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AU Bank’s Q1 FY24 performance was a mixed bag, which was characterized by 1) sustained strong asset growth, 2) NII coming below expectations, 3) stronger core fee income trends, 4) in-line cost growth and 5) higher net slippages. NIM decline was sharper than expectation, the bank utilized a large part of its contingent provisions, and PCR declined materially. RoA/RoE for the quarter stood at 1.7%/14%. After likely dipping in FY24, the return ratios could secularly improve from FY25 (even with normalizing credit cost) on account of moderation in cost/income ratio. The reversal of rate cycle and deepening of retail deposits franchise will be positive for AU Bank’s margins due to higher contribution of fixed rate book and non-urban asset customer profile. Further strengthening of fee income, reduced intensity of investments (as per lifecycle needs) and income/productivity benefits from strategic investments being incurred now would support RoE expansion from next fiscal. Bank expects to largely maintain RoA in FY24 and reach 2%+ sustainable RoA in three years. The rate of increase in opex has started to come-off even as bank continues to make evolutionary investments. The focus on extracting productivity from extant distribution assets, decision to reduce rate premium on deposits and maturing of offerings such as credit cards, merchant QR, AU0101 would lift profitability of the bank over time. Our earnings estimates undergo a mild upgrade, and the bank is trading at 3.5x FY25 P/ABV. Maintain ADD rating with increased 12m PT of Rs840.

Bank utilized excess liquidity to fund asset growth

Overall deposits were flat qoq as the bank consumed the excess liquidity created in preceding quarter (had an LCR of 151% as of March’23). CASA ratio fell materially qoq with CA/SA deposits declining 12%/8%. Overall CASA + Retail TD share was largely unchanged, as retail TDs grew by 8% qoq. Bank has reduced peak SA and TD rates by 25 bps recently, and the intention is to reduce pricing premium over larger banks over time and leverage other enablers like credit cards, cross-sell, wealth management, etc. The bank remains confident about growing granular deposits in-line with envisaged brisk asset growth. Gross Advances were up 8% qoq/29% yoy. Disbursements/growth momentum remained strong across loan products of Vehicle Finance, Affordable Home Loans, Business Banking, Agri Loans and NBFC Financing. Credit Cards & PL are scaling up faster on low base and improving customer acquisition. Growth in SBL MSME remains patchy. NIM decline was sh

NIM decline was sharper, causing further increase in cost/income

Hikes/tweaks in TD/SA rates and larger mobilization of Bulk TDs. NIM declined by 38 bps qoq owing to further significant increase in deposit cost and drag from excess liquidity (avg LCR at 139% v/s 128% qoq). Yield on advances has been static with relative faster growth in lower-yielding home loans and commercial banking products. Lending rates hikes across products have been calibrated to support growth/competitive position. Bank expects NIM in the range of 5.5%-5.7% for FY24. Bulk impact of liabilities re-pricing is behind, and margins would likely get support from improving disbursement yield (up 29 bps qoq). When interest rate cycle turns, the fixedrate nature of book would have positive impact on margin. Core fee growth (excl. PSLC, Treasury & Misc.) strengthened further (44% yoy) on improving liability, transaction, distribution, and credit cards related fees. Cost/Income ratio deteriorated to 65% on account of NIM decline and sustained investments in credit cards, merchant QR, video banking, distribution expansion and branding.

Net slippages normalized; bank utilized significant contingent provisions

Because of seasonality and normalization of credit environment, the gross slippages came higher (annualized 2%) and recoveries + upgrades were lower than seen in preceding quarters. Increase in Gross NPAs was seen across products. The credit cost for the quarter was low at 20 bps but it subsumes utilization of Rs620mn contingent provisions and a material reduction of PCR.

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