Microfinance Sector Note

Transcription

1 Microfinance Sector Note 2016 Equirus All rights reserved Fast track growth at the bottom of the pyramid a huge risk, prefer MFIs diversifying businesses, valuations at unfavorable risk-reward, Initiate with SHORT on Equitas and Ujjivan Microfinance aims at catering to economically active, low income, self-employed women who lack access to organized sector credit. We take a contra-view to the market as we believe microfinance has limited growth opportunities with multiple risks of overleveraging and pricing competition due to fast growth at the cost of due diligence and entry of new players. We believe the sector s risk reward is unfavorable and we are cautious on companies on the fast track path to grow AUM at all costs. We prefer diversified businesses such as Equitas, but rich valuation leaves room for near term price correction. We initiate on Equitas Holdings and Ujjivan Financial Services with SHORT rating and Sep 17 TP of Rs. 142/share and Rs. 372/share respectively. majority of customers being unbanked, the business operates largely on cash basis, with disbursements and collections in cash, leaving significant scope for frauds/thefts. Fast track growth at the bottom of the pyramid from too many players has a cost! Possible spread reduction due to supernormal growth will affect margins: Microfinance commands high interest rates due to high risk profile, and credit quality rests on social collateral and limited supply of credit. With too many participants looking to grow quickly, customers will have more choice, and pricing competition can reduce spreads and margins for microfinance business. Brief background and industry snapshot: As of FY16, 56 registered NBFC-MFIs have total gross AUM of Rs bn (47% CAGR between FY12-16) of which the top 10 MFIs command 72% share. South India leads in GLPs (35%), followed by North and West India (25% each) and East India (15%). Nonagricultural activities account for 64% of portfolio, agriculture and allied activities 31% and household finance 5%. Transition from SHG to JLG, emergence of SFBs: The microfinance industry has evolved from operating as a mediator for SHG-bank linkages, to for-profit companies providing JLG based loans to economically active self-employed women. In 2015, 8 MFIs received small finance banking (SFB) license from RBI. They are Ujjivan Financial Services, Janalakshmi Financial Services, Equitas Holdings, Disha Microfin, ESAF Microfinance, RGVN Microfinance, Suryoday Microfinance, and Utkarsh Microfinance. SFBs are required to make the bank operational within 18 months of receiving the license and to list the bank separately within 3 years of going operational. Our thesis: Limited headroom for microfinance industry growth, fast track growth would require unreal increase in penetration: We take a contra-view to the market as we believe the addressable market for microfinance is much lower than what headline numbers suggest. Notwithstanding India s large population of economically active poor, microfinance can address limited households (~120mn in FY16) with average ticket size growth of at most 10% yoy. Our calculations (exhibit 16) indicate that industry penetration has to increase from 25% in FY16 to 53% by FY21E to achieve 30% CAGR during this period. This is not possible without expansion in rural areas where economies of scale are difficult. Risks include bulk defaults from reckless growth: While social collateral protects credit quality, the business bears inherent risks. Previous microfinance crises in India, in Krishna (FY06), Karnataka (FY09) and A.P. (FY10) were preceded by high AUM growth leading to bulk defaults. At present, MFIs are targeting super-normal growth backed by increased investor interest and fund flow. However, we believe super-normal growth at the bottom of the pyramid is bound to be followed by mass defaults and subsequent crises. Also, with Enhanced risk of overleveraging from banks entering microfinance: While existing credit bureaus are regularly updated with borrowing data of customers (regulation stipulates microfinance customers can borrow upto Rs. 60K - recently increased to Rs. 0.1mn - from at most 2 MFIs), the entry of banks in microfinance complicates credit data efficiency as bank borrowing data may not be captured, leading to the risk of overleverage and credit defaults. Controlled growth appetite and picking quality over quantity will differentiate winners and losers: With increased investor interest, MFIs have targeted super-normal growth to attract funds at the cost of due diligence, a trend that has historically preceded the 3 microfinance crises in India. This will differentiate winners from losers in the medium to long term. A classic example of slow growth at the bottom of the pyramid is GRUH Finance, whose loan book stands at Rs. 110bn after 30 years of operations. Newer companies growing ultra-fast during favourable market conditions ignore the associated risks of unsustainable performance, volatility in growth and change in customer credit behaviour resulting from spurt in credit supply. Due diligence, control and supervision key to success, larger players score: Microfinance addresses economically active poor forming the top layer of the bottom of the pyramid, not the bottom itself. Our channel checks indicate that credit behaviour has a regional influence. Cherry-picking the right socio-economic group in the right geographies is crucial to maintain asset quality. Because of limited digitization, retaining strong control and supervision over operations is crucial in microfinance. This is where larger players with strong branch networks have an advantage over smaller players who are forced to operate with a broader radius of operations, reducing control over their domain. SHORT on Equitas Holdings, SHORT on Ujjivan Financial: We prefer Equitas s diversified business and their reducing dependence on microfinance but we believe their high valuation would lead to price correction and we are SHORT on the stock. We are cautious on Ujjivan s portfolio concentration in microfinance and unproven track record of scaling up individual lending business, and we initiate with SHORT rating on the stock. August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 1 of 63 Before reading this report, you must refer to the disclaimer on the last page.

