IPO: Capital Small Finance Bank

Capital Small Finance Bank (or Capital SFB) is coming out with its IPO (initial public offering) on February 7, 2024. Here's a breakdown of the bank's strengths, weaknesses, and growth prospects to help investors make an informed decision.

In a nutshell

• Quality: The bank reported a three-year average ROE of 13.0 per cent between FY21 and FY23. Moreover, it achieved an average net interest margin of 3.8 per cent in the last three financial years.
  
• Growth: Over the last three years, the bank grew its advances by 20.7 per cent and PAT by 51.5 per cent per annum between FY21 and FY23.
  
• Valuation: The stock will be priced at a P/E and P/B of 19.7 and 1.8 times, respectively.
  
• Overview: The surge in business activities and consumption has fueled the growth in India's banking sector. Capital Small Finance Bank is looking to capitalise on the growing industry, especially in the underpenetrated semi-urban and rural areas. However, an increase in competition from existing small finance banks and NBFCs, along with the entry of new fintech players, may pose hurdles to the bank's prospects.

About Capital Small Finance Bank

Incorporated in 1999, Capital SFB is one of the two non-NBFCs (non-banking finance companies) to receive the small finance bank licence in 2015. The bank operates through 173 branches across five states and one union territory. However, Punjab has the highest branch count of 149, contributing 84 per cent of the total advances and 94 per cent of total deposits as of September 2023. Agriculture loans comprise the majority of advances with a share of 39 per cent, followed by 26 per cent in mortgages and 20 per cent in MSME loans, as of September 2023.

Strengths of Capital Small Finance Bank

• Retail concentration in deposits - The share of retail deposits in total deposits was 93.6 per cent as of September 30, 2023. This share has been consistently over 90 per cent in the last three years.
  
• Secured portfolio - As of September 30, 2023, nearly all the loans (99.9 per cent) were backed by security, and most of these (84.3 per cent) were secured with immovable property.

Weaknesses of Capital Small Finance Bank

• Geographical concentration - Despite its presence in multiple states, the bank remains a Punjab-concentrated entity. Ninety-four per cent of deposits and 84 per cent of advances come from Punjab-based branches as of September 2023. Further, nearly 40 per cent of its total branches are in Jalandhar. Consequently, the bank's performance is highly susceptible to any adverse natural or economic events in the state.
  
• Inadequate provision coverage ratio (PCR) compared to peers - The bank's PCR for the last three financial years (FY23, FY22 and FY21) was 51.5, 46.0 and 46.1 per cent, respectively.
  
• High competition - The bank operates in a competitive environment with NBFCs, banks, fintechs, and other SFBs (small finance banks) trying to attract borrowers from semi-urban and rural areas.

Risk report

Management

• Is Capital Small Finance Bank free from regulatory penalties?
  Yes. The bank has paid a minimal penalty in the nine months ending in December 2023.
• 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. Its provision coverage ratio stood at 51 per cent as of September 30, 2023.
• Do the top five managers have stock as a significant part of their compensation (more than 50 per cent)?
  No. While ESOPs (employee stock ownership plans) were offered in the past, stock-based compensation does not form a significant part of the top five managers' income.

Financial strength and stability

• Does Capital 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 ratio stood at 3.4 per cent for the year ended FY23 and 1.7 per cent as of September 30, 2023.
• 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 and ROA of 16.6 and 1.2 per cent, respectively, in FY23.
• Has the Capital Small Finance Bank increased its loan book by 20 per cent annually over the last three years?
  Yes. The bank increased its loan book by 21 per cent annually between FY21 and FY23.
• Has the bank increased its net interest income (NII) by 20 per cent annually over the last three years? (Net interest income is the difference between the revenue generated from an SFB's assets and the expenses associated with paying its liabilities).
  Yes. It achieved an annualised growth rate of 27 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. Higher advances have translated into higher net interest income.
• Is the bank's capital adequacy ratio more than 15 per cent?
  Yes. It reported a capital adequacy ratio of 20.7 per cent as of September 30, 2023.
• Can the bank run its business without relying on any external funding in the next three years?
  Yes. Its capital adequacy ratio stood at 20.7 per cent as of September 30, 2023. The financial strength, supported by the IPO proceeds, would ensure the sustainability of business operations without external help.
• Did the bank generate an average net interest margin (NIM) of over 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 an SFB or financial institution relative to its interest-earnings assets like cash).
  Yes. Its average three-year net interest margin (NIM) stood at 3.8 per cent between FY21 and FY23.
• 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. It reported an average gross NPA of 2.5 per cent and an average net NPA of 1.3 per cent in the last three years.
• Does the bank have a cost-to-income ratio of less than 50 per cent?
  No. It reported a cost-to-income ratio of 62.4 per cent in the first half of FY24. This ratio has been over 50 per cent in the last three financial years (FY23, FY22 and FY21).

Growth and business

• Will Capital Small Finance Bank be able to scale up its business?
  Yes. The bank will capitalise on the surge in the organised lending business and streamlined banking operations in rural areas. Moreover, Capital SFB will also be utilising a portion of the IPO proceeds for branch expansion.
• Does the bank have more than Rs 1,00,000 crore loan book?
  No. It reported advances of Rs 5,784 crore as of September 30, 2023.
• Does the bank have a recognisable brand truly valued by its customers?
  No. Other banks, NBFCs and SFBs lend in the agricultural, MSME and home loan segments.
• Does Capital Small Finance Bank have a credible moat?
  No. It is broadly a regional bank and operates on a small scale.
• Is the level of competition faced by the bank relatively low?
  No. Although the competition was previously low, it has been rising with the entry of new small finance banks and big banks trying to grab a share in the rural segment.

Valuations

• Is the bank's price-to-earnings (P/E) ratio lower than its peers' median level?
  No. The bank is valued at a price-to-earnings ratio of 19.7, higher than its peers' median level of 11.8·
• Is the bank's price-to-book (P/B) ratio lower than its peers' average level?
  Yes. It is valued at a price-to-book ratio of 1.8, lower than its peers' median level of 2.1.

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

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