IGI Logo

On a long growth runway!

* AU Small Finance Bank (AUBANK) is well-positioned for strong growth, demonstrating a steady improvement in operating profitability as it capitalizes on the synergies resulting from the merger. A high-yielding loan book following the merger and broader product offerings, especially in the South, will facilitate profitable growth in the coming years.

* The bank’s recent application for a Universal Bank license is expected to streamline regulatory requirements, improve brand positioning, and foster growth by enhancing customer acquisition and deposit productivity.

* Although NIM may contract to 5.5-5.7% due to rising costs, improvements in disbursement yields and potential rate cuts are expected to enhance margins. We estimate the operating leverage to improve gradually with a C/I projection of 62% for FY25 and further recovery to 60% by FY27.

* The bank maintains robust asset quality with stable credit costs. It expects GNPA/ NNPA ratios to remain around 1.9%/0.6% by FY27 and PCR to improve to 70%.

* We estimate RoA to improve to 1.8% by FY27, aided by ~24% loan growth, resulting in a ~32% CAGR in earnings over FY25-FY27. We reiterate our BUY rating with a revised TP of INR830 (premised on 3.2x FY26E BV).

Estimate loan CAGR of ~24%; business mix to diversify further

AUBANK posted a robust CAGR of ~25% in its standalone advances over FY22- FY24, with a 3.4% QoQ growth in the loan portfolio during 1QFY25, adjusted for its merger with Fincare SFB. The merger will accelerate the company’s growth, enabling it to expand its geographic reach and meet the Priority Sector Lending (PSL) requirements through its stronger presence in high-yield segments such as MFI, while also strengthening its Small Business Loans (SBL) and gold loan portfolios. The complementary asset compositions of AUBANK’s and Fincare SFB’s portfolios bridge the gap in product offerings, creating a diversified suite that supports growth and solidifies the merged entity's leadership in the SFB sector.

Focus on deposit mobilization and strategic CD ratio management

AUBANK is strategically focusing on deposit mobilization while managing its cost of funds, having retired INR10b in high-cost bulk deposits during 1QFY25. AUBANK 's CD ratio was 92%, but when adjusted for refinance-backed loans, it stood at 84%. We estimate deposit mobilization to gain traction, enabling a moderation in the CD ratio to ~90% by FY25E (in line with the bank guidance). The bank targets 25% deposit growth in FY25, emphasizing granular retail deposits while it aims to maintain a CD ratio of ~90% (85% ex refinance). With a stable funding mix of 70% CASA and Retail TDs and 15% non-callable bulk TDs, we clock ~24% CAGR in AUBANK’s loan book, reaching INR1.64t by FY27E, and a similar growth rate for 500 deposits at INR1.84t.

Funding cost pressures to keep near-term margin under check

AUBANK’s NIM increased ~90bp QoQ to around 6.0% in 1QFY25, primarily due to a 120 bp rise in loan yields from its merger with Fincare SFB. Despite a 7 bp QoQ reduction in funding costs to 7.03%, aided by the retirement of high-cost bulk deposits, the elevated deposit rates and competition are expected to maintain high funding costs in the near term. The bank anticipates NIM to remain ~5.5-5.7% over FY25 as deposit mobilization accelerates. However, a potential turn in the repo rate cycle, with 62% of the loan book being fixed in nature, will support margins. We estimate NIM to gradually improve over FY25-FY27, aided by improved operating leverage and a possible capital raise in FY26 to support loan growth.

Near-term C/I ratio sticky; operating leverage to improve gradually

AUBANK is investing in sustainable growth through technology, streamlined processes, and geographic expansion with cost ratios projected to stay high at 62% in FY25 (slightly better than the management’s conservative estimate of ~63% for FY25; 60% cost-income ratio in 1QFY25). The bank’s merger with Fincare SFB is expected to drive revenue growth through cross-selling, enhanced distribution income, and benefits from the AD-1 license, with cost ratios expected to improve from FY26 as the merger synergies are realized. Additionally, AUBANK's recent application for a Universal Bank license is set to ease regulatory requirements and enhance brand positioning, supporting growth through increased customer acquisition and improved deposit productivity from the expanded branch network.

Estimate GNPA/NNPA ratio at ~1.9%/0.6% by FY27

AUBANK has maintained robust underwriting, characterized by in-house origination, strong asset monitoring, and efficient collections. The bank expects credit cost of 6.5-7.0% for its credit card business and around 3% for microfinance over the long term, having set aside an additional INR170m for the MFI segment in 1QFY25. During 1QFY25 the bank reported a credit cost of 33 bp (29 bp adjusting for recoveries), despite deteriorations in the retail unsecured segment. Although the MFI segment continues to report stress, AUBANK expects the credit cost to remain stable at ~1.2% for FY25. Asset quality ratios are, thus, expected to remain in control with GNPA/NNPA ratios at ~1.9%/0.6% by FY27E, while PCR improves to 70% from ~65% currently.

Valuation and view: Reiterate BUY with a revised TP of INR830

* AUBANK is well-positioned to deliver superior growth with a steady improvement in operating profitability as it benefits from the synergies following its merger with Fincare SFB. This merger enables the bank to benefit from a higher-yielding loan book and a broader product suite, thereby driving growth, particularly in the South.

* The bank’s recent application for a Universal Bank license is expected to ease regulatory requirements and enhance brand positioning, thus supporting growth while improving deposit productivity. While NIM may moderate slightly due to the rising cost of funds, improved disbursement yields and potential rate cuts are likely to improve margins over FY26E.

* AUBANK aims for a 1.6% RoA in FY25 with a potential for 1.8% by FY27E. We estimate AUBANK to deliver ~24% loan growth CAGR and ~32% PAT CAGR over FY25-FY27. With strong execution capabilities and a proven management track record, we remain optimistic about AUBANK’s growth and reiterate a BUY rating with a revised TP of INR830 (premised on 3.2x FY26E BV).

For   More   Motilal   Oswal   Securities   Ltd   Disclaimer http://www.motilaloswal.com/MOSLdisclaimer/disclaimer.html

SEBI Registration number is INH000000412