ESAF Small Finance Bank Q1 FY26: Decoding the Earnings - Is a Turnaround on the Horizon?
ESAF Small Finance Bank recently unveiled its Q1 FY26 earnings, painting a nuanced picture of a bank in transition. Against the backdrop of a cautiously optimistic Indian economy – characterized by resilient GDP growth, easing inflation, and the RBI maintaining an accommodative stance – small finance banks like ESAF SFB operate in a dynamic environment. While the broader banking sector has been an outperformer in recent quarters, the July market correction, driven by weak earnings and global uncertainties, underscores the need for selective, fundamentals-driven investing. ESAF SFB’s latest results highlight its strategic efforts to de-risk and diversify, but also reveal the lingering challenges of asset quality and core profitability.
Loan Book and Disbursements: A Purposeful Portfolio Reshuffle
One of the most telling stories from ESAF SFB’s Q1 FY26 performance is the deliberate recalibration of its loan book. While the Total Loan Book saw a modest 0.7% QoQ growth to ₹19,809 crore, the underlying composition changes are far more significant. The bank is actively shedding its higher-risk, unsecured Micro Loans, which declined from ₹13,236 crore in Q1 FY25 to ₹9,095 crore in Q1 FY26. This 31.2% YoY reduction is a strategic move to de-risk the portfolio, as confirmed by management commentary.
Simultaneously, the bank is aggressively pushing into secured lending. Loans to MSMEs grew significantly to ₹6,674 crore (up from ₹5,734 crore QoQ and ₹3,240 crore YoY). Agricultural loans also saw growth, reaching ₹1,598 crore. Notably, Gold Loans more than doubled YoY, reflecting a strong strategic focus. This pivot towards secured assets, now representing 54.79% of the total loan book (up sharply from 32.69% a year ago), aligns with the bank’s long-term goal of reaching 70% secured assets by March 2027.
Disbursements for the quarter tell a similar story of strategic realignment. Total disbursements surged 71% YoY to ₹7,694 crore, with secured loans making up a dominant 90% of this figure. This robust growth in disbursements, especially into more stable asset classes, indicates management’s commitment to its de-risking strategy. However, the true test will be how quickly these new, secured loans translate into healthier revenue streams and improved asset quality.
| Category | Q1FY25 | Q4FY25 | Q1FY26 | QoQ Change (%) | YoY Change (%) |
|---|---|---|---|---|---|
| Micro Loans | 13,236 | 9,705 | 9,095 | (6.49)% | (31.29)% |
| MSME | 3,240 | 5,734 | 6,674 | 16.39% | 105.99% |
| Gold Loans | 234 | 558 | 500 | (10.39)% | 113.68% |
| Total Loan Book | 19,664 | 19,643 | 19,809 | 0.84% | 0.74% |
| Total Disbursements | 4,503 | 6,878 | 7,694 | 11.87% | 70.86% |
Funding Growth: Deposits Remain a Pillar
On the liabilities side, ESAF SFB continued to strengthen its funding profile. Total Deposits grew 8.7% YoY to ₹22,698 crore, despite a slight 2.5% QoQ decrease from the March 2025 peak. This indicates the bank’s ability to attract and retain customer funds. Critically, Retail Deposits surged 13.17% YoY to ₹21,763 crore, now comprising a strong 96% of total deposits. This strategic focus on retail deposits helps reduce reliance on volatile and often costlier bulk deposits, enhancing funding stability.
The CASA (Current Account Savings Account) ratio held steady at 24.8%, with CASA balances growing 14% YoY to ₹5,628 crore. While the CASA ratio itself didn’t see a significant jump, the absolute growth in CASA balances is a positive sign of deepening customer relationships and a more stable, low-cost deposit base. Management expressed confidence in the sustainability of this CASA growth, driven by an expanding branch network, competitive offerings, and a focus on underserved communities. The cost of deposits also saw a marginal improvement.
Profitability Under Pressure: NII Squeeze, Other Income Surge
The bank’s core profitability metrics faced significant headwinds. Net Interest Income (NII), the lifeblood of banking, saw a substantial 35.8% YoY decline and a 13.0% QoQ decrease to ₹377.87 crore. This sharp contraction in NII is primarily attributed to:
- Shift in Asset Mix: The deliberate move from high-yielding unsecured micro loans to lower-yielding secured assets.
