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Visible traction on digital platform and omnichannel strategy

PAT was up 53% YoY and 48% QoQ to INR14.8b (8% miss) in 2QFY22. While NII at INR42.9b (10% beat) was up 26% YoY due to higher interest income from surplus liquidity and from IPO financing, it was mitigated by higher OPEX (up 48% QoQ and 40% above our estimate). Credit costs stood at INR13b (est. INR11b), which included additional COVID-19 provisions of INR3.5b in 2QFY22 to guard against contingencies from a potential third wave.  GNPL ratio/PCR improved by ~50bp/~400bp QoQ to 2.45%/55%. The majority of restructuring was in Mortgages in 2QFY22. Non-overdue OTR book stood at INR15.12b (~90bp of AUM). BAF has classified its OTR pool in Stage 2 and holds ECL provision of INR2.89b (19.1%) in this book.

* BAF is seeing healthy traction of its omnichannel strategy, both for acquisition of EMI card customers (~372k) as well as for loans at the EMI store (~248k; 4% of new loans in 2QFY22). Stimulation of customers at the point of sale (POS) by leveraging its integrated offline to online framework led to originations of INR3.9b in Personal loans and ~27k Credit Cards. While the majority of this is still supported by BAF’s customer data platform (CDP), it will become seamless and further reduce friction when its new consumer app upgrade is rolled out by mid-Dec’21.

* What we will now be looking forward to is the new features which will be rolled out in the second sprint of the consumer app. The payments stack of BAF will be exciting as it plans to leverage PPI, UPI, EMI cards, and Credit Cards, along with a rewards program. From QR-based payments to a presence at the POS machines and eventually to a payment gateway, BAF is looking to morph its erstwhile REMI business into a full-fledged payments offering by leveraging the merchants app, which it expects to go live in Feb’22.

* Barring any new COVID disruption, we expect BAF to deliver ~24% AUM growth in FY22E and a 25% CAGR thereafter. We expect margin to sustain driven by a reduction in the negative carry as excess liquidity normalizes and the decline in interest income reversals. We have increased our credit cost estimate for FY22E to 2.8% (v/s 2.6% earlier). We expect BAF to deliver a RoA/RoE of 4.4-4.7%/21-23% over FY23- 24E. Given the expected recovery in asset quality in 2HFY22 and the sustained milestones-driven progress made by BAF in its digital transformation program, we reiterate our Buy rating with a TP of INR8,650 per share (9x Sep’23E BVPS).

Sustained improvement in customer acquisition; AUM growth reverting to pre-COVID levels

* Total customer franchise increased to 52.8m (up 4.7% QoQ and 19.7% YoY). New loans booked rose 37% QoQ to 6.3m (v/s 3.6m YoY) and was back to preCOVID levels.

* AUM grew 22% YoY and ~5% QoQ to INR1.67t. Consolidated AUM grew by ~7% QoQ, adjusted for IPO financing. On a QoQ basis, AUM growth was driven by Urban B2B Sales Finance (+12%), Urban B2C (+7%), Rural businesses (+8%), and Commercial businesses, excluding LAS (+9%). Auto Finance (-5%) and LAS (-6%) were a drag in 2QFY22. SME business/Mortgages rose 8%/6% QoQ

Higher OPEX driven by greater collection costs and employee expenses

* Operating expenses were elevated on account of higher collection costs (owing to the second COVID wave) and employee expenses. In 2QFY22, BAF increased its employee strength by over 2,000 to support its growth stance.

* Collection costs were greater because of higher bounce rates during the second COVID wave (1QFY22) and also due to recovery efforts on loans that were written-off in FY21. Collection costs have peaked out, should reduce in 3Q, and normalize in 4QFY22.

* OPEX-to-NII stood elevated at 38% in 2QFY22. With a normalization in collections and an increase in NII as a result of Balance Sheet growth, OPEX-toNII should normalize to 32-33% in 2HFY22.

Highlights from management commentary

* Interest income reversal stood at INR3.22b in 2QFY22. The management expects quarterly interest reversals to normalize to INR1.8-2b in 3QFY22 and beyond.

* In the absence of a third COVID wave, loan loss and provisions should normalize to pre-pandemic levels of INR7b-INR8b in 3Q/4QFY22.

* BAF is currently investing in building the EMI store. Its contribution was 250k loans in 2QFY22. In 2QFY23, it could potentially originate 500k accounts.

* BAF could mostly likely diversify to other 2W OEMs in the near future.

Valuation and view

Despite the slightly higher credit costs and elevated operating expenses, 2QFY22 was a decent quarter for BAF. Customer acquisitions and new loans booked have not reached record highs, but have convincingly scaled back to pre-COVID levels. We expect BAF to be able to deliver a quarterly run-rate in AUM growth similar to preCOVID levels in 2HFY22. Provided there is no new COVID wave, we expect BAF to contain credit costs ~2.8% in FY22. Margin is likely to sustain on: a) lower cost of funds, b) reduced liquidity, and c) normalization in interest reversals. We update our estimates to factor in higher credit costs and operating expenses in 1HFY22, and expect BAF to deliver a RoA/RoE of 4.4-4.7%/21-23% over the medium term. Given the positive outlook, we maintain our Buy rating with a TP of INR8,650 per share (9x Sep’23E BVPS).

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