ESAF Small Finance Bank (ESFBL) has faced a setback as CareEdge Ratings downgraded its debt instruments, citing persistent weakness in asset quality and profitability. The rating action reflects the bank's ongoing challenges in the microfinance sector and its strategic shift towards secured lending.

Rating Downgrades

CareEdge Ratings has lowered the ratings for several of ESFBL's debt instruments:

• Tier-2 bonds revised from CARE A/Negative to CARE A-/Negative
• Proposed ₹385.00 crore lower tier-2 bonds assigned CARE A-/Negative
• ₹500.00 crore certificate of deposits downgraded from CARE A1+ to CARE A1

Financial Performance

The bank's financial performance has been under pressure:

• Net loss of ₹521.00 crore
• Net loss of ₹81.00 crore in Q1
• Four consecutive quarters of net losses

Asset Quality Concerns

ESFBL's asset quality has deteriorated significantly:

• Gross Non-Performing Assets (GNPA) ratio increased to 7.48% as of June 30, up from 4.76% on March 31
• Slippage ratio rose to 10.71% (annualized) in Q1 and 10.29%
• Net Non-Performing Assets (NNPA) to net worth ratio surged to 40.06% as of June 30, from 16.92% on March 31

Strategic Shift

In response to the challenges, ESFBL has implemented strategic changes:

• Recalibrated micro-banking disbursements
• Increased focus on secured lending, particularly gold loans
• Share of micro-banking (including agri) declined from 75% to 51% of total advances
• Share of secured loans increased from 23% to 59%, with gold loans rising from 15% to 34%

Outlook

CareEdge Ratings maintains a negative outlook on ESFBL, expecting continued pressure on profitability and asset quality in the near term. The outlook may be revised to 'Stable' if the bank:

• Successfully raises substantial equity capital
• Demonstrates improved asset quality with a significant reduction in slippage
• Maintains a comfortable capital adequacy buffer above regulatory requirements

Capital Adequacy

Despite the challenges, ESFBL maintains adequate capitalization:

• Capital Adequacy Ratio (CAR) of 22.74% as of June 30
• Tier I CAR of 18.44%
• Raised tier II capital of ₹115.00 crore in July and August

The bank's ability to maintain sufficient capital adequacy by raising additional equity capital will be crucial for its future performance and rating stability.

ESAF Small Finance Bank will need to navigate these challenges carefully, focusing on improving asset quality, strengthening its secured lending base, and enhancing profitability to regain investor confidence and improve its credit ratings.

ESAF Small Finance Bank has reported a mixed set of financial results for the first quarter, reflecting its strategic shift towards secured lending amidst challenging market conditions.

Business Growth and Portfolio Composition

The bank's total business stood at INR 42,507.00 crores, marking a 4.82% year-on-year growth. Deposits grew by 8.7% to INR 22,698.00 crores, while gross advances declined to INR 18,224.00 crores from INR 18,783.00 crores in the previous year.

In line with its strategy to de-risk the portfolio, ESAF SFB's micro loan book saw a significant reduction, falling to INR 9,095.00 crores from INR 13,236.00 crores a year ago. Conversely, gold loans emerged as a standout performer, growing 16% quarter-on-quarter and more than doubling year-on-year. The bank has expanded its gold loan offering to 662 branches, representing about 80% of its network.

Financial Performance

Net interest income for Q1 dropped to INR 378.00 crores from INR 588.00 crores in the same quarter last year. The net interest margin compressed to 6.00% from 9.40% previously, primarily due to:

• Shift in loan portfolio mix towards secured assets
• Reduction in repo rates
• Strategic decision to maintain excess liquidity
• Higher delinquencies in the high-yielding micro loan portfolio

Asset Quality

The bank faced asset quality challenges with:

• Gross non-performing assets (GNPA) at 7.50%
• Net non-performing assets (NNPA) at 3.80%
• Provision coverage ratio improved to 73.20%

During the quarter, ESAF SFB executed NPA sales of INR 733.40 crores, comprising NPAs of INR 362.43 crores and technical write-offs of INR 371.00 crores, resulting in a net P&L benefit of INR 45.76 crores.

Strategic Focus

K. Paul Thomas, Managing Director and CEO of ESAF Small Finance Bank, emphasized the bank's commitment to financial inclusion while expanding across all customer segments. He stated, "Our strategy is built on balanced growth, delivering sustainable profitability while staying true to our mission of empowering underserved communities."

The bank has made significant progress in increasing its share of secured assets, which now account for 54.79% of the total loan book, up from 32.69% a year ago. ESAF SFB aims to achieve 70% secured assets by March 2027.

Outlook

Management expects:

• Stress levels to stabilize in the second quarter
• Positive traction from the third quarter
• Positive Return on Assets (ROA) by the end of FY26

These expectations are driven by enhanced monitoring, proactive collection strategies, and sharper risk management across all lending segments.

George K. John, Executive Director, commented on the rural economy outlook, stating, "Stronger agriculture output and farm incomes are expected to lift rural sentiment and drive consumption growth in the coming quarters."

ESAF Small Finance Bank remains focused on building a healthy, diversified, and future-ready loan portfolio, aiming to minimize risk, serve customers responsibly, and drive sustainable value creation for all stakeholders.

Recent Recognition

The bank's QR loan was recognized as the best UPI-based digital payment solution at the ETBFSI FinNext Awards, underscoring its ability to innovate in inclusive digital finance.

As ESAF Small Finance Bank navigates through this transitional phase, it continues to balance growth with sustainability and prudent risk management, positioning itself for consistent and sustainable performance in the coming quarters.