Detailed Rationale

CRISIL Ratings has placed its rating on the lower tier II bonds (under Basel II) of North East Small Finance Bank Limited (NESFB) on ‘Rating Watch with Negative Implications’.

 

The rating action follows the breach of the minimum regulatory capital adequacy ratio (CAR) reported by the bank. Overall CAR stood at 11.26% as on June 30, 2022, against the minimum regulatory requirement of 15%. Additionally, the bank’s earlier plans to raise upto Rs 210 crore of equity capital has been further delayed.

 

Breach of the regulatory minimum CAR is due to an extraordinary event of floods in the core operating territory of Assam. This led to a sharp rise in gross non-performing asset (GNPA) levels to 28.4% in June 2022, from 10.9% in March 2022. This necessitated an increase in provisioning requirement, along with reversal of accrued interest income on NPA accounts. Consequently, the bank reported a loss of Rs 128 crore in the first quarter of fiscal 2023, vis-à-vis a loss of Rs 123 crore for fiscal 2022.

 

However, CRISIL Ratings understands that the Assam state government has declared these floods as a natural disaster. Hence, the bank can restructure its delinquent accounts and modify the asset classification. This will also enable the bank to reverse the provisioning done in the first quarter of fiscal 2023 and also account for interest income. The bank is likely to recast the financials for the said quarter, post decision by the State Level Bankers Committee (SLBC) on the restructuring that can be offered for flood affected borrrowers. As per management, the financials for first quarter of fiscal 2023 is likely to be revised latest by August 31, 2022. With these revised financials, the CAR could improve and cross the minimum regulatory requirement of 15%.

 

CRISIL Ratings understands that the capital infusion of Rs 210 crore from few foreign investors has been put on hold due to negative performance in the first quarter of fiscal 2023. However, the bank will engage with these investors once again post revised financials. Ability to raise equity funds will remain a key monitorable.

 

CRISIL Ratings will resolve the rating watch based on the progress met in restoration of the CAR as well as raising of fresh equity capital.

 

The rating continues to reflect the established position of the bank in north-eastern India, supported by the extensive experience of its management, and the moderate deposit profile. The strengths are partially offset by weakening of asset quality amidst challenges in core operating territories, weak capitalisation, weak earnings and heightened susceptibility to local socio-political issues.

Analytical Approach

CRISIL Ratings has assessed the standalone business and financial risk profile of NESFB.

Key Rating Drivers & Detailed Description

Strengths:

Established position in the north-eastern region supported by the extensive experience of the management

NESFB has a strong track record and firm foothold in the north-eastern region. Before starting operations as a bank in October 2017, NESFB operated as a non-banking financial company-microfinance institution (NBFC-MFI) named RGVN (North East) Microfinance Ltd since 2008. As on June 30, 2022, the bank has spread across 62 districts in nine states, with a network of 214 branches.

 

Ms Rupali Kalita, the managing director and chief executive officer, has 33 years of experience in the banking and financial sector, and has been with the organisation for over 17 years. The bank also benefits from an experienced board and senior management, comprising renowned professionals from the financial services sector, strongly oriented towards establishing high-quality and scalable systems and processes. The bank also has support from marquee investors such as Small Industries Development Bank of India (SIDBI), Dia Vikas Capital Pvt Ltd, Nordic Microfin, Oiko Credit, MUDRA, Matterhorn Projects LLP. which together held a 72.1% stake via RGVN (North East) Microfinance Limited as on June 30, 2022.

 

Moderate deposit profile

In around five years of banking operations, NESFB has garnered deposits of Rs 1,538 crore as on June 30, 2022, which constituted 82% of total borrowings, as against 68.6% as on March 31, 2021, and 20% as on March 31, 2019. Moreover, the deposit mix has been evolving, with focus on retail deposits. The share of current account and savings account (CASA) deposits rose to 43.1% as a proportion of total deposits and 35.3% as a proportion of total borrowing as on June 30, 2022, from 22% and 4.3%, respectively, as of March 2019. Aggregate share of retail deposits (savings and retail term deposits below Rs 2 crore) in the total deposit base has grown consistently, to 58.8% as on June 30, 2022, as against 52.8% as on March 31, 2020.

 

In terms of tenure-wise break-up, 87.5% of term deposits are stable with a tenure of over a year. The bank has bulk deposits from government-linked institutions, based in north-east India and has strong relationships with them. With growth in deposit base, cost of funds improved to 6.1% (annualised) as on June 30, 2022 from 7.9% as of March 2021 and 9.1% as of March 2020, also aiding profitability of the bank.

