IPO: Utkarsh Small Finance Bank

In a nutshell

• Quality: Utkarsh Small Finance Bank's three-year average ROE of 12.3 per cent. Additionally, it has reported a healthy three-year average net interest margin (NIM) of 8.8 per cent.
  
• Growth: Over the past three years, the bank has achieved growth in net interest income (NII), deposits, and advances, with annual growth rates of 35 per cent, 26 per cent, and 35 per cent, respectively.
  
• Valuation: The stock is expected to be listed at a lower valuation compared to its peers, as indicated by its P/E and P/B ratios.
  
• Overview: Utkarsh Small Finance Bank stands to benefit from the increasing demand for credit, rising income levels, and growing business activities in rural and semi-urban areas. However, the bank faces intense competition in the industry and potential risks associated with the possibility of economic downturns and an increase in non-performing assets (NPAs).

About Utkarsh Small Finance Bank

Utkarsh Small Finance Bank was established on April 30, 2016, as a wholly-owned subsidiary of Utkarsh CoreInvest Limited. The bank operates across 26 states and union territories of India, with a total of 830 branches. As of March 31, 2023, the micro-banking segment accounted for 66 per cent of the bank's gross loan portfolio.

Strengths of Utkarsh Small Finance Bank

• The bank has experienced robust growth in total deposits and CASA (current account and savings account) deposits over the past three years. This has helped lower the cost of funds from 8.27 per cent in FY21 to 6.96 per cent in FY23.
• As of March 31, 2023, the bank reported a strong liquidity position with an LCR (liquidity coverage ratio) of 357.8 per cent, surpassing the regulatory requirement of 90 per cent.

Weaknesses of Utkarsh Small Finance Bank

• More than 55 per cent of the gross loan portfolio is concentrated in Bihar and Uttar Pradesh. Any economic slowdown, downturn, or natural calamity in these regions could significantly impact loan recovery and the bank's net interest income.
• The bank's top 20 depositors accounted for over 20 per cent of the total deposits in FY23. The loss of any of these customers would result in reduced deposits and increase the bank's exposure to funding risks.
• Unsecured loans, including micro banking loans and certain retail loans, make up 66.9 per cent of the bank's total loan portfolio. Unsecured loans carry higher credit risk and have a lower probability of recovery in the event of default.

IPO questions

Management

• Is Utkarsh Small Finance Bank free from regulatory penalties?
  No, the RBI imposed a penalty of Rs 1 crore on the bank in 2018 for advances sanctioned to NBFCs. The penalty was paid on July 17, 2021.
• Does the bank provide for its non-performing assets (NPAs) adequately? Specifically, is the provision-to-gross NPAs ratio more than 50 per cent?
  Yes, the bank's provision-coverage ratio for FY23 stood at 95.8 per cent.
• Do the top five managers have stock as a significant part of their compensation (more than 50 per cent)?
  No, while ESOPs have been offered in the past, stock-based compensation does not form a regular or substantial part of the top five managers' income.

Financial strength and stability

• Does Utkarsh Small Finance Bank have a fresh slippage-to-total advances ratio of less than 0.25 per cent? (fresh slippages are loans that became NPAs in the last financial year)
  No, the bank has a fresh slippage-to-total advances ratio of 3.7 per cent.
• Did the bank generate a current return on equity (RoE) of more than 12 per cent and a return on assets (RoA) of more than 1 per cent?
  Yes, the bank reported an RoE of 22.6 per cent and RoA of 2.37 per cent in FY23.
• Has the bank increased its loan book by 20 per cent annually over the last three years?
  Yes, the bank has increased its loan book by 26.1per cent annually between FY21 and FY23.
• Has the bank increased its net interest income (NII) by 20per cent annually over the last three years? (Net interest income is the difference between the revenue that is generated from a bank's assets and the expenses associated with paying out its liabilities).
  Yes, the bank has achieved an annual growth rate of 35 per cent in net interest income between FY21 and FY23.
• Is there a direct relationship between the increase in the loan book and the increase in net interest income (NII)?
  Yes. Over the past three years, the bank has managed to increase its retail deposits, lowering the cost of funds while simultaneously increasing its loan book.
• Is the Utkarsh Small Finance Bank's capital adequacy ratio more than 15 per cent?
  Yes, the bank reported a capital adequacy ratio of 20.64 per cent as of March 2023, surpassing the required 15 per cent.
• Can the bank run its business without relying on any external funding in the next three years?
  Yes, the bank has a strong liquidity position, a statutory liquidity ratio of 31.5 per cent, and a capital adequacy ratio of 20.64 per cent. The increase in deposits, along with strong liquidity and capital raised through the IPO, should support the bank's growth without external funding.
• Did the bank generate an average net interest margin (NIM) of more than 3 per cent in the last two years? (Net interest margin or NIM denotes the difference between the interest income earned and the interest paid by a bank or financial institution relative to its interest-earnings assets like cash).
  Yes, the three-year average net interest margin (NIM) stood at 8.8 per cent.
• Is the bank's average gross NPA ratio (Gross NPAs/Total advances) over the last three years less than 1 per cent and the average net NPA ratio (Net NPAs/Total advances) less than 0.5 per cent?
  No, the bank reported an average gross NPA ratio of 4.36 per cent and a net NPA ratio of 1.34 per cent over the last three years.
• Does the bank have a cost-to-income ratio of less than 50 per cent?
  No, the bank reported a cost-to-income ratio of 54.2 per cent in FY23.

Growth and business

• Will Utkarsh Small Finance Bank be able to scale up its business?
  Yes, the bank has demonstrated substantial growth since its incorporation in 2016. Over the last three years, the bank has achieved an annual growth rate of over 25 per cent in advances and deposits. The growing demand for credit in the retail segment, along with the expansion of the bank's distribution network, supports future business growth.

• Does the bank have a loan book of more than Rs 1,00,000 crore?
  No, the bank reported total advances of Rs 13,069 crore as of March 31, 2023.

• Does the bank have a recognisable brand truly valued by its customers?
  No, although the bank has a strong presence and recognisable brand in Bihar and Uttar Pradesh, it is not widely popular in other regions of India. Bihar and Uttar Pradesh account for over 50 per cent of the bank's total deposits and advances.

• Does Utkarsh Small Finance Bank have a credible moat?
  No, the bank operates at a small scale in a highly competitive market.

• Is the level of competition faced by the bank relatively low?
  No, the banking industry in India experiences intense competition with an increasing number of banks, small finance banks, NBFCs, and fintech companies all competing against each other.

Valuations

• Is Utkarsh Small Finance Bank's price-to-earnings ratio lower than its peers' median level?
  Yes, the bank's P/E ratio of 6.8 times is lower than the peers' median level of 17.9 times.
• Is the bank's price-to-book ratio lower than its peers' average level?
  Yes, the bank's P/B ratio of 1.1 times is lower than the peers' average of 2.3 times.

Disclaimer: This is not a stock recommendation. Do your due diligence before investing.

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