SFBs get a boost as they can absorb the holding company

In the last few days, small finance banks and their parent companies have shown a sharp rally. What exactly has changed? Both Equitas Small Finance Bank (SFB) and Ujjivan Small Finance Bank (SFB) propose to apply for amalgamation of their parent with the SFB. While Ujjivan Financial is the holding company of Ujjivan SFB; Equitas Holdings is the holding company for Equitas SFB. This was after the RBI permitted SFBs to merge their holding companies into themselves. How this announcement relevant.

It assumes significance as both Equitas SFB and Ujjivan SFB are about to complete five years of operations. Under the RBI regulations, on completion of 5 years the holding company must dilute its stake in the SFB to below 40%. Both the holding companies; Ujjivan and Equitas, hold nearly 82% in the SFB arms. Reducing this stake to below 40% would entail a massive surge in free float depressing prices. The new RBI rule will allow the SFB holding companies to avoid dilution by merging the holding company into the SFB. This will ensure that the valuation of the group improves.

In the last few months, this mandatory holding company dilution was the reason for stock prices being tepid. With RBI allowing SFB holding companies to amalgamate with the SFB, this dilution issue is automatically addressed. But there is a bigger takeaway. Most holding companies in India are subjected to a holding company discount and this was depressing valuations. With the new rule, that discount should go away, allowing more value based pricing for SFBs. That is what is getting markets excited about Ujjivan and Equitas.