2 Microfinance Sector Note Industry statistics: Exhibit 1: Industry dominated by MFIs with (GLP) >Rs5bn Source: MFIN 8% 1% 91% 31 st March 2016 MFIs (small - glp < Rs 1Bn) MFIs (medium - glp < Rs 1-5Bn) MFIs (large - glp > Rs 5Bn) Exhibit 2: South India leads in total GLP followed by North, West and East 25% 25% 15% 35% 31st March 2016 South North East West Exhibit 4: Top 5 states command 60% of industry GLPs 4% 5% 5% 6% 6% 14% 8% 31st March % 16% 12% 13% Source: MFIN Exhibit 5: Category-wise breakup of key indicators 100% 80% 60% 40% 20% 0% 81% 85% 86% 89% 91% 90% 89% 15% 12% 11% 9% 8% 8% 9% Branches Employees Loan Officers Clients GLP Loan Amount Disbursed Funding Tamil Nadu Karnataka Maharashtra Uttar Pradesh Madhya Pradesh Orissa West Bengal Bihar Kerala Gujarat Others MFIs (Large) MFIs (Medium) MFIs (Small) Source: MFIN Exhibit 3: Trade & Services dominates end use of MFI loans Source: Micrometer, MFIN report Exhibit 6: Industry AUMs have grown at 47% CAGR between FY st March Total Gross AUMs Off balance sheet portfolio % 5% 31% Agriculture/allied activities Non Agriculture Household Finance FY12 FY13 FY14 FY15 FY16 Source: MFIN Source: Micrometer, MFIN report August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 2 of 63

3 Microfinance Sector Note Exhibit 7: State-wise Portfolio At Risk (PAR) at comfortable level States PAR 30 PAR 90 PAR 180 Tamil Nadu 0.21% 0.11% 0.05% Karnataka 0.49% 0.33% 0.19% Maharashtra 0.29% 0.19% 0.08% Uttar Pradesh 0.39% 0.23% 0.16% Madhya Pradesh 0.46% 0.30% 0.17% West Bengal 0.18% 0.13% 0.08% Bihar 0.22% 0.14% 0.08% Gujarat 0.53% 0.33% 0.14% Kerala 0.10% 0.06% 0.04% Odisha 0.09% 0.06% 0.03% Haryana 0.38% 0.20% 0.11% Rajasthan 0.64% 0.47% 0.18% Punjab 0.19% 0.13% 0.10% Assam 0.07% 0.04% 0.03% Delhi 1.80% 0.71% 0.31% Source: Micrometer, MFIN report Exhibit 7 provides comfort on players operating in Tamil Nadu. Equitas has the lion s share of overall as well as MFI AUMs concentrated in Tamil Nadu. Although the company s NPAs have shot up with its entry into new businesses and change in recognition days, the low PAR of the states it is present in provides comfort on structural soundness of asset quality in its chief areas of operation. Exhibit 8:Top 10 MFIs in India according to GLP (Mar 16 data) Janalakshmi Source: MFIN 76.8 SKS 46.9 Ujjivan 32.8 Equitas Gross Loan Portfolio (Rs Bn) GK Ujjivan and Equitas are the 3 rd and 4 th largest microfinance companies in India. In terms of total Gross AUMs, Equitas is bigger than Ujjivan, as the latter has ~87% of its book accounted for by microfinance, while Equitas has diversified its book so that microfinance accounts for ~52% of its total book. Among the top 4 companies, Bharat Financial Inclusion Ltd (earlier SKS Microfinance) is the only company that hasn t received a small banking license, and will focus solely on microfinance business here-on, while Janalakshmi, Equitas, Ujjivan and the other SFB licensees will focus on building their banking business for the next few years. Consequently, Bharat Financial Inclusion is likely to emerge as the leading pure-play microfinance company while others position themselves as banks with varying portions of their book focused on microfinance. Satin L&T Finance ESAF GV Utkarsh August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 3 of 63

4 Microfinance Sector Note Exhibit 9: Evolution of industry key metrics in the last 4 years FY12 FY13 FY14 FY15 FY16 Number of clients (mn) Total loans disbursed (mn) NA Total loan amount disbursed (Rsbn) NA Number of employees ('000) Number of loan officers ('000) Gross AUM Average loan outstanding per client (Rs '000) Average loan disbursed per account NA Average clients per branch 2,135 2,161 2,415 2,851 3,358 Average GLP per branch (Rsmn) Average client per loan officer Average GLP per loan officer (Rsmn) August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 4 of 63

5 Microfinance Sector Note Exhibit 10: State-wise key indicators for Microfinance industry States MFI count GLP (Rsbn) Loan amount disbursed (Annual, Rsbn) Loan disbursed (Annual, mn) Average amount disbursed per account ('000) Clients (lakhs) Branches Employees Tamil Nadu ,352 12,665 Karnataka ,198 11,475 Maharashtra ,174 10,224 Uttar Pradesh ,717 Madhya Pradesh ,494 Odisha ,525 West Bengal ,541 Bihar ,087 Kerala ,630 Gujarat ,360 Rajasthan ,990 Haryana ,670 Punjab ,199 Jharkhand ,850 Chattisgarh ,826 Assam ,306 Uttarakhand Delhi ,370 Puducherry Andhra Pradesh ,135 Tripura August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 5 of 63

6 Microfinance Sector Note Exhibit 11: Peer comparison chart Categories Equitas Microfinance Ujjivan Financial Bharat Financial Inclusion Janalakshmi Gross AUM (RsBn) Average lending rates 22.0% 23.60% 19.75% 23.70% 24% Average loan o/s per client (Rs.) Loan amount disbursed (RsBn) Average loan amount disbursed per account (Rs.) States Presence Districts Covered NA No. of Branches No. of Employees Loan Officers No.of Clients (Mn) GLP Per Employee (RsMn) GLP Per Branch (RsMn) Clients Per Employee Clients per loan officer Revenue NA PAT (RsMn) NA ROAA 3.04% NA 4.20% 2.0% 2.20% ROAE 19.12% NA 25.10% 13.9% 22.1% Source: Company filings, MFIN Satin August 16, 2016 Analyst: Anirvan ( ) Page 6 of 63

