Detailed Rationale

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

 

Rating action follows the receipt of No Objection Certificate from the Reserve Bank of India (RBI) on the proposed scheme of arrangement between NESFB and Garagepreneurs Internet Pvt Ltd (‘GIPL’), including its subsidiaries Quadrillion Finance Private Limited (QFPL) and Intergalactory Foundry Private Limited (IFPL) [GIPL, QFPL and IFPL  are together referred to as slice group].

 

On October 4, 2023, NESFB announced the receipt of RBI no objection certificate for its scheme of arrangement with slice group whereby the latter is to get amalgamated into NESFB. As part of this scheme, RGVN (North-East) Microfinance Ltd - which held 79.43% stake in NESFB as on June 30, 2023 and is classified as its promoter entity – will get reverse merged into the bank. The scheme is expected to come into effect in 9-12 months subsequent to which only one entity i.e, NESFB, shall exist. This proposed merger is subject to various regulatory approvals and developments pertaining to this scheme will remain key monitorable.

 

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 prolonged weakness in asset quality due to challenges in core operating territories, weak capitalisation and modest earnings and, heightened susceptibility to local socio-political issues.

 

At a standalone level, the bank’s capitalisation remains vulnerable reflected in a modest overall capital adequacy ratio of 6.5% as on June 30, 2023, which is in breach of the minimum regulatory capital adequacy ratio (CAR) requirement. To restore its capital adequacy position to above stipulated levels, the bank is exploring various options, including raising incremental capital and, the same has been centrally factored into the rating. CRISIL Ratings also understands that the overall CAR of the merged entity, on a pro-forma basis, was close to 30% as on March 31, 2023.

 

The bank’s asset quality has remained weak, impacted by the pandemic outbreak and occurrence of floods in Assam (84% of the gross portfolio as on June 30, 2023) and the adjacent north-eastern region. As a result, the gross non-performing assets (NPAs) surged to 18.2% as on March 31, 2023 and further to 24.9% on June 30, 2023, from 10.9% on March 31, 2022. However, as the provisioning coverage ratio (PCR) has increased to 92% on March 31, 2023 from 70% on March 31, 2022, the net non-performing assets (NNPAs) have declined to 1.7% from 3.6% over the same period over the first quarter of fiscal 2024, NNPA as a percentage of loan book has risen to 6.7% owing to decline in loan book and incremental slippages.

 

As of June 30, 2023, total stressed assets remained elevated at Rs 646 crore (GNPA plus restructured assets) which accounts for 35% of the gross advances as on that date. CRISIL Ratings understands that the bank is discussing with various Asset Reconstruction Companies (ARCs) to sell stressed portfolio post which, the reported NPAs are expected to decline materially. This portfolio comprises bank’s outstanding NPAs, restructured assets and technically written off accounts. CRISIL Ratings also understands that the bank has collected Rs 252 crore (including interest) cumulatively since March 2021, under Assam Micro Finance Incentive and Relief Scheme (AMFIRS).

 

Profitability, constrained by elevated provisioning requirement, has remained modest over the recent past. For fiscal 2023, the bank reported a loss of Rs 213 crore vis-à-vis a loss of Rs 123 crore for fiscal 2022. For Q1 2024, the bank reported a loss of Rs 8 crore.

 

In terms of liability franchise, NESFB has garnered deposits of Rs 1,810 crore as on June 30, 2023 with a 17% growth year-on-year and retail deposit forming 58% of the total deposits. The bank has a CASA of 37.9% as on June 30, 2023. Ability of the bank to maintain the CASA and deposit ratio post-merger will remain a key monitorable.

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 is spread across 62 districts in nine states, with a network of 226 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. In light of the proposed merger, the bank will further benefit from slice group’s tech based platform which will allow it to expand pan digitally

 

• Moderate deposit profile

Over five years of its operational history as a bank, NESFB has built a stable deposit profile. It had a deposit base of Rs 1,810 crore as on June 30, 2023, which constituted 83.0% 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 in total deposits, was stable at 35.9% as on June 30, 2023, as compared to 35.6% as on March 31, 2022. Aggregate share of retail deposits (savings and retail term deposits below Rs 2 crore) in the total deposit base has grown to 58.8% as on June 30, 2023 from 38% as on March 31, 2022

 

In terms of tenure-wise break-up, 55.6% 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 benefits from having strong relationships with them. With growth in deposit base, cost of funds has improved over time thereby aiding the profitability of the bank. For the first quarter of fiscal 2024, the bank’s cost of funds was 6.3% (annualised) as compared to 7.9% for fiscal 2021 and 9.1% for fiscal 2020. Over the medium to long term, the ability of the bank to maintain a stable and granular deposit mix and, sustain its cost of funds post-merger, will be a key monitorable.

 

Weaknesses:

• Prolonged weakness in asset quality stemming from challenges in core operational territories

NESFB had stable GNPAs of 1.9% in March 2020 and 1.0% in March 2019. However, asset quality started weakening due to political uncertainty in Assam, as political parties made various promises of loan waivers to win over the voters, and subsequently due to the pandemic. Consequently, GNPAs rose to 24.9%as on June 30,2023 from 10.9% as on March 31, 2022.

 

NESFB had a total stressed portfolio of Rs 646 crore which accounts for 35% of the gross loans as on June 30, 2023. The bank 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) against which the bank was expected to receive bulk of the funds from the government. However, NESFB has received only Rs 252 crore out of a total claim of Rs 999 crore till September 2023. Due to this, GNPAs have remained elevated at 24.9% on June 30, 2023. Nevertheless, the bank is in discussion with various Asset Reconstruction Companies (ARCs) to sell off the stressed loan book which is around one-third of the total portfolio. Over the near term, the pace and magnitude of improvement in asset quality, remains critical and a key rating sensitivity factor.

