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Accelerated rundown in gold loan; other segments also slowed

Earnings miss due to elevated provisions and lower other income

* NII grew 10% YoY but declined ~13% QoQ to ~INR14.4b (in line) in 1QFY25. The loss due to the unwinding of prior assignments was ~INR1.6b. Other income loss stood at INR43m (PY: +INR1.3b).

* Opex grew 18% YoY to INR7.5b (in line), with the cost-to-income ratio of 52% (PY: 44%). PPoP declined ~15% YoY to INR6.9b (15% miss).

* PAT (post-NCI) declined 32% YoY/23% QoQ to ~INR2.9b (34% miss). RoA/RoE stood at 2.3%/10.3%, with IIFL’s (standalone) CRAR at ~28% (T1: ~22%). During the quarter, IIFL raised ~INR29b through term loans, bonds, and refinance. Additionally, ~INR18b was raised through direct assignment.

Higher credit costs and calibration in MFI segment

* Consol. AUM grew 2% YoY but declined ~12% QoQ to INR696b. On-book loans grew ~10% YoY. Off-book formed ~35% of the AUM mix, including colending, which formed ~14% of the AUM mix.

* The sequential AUM decline was led by gold loans (-37%), wholesale CRE book (-22%) and microfinance (-8%). Home loans rose ~2% QoQ and digital loans grew ~7% QoQ.

* Gold loan AUM declined to ~INR147b as of Jun’24 and further to ~INR122b as on 5th Aug’24. Disbursements (core products) declined ~71% YoY to ~INR43b, mainly due to the ban on gold loans and a deceleration in MFI and LAP disbursements.

* MFI business was affected by a squeeze in funding and Samasta’s own calibration in the context of industry headwinds. It has already implemented the guardrails proposed by MFIN. Samasta had sensed customer over-leveraging, early in Jan’24 itself and had started looking at the credit scores of customers while approving/sanctioning loans.

* We estimate consolidated AUM to decline ~3% YoY in FY25 and grow ~23% YoY in FY26, resulting in consol. AUM CAGR of ~9% over FY24-26E.

NIMs compression due to ~60bp QoQ decline in yields

* Consolidated yields and CoB declined ~60bp and ~20bp QoQ to ~13.3% and ~9.5%, respectively. Calculated NIMs contracted ~70bp QoQ. Cost ratios to remain elevated; no rationalization in gold business opex

* Opex grew 18% YoY to INR7.5b (in line), with the cost-income ratio of 52%. This increase was attributable to a decline in the gold loan business.

The management shared that the cost ratios are expected to remain elevated until gold loan operations resume and normalize.

* IIFL Finance has not done any employee layoffs and has not shut down any branch during the quarter. The management sounded confident that it expects the RBI embargo on its gold loans business to be revoked in the near future.

* We expect opex-to-avg AUM of 4.0%/4.1% for FY25/FY26.

Asset quality largely stable despite seasonality; MFI GS3 deteriorated

* GS3/NS3 declined ~5bp QoQ each to 2.25%/1.1%. During the quarter, the company also sold stressed loans of ~INR4.3b from the CRE book to ARCs. Total SRs stood at ~INR35.3b as of Jun’24. IIFL reported a deterioration in its MFI asset quality, with MFI GS3 increasing to 2.3% (PQ: 1.9%).

* Consolidated credit costs rose to ~2.1% (PQ and PY at ~1.9% each). The higher provisioning during the quarter was led by increase in PCR on Stage 2 and Stage 3 loans. The company also increased the ECL provisioning on its CRE portfolio. We expect credit costs to increase to ~2.1% in FY25 and then gradually decline to ~1.7% in FY26.

Highlights from the management commentary

* The company has guided that within digital loans, the focus is on MSME. The digital loans business has been growing well.

* Both Home Finance and LAP recorded >20% YoY growth in AUM.

* The management shared that once the embargo on gold loans is lifted, it can restart its gold loans offering quickly, but it is difficult to guide how long it will take to reach pre-ban levels.

* IIFL has made hiring at CXO level and is in the process of hiring a few more people, so that audit and compliance (entire risk assurance) functions are strengthened.

Valuation and view

* IIFL management shared that the company is now compliant with all the RBI observations, which led to the ban on gold loans. The company has completed the special audit required by the RBI. IIFL will focus on making its assurance functions across risk management, audit and compliance more robust for better-quality AUM growth.

* The stock trades at 1.3x FY26E P/BV and ~9x P/E for a PAT CAGR of ~8% over FY24-FY26E. We estimate RoA/RoE to decline to 1.9%/8.6% in FY25 (impact of gold loan ban) but recover to 3.2%/15% in FY26. Our estimates are based on the assumption that the gold loan ban will be revoked by end-Aug’24 and IIFL will regain gold business momentum in 2HFY25. We have a BUY rating on the stock and a TP of INR560 (based on SOTP valuation; refer table below).

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SEBI Registration number is INH000000412