7 Microfinance Sector Note Exhibit 12: RoA Tree Comparison for peers FY16 RoA tree Ujjivan Equitas Bharat Financial Inclusion Satin Creditcare Yield on Gross AUMs 21.5% 20.0% 18.0% 17.5% Cost of Funds 10.7% 11.3% 11.5% 13.3% Net Interest Margin (on and off balance sheet) 10.4% 9.8% 7.9% 7.0% Advances (A) 50, , , ,995.2 Off-balance sheet 3, , , ,712.8 Cash and Bank Balance (B) 4, , , ,310.6 Interest Earning Assets (A+B) (incl off balance sheet) 58, , , ,018.6 Average Interest Earning Assets (incl off balance sheet) 48, , , ,331.9 Interest Earning Assets (A+B) (excl off balance sheet) 55, , , ,305.9 Average Interest Earning Assets (excl off balance sheet) 47, , , ,355.4 Asset multiplier 104.0% 115.7% 134.3% 132.8% NII/AvgInt Earning Assets (excl off balance sheet) 10.8% 11.3% 10.6% 9.3% Productivity (AvgInt Earning Assets/Avg Total Assets) NII/Average total assets 10.5% 10.5% 10.1% 8.5% Non IntInc/Average total assets 2.0% 1.8% 4.0% 1.6% Total Income/Average total assets 12.5% 12.4% 14.1% 10.1% Op. Costs/Average total assets 6.4% 6.6% 6.8% 6.5% PPI/Average total assets 6.1% 5.8% 7.3% 3.6% Provisions/Average total assets 0.5% 1.1% 0.7% 0.3% Taxes/Average total assets 2.0% 1.7% 1.5% 1.1% Return on Average total assets 3.7% 3.0% 5.1% 2.2% Adj Return on Average total assets 3.7% 3.0% 5.1% 2.2% Leverage (Average Total Assets/Average Equity) Return on Average Equity 18.3% 13.3% 24.9% 22.1% Source: Company filings August 16, 2016 Analyst: Anirvan ( ) Page 7 of 63

8 Microfinance Sector Note Ujjivan is the 4 th largest microfinance company in India by total gross AUM, and the 3 rd largest by gross microfinance AUM, enjoys better geographical spread With a total Gross AUM of Rs. 53.9bn (microfinance AUM of Rs 46.9bn) as of Mar 16, Ujjivan is the 4 rd largest NBFC-MFI in India behind Bharat Financial Inclusion Ltd, Janalakshmi Financial Services and Equitas Holdings. In terms of microfinance portfolio gross AUM, Ujjivan ranks 3 rd, as Equitas holdings has a smaller microfinance portfolio and a larger individual lending portfolio. While Equitas and Bharat Financial Inclusion have a larger branch network than Ujjivan, the latter has a more diversified presence across more states and UTs compared to the other 2. As of Mar 16, Equitas has 549 branches across 14 states/uts, BFIL has 1,191 branches across 19 states and 329 districts, and Janalakshmi has 341 branches across 17 states. Compared to them, Ujjivan has 469 branches spread across 24 states and UTs. While concentration risk is higher for the other companies, it does provide a strong regional growth opportunity if they target the right areas of growth and execute well. Bharat Financial Inclusion (BFIL) has higher RoA/RoE than Ujjivan, followed by Equitas and Satin Creditcare Exhibit 13: Comparison of FY16 RoA/RoE/leverage across companies 30% 25% 20% 15% 10% 5% 0% Source: Company filings, Equirus Research RoA RoE Ujjivan Equitas Bharat Financial Inclusion Satin Creditcare BFIL enjoys stronger other income profile than Ujjivan, Equitas and Satin, and hence higher RoA/RoE (5.1%/24.9% for BFIL compared to 3.7%/18.3% for Ujjivan, 3.0%/13.3% for Equitas and 2.2%/22.1% for Satin). Satin has extremely high leverage for an NBFC-MFI, at 10.2x, compared to 4.9x for each of Ujjivan and BFIL and 4.4x for Equitas. Although higher expenses in the next few years will bring down the RoA for Ujjivan and Equitas, they have room for leverage growth as they transform into a bank, so RoE decline will be protected. Ujjivan has stronger other income and total income profile and higher cost efficiency compared to Equitas and Satin and thus enjoys higher RoA/RoE. Satin has one of the lowest RoAs among NBFC-MFIs (2.2%) in the peer group, owing to high costs (6.5% of avg assets) and needs to gain cost efficiency in order to ramp up its return ratios. While both Equitas and Ujjivan have started offering fee income products (insurance), it will take time to build up and this is not a primary focus area for either of the companies. Any positive surprise on this would boost returns even higher. August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 8 of 63

9 Microfinance Sector Note Exhibit 14: Competitive scorecard for Equitas and Ujjivan Category Ujjivan Equitas Business Microfinance will reman core business with 60% of gross AUMs in microfinance by FY22E Rapidly diversifying product mix to reduce microfinance to 20% of book by FY22E Transition so far Individual loan book has grown on a low base, no proven track record of scaling up individual loan book without breaching healthy NPA levels Proven track record - has increased individual lending to 48% of book in 1QFY17 from 23.5% in FY13 Individual product focus Credit costs outlook Lower, within individual loans they are focusing on both housing and MSE. Lower ticket unsecured loans forms bulk of housing book, enhancing asset quality risk Credit costs will build up due to buildup of individual loan book and change in recognition days but will remain lower than Equitas in the near term Higher, within individual lending focus is on UCV and MSE, with housing at 10% of total individual book and will not be a focus area. Credit costs will build up and will remain higher due to bigger individual loan book and change in recognition days Opex outlook Opex will increase with investments in branch infrastructure, technology and people, will remain lower than Equitas Opex will increase and will be higher than Ujivan because of more investment in liability expansion Deposit scale up Will be slower than that of Equitas. 280 out of 550 will be bank branches by FY17E, with no mention of physically separate locations for liability expansion Will gain quicker traction in deposit momentum as 412 out of 550 will be bank branches and each bank branch will have a physically separate liability premise in a nearby, more visible location Return ratios RoA will pick up after FY18E and stabilize at ~1.9% RoA wwill pick up after FY18E and stabilize at ~1.8% Risk reward Source: Equirus Securities Risks are not diversified, any cyclical correction in microfinance will obliterate the loan book. High valuations assume seamless transition and do not factor in transition pains or cyclical sector correction Risks getting rapidly diversified, individual lending growing and microfinance dependence diminishing rapidly. High valuations assume seamless transition and do not factor in transition pains August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 9 of 63