 

Weakness:

Weakening of asset quality amidst challenges in core operational territories

NESFB had stable GNPAs of 1.9% in March 2020 and 1% in March 2019. However, asset quality started weakening due to political uncertainty in Assam, as political parties made various promises of loan waivers to woo voters, and subsequently due to the pandemic. Consequently, GNPAs rose to 11% as on March 31, 2021, and remained high at 10.9% as on March 31, 2022.

 

In light of above challenges, NESFB had restructured Rs 877 crore of its book in the first half of fiscal 2022. Out of this amount, Rs 844 crore was covered under the Assam Micro Finance Incentive and Relief Scheme (AMFIRS), under which the borrowers would receive incentive cheques from the Assam government and the bank will receive dues for delinquent accounts. The bank expected to receive bulk of the funds from borrowers, which would help clear overdues and recover from NPA accounts. However, in April 2022, Assam was hit by floods, which affected livelihoods of borrowers and constrained their repayment capabilities. Due to this, GNPAs deteriorated to 28.4% on June 30, 2022 from 10.9% in March 2022. Nevertheless, as these floods were declared as a ‘severe natural calamity’ by the central government, the bank will be able to restructure these accounts and its GNPAs should come down substantially. Ability to recover from the restructured book and timely disbursement of funds by the government under AMFIRS remain critical for improvement in asset quality and profitability.

 

Weak capitalisation

As on March 31, 2021, NESFB was adequately capitalised with networth of Rs 372 crore and overall CAR of 21.22%, vis-à-vis Rs 365 crore and 24.98%, respectively, a year earlier. However, higher provisioning for the restructured book led to a loss in fiscal 2022 and eroded the networth by Rs 123 crore in fiscal 2022. Subsequently the bank received a capital infusion of Rs 34 crore, primarily from existing investors - Dia Vikas Capital Pvt Ltd, NE Development Fin Corp, and Matterhorn in March 2022. This helped the CAR improve to 17.05% in March 2022. However, in the first quarter of fiscal 2023, the CAR dropped below the stipulated regulatory requirement of 15% and stood at 11.3%.

 

Breach of the regulatory minimum CAR is due to an extraordinary event of floods in the core operating territory of Assam. This led to a sharp rise in gross non-performing asset (GNPA) levels to 28.4% in June 2022, from 10.9% in March 2022. This necessitated an increase in provisioning requirement, along with reversal of accrued interest income on NPA accounts. Consequently, the bank reported a loss of Rs 128 crore in the first quarter of fiscal 2023, vis-à-vis a loss of Rs 123 crore for fiscal 2022.

 

However, CRISIL Ratings understands that the Assam state government has declared these floods as a natural disaster. Hence, the bank can restructure its delinquent accounts and modify the asset classification. This will also enable the bank to reverse the provisioning done in the first quarter of fiscal 2023 and also account for interest income. The bank is likely to recast the financials for the said quarter, post decision by the State Level Bankers Committee (SLBC) on the restructuring that can be offered for flood affected borrrowers. As per management, the financials for first quarter of fiscal 2023 is likely to be revised latest by August 31, 2022. With these revised financials, the CAR could improve and cross the minimum regulatory requirement of 15%.

 

CRISIL Ratings understands that the capital infusion of Rs 210 crore from few foreign investors has been put on hold due to negative performance in the first quarter of fiscal 2023. However, the bank will engage with these investors once again post revised financials. Ability to raise equity funds will remain a key monitorable.

 

Weak earnings owing to higher interest reversals and credit cost

Profitability was impacted in fiscals 2020 and 2021 due to the high provisioning cost. Return on assets (RoA) stood at 0.7% in fiscal 2020 (2.2% in fiscal 2019) and declined to 0.3% in fiscal 2021, owing to higher provisioning of Rs 43 crore and Rs 44 crore in fiscals 2020 and 2021, respectively. Post the second wave of the Covid-19 pandemic, the bank incurred a loss of Rs 123 crore, owing to higher provisioning requirement of Rs 187 crore (10.7% of assets under management [AUM]) in fiscal 2022.

 

The financial position of the bank deteriorated further in the first quarter of fiscal 2023, due to occurrence of severe floods in the region, leading to a loss of Rs 128 crore. The sharp rise in losses can be attributed to interest income reversals and additional provisioning. However, CRISIL Ratings understands that the Assam state government has declared these floods as a natural disaster. Hence, the bank can restructure its delinquent accounts and modify the asset classification. This will also enable the bank to reverse the provisioning done in the first quarter of fiscal 2023 and also account for interest income. As per management, the financials for first quarter of fiscal 2023 is likely to be revised latest by August 31, 2022. Nevertheless, any incremental slippages from the restructured book will attract higher provisions and larger quantum of interest income reversals. Consequently, the earnings remain sensitive to recovery expected from the Assam government under AMFIRS and increasing collection from the restructured book remains a monitorable.