 

• Weak capitalization, implementation of capital infusion plan remains critical

NESFB was adequately capitalized until fiscal 2021. However, as credit losses surged in the aftermath of socio-political challenges in Assam, losses started to accumulate. This increase in stressed portfolio resulted in a loss for fiscal 2022 and fiscal 2023 and eroded the networth to Rs 106 crore in June 2023 from Rs 372 crore on March 31, 2021. Correspondingly, the overall CAR also declined to 6.5% as on June 30, 2023 thereby breaching the regulatory stipulation of 15%. Earlier, the bank had reported an overall CAR of 11.3% on June 31, 2022 post which, it received a capital infusion of Rs 43.9 crore which restored this metric to 16.34% on September 30, 2022. Subsequently, as the bank reported further losses for fiscal 2023, capital adequacy ratio declined to below regulatory stipulation again in March 2023 and has remained so over the first half of fiscal 2024.

 

The bank has received Rs 10.3 crore as capital from slice group in Q1 FY2024, in addition to Rs 30 crore of capital infused by slice group in fiscal 2023. The bank is further is exploring various options, for raising  incremental capital. This infusion is expected to uplift the bank’s capital adequacy ratio to above 15% by April 2024. The quantum and timing of this capital infusion along with its ultimate impact on the capitalization metrics of the bank will be key monitorables.

 

• Modest earnings profile

Profitability has weakened since after fiscal 2020 due to asset quality challenges leading to high provisioning cost. Return on assets (RoA) stood at -5.2% in fiscal 2022 and declined to -8.2% in fiscal 2023 as credit costs increased to 7.9% of total assets (Rs 277 crore) and 8.8% (Rs 227 crore) in respective years. However, the bank provided for majority of the stressed assets in fiscal 2023 resulting in an increased provisioning coverage (PCR) of 92% and Net NPA of 1.7% as on March 31, 2023.

 

For Q1 2024, the bank reported a loss of Rs 8 crore. While the PCR remained comfortable at 78%, incremental slippages and degrowth in loan book resulted in the net NPA rising to 6.7% as a share of total portfolio as on June 30, 2023.

 

In light of the proposed scheme of merger being underway, the bank is exploring to sell off its legacy distressed portfolio (one-third% of the total portfolio) to ARCs. This, in addition to highly calibrated growth in loan book hereafter until the merger, is expected to result in some stability in asset quality over the near term. Consequently, credit costs are expected to start tapering down gradually leading to normalisation in profitability in the normal course of business.

 

The bank’s ability to accelerate the revival in its overall profitability and sustain it at optimal levels, even after the amalgamation, remains critical.

 

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

A significant portion (53% as on June 30, 2023) 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 put pressure on cash flow of such borrowers, thereby restricting their repayment capability. This segment of borrowers is subjected to idiosyncratic risks on account of socio-political factors. Considering the sensitivity of this market segment to socio-political unrest, the ability of the bank to reinstate repayment discipline among customers to pre-covid levels, will be a key monitorable. As far as the non-microfinance segment is concerned (accounts for 47% of the loan book as on June 30, 2023), the bank has a limited track record, with low vintage. Additionally, its portfolio remains concentrated (84% of the loan book as on June 30, 2023) in Assam. Post amalgamation of NESFB with slice group, the merged entity’s market position has the potential to benefit from the latter’s digital presence however, the ability to demonstrate improvement from this synergy is yet to be seen.

Liquidity: Adequate

Liquidity position of the bank remains comfortable. Bank had an excess SLR of 0.7% and a liquidity coverage ratio of 123.7% as of June 30, 2023. Banks also has refinance lines available from NABARD and SIDBI.

Rating Sensitivity factors

Upward factors

• Restoration of asset quality and profitability to pre-Covid levels or better, and sustenance thereof on steady state basis.
• CAR restoring to and remaining above 15% on a steady state basis, coupled with improvement in profitability

 

Downward Factors

• Inability to restore the capital adequacy ratio to above minimum requirement of 15% and maintain it at that level thereafter
• Lack of improvement in asset quality resulting in GNPA remaining elevated and straining the profitability

About the Company

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. Further on October 03, 2023 RBI granted No Objection Certificate for merger of the slice group with Bank.

 

As on June 30, 2023, NESFB is present in nine states with 84% of the portfolio concentrated in Assam. It caters to over 7.4 lakh customers through 226 branches. The AUM stood at Rs 1,839 crore as on June 30, 2023. The bank also had outstanding deposits aggregating Rs 1,810 crore as on June 30, 2023.

Key Financial Indicators

Particulars for the period ended	Unit	Jun-23	Mar-23	Mar-22	Mar-21	Mar-20
Total assets	Rs crore	2,417	2,710	2,352	2,258	2,067
Total income	Rs crore	127	335	329	332	325
PAT	Rs crore	(8)	(213)	(123)	7	13
Gross NPA	%	24.9%	18.2%	10.9%	11.1%	1.9%
Overall CAR	%	6.5%	5.5%	17.05%	21.22%	24.98%
Return on assets@	%	(1.2%)	(8.2%)	(5.3%)	0.3%	0.7%

@ Annualized for Q1FY2024

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 BB+/Watch Developing

^Of this, the bank has raised Rs 19 crore in fiscal 2023 via a Promissory Note – the remaining amount yet to be issued.