10 Microfinance Sector Note Microfinance: The road ahead Addressable microfinance market is less than what headline numbers reflect, limiting growth opportunities for pureplay microfinance companies: While microfinance is a great business to replace the moneylender and provide access to organized sector financing for economically weaker sections, the actual market which microfinance can address in an economically viable manner is quite limited and not reflected by total rural population. We take a look to analyze the actual addressable market and what penetration it would take to sustain the present growth rates. Exhibit 15 shows income distribution in India as of From the different income groups shown, the maximum targetable households for microfinance in India are the middle and low income groups, i.e. a total of 164mn households. Since microfinance targets economically active women only, not all of these households can be targeted, which further reduces the targetable market size. We assume ~75% of these households constitute the target market for microfinance, which comes to ~120mn households. Exhibit 15: Income distribution in India Classification Monthly income (Rs '000) No of households (in mn) Rich 93 2 High income Middle income Low income Poor Total 275 Source: CMIE report The FY16 average ticket size for microfinance in India was Rs. 17.8K. We estimate that sustainable healthy ticket size growth can be up to 10% per annum, marginally above GDP growth rate and inflation. As shown in exhibit 16, for microfinance industry gross AUMs to grow at 30% CAGR for the next 5 years, industry penetration would have to go up from 25% in FY16 to 53% in FY21E and 72% in FY23E. This is not feasible for the industry, as it needs expansion into remote areas where economies of scale cannot be achieved. This implies that the growth spurt witnessed in the last few years cannot be sustained. For urban and semi-urban focused companies like Ujjivan, growth would be an additional challenge as a large part of the targetable market is based in rural India. Exhibit 16: Increase in penetration with growth in MFI AUMs Total addressable households (mn) Household growth Average ticket (Rs '000) Addressable market (Rsbn) Present market (Rsbn) yoy growth Market penetration Source: CMIE, MFIN, Equirus Securities FY16 FY17E FY18E FY19E FY20E FY21E FY22E FY23E % 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% ,137 2,386 2,663 2,974 3,320 3,707 4,139 4, ,170 1,520 1,977 2,569 3,340 30% 30% 30% 30% 30% 30% 30% 25% 29% 34% 39% 46% 53% 62% 72% Microfinance crises in the past have been preceded by periods of aggressive growth causing NPA spikes: India s past microfinance crises (Karnataka (FY09) and A.P (FY10)) were preceded by periods of aggressive AUM growth, leading to overleveraging and subsequent building up of uncontrollable NPAs. Post the A.P. crises, MFI AUM growth was muted till FY13 post which MFI AUMs have grown at a 66% CAGR between FY13-FY16 fueled by equity infusion by PE/VC funds, and with increased investor interest in the industry as well as banks entering into microfinance lending, this will lead to overleveraging which will cause asset quality crisis. Convergence of domains across banks and NBFC-MFIs, emergence of more diversified businesses and Universal Banks: While SFBs like Ujjivan, Equitas, Satin, ESAF etc are ramping up their individual lending products in an attempt to diversify their businesses and position themselves as banks, large private sector banks such as Indusind Bank and YES Bank have focused on growing their microfinance portfolio (not as a core business) in view of the attractive RoAs in this segment. This indicates that the financial sector in India is witnessing a convergence of domains across banks and NBFCs. This especially holds for retail focused banks and retail NBFCs, housing finance companies, NBFC-MFIs etc. This, however, increases asset quality risk in microfinance due to possible overleveraging by customers due to oversupply of credit and information inefficiency. This also introduces risks to profitability from possible price competition in a crowded space which offers more choice to customers. August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 10 of 63

11 Microfinance Sector Note Twin impact of corporate lending asset quality disaster with Government s Financial Inclusion initiatives will encourage more universal banks: The increased focus of the government on financial inclusion and bringing small scale industries under organized sector financing has timed itself with rising NPAs in corporate banking. This leads to 2 things a) more banks shifting focus from corporate to retail and b) more banks/fis diversifying their retail lending portfolio to reduce product concentration risk. This will lead to more banks/fis re-positioning themselves as Universal Banks to avoid failures due to stress on any one particular consumer segment. NBFC-MFI recipients of SFB licenses risk not being able to scale up banking business: In the light of NBFC-MFIs being granted SFB licenses, it should be noted that we have no historical precedence of conversion of an NBFC-MFI to a bank. There remains a risk that they fail to scale up deposits to counter the drop in yields with reduced cost of funds, in which case returns will drop substantially. While we have been conservative with our assumptions, we will revisit our thesis post more clarity on their deposit strategy and visible traction. Government initiatives expected to benefit Affordable housing and MSME segments, positive for Ujjivan and Equitas who are expanding their individual lending portfolio in these segments: Government initiatives to encourage affordable housing: The affordable housing industry in India has received a boost from the Credit Linked Subsidy Scheme (CLSS) under the Pradhan Mantri AwasYojana (PMAY). Under CLSS, customers from the EWS and LIG categories purchasing homes having carpet area within 30 sqm (EWS) and 60 sqm (LIG) would be given a subsidy of Rs. 0.22mn. PMAY allows 100% tax deduction for builder profits from housing projects for flats up to 30 sqm. in 4 metro cities and 60 sqm. in other cities during Jun 16 Mar 19 and completed within 3 years of approval (Minimum Alternate Tax is still applicable). First time home buyers are allowed an additional Rs. 50K of interest deduction from income tax for loans up to Rs. 3.5mn sanctioned during FY17, provided the home value is within Rs. 5mn. Under section 87A of IT Act, the tax rebate limit is raised from Rs. 2,000 to Rs. 5,000 for tax payers with income of up to Rs. 0.5mn. This move will benefit 20mn tax payers in this category. The house rent rebate has been raised from Rs. 24K to Rs. 60K under section 80GG which will benefit people staying in rented accommodation. Our channel checks indicate that the implementation of CLSS has been swift, and housing finance companies as well as banks have seen a surge in demand driven by the scheme. However, due to supply shortage in urban areas/tier 1/metro cities, housing finance providers in Tier 2/3 cities and sub-urban areas would benefit the most from the increased demand. Multiple tax incentives for the MSME segment to encourage Make in India : Under section 44AD of Income Tax Act, MSME units having gross receipts of up to Rs. 20mn (earlier limit was Rs. 10mn) don t need to maintain detailed books of accounts and get them audited. This will benefit 3.5mn MSME units. Under the same Income tax section, the gross receipt limit for professionals has been raised from the existing level of Rs. 2.5mn to Rs. 5mn to be exempt from account keeping and audit. On taxation, income tax rate for an MSME unit whose turnover does not exceed Rs. 50mn, has been lowered to 29% from 30%. As part of Make in India Program, start-up unit profits will be tax exempt for 3 out of 5 years during Apr 16 to Mar 21 Capital gains will not be taxed if invested in regulated / notified funds even if invested by individuals in notified start-ups. Suitable changes have been made in customs and excise duty structure on certain inputs, raw materials, intermediaries and components to reduce costs and improve competitiveness. These moves are expected to encourage more capacity expansion and job creation in this segment. Encouraging data for used and new commercial vehicle financing from top 8 companies a positive for Equitas which is building its portfolio in this segment: Data for 8 CV financiers in India from Growth: While new CV AUM has grown at a CAGR of 9%, used CV financing has grown at a CAGR of 22%. In FY16 New CV grew by 14% and used CV grew by 19%. Over this period UCVs have grown consistently whereas NCV has seen some volatility. August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 11 of 63

