mix: Banks form 57% of funding (%) Yield (%) Spread (%) (rhs) NIMs (%) (Lhs) NCD Fis Banks FY11 FY12 FY13 FY14 FY15 9MFY Exhibit 10: AUM per branch is up 4x sincefy12 Number of branches AUM per branch (INR M) Exhibit 11: Opex/AUM on a decline Number of employees Opex/AUM (%) ,492 2, ,148 4, , , FY11 FY12 FY13 FY14 FY15 9MFY16 FY11 FY12 FY13 FY14 FY15 9MFY16 Exhibit 12: Consol. Asset quality healthy Gross NPA (%) Net NPA (%) FY11 FY12 FY13 FY14 FY15 9MFY16 Exhibit 13: RoE low due to continuous dilution & low leverage RoA (%) RoE (%) FY11 FY12 FY13 FY14 FY15 9MFY16 1 April

5 Microfinance business Equitas started its business in 2007 as an MFI, focusing on transparency and corporate governance. It is now the 5th largest MFI in India, with 377 branches spread across seven states and one union territory. It offers loans for up to two years, ranging from INR5,000 to INR35,000 through the Joint Liability Group (JLG) model. Sourcing of customers happens through own employees and Equitas does not involve any intermediaries. Collections happen on a fortnightly or monthly basis. In 2007, when Equitas started, the MFI sector was completely unregulated. The lending rate was high at 40%, though such rates were justified, as CoF was 14-15% and opex cost was 15-20%. However, during the initial days, Equitas decided that cost of growth would be borne by the investors and customers would only bear the steady state opex cost (it estimated steady state opex at 7.5%). This led to lending rate of ~25%, the lowest in the industry at that time. To achieve low opex, the company relied heavily on technology and innovative methods to bring down opex. However, it did not change the customer facing model and stuck to the Grameen model (started by Dr Mohd Yusuf of Grameen Bank). Equitas still follows the Grameen model for its MFI customers. After the AP crisis, the RBI came up with regulations for the sector. It imposed a lending cap of 26% (based on a simple formula of 10-12% margin or base rate x 2.75, whichever is less). RBI also allowed MFIs to charge 1% flat processing fees in addition to interest. Equitas, which was already lending at 25%, did not face much issue. However, it started charging 1% processing fees to build in additional buffer for adverse times. Exhibit 14: Financial snapshot: MFI business INRm FY11 FY12 FY13 FY14 FY15 9MFY16 AUM 7,938 7,240 11,347 15,030 21,440 29,348 AUM Growth (%) NA -8.8% 56.7% 32.5% 42.6% 36.9% Net Profit Yield 31.7% 23.1% 22.5% 23.4% 22.0% 20.8% Cost of Funds 13.5% 11.2% 12.0% 12.4% 12.7% 11.9% Spread 18.3% 11.9% 10.6% 11.0% 9.3% 8.8% Net Interest Margin 21.9% 14.9% 12.3% 12.2% 11.8% 11.1% Gross NPA / On-Book AUM (%) 0.7% 1.3% 0.1% 0.1% 0.1% 0.1% Net Profit Total Loan Accounts 1,430,406 1,241,453 1,428,752 1,935,003 2,449,694 2,782,147 Number of branches Number of employees 2,492 2,159 2,402 3,074 3, Return on Average Assets (%) 3.5% 2.0% 2.5% 3.6% 3.5% 2.9% Return on Average Net Worth (%) 10.5% 7.2% 12.0% 19.9% 19.8% 19.1% Earnings Per Share Book Value Per Share April

