ESAF Small Finance Bank Ltd Q3 FY2024 Concall Summary

Key Takeaways

• Profit surge, but asset quality cracks appear: PAT jumped 199% YoY to ₹112 crores, yet NPAs nearly doubled QoQ from ₹186 crores to ₹335 crores as stress hit Kerala, Tamil Nadu, Madhya Pradesh and Chhattisgarh.
• The stress is local, not systemic: Management blames staff attrition at a principal BC, unregulated lender entry, and its own deliberate pullback in stressed markets, not a broad deterioration in the microfinance cycle.
• Deposit franchise strengthening: Deposits grew 41% YoY to ₹18,860 crores, with retail deposits up 27%, giving the bank a stable funding base as it navigates the credit bump.
• Elevated credit costs to persist: Management expects the current high provisioning to continue for one or two quarters, with normalization only after H1 FY25, making near-term earnings visibility poor.
• What to watch next quarter: Whether the QoQ NPA jump was a one-off cleanup or the start of a trend, the pace of PCR recovery from 59.5%, and any sign that BC staff attrition is stabilizing.

Asset Quality: The Quarter's Central Story

• NPA spike concentrated in four geographies: Kerala (central and south), central Tamil Nadu, Madhya Pradesh and Chhattisgarh drove the ₹149 crore QoQ gross NPA increase, prompting the bank to deliberately reduce exposure and disbursements in those markets.
• BC staff attrition broke the collection model: The principal BC saw around 40% staff attrition, and because microfinance collection is highly people-centric, recoveries suffered directly. The bank is evaluating options to directly take over some BC functions.
• Unregulated lenders are disrupting Kerala: After interest rates were freed, unregulated entities entered border districts of Kerala with aggressive practices the bank refuses to match, creating a competitive distortion in borrower repayment behavior.
• Provisioning math masked the full hit: Provision costs rose only 36-37% QoQ despite NPAs nearly doubling because the bank drew down ₹19 crores of SMA provisions already built, with a net charge of just ₹11 crores after creating ₹30 crores in fresh SMA provisions.
• PCR dipped on fresh slippages, not write-offs: The provision coverage ratio fell because new slippages entered the book at lower coverage; management expects PCR to improve drastically once the slippage ratio comes down in one or two quarters.

Hari Velloor: "We have been seeing a bit of stress in some of our markets, particularly in Kerala. There are a few factors behind this. One is of course that our principal BC with whom we have a lot of business going on. We have seen a lot of staff attrition happening... Second, there is a lot of unregulated entities who have also entered this business in the last two years or so."

Credit Cost & Normalization Path

• Elevated credit cost has a shelf life: Management expects the current high provisioning to persist for one or two quarters, with normalization after H1 FY25 as the measures taken, reducing exposure in stressed markets and controlling disbursements, yield results.
• The long-run benchmark is 1%: In a normal year without black swan events, management says the traditional credit cost experienced in micro banking is around one percentage point, with pre-COVID FY20 coming in at less than half a percent.
• Next year's credit cost guided at 2.5%+: For FY25, credit cost is expected to be somewhere around 2.5 percentage points plus, reflecting the lagged impact of current stress before normalization takes hold.
• SMA provisioning provides a buffer: The bank holds around ₹30 crores in additional SMA provisions and maintains 40% provisioning on the NPA book, which partially absorbed the Q3 slippage shock and will cushion near-term volatility.

Gireesh C.P: "There could be some level of this current elevated credit cost position may continue for one quarter or two quarters. That is what we expect as things stand today. We can't precisely quantify, but the current elevated levels may continue on the credit cost aspect maybe couple of quarters."

Growth & Franchise Strength

• Loan book grew 37% YoY to ₹17,153 crores: Growth was driven by the core mission of serving unbanked and underbanked customers in rural and semi-urban areas, where 70% of gross advances are deployed and 62% of banking outlets are located.
• Deposits outpaced advances at 41% YoY: Retail deposits, the strategic priority, grew 27% to ₹16,994 crores, providing a stable and granular funding base that reduces reliance on wholesale sources.
• Geographic diversification is real but incomplete: Gross advances outside Kerala now stand at ₹10,412 crores (60.7% of total), with the top five states outside Kerala contributing ₹8,301 crores (48.4%). The target is to bring Kerala exposure down to 25% over the next two to three years from the current 39%.
• Secured book being pushed hard: Gold loans and agri loans are being aggressively expanded across the country to reduce dependence on the unsecured microfinance book, which management wants to bring from 72% to around 60% by FY26-27.
• BC network has expanded but concentration risk remains: The bank started with one BC, a related-party cooperative, in 2017 and has since expanded to 30 BCs. Management did not directly address whether the regulator has expressed concern about the related-party BC.

Hari Velloor: "In terms of, we are not able to give a concrete figure to you for obvious reasons as you know. But generally, we have been saying that a minimum of 25% growth, compared to our record it is a little less, but we generally come in saying a minimum of 25% growth."

Profitability & Operating Metrics

• NIM expanded to 10.6% from 9.9% YoY: Net interest income rose 32.3% to ₹597 crores, reflecting strong yield management on the asset side and a stable deposit franchise.
• ROA and ROE surged on profit growth: ROA improved to 2.3% from 1.5% and ROE to 25.5% from 17.6%, though sustainability depends on credit cost normalization. Management targets around 2% ROA on a sustainable basis.
• Cost-to-income stable despite expense pressure: The ratio held at 56-57% in Q3, with the one-off being only ₹9 crores in backlog third-party product income. Management expects to maintain cost-to-income at around 60% (marginally plus or minus) for FY25 and FY26.
• BC expenditure rose with volumes, not formula changes: BC expenses increased 48% to ₹180 crores because business volumes and collection efficiency rose, with the cost primarily linked to a percentage of collections. Management stated there was no change in the formula structure.
• Ad spend was a one-quarter branding push: ₹17 crores in incremental advertisement and publicity spend during Q3 may not repeat in all quarters, providing some operating expense relief ahead.

Strategic Initiatives & Book Evolution

• NABARD and agri infrastructure partnerships signed: The bank entered a guarantee fund partnership with NABARD for lending to farmer producer organizations and signed up for the Government of India's agri infrastructure funding scheme, both carrying guarantees that reduce credit risk.
• Agri team being built with domain expertise: The bank will expand its team of agri relationship officers, all of whom are agricultural graduates with experience in agri-finance domains, signaling a serious push into secured agri lending.
• Third-party product income is small but growing: ₹25 crores in total third-party income, with ₹15 crores from the current quarter and ₹9 crores from backlog, mainly insurance penetration bonuses and higher business volumes.
• Underwriting control remains fully with the bank: The regulator does not permit outsourcing of underwriting, and the bank's business rule engine and systems are completely controlled in-house. BCs are only the front end for sourcing and collection.
• Credit monitoring uses real-time data: The bank constantly scans credit bureaus, monitors exposure levels, and uses heat maps from Enfin to make granular, geography-level lending decisions.

Gireesh C.P: "When the impact of all the black swan events are out of business, then definitely one percentage is the traditional kind of credit cost which is experienced in this micro banking field."

Guidance & Commitments

Key Metrics