- Excess Liquidity: The bank held approximately ₹2,000 crore in excess liquidity, impacting interest earned.
- RBI Rate Cuts: Recent rate cuts affected yields on the gold loan book and external benchmark-linked loans.
Consequently, the Net Interest Margin (NIM) moderated to 6.0% from 9.4% YoY. Management acknowledges this pressure but expects NIMs to improve as fresh disbursements occur at moderated rates and the liability side reprices fully in 1-1.5 years.
A bright spot for the quarter was Other Income, which surged 69.1% YoY and 34.8% QoQ to ₹195.14 crore. This was largely propelled by:
- Profit on sale of investments: A whopping 614% YoY increase, and 76% QoQ. While a welcome boost, such treasury gains can be volatile and are not a sustainable core income driver.
- PSLC Income (Priority Sector Lending Certificates): Doubled YoY.
- Recovery on written-off loans: Increased 147% YoY.
Despite the strong ‘Other Income’, the sharp decline in NII meant Net Total Income still fell 18.6% YoY and 1.1% QoQ.
Operating Expenses saw a slight 8.3% QoQ decrease, which is commendable, but remained largely flat YoY. Employee benefits expenses notably increased 84% YoY, partly due to the strategic absorption of 5,109 trained employees from its largest business correspondent, ESMACO, in FY25, and a one-time compensation of ₹58 crore.
The combined effect of declining NII and rising provisions impacted the Pre-Provision Operating Profit (PPOP), which declined 50.8% YoY to ₹124.92 crore, although it showed a healthy 37.8% QoQ improvement. This sequential PPOP growth, despite NII pressure, suggests improving operational efficiency excluding provisions.
| Metric | Q1FY25 | Q4FY25 | Q1FY26 | QoQ Change (%) | YoY Change (%) |
|---|---|---|---|---|---|
| Net Interest Income | 588 | 436 | 378 | (13.30)% | (35.71)% |
| Non-Interest Income | 115 | 141 | 195 | 38.30% | 69.57% |
| Pre-Provision Operating Profit | 254 | 91 | 125 | 37.36% | (50.80)% |
| NIMs (%) | 9.4% | 6.9% | 6.0% | (13.04)% | (36.20)% |
Asset Quality: The Persistent Challenge
Asset quality remains a critical area for ESAF SFB. Both Gross NPA (GNPA) and Net NPA (NNPA) deteriorated QoQ and YoY. GNPA increased to 7.5% in Q1 FY26 from 6.9% in Q4 FY25 (and 6.6% in Q1 FY25), while NNPA rose to 3.8% from 2.9% QoQ (and 3.2% in Q1 FY25). This indicates persistent stress, primarily stemming from the micro banking book.
However, the bank undertook a significant balance sheet clean-up exercise during the quarter by transferring stressed loans worth ₹733.4 crore to an Asset Reconstruction Company (ARC). This is a crucial step to offload non-performing assets and improve the balance sheet health, although it also underscores the extent of the asset quality challenge. The bank received a slightly higher consideration than the net book value of these loans, resulting in a net P&L benefit of ₹45.76 crore.
Despite the rise in NPAs, the Provision Coverage Ratio (PCR), a measure of how well a bank has covered its bad loans, decreased QoQ to 73.2% from 80.5%, though it improved from 61.9% YoY. Management targets a 70% PCR, suggesting a degree of comfort. Slippages, mainly from Karnataka and Tamil Nadu in the micro banking segment, contributed to the GNPA increase, but the bank notes that SMA (Special Mention Accounts) levels are moderating, which could hint at reduced future slippages. The rigorous implementation of MFIN Guardrails 2.0 in microfinance underwriting should also contribute to long-term asset quality improvement.
| Period | GNPA (%) | NNPA (%) | PCR (%) |
|---|---|---|---|
| Q1FY25 | 6.6% | 3.2% | 61.9% |
| Q4FY25 | 6.9% | 2.9% | 80.5% |
| Q1FY26 | 7.5% | 3.8% | 73.2% |
Earnings Performance: A Glimmer of Hope on the Road to Recovery
ESAF SFB reported a net loss of ₹81.22 crore in Q1 FY26. This marks the third consecutive quarter of losses for the bank. However, it’s crucial to note that this is a significant sequential improvement, reducing the loss by over 55% from the ₹183.20 crore loss in Q4 FY25. This sequential improvement was driven by a combination of lower provisions and higher other income, alongside a slight improvement in operating profit.