6 Vehicle finance business The vehicle finance business is conducted through the subsidiary, Equitas Finance Limited (EFL). The used commercial vehicle finance customers are typically first-time formal financial channel borrowers purchasing commercial vehicles. The customers also include small fleet operators. As of December 31, 2015, the vehicle finance business operations included a network of 134 branches in Tamil Nadu, Gujarat, Maharashtra, Madhya Pradesh, Karnataka, Chhattisgarh, Rajasthan, Delhi, Haryana, Punjab, Telangana and Andhra Pradesh. Most of these branches are in the same premises as the microfinance branches at these locations. The vehicle finance business had 52,274 loan accounts and AUM of INR14.05b as of December 31, 2015, which forms 25.53% of the aggregate AUM. Equitas also operates in the used CV space and provides loans to small fleet operators. Such customers are typically first-time formal financial channel borrowers, purchasing used commercial vehicles. However, they are required to have the relevant driving license and knowledge about the vehicle being purchased. These customers typically have limited access to bank loans for commercial vehicle financing and mostly have limited or no credit history, but generally own assets such as a house or property or vehicle. Average ticket size is INR0.38m and average tenure is 3-4 years. Sourcing is done through relationships with transporters and direct marketing activity in transport hubs. Credit appraisal involves personal interview, guarantor, inspection of vehicle, and document check. Customers are sourced via field staff from their networks and relationships with transporters through various means including telecalling and direct marketing activities in transport hubs, where transporters tend to congregate. In addition, Equitas enters into arrangements with dealers of used commercial vehicles. Exhibit 15: Financial snapshot: Vehicle finance business INR m FY12 FY13 FY14 FY15 9MFY16 AUM , , , ,056.2 On-Book AUM , , , ,032.0 Off-Book AUM AUM Growth (%) % 163.2% 46.7% 19.6% Average AUM , , , ,905.1 Disbursements , , , ,298.8 Disbursement Growth (%) NA 204.1% 142.5% 23.8% Total Loan Accounts 3,100 11,051 26,877 41,644 52,274 Interest Income , , ,955.9 Credit Cost GNPA / On-Book AUM (%) 0.5% 1.0% 1.8% 2.8% 3.8% NNPAs / On-Book AUM (%) 0.4% 0.7% 1.6% 2.1% 2.8% Number of branches Number of employees ,292 2,235 2,774 Number of loan accounts 3,100 11,051 26,877 41,644 52,274 1 April

7 Micro and small enterprise finance (MSE) Equitas provides asset-backed financing, primarily focused on self-employed individuals operating micro and small enterprises, typically in urban and semi-urban locations. Most of its MSE finance business represents cross-sales to eligible higher income microfinance business customers with a satisfactory track record. It has presence in Tamil Nadu, Maharashtra, Madhya Pradesh, Gujarat, Rajasthan and Karnataka. As on December 31, 2015, MSE loan book was INR9.35b, with 46,000 customers and average loan size of INR170k. Yields in this segment are 22% (similar to yields on MFI loans). These loans are offered to top-end MFI customers, who have spent certain time with the company and are credit-tested. These MSE loans are individual loans and not group loans, and are secured by immovable property. Though the loans are individual loans, group recommendation is required. The book is clean, with no NPA. As income appraisal in this segment is tough, there are two layers of checks credit appraisal team and credit supervision team. The credit appraisal team consists of the credit officer and the branch manager, who try to assess income through field visits. The credit supervision team randomly scrutinizes the cases to see if the income assessment is done correctly. Exhibit 16: Financial snapshot: MSE business INR m FY14 FY15 9MFY16 AUM 874 5,110 9,355 AUM Growth (%) Disbursements 902 4,633 5,216 Total Loan Accounts 2,232 22,198 45,992 Credit Cost Gross NPA / On-Book AUM (%) - 0.2% 0.3% Net NPAs / On-Book AUM (%) - 0.2% 0.3% Number of branches Number of employees 1,292 2,235 2,774 Number of loan accounts 2,232 22,198 45,992 Closing AUM per branch (INR M) Closing AUM per employee (INR M) Closing AUM per loan account ('000) April

8 Housing finance Equitas provides housing finance through a wholly-owned housing finance subsidiary, which extends micro-housing and affordable-housing loans to selfemployed individuals, who have limited access to loans from banks and larger housing finance companies. A significant percentage of micro-housing finance products are cross-sell products offered to eligible higher income microfinance customers with good track record. Customers in this segment typically run small enterprises and/or are employed in the informal segment. The typical tenure of such loans is 3-20 years. As on December 31, 2015, AUM was INR2.3b (4.16% of consolidated AUM), with average ticket size of INR0.26m and customer base of 4,022. Exhibit 17: Financial snapshot: Housing finance INR m FY12 FY13 FY14 FY15 9MFY16 AUM ,795 2,292 AUM Growth (%) Disbursements , Total Loan Accounts ,617 3,111 4,022 Cost of Funds - 3.7% 10.4% 11.9% 11.3% Credit Cost Yield 2.9% 14.1% 16.5% 16.4% 15.8% Spread 2.9% 10.4% 6.1% 4.5% 4.5% Net Interest Margin 2.9% 13.0% 10.1% 6.6% 5.9% Operating Expense / Average AUM 72.3% 21.7% 9.3% 6.1% 5.6% Gross NPA / On-Book AUM (%) % 1.7% 3.0% Net NPAs / On-Book AUM (%) % 1.4% 2.5% Net Profit Return on Average Assets (%) -44.0% 2.1% 1.9% 1.4% 0.7% Return on Average Net Worth (%) -45.4% 2.8% 4.1% 5.8% 4.0% Earnings Per Share Book Value Per Share April

