Secured Lending Expansion And Digital Transformation Will Drive Stronger Long Term Bank Performance

Catalysts

About Utkarsh Small Finance Bank

Utkarsh Small Finance Bank is a pan India small finance bank focused on micro banking, secured MSME, affordable housing, vehicle finance and retail deposit products.

What are the underlying business or industry changes driving this perspective?

• Acceleration in secured lending across MSME, Micro LAP, housing, BBG and used CV/CE, where annual growth is already above 30%, should steadily lift yield weighted assets and support expansion in net interest margins and fee income.
• Shift of the portfolio mix away from JLG towards over 50% secured assets over the next 2 to 3 years, combined with tighter underwriting and digital credit filters, is likely to dampen credit cost volatility and structurally improve net margins and earnings stability.
• Credit guarantee coverage on incremental JLG and MBBL loans, with roughly three quarters of eligible losses reimbursable, materially reduces loss given default and should pull down normalized credit costs, improving net profit conversion from micro banking revenues.
• Strong liability franchise with rising CASA and retail term deposits, an improved CASA plus retail term deposit ratio of 78% and scope to reprice deposits lower after policy rate cuts, positions the bank for a declining cost of funds and healthier spread on assets, directly aiding NIMs and return on equity.
• Technology and process transformation under the Utkarsh 2.0 program, including digital underwriting, centralized collections and automation across the loan lifecycle, is expected to enhance operating efficiency and employee productivity, compressing cost to income and boosting earnings over the medium term.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Utkarsh Small Finance Bank's revenue will grow by 80.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from -99.5% today to 16.3% in 3 years time.
• Analysts expect earnings to reach ₹7.3 billion (and earnings per share of ₹2.9) by about December 2028, up from ₹-7.5 billion today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 5.6x on those 2028 earnings, up from -3.5x today. This future PE is lower than the current PE for the IN Banks industry at 11.4x.
• Analysts expect the number of shares outstanding to grow by 0.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 13.27%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Legacy stress in the JLG microfinance book remains high, with around 23% of the JLG portfolio in NPA and additional SMA exposure, and management acknowledging that elevated credit costs will persist. This could keep net margins compressed and delay a sustainable recovery in earnings and return on equity.
• Structural concentration in high risk geographies such as Uttar Pradesh and Bihar, where recent slippages and guardrail related disruptions have been pronounced, means any renewed local economic or political stress could quickly translate into higher delinquencies, weaker collection efficiency and pressure on revenue growth from micro banking.
• The strategic pivot towards secured MSME, housing, LAP and CV or CE lending assumes stable asset quality and better yields. However, recent elevated credit costs in the Wheels business and rising used vehicle exposure highlight the risk that new secured segments could also deteriorate, undermining the planned improvement in net interest margins and overall profitability.
• Dependence on regulatory schemes such as MFIN Guardrail 2.0 and CGFMU credit guarantees to stabilize the unsecured book may mask underlying borrower fragility. Any change in scheme economics, caps or eligibility could sharply increase loss given default and push credit costs above the assumed 2% steady state level, hurting earnings and capital generation.
• Ambitious medium term targets of around 25% loan growth, 8.5% NIM and 15% return on equity rest on successful execution of Utkarsh 2.0, technology and branch productivity improvements. Yet recent high attrition, slow non MFI growth and repeated rights equity raises suggest execution risk that could result in weaker than projected revenue expansion and subdued earnings.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of ₹25.5 for Utkarsh Small Finance Bank based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be ₹44.8 billion, earnings will come to ₹7.3 billion, and it would be trading on a PE ratio of 5.6x, assuming you use a discount rate of 13.3%.
  
• Given the current share price of ₹15.0, the analyst price target of ₹25.5 is 41.2% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.