12 Microfinance Sector Note Lending rate: Lending rate for new vehicles in FY15 and 1HFY16 stood at 11.3% for MHCV and 13.5% for LCVs. For used vehicle lending rate has remained largely unchanged at 15.4% for used MHCVs and 16.5% for used LCV s. LTV: LTV in used CV is 77% for both MHCV and LCV. Average tenure in used MHCV and LCV segments is 31 months Improvement in asset quality and recovery/upgradations in the CV segment: The percentage of repossessed vehicles being released back to customers on payment of dues has increased to 50-60% compared to 20-30% at peak stress levels. Time taken to sell the vehicle after repossession has also come down to days from days earlier. Delinquency level in used CV segment for 90+ dpd and 180+ dpd are at 6.7% and 2.3% in Mar 16 compared with 7.3% and 2.2% as on Mar 15. Jharkhand, Bihar, Goa and Puducherry have been impacted by mining related issues are performing weaker compared to other states. Maharashtra and MP are also performing weak where financiers have good presence due to drought situation. Delhi also seems to be performing weak. Flow Rate analysis carried out in respect to 4,500 contracts that were more than 180 days overdue (as on Sept 30th, 2015) says that in 65% of cases either the account has been fully resolved (11% of cases) or borrower has paid some amount despite slipping by more than 6 EMIs in past. In 30% of cases the contract continues to be in 180 dpd bucket as the overdue amount has not yet come down; however, borrower is making 1 full EMI payment regularly. In 20% of cases, the borrower has paid some amount but not paid full EMI amount. Average loss incurred by financiers at the time of vehicle sale in MHCV segment has increased by 48% in FY14. However, loss levels have come down to 35% in 1HFY16. Loss level continues to remain high in LCV segment at average loss of 46% in 1HFY16. August 16, 2016 Analyst: Anirvan Sarkaranirvan.sarkar@equirus.com ( ) Page 12 of 63

13 Exhibit 17: State-wise MSME statistics State/UT Microfinance Sector Note Number of enterprises (lakhs) Unregistered sector Employment (lakhs) Unregistered sector Registered sector Sample EC 2005 Total Registered sector Sample EC 2005 Total Jammu and Kashmir Himachal Pradesh Punjab Chandigarh Uttarakhand Haryana Delhi Rajasthan Uttar Pradesh Bihar Sikkim Arunachal Pradesh Nagaland Manipur Mizoram Tripura Meghalaya Assam West Bengal Jharkhand Odisha Chattisgarh Madhya Pradesh Gujarat Daman and Diu Dadra and Nagar Haveli Maharashtra Andhra Pradesh Karnataka Goa Lakshadweep Kerala Tamil Nadu Puducherry Andaman and Nicobar Islands Total Source: MSME Annual Report FY15 August 16, 2016 Analyst: Anirvan ( ) Page 13 of 63