9 Competitive strengths Among the top-5 microfinance companies in India Equitas is among top-5 MFIs in India; its microfinance operations span across 391 branches in seven states. Microfinance business AUM increased at a CAGR of 43.60% from INR7.2b as of FY12 to INR29.3b as of 9MFY16 and forms 53.47% of aggregate AUM Its large customer base helps the company to cross-sell other products to existing clients. 1 April Exhibit 18: Equitas among top 5 MFI operations in India AUM Client base Bandhan SKS Microfinance Janalakshmi Ujjivan Equitas Source: RHP Successful track record in underserved customer segment, offering significant growth opportunities India is home to 21% of the world s unbanked adults and there are approximately 57.70m small business units, mostly individual proprietorships, which operate manufacturing, trading or services activities. Equitas has developed an understanding of this segment and focuses on the individual and MSE customer segments that are underserved by formal financing channels. Given the significant growth opportunities, Equitas intends to continue expanding its product portfolio to cater to the various financing requirements of these customer segments. Governance standards and transparent operations lead to investors confidence and customer goodwill Corporate governance standards and transparent operations have enabled Equitas to strengthen its relationships with target customer segments, and leverage its reputation and goodwill to expand operations and product portfolio. The company has received the CRISIL Governance and Value Creation Level-2 rating. Its high governance standards and stringent operational controls have enabled it to generate confidence among, and attract significant equity support from, several investor groups including international development finance institutions such as IFC, CDC, FMO and DEG as well as various private equity investment funds. Diversified product offering and markets, with significant cross-selling opportunities Diversification of business and revenue base with respect to product offerings and markets served is a key strength. Equitas offers a range of financial products and services, including microfinance, used commercial vehicle finance, MSE finance and housing finance, that provide cross-selling and up-selling opportunities. For example, a majority of MSE finance business and a significant percentage of the micro-housing segment business represent cross-sales opportunities to eligible higher income microfinance customers with satisfactory track record.

10 Experienced management The senior management team has significant experience in the financial services industry. It has developed and implemented its business strategy and is committed to to fair and transparent business practices while maintaining effective risk management and competitive margins. Managing Director, Mr PN Vasudevan and other members of the senior management team have significant experience in the financial services sector. 1 April

11 Business strategies 1 April Leverage existing network and customer base: Equitas intends to leverage its large branch network and large customer base across India to develop its proposed SFB operations. It is already offering diversified products and has experience in the same. It will add only one new product, Gold Loans once the bank starts, as there is good demand from farmers. The product is already offered on a pilot basis from 5-6 branches. The management is targeting to start banking operations by October- November 2016, though the deadline is April Expand operational network and strengthen marketing and sourcing partnerships: Equitas continues to expand its operations in target markets by establishing additional branches across India, particularly for its microfinance and vehicle finance businesses, with other financing products following into such new markets. It intends to further increase penetration in the western and northern states of India as well as commence operations in eastern states of India. Its customer origination and servicing efforts strategically focus on building long-term relationships with its customers and address specific requirements in a particular region. In addition, Equitas continues to expand its customer origination network for its vehicle finance, MSE finance and housing finance business across India by entering into sourcing arrangements with used commercial vehicle dealers, direct sourcing agents and other intermediaries. Leverage large customer base, operational network and industry experience: Equitas intends to further diversify its product portfolio by growing MSE finance, vehicle finance and housing finance businesses. It continues to leverage its large customer base, branch network across India, and experienced employee-base to offer additional financing products to existing customers and expand its customer base. In addition to the microfinance business, its used commercial vehicle and MSE customer segments provide significant opportunities for cross-sales of two-wheeler loans. Its fast growing business and network with commercial vehicle owners, potential commercial vehicle purchasers, vehicle dealers, and various market intermediaries including direct selling agents provide significant opportunities for the development of an e-platform to enable manufacturers, traders and distributors to effectively engage with and negotiate freight terms with transporters. EHFL has set up a subsidiary, ETPL in October 2015, to develop such an e-platform to support settlement freight transactions on a fee based model. In addition, it intends to deploy real-time tracking systems in commercial vehicles using such services to enable real-time freight status information. Continue to reduce operating costs and improve operational efficiencies: Equitas operating expenses as a percentage of its AUM have been declining in recent years, and it continues to identify and implement measures that will enable it to sustain and further decrease its operating expenses. It continues to invest in its technology platform and technology-enabled operating procedures to increase operational and management efficiencies and ensure strong customer credit quality. Further, it intends to implement mobile-based applications to make the loan application process convenient to its customers and streamline credit approval, administration and monitoring processes.

