Whalesbook
SFB Valuations Hit Lows Amid Growth Forecasts
Small Finance Banks (SFBs) are at a point where analysts like Systematix see valuations at "trough levels," suggesting limited further decline. This view is supported by forecasts of strong earnings growth, with projected increases of about 31% in net interest income and 74% in profit after tax. This growth is expected from expanding loan books and better recoveries. However, structural challenges and emerging risks mean investors should remain cautious. The growth outlook, especially for Ujjivan Small Finance Bank (whose stock has risen over 50% in a year) and Equitas Small Finance Bank, must be considered alongside a tightening financial system and operational hurdles within the sector.
Sector Growth Driven by Secured Lending Shift
SFBs achieved loan portfolio growth of over 20% in the recently concluded fiscal year 2026, significantly outperforming the broader banking sector's 13.8% credit growth. This expansion was partly driven by a microfinance recovery, but SFBs are actively cutting direct microfinance exposure to focus on secured lending and reduce risks. Equitas SFB's Assets Under Management (AUM) grew 21.6% to ₹46,183 crore, and Ujjivan SFB reported 26.6% growth to ₹40,655 crore. This shift to secured retail and MSME loans is supported by a regulatory change: the Reserve Bank of India lowered SFBs' priority sector lending (PSL) target from 75% to 60% starting FY26. This provides more flexibility, allowing SFBs to potentially boost profits and manage risk by moving into more profitable areas.
Valuation Gaps and Funding Costs Rise
Systematix recommends 'Buy' for Ujjivan SFB and Equitas SFB, but valuations differ significantly across peers. Larger AU Small Finance Bank trades at a Price-to-Earnings (P/E) ratio of about 25.6x. Bandhan Bank's P/E varies between 11.4x and 26.9x. Ujjivan SFB's P/E is around 23.76-26.00, similar to AU SFB. Equitas SFB's figures are mixed: a negative TTM P/E of -111.00 indicates recent losses, while its normalized P/E stands at roughly 41.42. These differences point to potential earnings volatility. Meanwhile, the wider banking sector faces tighter liquidity due to factors like capital outflows and global tensions, pushing short-term interest rates up by 50-70 basis points. This pressure on funding costs could squeeze SFBs' net interest margins (NIMs), which have already been strained. While regulatory easing on PSL targets offers flexibility, it also means SFBs will compete more intensely for capital deployment.
Concerns Over Guidance Misses and Liquidity
The Systematix report highlights a key risk for Jana Small Finance Bank, stating its earnings estimates are "materially below management's PAT guidance." This repeated failure to meet its own targets, described as a "historical trend" for Jana SFB, raises significant questions about its execution abilities. Despite a strong 5-year profit growth rate of 72.4%, Jana SFB faces concerns including a low interest coverage ratio, low promoter holding, and reliance on 'other income'. Its P/E ratio of about 13.30 looks appealing but hides these operational issues. Adding to sector-wide challenges, the banking system is experiencing a liquidity squeeze, pushing banks towards capital markets and likely raising funding costs for SFBs. A sharp drop in foreign direct investment (FDI) into India's banking sector, from USD 898 million in FY23 to USD 115 million in FY25, suggests broader capital constraints and investor caution, posing a greater risk for smaller SFBs. Equitas SFB's negative TTM P/E also demands a closer look at its earnings stability and its capacity to manage asset quality, particularly within its microfinance portfolio, which remains a sector-wide worry.
Outlook: Balancing Growth and Risk
As SFBs navigate this challenging landscape, the lower PSL targets provide a strategic path to strengthen balance sheets and pursue growth in less capital-intensive, higher-yield segments. The sector's success will depend on its ability to manage funding costs amid tight liquidity and consistently implement its strategies. While analysts expect continued growth in retail and MSME lending, overall stability relies on strong asset quality management and effective operational execution. This is especially true for banks like Jana Small Finance Bank, where the persistent gap between its guidance and analyst forecasts remains a key concern.