14 2016 Equirus All rights reserved Rating Information Price (Rs) 176 Target Price (Rs) 142 Target Date Target Set On Implied yrs of growth (ERE) Sep Aug-16 Fair Value (ERE) 141 Fair Value (DDM) NA Ind Benchmark BANKEX Model Portfolio Position NA Stock Information Market Cap (Rs mn) 59,109.8 Free Float (%) 100% 52 Wk H/L (Rs) / Avg Daily Volume (1yr) 63,88,685.1 Avg Daily Value (1yr) 1,061.7 Equity Cap (Rs Mn) 3,353.7 Face Value (Rs) 10.0 Bloomberg Code EQUITAS IN Ownership Recent 3M 12M % Promoters 0.00% 0.0% 0.0% DII 29.3% 0.0% 0.0% FII 48.1% 0.0% 0.0% Public 22.6% 0.0% 0.0% Price % 1M% 3M% 12M% Absolute -0.5% 17.3% NA Vs Industry -0.9% 2.8% NA UJJIVAN 11.5% 74.7% NA BHARATFIN 2.6% 25.2% 45.3% Consolidated Quarterly EPS forecast Rs/Share 1Q 2Q 3Q 4Q EPS (16A) EPS (17E) Equitas Holdings Absolute : SHORT Relative : UNDERWEIGHT Initiating Note Regular Coverage 20% downside in 14 months Perfectly positioned to leverage quality growth across verticals, rich valuations leave room for near term Financials correction, initiate with SHORT Equitas Holdings is the 4 th largest Indian microfinance company with ~8% market share and microfinance Gross AUM of Rs. 32.8bn as of 4QFY16. We expect them to benefit from sustainable quality growth in both group and individual lending portfolios to attain 30% CAGR in total Gross AUM from FY16 to FY22E on the back of regional presence across flourishing markets in India. However, the stock is trading at 2.7x FY17E P/ABV and we believe the robust growth prospects, sturdy asset quality and solid strategy are priced in the CMP, but near-term uncertainties on bank transition and profitability are not. We believe the stock will correct in the near-term and initiate coverage with a SHORT rating, arriving at ERoE based Sep 17 TP of Rs. 142 implying 20 years of growth with average RoE of 15.5% and cost of equity of 14.4%. Branch concentration in the right states will support robust growth in next 5 years: Equitas has ~83% of its 572 branches in states like TN, Mah, Kar, Raj and MP which contribute to 88% of Gross AUMs. There is a flourishing market in microfinance, affordable housing, used CV financing and MSME financing in these states. They are converting 412 existing branches to bank branches, which will help them scale up deposit base and maintain return ratios during the transition phase. We expect Equitas Gross/Net AUMs to reach Rs bn/284.7bn by FY22E and their deposit base to reach 40% of total loans and advances, i.e. Rs bn by FY22E. Asset quality will remain sound backed by stringent credit quality monitoring and controlled ticket size: Equitas GNPA/NNPA ratios are 1.61%/1.14% for the total portfolio. While the microfinance business enjoys low GNPA/NNPA of 0.23%/0.05%, the UCV/MSE and housing finance portfolios have GNPA/NNPA of 2.94%/2.19% and 5.54%/4.90% respectively. During transition to bank, NPAs are expected to grow due to reduction of recognition days from 150 to 90. Given low Portfolio At Risk (PAR) for the industry in Equitas s states of presence, low ticket size and stringent risk management practices, asset quality should improve after initial bumps. Reducing dependence on microfinance a positive, proven track record in scaling up MSE/UCV financing business ensures transition into more diversified asset base: While Equitas has steadily reduced dependence on microfinance, their individual loan book growth will be boosted by multiple government initiatives, such as CLSS under PMAY, lack of organized players in UCV financing and enhanced MSME tax incentives. Key Risks relate to slower scale up in deposit base and regulatory pressure in microfinance: The fixed deposit market is hyper competitive and scale up of deposits to 40% of total loans could face challenges. Regulatory clampdown remains a risk for microfinance companies. Consolidated Financials Rs. Mn YE Mar FY16A FY17E FY18E FY19E Interest Income 10,368 14,013 17,791 21,352 Interest Expense 4,360 5,413 6,949 8,634 Net Interest Inc. 5,777 8,599 10,842 12,718 Other Income 1,012 1,675 2,457 3,101 Operating Exp 3,597 5,753 8,644 9,966 Provisions ,657 2,181 PAT 1,671 2,346 1,948 2,387 Loan and Advances 50,702 68,544 84,194 1,07,670 Deposits 0 6,854 12,629 26,917 Net Worth 13,414 22,754 24,703 27,090 NIM 11.40% 9.87% 9.47% 8.93% Credit Cost 1.39% 1.49% 2.17% 2.27% Rs Per Share FY16A FY17E FY18E FY19E EPS Adjusted EPS Book Value Adjusted BVPS DPS P/B (x) 3.5x 2.6x 2.4x 2.2x Adj P/B (x) 3.7x 2.7x 2.6x 2.4x Adj ROE (%) 13.31% 12.97% 8.21% 9.22% RoA (%) 3.05% 2.71% 1.59% 1.53% August 16, 2016 Analyst: Anirvan Sarkar anirvan.sarkar@equirus.com ( ) Page 14 of 63 Before reading this report, you must refer to the disclaimer on the last page.

15 Company Snapshot Equitas Holdings Absolute SHORT Relative UNDERWEIGHT 20% downside in 14Months How we differ from Consensus - Equirus Consensus % Diff Comment EPS NII + Other Inc PAT FY17E % FY18E % FY17E 10,275 9,924 4% FY18E 13,299 13,744-3% FY17E 2,346 1,937 21% FY18E 1,948 2,520-23% We are conservative in our assumptions on loan growth and provisioning expenses and hence our estimate for FY18 PAT is 23% lower than that of the street Our Key Investment arguments: Equitas will experience super-normal growth in the near to medium term and we like their low dependence on microfinance, low ticket sizes and robust risk management; High valuations are a concern and we initiate coverage with a SHORT rating expecting near term correction in the stock price. Key Assumptions 2016A 2017E 2018E 2019E 2020E Yields on Advances (%) 20.0% 19.0% 18.3% 17.8% 17.5% Yield on Investments (%) 12.3% 5.0% 7.2% 7.2% 7.2% Cost of Funds (%) 11.3% 9.9% 9.9% 9.4% 9.1% NIMs (%) 11.4% 9.9% 9.5% 8.9% 8.6% NII Growth (%) 47.3% 48.8% 26.1% 17.3% 29.7% PPI Growth (%) 49.2% 41.6% 2.9% 25.7% 41.1% Credit costs (%) 1.4% 1.5% 2.2% 2.3% 2.2% PAT Growth (%) 56.8% 40.4% -17.0% 22.5% 45.7% Advances Growth (%) 46.3% 35.2% 22.8% 27.9% 43.2% Deposit Growth (%) NA NA 84.2% 113.1% 71.8% Key Risks: Delay in building deposit base, unfavorable political intervention. Key Triggers: Execution and credit risk monitoring, positive news on scaling up advances and deposits base Sensitivity to Key Variables % Change % Impact on EPS Net Interest Income 10 % 36.7 % Provisioning Costs 10 % -3.8 % ERoE Valuations & Assumptions Rf Ke Term. Growth RoE in Terminal Yr 7.2% 14.4% 5.0% 18.2% FY16A FY17-21E FY22-26E FY27-36E NII Growth 47.3% 20.7% - - NIM (%) 11.3% 10.0% - - Adj EPS Adj RoE (%) 13.3% 11.6% 16.6% 18.0% Years of strong growth Valuation as on date (Rs) Valuation as of Mar Our Sep 17 target price of Rs. 142 is based on ERoE valuation assuming 20 years of growth, implying FY17E P/ABV multiple of 2.2x with an average RoE of 15.5%. Company Description: Incorporated in 2005, Equitas Financial Services Ltd (Equitas) is a Tamil Nadu headquartered microfinance company which has been granted a small banking license by RBI in The company offers Microfinance loans, housing loans, Used Commercial Vehicle (UCV) loans and MSE loans. As on June 30th, 2016, the firm has a distribution network of 572 branches across 14 states/uts. - Comparable valuation Mkt Cap Rs. Price Target EPS P/E BPS P/B RoE Div Yield Company Reco. CMP Mn. Target Date FY16A FY17E FY18E FY16A FY17E FY18E FY16A FY17E FY16A FY17E FY18E FY16A FY17E EQUITAS SHORT , Sep ' % 13.0% 8.2% 0.0% 0.5% UJJIVAN SHORT , Sep ' % 13.8% 9.9% 0.1% 0.2% BHAFIN NA ,884 NA NA % 34.1% 25.9% 0.0% 0.4% August 16, 2016 Analyst: Anirvan Sarkar anirvan.sarkar@equirus.com ( ) Page 15 of 63