12 Key challenges Challenges in conversion to small finance bank include compliance with the shareholding pattern, maintenance of statutory ratios, ability to raise deposits and ramping up the branch network to make in compliant with bank standards. Below is our take on each of them: Building deposit franchise: Buling a deposit franchise will be the biggest challenge, while Equtias has a strong customer base of 2.88m; however this segment is not a big saver. Moreover once restrictions on inter-bank borrowings kick-in, Equitas will have to depend on deposits to fund its growth. While garnering low cost CASA deposits will be a slow process, Equitas could resort to bulk deposits by offering slightly higher rates than commercial Maintenance of statutory ratios: Starting March 2017, Equitas would have to comply with CRR and SLR norms. This would be a negative carry on as the blended cost of funds is over 11% as of now and building CASA would take time. Complying with shareholding norms: To reduce the FII stake from 93% to below 49%, Equitas has come up with an IPO, where FIIs would sell a part of their stake to domestic investors. At the same time, there would be some fresh equity infusion, where all the subscribers would be domestic. This would help build net worth and lower leverage, but would also suppress RoE for a few years. Ramping up branch network: Existing network of 539 branches are inadequate to handle all the functions of a small bank. Reasonable investments would be needed to scale up the branch infrastructure to make it compliant to banking standards. 1 April

13 Key risks No operating history in the banking business: Equitas has no operating history or experience in the banking business. Accordingly, inability to manage the business risks and uncertainties associated with setting up any new business venture may adversely affect its operations, financial condition and prospects. Business model and regulatory framework governing SFBs are untested in India: The RBI issued the SFB Guidelines on November 27, 2014 to license SFBs in the private sector to, inter-alia, supply credit to micro and small enterprises and agriculture and provide banking services in unbanked and underbanked areas in India. The RBI granted SFB In-Principle Approval through a letter dated October 7, 2015 to Equitas. It cannot be assured that such SFBs will be able to provide credit and banking services to the unbanked or underbanked populations in a profitable manner or at all or that the products and services offered by such SFBs would achieve market acceptability. While Equitas intends to rely on its experience in the microfinance, vehicle finance and housing finance businesses to develop and implement certain processes and policies for the proposed SFB, it cannot be assured that such policies and processes will be effective. Concentration in the state of Tamil Nadu: Approximately 60% of its overall portfolio is in the state of Tamil Nadu. This exposes Equitas to the risks and rewards of being overly dependent on a single state. Deficient rainfall, unfavorable political environment, and slowing state economy could impact its ability to grow and operate in that state. We also note that outstanding credit per household is amongst the highest in Tamil Nadu and could imply slower growth in the coming years. It also implies that the borrower leverage is relatively high in the state. Ability to convert itself into a small bank: Conversion to small finance banks involves multiple challenges such as complying with shareholding norms, revamping the branch network, ability to manage liabilities and statutory requirements. This would require management bandwidth that is far different than the one required for managing an NBFC. Rising NPAs in relatively unseasoned vehicle finance book: Approximately 70% of its vehicle finance book has been disbursed in the past twelve months, implying that the book is largely unseasoned. Despite this, GNPAs have increased to 3%. While 3% GNPAs are not unusual for NBFCs operating in used CV space, we will monitor the NPA levels, as the book gets seasoned. 1 April

14 Financials and valuations INCOME STATEMENT (INR Million) Y/E MARCH Interest Income 2,220 1,811 2,546 4,355 6,868 Interest Expense ,076 1,895 2,947 Net Interest Income (Incl Sec.) 1,532 1,169 1,470 2,460 3,921 Change (%) Other income Net Income 1,704 1,344 1,755 2,940 4,612 Change (%) Operating Expenses 986 1,187 1,260 1,618 2,472 Pre Provision Profits ,322 2,140 Change (%) Provisions (excl tax) PBT ,138 1,636 Tax Tax Rate (%) Add: Prior period adjustments Profits for Equity SH ,066 Change (%) , Proposed Dividend BALANCE SHEET (INR Million) Y/E MARCH Equity Share Capital ,689 Reserves & Surplus 2,574 2,578 4,142 6,694 9,019 Networth 3,018 3,023 4,719 7,420 11,708 Borrowings 5,919 5,638 12,744 18,492 30,322 Change (%) Other liabilities ,076 1,604 2,619 Change (%) Total Liabilities 9,671 9,608 18,539 27,516 44,649 Receivables 6,268 6,160 12,135 21,232 34,646 Change (%) Investments ,757 Net Fixed Assets Other assets 3,172 3,196 6,093 5,976 7,778 Total Assets 9,671 9,608 18,539 27,516 44,649 E: MOSL Estimates 1 April

15 Financials and valuations RATIOS Y/E MARCH Spreads Analysis (%) Avg Yield on loans Avg Cost of funds Spreads on loans NIMs on AUM Profitability Ratios (%) RoE RoA RoA on AUM Cost to Income Empl. Cost/Op. Exps Asset-Liability Profile (%) Net NPAs to Adv Debt/Equity (x) Average leverage April

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