Riding the wave of SME lending, Fedbank Financial Services’ initial public offer (IPO) is waiting to hit the bourses. This is the second public issue in the financial services sector this year and third so far in the IPO season that kickstarted in mid-2022.

Promoted by Federal Bank which will continue to remain the major investor in the non-bank (62.4 per cent stake) post issue and backed by homebred private equity major True North (14.4 per cent stake), the biggest advantage of Fedbank Financial is a well-diversified loan book, spread across gold loans, loan against property, unsecured business loans and a relatively small proportion of mortgages. In terms of branches, nearly 75 per cent of the physical presence is towards gold loan business.

That said, the compelling reason for investors to consider the IPO is the valuations.

Five Star Business Finance’s asking rate at the time of its IPO was around 3.2x 12-month trailing price to book value. SBFC Finance’s IPO was priced at 2.3x price to book. Factoring for ₹600 crore of fresh issuance, on a post money basis, Fedbank’s IPO is valued at 2x price to book, making it a compelling issue, especially considering how its predecessors have seen a sharp run up in multiples post listing.

Business overview

Fedbank Financial Services (formerly Fedfina Financial Services) works very similar to how most non-banks in the small and medium enterprises lending space.

The company caters to a set of customers who would normally not be able to access bank funding to begin with. Therefore, at over 16 per cent overall yield (as on June 30, 2023), this is a high yield play. Although cost of funds may catch up (7.77 per cent in FY23, up 33 bps year-on-year), the target segment is such that pass through of cost is seldom an issue. In fact, this is one of the biggest advantages that SME lenders have and Fedbank would be no exception.

Therefore, in terms of business, there would be little to complain for investors.

The lender has been witnessing a decent growth, managing a 3-year AUM growth (CAGR) of 33 per cent between FY20 and FY23. Being a high yield business, NIM at around 9 per cent (FY23) has the headroom to absorb pricing pressure if the lender should encounter in the quarters to come. Perhaps, the only deterring aspect is the lender’s asset quality, when seen on an isolated basis.

From 1.01 per cent in FY21, gross non-performing assets ratio has risen to 2.26 per cent in Q1 FY24 (2.03 per cent in FY23). While the overall NPA ratios for SME lenders has seen a reset post covid, and at 2.26 per cent, Fedbank’s gross NPA is benign compared to SBFC’s 2.54 per cent and therefore not very out of whack, given that the sector is still in a cleansing mode.

Nevertheless, there are two positives which should comfort investors. One, Fedbank Financial Services has little or no customer or operational overlaps with its parent company—Federal Bank. Two, both run as independent entities and Fedbank Financial has a diversified liabilities base which reflects in its bank borrowing profile. With its borrowings spread across over 20 banks, there is virtually no dependence on Federal Bank for its ALM (asset liabilities mismatch) management.

On the whole, with IPO valuations leaving room for upside, investors wanting to cash in on the SME lending boom could consider Fedbank Financial Services IPO.

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