16 Equitas Holdings Absolute SHORT Relative UNDERWEIGHT 20% downside in 14Months Investment Rationale AUM growth to be helped by strategic concentration in high growth markets in Microfinance, MSE, UCV and affordable housing, conversion into bank branches will help build deposit momentum: Equitas enjoys a large branch network concentrated in relatively fewer states. As of Jun 16, the company had 572 branches across 12 states, 1 UT and Delhi. As of 4QFY16, 83% of their branches were concentrated in the top 5 states of TN, Karnataka, Maharashtra, Rajasthan and M.P. and they contribute to 88% of total gross AUMs (refer Exhibit 1). Exhibit 1: Branch concentration coincides with AUM concentration Source: Company Filings Branch concentration 2.9% 7.8% 8.4% 6.9% 8.6% 7.7% 17.3% 40.4% Tamil Nadu Maharashtra Karnataka Rajasthan MP Gujarat Chhattisgarh Others 3.9% Equitas has scaled up their individual lending portfolio which stands at ~48% of total gross AUMs as of 1QFY17 compared to 23.5% in 4QFY13. The company aims to further reduce microfinance to 30% of their gross AUMs by FY20E. Within individual lending portfolio, UCV financing (52%) and MSE financing (40%) contribute to 92% while housing finance constitutes 8% of individual book gross AUMs and 4.7% 4.1% 7.7% AUM concentration 14.8% 1.5% 6.4% 56.9% 4% of total gross AUMs. Equitas primary focus is to grow its UCV and MSE segments to the bulk of its total gross AUMs while housing finance will remain a smaller part of the total portfolio. We estimate that by FY22E, the total gross AUMs will consist of 20% in MFI loans, 75% in UCV and MSE, and 5% in housing finance. Equitas has received approval from RBI to convert 412 of its branches to bank branches, which should help deposit building momentum and help them maintain NIM and profitability. However, scaling up deposits is a gradual process and we estimate that Equitas will fund 40% of their loan book with deposits by FY22E. 1. Unambitious target for microfinance growth to be easily met due to impressive Overlap with large Microfinance markets: As of 31 st March 2016, the top 5 states in India (by Microfinance Gross Loan Portfolio (GLP)) accounted for 60% of total microfinance GLP in India. From exhibit 2, we see that Equitas Microfinance has 87% of its MF AUMs concentrated in these 5 states, of which 61% of is in Tamil Nadu, the largest Microfinance market in India. This strong overlap in focus areas with the overall industry should help them achieve their targeted growth in their MF portfolio. Exhibit 2: Comparison of microfinance AUM distribution across states for Equitas vs. industry States Percentage of total GLP Percentage of Equitas' GLP Tamil Nadu 16% 61% Karnataka 13% 7% Maharashtra 12% 13% Uttar Pradesh 11% 0% Madhya Pradesh 8% 6% Orissa 6% 0% West Bengal 6% 0% Bihar 5% 0% Kerala 5% 0% Gujarat 4% 0% Others 14% 13% Source: Company Filings We estimate that Equitas microfinance gross AUM will grow at 11% CAGR from FY16 FY22E to Rs. 60.1bn, in-line with the company s target of gradually lowering the microfinance share of the total book by diversifying into UCV, MSE and housing finance. August 16, 2016 Analyst: Anirvan Sarkar anirvan.sarkar@equirus.com ( ) Page 16 of 63

