ESAF Small Finance Bank Ltd Q2 FY2026 Concall Summary

Key Takeaways

• Microfinance stress may have bottomed: Slippages moderated to ₹340 crores from ~₹450 crores in prior quarters, and early normalization signals are appearing, though the older 2022-2023 vintages still dominate the pain.
• Secured pivot hit its target early: Secured assets reached 61% of gross advances, a milestone originally planned for 2027, driven by gold loans more than doubling YoY.
• NIM compressed on mix, not on margin pressure: NIM fell to 5.9% as the deliberate shift toward lower-yield secured assets outpaced the benefit from falling deposit costs, a trade-off management accepts because operating expenditure also declines.
• Deposit repricing tailwind is only half-done: Cost of deposits has eased from 7.5% to 7.2%, but the full benefit will accrue only as term deposits mature and renew at lower rates over coming quarters.
• What to watch next quarter: Whether the Q3 positive ROA target materializes, the pace of GNPA reduction from 8.5%, and any sign that microfinance disbursements are accelerating beyond the August inflection point.

Microfinance Cycle: Stress, Bottom & Recovery

• Stress concentrated in older vintages: The 2022 and 2023 books account for the bulk of microfinance pain. The new book disbursed since June 2024 is behaving according to traditional microfinance norms, with NPA of roughly 2-point-something percent of disbursements.
• Slippage composition confirms the pattern: Of the ₹340 crores in total slippages this quarter, ₹255 crores came from microfinance, overwhelmingly from the older vintages.
• Regional divergence is sharp: Kerala stress is coming down significantly, giving management confidence to restart lending with guardrails. Tamil Nadu and Karnataka remain the bigger stressed states, though Karnataka's political dimension has improved in the last three months with better portfolio control.
• Collections turned a corner in August: Till July 2025, the bank was collecting more than it disbursed in microfinance. Since August, disbursements have exceeded repayments, a sign that the deliberate contraction phase is ending.
• Recovery strategy is multi-pronged: The bank is revamping the Sangam meeting process, targeting new customer acquisition, graduating group loans to individual loans, and pursuing delinquent borrowers with dedicated follow-ups.
• Digital repayments reduce operational dependency: Roughly 40% of repayments now come through digital modes like GPay, reducing reliance on employees for customer contact and collection pressure.

Hari Velloor: "We will assess this very, very carefully. I can tell you what we have done. Till July 2025, we were collecting more than we disbursed. Since July, that is from August onwards, our disbursements have exceeded the repayments. So we will be very, very careful. We will be very choosy in whom we lend."

Secured Portfolio Transformation

• Gold loans are the engine: Gold loans grew 12% QoQ and more than doubled YoY, reflecting robust and recurring demand from the rural and semi-urban customer base. The portfolio is expected to remain in the region of roughly 40% of the book going forward.
• Yield improvement has room to run: Gold loan yields have been steadily increased from 11%-11.5% to roughly 13.5% over three to four years. The incremental lending rate is now 15%, and management sees nothing preventing further increases.
• Secured target achieved early, next milestone set: The 61% secured mix was originally planned for 2027. The current-year plan is to keep the mix at roughly 35% unsecured and 65% secured, with unsecured moderating to roughly 30% by FY27.
• Disbursement growth was broad-based: Total disbursement grew 119% YoY and 16% QoQ, led by gold, MSME, agri and affordable housing, while the micro loan book contracted from ₹11,125 crores to ₹7,426 crores in line with the de-risking strategy.

K. Paul Thomas: "Secured almost at the same level, so to keep the mix at around 35% unsecured and 65% secured is our plan by the current year end."

Margins: The NIM-Opex Trade-Off

• NIM compression is structural, not cyclical: NIM at 5.9% reflects the portfolio mix shift toward secured lending. Microfinance carries higher yield, so shifting proportion to secured advances reduces NIM. However, the operational expenditure tied to microfinance, principally BC commission, also declines in parallel.
• Repo rate pass-through is underway: The 1% repo rate change has been passed on to customers via variable interest rates. Roughly 25 bps of benefit is already visible, with the full benefit to flow in coming quarters.
• Deposit cost tailwind is material and lagged: Cost of deposits has come down from 7.5% last year to 7.3% this year to 7.2% last quarter. The benefit of repricing is partial so far because only a portion of term deposits have matured and renewed at lower rates. A substantial portion will flow in coming months.
• No immediate further rate cuts planned: Management does not envisage immediate further moderation in deposit rates, but expects cost of funds to moderate over the next 12 months as the already-implemented cuts work through the book.
• CASA improvement supports the liability side: CASA grew 14% YoY and the ratio improved 180 bps to 26.4%, driven by branch network expansion, focus on senior citizen and NR segments, QR handle introduction, and payment system tie-ups.

C. P. Gireesh: "Yes, microfinance is giving me more yield, so when I have shifted the micro banking proportion with more secured advances, the NIM is bound to come down. However, the operational expenditure, it is directly related to the BC commission, etc. That also has come down."

Asset Quality: The Stock and Flow Picture

• Gross NPA rose, net NPA held steady: Gross NPA marginally increased to 8.5% while net NPA remained stable at 3.8%, reflecting prevailing macro conditions and the cautious stance on microfinance lending. Provision coverage ratio improved to 74.4% due to a stringent policy of providing over and above minimum regulatory levels.
• Slippages are moderating: Slippages fell to ₹340 crores from roughly ₹450 crores in each of the previous two quarters, driven by improved trends in the micro banking segment and better SMA performance.
• Retail book is behaving well: The retail book excluding NBFC lending shows NPA and SMA figures under control. The marginal increase in retail SMA is attributable to one NBFC account of roughly ₹40 crores slipping into SMA 1, which management is negotiating and hopeful of controlling before quarter end.
• Pre-provisioning operating profit fell: PPOP declined to ₹93 crores from ₹125 crores, impacted by lower other income. However, non-interest income ex-treasury and PSLC improved 182% sequentially from ₹29 crores to ₹82 crores.
• Management expects substantial NPA improvement over a one-year horizon: As stress at the micro banking level fades and SMA levels continue moderating, both gross and net NPA are expected to move to more sustainable levels.

Deposit Franchise & Liability Strategy

• Retail deposit share is near-universal: Retail deposits rose 11% YoY and the retail share improved from 93% to 96%, reflecting a granular and stable liability base.
• Branch network is diversifying geographically: Roughly 470 branches are now outside Kerala, with Delhi representing the fifth-largest book. The liability base outside Kerala is expected to grow as these branches gain momentum.
• Savings and term deposit costs are distinct: The average cost of savings deposits stands at 5.1%, while fixed deposits cost roughly 8%, giving a clear path for downward repricing as higher-cost term deposits mature.

K. Paul Thomas: "Small finance banks have been created to serve the underserved segments and the lower middle income segments of the country. And that segment is very promising, 70% of our Indian population belongs to low and middle income segment."

Guidance & Commitments

Key Metrics