On a YoY basis, the picture remains challenging, with a shift from a profit of ₹62.77 crore in Q1 FY25 to the current loss, largely attributable to the steep decline in NII and higher overall provisions compared to the prior year.
The Return on Assets (ROA) and Return on Equity (ROE) remained negative but also showed sequential improvement, reflecting the reduced net loss. Management’s guidance for achieving positive ROA by the end of FY26 positions the current fiscal year as one of consolidation and laying the groundwork for a turnaround. Given the current performance, ESAF SFB can be classified as a Turnaround story, aggressively addressing its legacy asset quality issues and strategically re-orienting its business model.
| Metric | Q1FY25 | Q4FY25 | Q1FY26 | QoQ Change (%) | YoY Change (%) |
|---|---|---|---|---|---|
| Profit After Tax | 63 | (183) | (81) | 55.74% | (228.57)% |
| ROA (%) | 0.9% | (1.9)% | (1.2)% | 36.84% | (233.33)% |
| ROE (%) | 9.9% | (22.8)% | (17.1)% | 25.00% | (272.73)% |
Capital and Financing: Building Buffers for Growth
The bank’s Capital Adequacy Ratio (CRAR) improved slightly to 22.7% in Q1 FY26 from 21.8% in Q4 FY25, remaining well above regulatory requirements. Tier 1 capital also saw a marginal improvement. This healthy capital buffer provides resilience and supports future growth initiatives. The bank also strengthened its position by raising Tier 2 bonds worth ₹65 crore in July 2025.
However, management did acknowledge that as a “growing bank with aggressive asset book expansion plans,” it remains capital-hungry. While no concrete decisions on fresh equity raising have been announced, this indicates that further capital infusions might be on the horizon to fuel its strategic expansion, particularly into secured lending. The bank’s debt-to-equity ratio improved to 0.51 from 0.56 QoQ, indicating a healthier reliance on equity.
Key Takeaways and Outlook: A Cautious Path Forward 🧭
ESAF Small Finance Bank’s Q1 FY26 results reveal a bank in the midst of a significant strategic overhaul.
The Positives ✨:
- Sequential Reduction in Loss: The most encouraging sign, indicating improved operational performance and provisioning management.
- Strategic De-risking: Aggressive shift towards secured lending (MSME, Agri, Gold Loans) and away from microfinance.
- Strong Secured Loan Disbursements: Validation of the strategic pivot.
- Robust Retail Deposit and CASA Growth: Enhancing funding stability.
- Balance Sheet Clean-up: Significant NPA sale to ARC.
- Improved Capital Adequacy: Providing a strong buffer for future growth.
The Challenges ⚠️:
- Continued Net Losses: Third consecutive quarter in the red, despite sequential improvement.
- Steep NII Compression: Core banking income remains under significant pressure due to asset mix shift and liquidity.
- Deteriorating Asset Quality: GNPA and NNPA rose, though SMA levels are moderating.
- Reliance on ‘Other Income’: While helpful, treasury gains are not sustainable as core earnings.
Investment Insight: ESAF SFB is undeniably navigating a challenging period, akin to a “Turnaround” story. Its strategic pivot towards secured lending aligns well with the domestic-growth themes favored by the current Indian market, which sees banks as outperformers. However, investors should remain vigilant. The ability to sustain the sequential improvement in profitability, normalize asset quality (especially in microfinance), and demonstrate a path to NIM recovery will be paramount. Management’s guidance of achieving positive ROA by FY26 end is a key target to watch. The bank’s execution of its de-risking strategy and its ability to raise capital efficiently will determine its long-term trajectory in the dynamic Indian financial landscape.
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