17 Equitas Holdings Absolute SHORT Relative UNDERWEIGHT 20% downside in 14Months Given their strong presence in microfinance hubs in India, this growth is an easily achievable target. Exhibit 3: Projected growth in Equitas Microfinance Gross AUMs 70,000 60,000 50,000 40,000 30,000 20,000 10, , ,830.0 Source: Company, Equirus Research Microfinance Gross AUM (Rs mn) 36, , , , , ,090.3 FY15A FY16A FY17E FY18E FY19E FY20E FY21E FY22E Exhibit 4: Equitas branch network and MSE financing book distribution in top states by number of enterprises % of total MSME enterprises Equitas branches Equitas MSE financing AUM % Uttar Pradesh 12% 0 0% West Bengal 10% 0 0% Tamil Nadu 9% % Maharashtra 8% 96 19% Andhra Pradesh 7% 9 0% Kerala 6% 0 0% Gujarat 6% 39 6% Karnataka 6% 50 11% Madhya Pradesh 5% 43 5% Total 70% % Source: MSME AR 2015, company filings 2. MSE financing to be boosted by credit growth in the sector, branch and AUM concentration in MSE hubs and multiple tax initiatives by GOI towards Make in India a) Concentrated branch network in MSE hubs in India, proven track record in scaling up MSE financing provides comfort on ability to grow: As shown in Exhibit 4, Equitas has 52% of its total MSE AUMs concentrated in the top 5 states with the largest number of MSMEs. Tamil Nadu, the strongest hub of Equitas is home to a flourishing MSME sector as the state ranks 3 rd in terms of number of enterprises as well as employment. Tamil Nadu ranks 2 nd in terms of total fixed assets of MSME sector, as shown in Exhibit 22 in annexure, the first position being held by Gujarat where Equitas has an extensive network as well. Equitas has already demonstrated its ability to scale up its MSE lending book as MSE AUMs form 19% of total gross AUMs. August 16, 2016 Analyst: Anirvan Sarkar anirvan.sarkar@equirus.com ( ) Page 17 of 63

18 Equitas Holdings Absolute SHORT Relative UNDERWEIGHT 20% downside in 14Months b) Multiple tax incentives for the MSME segment to encourage Make in India : Under section 44AD of Income Tax Act, MSMEs having gross receipts of up to Rs. 20mn (earlier limit was Rs. 10mn) don t need to maintain detailed books of accounts and get them audited. This will benefit 3.5mn MSMEs. Under the same Income tax section, the gross receipt limit for professionals has been raised from the existing level of Rs. 2.5mn to Rs. 5mn to be exempt from account keeping and audit. On taxation, income tax rate for MSMEs whose turnover does not exceed Rs. 50mn, has been lowered to 29% from 30%. As part of Make in India Program, start-up unit profits will be tax exempt for 3 out of 5 years during Apr 16 to Mar 21. Capital gains will not be taxed if invested in regulated / notified funds even if invested by individuals in notified start-ups. Suitable changes have been made in customs and excise duty structure on certain inputs, raw materials, intermediaries and components to reduce costs and improve competitiveness. These moves are expected to encourage more capacity expansion and job creation in this segment. Exhibit 5: Growth in Bank credit to MSME sub-segments Rs million Mar'08 Mar'09 Mar'10 Mar'11 Mar'12 Mar'13 Mar'14 Mar'15 Micro & Small enterprises 1,327 1,690 2,064 2,102 2,367 2,843 3,482 3,800 yoy growth NA 27% 22% 2% 13% 20% 22% 9% Medium enterprises 1,108 1,222 1,326 1,165 1,248 1,247 1,241 1,245 yoy growth NA 10% 9% -12% 7% 0% -1% 0% Total 2,435 2,912 3,390 3,267 3,614 4,091 4,723 5,046 Source: RBI Exhibit 6: Projected growth in Equitas s MSE gross AUMs 1,20, ,00,000.0 MSE gross AUMs (Rs mn) 98,127.5 These incentives are expected to boost MSME growth in the country and will enhance financing needs, creating more opportunities for Equitas. 80, ,861.4 c) Bank credit growth points to healthy growth in MSE financing: Bank credit to MSE segment has grown much more compared to medium and large enterprises (Exhibit 5), reflecting that number of enterprises in this segment has grown and hence the market opportunity for financiers is more for the micro and small enterprises compared to medium. 60, , , , , , ,077.2 We expect Equitas to grow its MSE AUMs at a 41% CAGR between FY17 and FY22E to reach Rs. 98.1bn in gross MSE AUMs by FY22E 0.0 FY17E FY18E FY19E FY20E FY21E FY22E Source: Equirus Research, company filings August 16, 2016 Analyst: Anirvan Sarkar anirvan.sarkar@equirus.com ( ) Page 18 of 63

19 Equitas Holdings Absolute SHORT Relative UNDERWEIGHT 20% downside in 14Months 3. Used commercial vehicles has a huge potential market dominated by informal financiers, UCV financing at 25% of total gross AUMs provides comfort on ability to scale up business: Market dominated by informal financiers provides easy growth for Equitas, proven track record in UCV financing growth provides comfort on ability to grow AUMs: The used commercial vehicle (UCV) market in India is dominated by the unorganized sector which dominates 55% of the market, with the only organized sector participation coming from Shriram City Union Finance, TATA OK, Tata Motors Assured and Eicher Sure. This leaves a vast opportunity for the organized sector. Equitas has grown its UCV financing gross AUMs to Rs bn (25% of total gross AUMs) in 1QFY17. Their extensive presence in Tamil Nadu will help them since the only significant local competition is from Shriram City Union Finance, and informal financiers provide an easy way of growing market share. The entry barrier in this segment is high, with dealer network establishment being the prime criteria for gaining business traction, so we expect healthy growth by taking market share from informal financiers. UCV financing growth has been more consistent compared to new CV financing: Data from 8 CV financiers from shows that while new CV AUM has grown at a CAGR of 9%, used CV financing has grown at a CAGR of 22%. In FY16 New CV grew by 14% and Used CV grew by 19%. Even for the period under consideration, UCVs have grown consistently whereas NCVs have seen some volatility. Exhibit 7: Expected Growth in UCV portfolio AUMs 1,40,000.0 UCV gross AUMs (Rs mn) 1,27, ,20, ,00, , , , , , , , , , FY17E FY18E FY19E FY20E FY21E FY22E Source: Equirus Research, company filings Moreover their recent initiative, Equitas Technologies Pvt. Ltd. provides freight facilitation by connecting transport service providers to customers. This should help them pick up traction in financing transporters and should further help UCV portfolio growth. We expect Equitas to grow its UCV financing gross AUMs at a 41% CAGR between FY17E and FY22E to Rs bn in FY22E August 16, 2016 Analyst: Anirvan Sarkar anirvan.sarkar@equirus.com ( ) Page 19 of 63