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Asset quality improves; expect a normalized FY22

* Bajaj Finance (BAF)’s 4QFY21 PAT grew 42% YoY / 18% QoQ to INR13.5b (2% miss). While NII beat our estimates by 7%, opex was 12% above our expectations. With in-line provisions, PAT came in largely in line with our expectations. For FY21, the company reported AUM/NII/PPoP growth of 4%/3%/6% YoY. However, PAT declined 16% on the back of aggressive cleanup stress due to COVID.

* The proforma GNPL ratio declined from 2.9% to 1.8% QoQ. BAF wrote off ~INR15b worth of loans (1.0% of loans). The company has a provisioning coverage ratio of 58% on GS3 and 181bps on GS1&2. BAF continues to carry COVID-related provisioning of INR8.4b.

* With growth drivers back in place, we expect BAF to deliver ~25% AUM CAGR going forward. FY22 is also likely to see margin improvement with a) a reduction in negative carry as excess liquidity would reduce, b) the continued fall in Cost of Funds, and c) a shift in the asset mix toward highyielding assets. With greater clarity on the stressed pool, we cut our FY22E credit cost estimate by ~20bp to 1.6%. We estimate ~4.8% RoA / 22% RoE over the medium term. BAF’s return ratios have not only been consistent but are also the highest in our Coverage Universe after the gold financiers. Given the improved clarity on business trends, we upgrade the stock to Buy, with Target Price of INR5,865 per share (6.5x FY23E BV).

Disbursements exceed 90% of YoY levels; guidance positive

* In 4QFY21, disbursements scaled above 90% of YoY volumes for most segments – B2B (urban) was at 105%, B2B (rural) at 119%, Credit Card Origination at 95%, E-Commerce at 84%, Auto Finance at 80%, B2C (urban) at 87%, B2C (rural) at 115%, SME at 138%, and Mortgages at 147%.

* AUM grew 6% QoQ to INR1.53t (4% YoY). The loan mix was largely stable on a sequential basis.

* The management is positive about delivering on long-term target metrics in FY22 (AUM growth of ~25%; RoE of ~20%) – provided there are no large-scale lockdowns.

Liquidity maintained on the books; CoF declining

* The company has largely maintained liquidity on the books (at 12.5% of borrowings) – contrary to the management’s guidance for a further reduction in the coming months to a run-rate of 7–8%.

* Spreads (calculated) improved 23bp QoQ to 11.6%, driven by stable yields and 72bp decline in cost of funds to 6.9%. Interest reversals during the quarter stood at INR2.98b v/s INR4.5b QoQ.

* During the quarter, the share of bank borrowings declined 300bp to 32%, offset by 250bp share gains in the money markets (44%). While the total deposit book grew ~19% YoY to INR263b, the share of retail increased to 77%, from 67%, over this period.

GS2 pool at 4.5% of loans, of which RL forms INR17b (1.1%)

* Proforma GS3 loans improved 110bp QoQ to 1.8%, with PCR of 58%. The nonoverdue one-time restructuring (OTR) book stood at INR17.4b. This includes secured exposures of INR9.2b, one large B2B retailer account of INR4b, and INR4.2b unsecured assets. BAF has classified this as Stage 2. ECL provisions on the same stood at INR3.3b (19%).

* Non-OTR stage 2 assets stood at ~INR50b, against which there is an ECL provision of INR12.4b (25%).

* The management expects credit costs to normalize in FY22, barring any largescale adverse macros. The management overlay now stands at INR8.4b.

Highlights from management commentary

* It would see meaningful decline in the C/I ratio post the launch of the business transformation process.

* New loan originations, barring auto finance, are back at pre-COVID levels. The Wallet Loans business (paused) and Retail EMI business have moderated. REMI is doing 50k/month instead of a 150k/month run-rate.

Other highlights

* Opex increased by INR1.53b YoY, led by an INR1.40b/INR1.51b increase in recovery commissions and employee expenses. This was partially offset by a reduction in other expense heads.

* The capital adequacy ratio stood at 28.34%, of which Tier-1 capital was 25.10%.

* The Housing Finance arm’s AUM grew 19% YoY to INR388.7b and reported PAT stood at INR4.5b (+8% YoY).

* Despite significant disruptions, BAF remains open for business across geographies, in line with local administration advisories. In the last 7–10 days, the company has continued to originate 50–55% of daily volumes in the B2B business, 80–85% in the B2C and SME businesses, and 40–50% in Mortgages.

Valuation and view

4QFY21 was a healthy quarter for BAF. Disbursements have exceeded 90% of YoY levels across most segments. The initial asset quality performance of incremental disbursements is in line with or marginally better than pre-COVID levels. This bodes well for asset quality in the medium term. In the near term, we do not foresee any major asset quality disruption, unless the impact of the second wave is worse than expected. Margins are likely to see a sharp improvement in FY22 on a) lower cost of funds, b) a reduction in liquidity, and c) a favorable base due to interest reversals. We largely keep our estimates unchanged and expect the company to deliver ~4.8% RoA / 22% RoE over the medium term. Given the positive outlook, we upgrade our Neutral rating to BUY, with TP of INR5,865 per share (6.5x FY23E BVPS).

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