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Transition underway

Wading through challenges and uncertainty     

AU Small Finance Bank (AUBANK IN) PAT of INR 3.75bn in Q3FY24 was marginally lower than our estimates driven by higher opex (sustained investment) and higher credit cost, although higher Other income and NII (benefitting from securitization), cushioned the impact. The key discussion points would be: 1) NIM trajectory as the bank runs toward the lower end of guidance range and limited near-term triggers for improvement, 2) deposit growth, which, in turn, would drive credit growth, 3) consequent ROA delivery – it has climbed down at a good clip from the earlier cycle delivery, and 4) merger outcomes, which we believe will have its challenges. Thus, merger integration challenges (seen with various entities), change in underlying business practices & likely increasing volatility during the downturn may hit structural valuation. Downside and longer time correction are likely until merger synergies play out.

Soft core; NIM trajectory is key

Q3 saw flat NIM at 5.5%; however, a part was supported by benefits of securitization and change in recognition method (one-time impact). We expect transitioning through this period to be challenging. Opex remains elevated as AUBANK continues to invest in building its franchise, which restrained core PPOP. This strategy may strain near- to medium-term outlook, but is good for future capabilities.

Asset quality sees negative surprise

Slippages rose to INR 4bn, ~2.5% of lagged loans; however, higher write-offs (INR 1.19bn vs INR 310mn QoQ) cushioned headline GNPL. The credit cost increased, primarily driven by higher slippages in credit card book, an 18bp impact on overall credit cost of 62bp, which is from credit cards. While we agree credit card book is scaling up and may see transitionary pressure, the outcome has been subdued to date.

Valuation: retain Reduce with a TP of INR 680

Q3 earnings were weak with pressure on core NIM, softer growth and higher credit cost. Near-term discussions may depend on merger outcome than earnings resilience. We have yet to move to merged financials, but we believe there is uncertainty to bake into our estimates in the near term with moving variables. The bank has taken a reasonable stepdown from the earlier cycle ROA delivery and it does face headwinds as it grows into the bigger league. We introduce FY26 earnings and roll forward to September 2025, resulting in a higher TP of INR 680 from INR 645 based on 3x (unchanged) Sept’25 P/BV. These transitionary times entail challenges and would translate into a time correction; hence, we retain Reduce, given the limited scope for maneuverability.