 

Regional concentration and exposure to socio-political risks inherent in the micro loan business

A significant portion (53% as on June 30, 2022) of the portfolio comprises micro loans to clients with below-average credit risk profiles and lack of access to formal credit. These customers belong to the semi-skilled self-employed category and their incomes tend to fluctuate, depending on the local economy. Slowdown in economic activity has put pressure on cash flow of such borrowers, thereby restricting their repayment capability. This segment of borrowers remain subjected to idiosyncratic risks on account of socio-political factors. As economic growth picks up, ability of the bank to reinstate repayment discipline among customers will be a key monitorable. As far as the non-microfinance segment is concerned (accounts for 47% of the AUM), the bank has a limited track record, with low vintage. Additionally, its portfolio remains concentrated (84% of the book) in Assam. As the bank intends to increase share of the non-microfinance segments, its ability to diversify geographically and maintain sound asset quality while managing growth and profitability across economic cycles will be a key monitorable.

Liquidity: Adequate

As per the Asset Liability Management (ALM) statement of June 30, 2022, NESFB has no negative cumulative mismatches across all buckets upto one year. The liquidity coverage ratio was adequate at 144.8% as on June 30, 2022. The management has maintained high liquidity, with excess statutory liquidity ratio of 1.85% as of June 30, 2022. The bank also has access to refinancing lines from National Bank for Agriculture and Rural Development (NABARD) and SIDBI.

Rating Sensitivity Factors

Upward Factors

• Restoration of asset quality and profitability to pre-Covid levels or better, on a steady state basis.
• Increase in CAR above 20% on a steady-state basis with improvement in profitability

 

Downward Factors

• Inability to restore the capital adequacy ratio to over minimum requirement of 15%
• Delay in receipt of funds from the Assam government under AMFIRS, straining profitability and asset quality further
• Delay in raising equity capital

About the Bank

NESFB started operating as a society, Rashtriya Gramin Vikas Nidhi, with an initial corpus contribution from IDBI and IFCI and later from NABARD and Dorabji Tata Trust, which forayed into microfinance activities with the help of SIDBI in 1995. In 2008, a new company, RGVN (North East) Microfinance Ltd was incorporated. It obtained the NBFC licence in August 2010 and the NBFC-MFI certification from the Reserve Bank of India (RBI) in 2014, and an in-principle approval from the RBI to set up a small finance bank in 2015.

 

In July 2016, NESFB was incorporated as a 100% subsidiary of RGVN (North East) Microfinance Ltd. Headquartered in Guwahati, it started operations in October 2017, and got a fresh equity infusion from Dia Vikas Capital Pvt Ltd; NMI Fund III KS, Norway; OikoCredit Ecumenical Development Co-operative Society UA, Netherlands; and through conversion of optionally convertible preference shares (OCPS) by SIDBI. In 2019, the RBI granted the scheduled commercial bank status to the bank.

 

As on June 30, 2022, NESFB is present in nine states with 84% of the portfolio concentrated in Assam. It caters to over 7.4 lakh customers through 214 branches. The AUM stood at Rs 1,554 crore as on June 30, 2022. The bank also had outstanding deposits aggregating Rs 1,538 crore as on June 30, 2022.

Key Financial Indicators

Particulars for the period ended	Unit	June-22	Mar-22	Mar-21	Mar-20	Mar-2019
Total assets	Rs crore	2,104	2,352	2,258	2,067	1,770
Total income	Rs crore	5.4	329	332	325	287
PAT	Rs crore	(128)	(123)	7	13	37
Gross NPA	%	28.4%	10.9%	11.1%	1.9%	1.0%
Overall CAR	%	11.3%	17.05%	21.22%	24.98%	22.82%
Tier-I capital	%	9.3%	15.09%	20.18%	23.26%	22.27%
Return on assets@	%	(23.0%)	(5.3%)	0.3%	0.7%	2.2%

@Annualised for Q1FY23

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue size (Rs.Crore)	Complexity Level	Rating assigned with outlook
NA	Lower Tier-II Bonds (under Basel II)^	NA	NA	NA	50	Complex	CRISIL BBB-/Watch Negative

^Yet to be issued