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Signs of mild stress emerging, though transitory

Aavas Financiers’ (Aavas) Q1FY22 performance showed signs of mild stress emerging in its portfolio. This was evident from: i) stage-3 assets at 1.14% (vs 0.98% QoQ), ii) spike in 1+ dpd pool to 12.7% (vs 6.4% QoQ), iii) 1.2% restructuring (vs nil till FY21), and iv) >70bps annualised credit cost (vs sub-50bps for FY21).

We revise our credit cost estimate to >50bps for FY22E (vs 35bps earlier) anticipating: 1) further restructuring of 50-75bps in Q2FY22, 2) forward flows from 1+ dpd bucket into stage-3, and 3) cumulative provisioning at 85bps of AUM. Encouraging momentum in June/July collections gives confidence of 1+ dpd having peaked and likely to descend hereon.

Though disbursement was down 50% QoQ, AUM sustained 21% growth on a low base. With revival in demand sentiment and Aavas’s investment in building capabilities, we expect it to grow its AUM by 20-25% in the medium term. With sustained NIMs, it will deliver 3.5% RoA and 13-15% RoE by FY22E/FY23E. The stock trades at 6.4x FY23E book and 47x earnings. We downgrade it to HOLD from Buy with an unchanged target price of Rs2,668. Key risks: 1) higher stress unfolding in next 2 quarters, and 2) better than expected AUM growth.

* Signs of mild stress build-up visible (1+ dpd spikes to 12.67%); stage-3 at 1.14%, restructuring at 1.2%: Disruption in collection efficiency during Q1FY22 resulted in sharp spike in 1+ dpd to 12.67% (vs 6.37%/8.21%/6.2%/1.5% in Q4/Q3/Q2/Q1FY21 respectively). However, collections in Jun/Jul’21 have been encouraging, which suggests 1+dpd has peaked out and will likely descend hereon. However, for 1+ dpd to normalise to previous quarters’ average might take a couple of quarters. Gross stage-3 inched up to 1.14% (vs 0.98%) QoQ with uptick in home loans as well as mortgage segment. Moreover, restructuring, which was absent in FY21, now constitutes 1.2% of AUM at Rs1.2bn (897classified under stage-2 and provided at ~14%). Overall, we remain conservative and build-in stage-3 at 1.45% and 1.2% for FY22E and FY23E respectively.

* Credit cost at 70bps for Q1FY22; carries 15bps contingency buffer: Credit cost came in at 70bps for Q1FY22 vs sub-50bps for FY21, which was higher than our expectations due to provisions on restructured assets (pool of Rs1.2bn). Aavas also utilised Rs42mn from the covid buffer and outstanding buffer declined to Rs148mn (15bps of AUM). As the restructuring window is still open, we expect an incremental 50-75bps of restructuring by Sep’21. Overall, considering higher dpd, restructuring pool and cumulative provisioning at 85bps of AUM, we revise our credit cost estimate to >50bps for FY22E vs our initial estimate of 35bps.

* Restricted business activity led to >50% QoQ decline in disbursements: Disbursement growth after registering 23% YoY / 33% QoQ growth in Q4FY21 slowed down due to restrictions in business operations. Disbursements were down 54% QoQ (albeit up 117% YoY) with home loans witnessing 64% QoQ decline. On a low base, AUM growth momentum YoY sustained at 21% and AUM reached Rs96.2bn (up 2% QoQ). With easing of restrictions and improvement in demand sentiment, we expect disbursements to regain momentum. We are building-in disbursement growth of 35% for FY22E/FY23E and expect AUM growth of >20%/25% YoY for FY22E/FY23E. Aavas ran tight filters for self-employed customers and was cautious in the LAP segment since FY21.

* Continuing to invest in franchise and expand areas of operations: Company is working consistently into building its distribution franchise and increasing people capacity. It added 4 branches during the quarter to take the total tally to 284 branches and also commenced operations in one new state taking the state tally to 11. Franchise investment will aid the company in achieving its targeted consistent growth rate of >20%. It has also strengthened its leadership in technology as that will be the key driver to make it competitive and bring in efficiency. We are building-in ‘opex to assets’ ratio of 2.9% and 2.7% over FY22E and FY23E respectively.

* NIMs stable as interest reversals impact offset by funding cost benefit: Reported yields were lower by 17bps QoQ, but the decline was offset by 15bps QoQ reduction in borrowing cost, eventually resulting in stable spreads at ~5.7%. In the absence of sell-downs during the quarter, securitisation income was nil (vs Rs274mn in Q4FY21). We expect yields to sustain near 13% and funding cost at ~7.5%, which will hold NIMs at ~7.0% for FY22E/FY23E.

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