Company Overview:

The company was originally incorporated as ‘L.N. Finco Gems Private Limited’ on January 10, 1996 as a private limited company under the Companies Act, 1956 with the RoC. Pursuant to the change of name of the company to Au Financiers (India) Private Limited to reflect the diversified finance business of the company, a fresh certificate of incorporation was issued by the RoC on May 24, 2005. The company was converted into a public limited company by way of a special resolution passed by its shareholders at the EGM held on January 10, 2013 and the name of the company was changed to ‘Au Financiers (India) Limited’. A fresh certificate of incorporation consequent upon conversion to a public limited company was issued by the RoC on January 11, 2013. The company was granted the in-principle approval to establish an SFB by the RBI, pursuant to its letter dated October 7, 2015. Subsequently, the RBI granted the company the final approval to establish an SFB by its letter dated December 20, 2016. Pursuant to the company being established as an SFB, the name of the company was changed to ‘AU Small Finance Bank Limited’ and a fresh certificate of incorporation was issued by the RoC on April 13, 2017. The company is a small finance bank (SFB) that has recently transitioned from a prominent, retail focused non-banking finance company (NBFC), which primarily served low and middle-income individuals and businesses that have limited or no access to formal banking and finance channels. It received a license from the Reserve Bank of India to set up an SFB on December 20, 2016 and it was the only NBFC categorized as an asset finance company to obtain such license. It commenced its SFB operations with effect from April 19, 2017. Prior to such date, the company was categorized as a ‘Systemically Important, Non-Deposit Accepting Asset Finance Company’ (NBFCND- AFC) by the RBI.

AU Small Finance Bank Limited, as an NBFC, operating in three business lines: vehicle finance; micro, small and medium enterprises (MSMEs) loans; and small and medium enterprises (SMEs) loans. As it commenced the small finance bank (SFB) operations, it has expanded and strengthened its business model to offer a diverse suite of banking products and services by leveraging its asset-based lending strengths, NBFC customer base and cost efficient, technology driven hub-and spoke branch operating model to successfully operate the SFB. In addition to its vehicle finance, MSME and SME offerings, its asset product offerings include working capital facilities, gold loans, agriculture related term loans, Kisan credit cards for farmers and loans against securities. Its liability product offerings include current accounts, savings accounts, term deposits, recurring deposits and collections and payments solutions for MSME and SME customers.

Industry Overview

As per the Reserve Bank of India (RBI), India’s banking sector is sufficiently capitalised and well-regulated. The financial and economic conditions in the country are far superior to any other country in the world. Credit, market and liquidity risk studies suggest that Indian banks are generally resilient and have withstood the global downturn well. The Indian banking industry has recently witnessed the rollout of innovative banking models like payments and small finance banks. In recent years India has also focused on increasing its banking sector reach, through various schemes like the Pradhan Mantri Jan Dhan Yojana and Post payment banks. Schemes like these coupled with major banking sector reforms like digital payments, neo-banking, a rise of Indian NBFCs and fintech have significantly enhanced India’s financial inclusion and helped fuel the credit cycle in the country. Indian Fintech industry is estimated to be at US$ 150 billion by 2025. India has the 3rd largest FinTech ecosystem globally. India is one of the fastest-growing Fintech markets in the world. There are currently more than 2,000 DPIIT-recognized Financial Technology (FinTech) businesses in India, and this number is rapidly increasing. The digital payments system in India has evolved the most among 25 countries with India’s Immediate Payment Service (IMPS) being the only system at level five in the Faster Payments Innovation Index (FPII). India’s Unified Payments Interface (UPI) has also revolutionized real-time payments and strived to increase its global reach in recent years.

Technical View: Au Small Finance Bank ltd:

2QFY25 Concall Highlights:
Operating Performance:

• Around 43% of branches which were live before Dec'23 are now profitable in 2QFY25 as compared to around 25% of branches being profitable as on Dec'23; supported by increased productivity and focus on overhead cost controls.
• The bank has been able to improve the incremental cost of funds. It stood at 7.3% for 2QFY25 (vs. 7.7% for 4QFY24).
• The bank has enhanced its disbursement yield across core asset portfolio in 1HFY25 with wheels/MBL/housing portfolio witnessing yields increasing by 30bps/40bps/130bps respectively.
• The credit Card portfolio has the potential to deliver RoA of around 5%.
• The bank is growing its insurance distribution business (which currently has around 14 partners) by increasing penetration in its customer base.
• The bank expects (a) deposit and lending related fees and charges to increase in line with growth in business volumes and, (b) credit card interchange and other fees to build up as the business matures.
• Treasury income from interest rate movement, PSLC or capital markets are market dependent and can impact other income by 5% to 10%.

Advances and Deposits:

• Around 80% of the bank's loan book is towards the informal segment where the customers are dependent on business earnings rather than fixed monthly income and any discontinuity directly impacts their earnings and cash flows.
• With the objective of leveraging fin care branch network and increasing the bank’s product coverage in each touch point, the bank plans to make available wheels/MBL to around 100- 250 fin care touch points by the end of FY25.
• In case of the micro finance book, the two challenging states for the bank are Bihar and Odisha. However, the bank's exposure to these two states are limited to 7.86% and 2% of the overall micro finance loan book respectively.
• Micro Finance loan book is not a significant portion of the overall loan mix for the bank (at 7.8% for 2QFY25 vs. maximum cap of 10%).
• The number of micro finance borrowers borrowing from 5 and more lenders stood at around 8% (of total micro finance customer); down from 11% in 1QFY25. The bank expects the number to go down further over next couple of months; supported by (a) new guardrails setup by regulator (MFin) in terms of the number of lenders a customer can borrow from, and, (b) banks' guardrail relating to same being more stringent than the regulator.
• Earlier the bank sourced 1mn credit card of which only around 25% customers used the credit limit and 3% of them defaulted in payment, using their full credit limit and the credit cost was around 7%.
• The share of revolver and EMI customer in credit card portfolio has increased from 37-38% in Dec'23 to around 44% in Sept'24. The EMI book has further increased from 17-18% in Mar'24 to 20% in Sept'24.

Asset quality:

• The uptick in GNPA during the quarter was driven by seasonality and weather induced challenges and the bank expects a pullback in the second half driven by both pickup in economic activity and seasonality.
• Credit cost on commercial banking assets (constituting around 20% of loan book) remained in line with the expectations while in the case of micro finance, it remained elevated driven by industry wide issue of over leveraging of customers.
• The bank had earlier expected credit cost to be around 3% in the micro finance portfolio and was building the provision buffer accordingly. However, the current cycle has come earlier than anticipated and hence the bank expects credit loss to be higher in the short term.
• Credit Cost in the credit card segment remained at elevated levels, as per the expected line and headline numbers and was further impacted by lower base effect. Expecting credit cost to remain elevated for 2HFY25.
• Of the total slippages in 2QFY25, around 33% was from unsecured loans (credit card; micro finance and personal loan) and 67% was from secured loans. Slippages from unsecured loans (as a % of total slippages) during 1QFY25 stood at around 25%.
• The bank has started taking CGFMU coverage on the micro finance segment from 2QFY25 onwards. The erst. Fincare Small Finance loan book didn't have any CGFMU cover on its micro finance loan book.
• Provision Coverage Ratio (incl. write offs) stood at around 82% as on 30th Sept'24. Coverage on overall asset base stood at around 63%. PCR on unsecured loan book is close to 90%.
• Collection Efficiency from the micro finance segment stood at around 98.44% (vs. 99.07% in 1QFY25). The overall collection efficiency in current bucket for 1HFY25 stood at 98.75%; better than the commentary received from the ground.
• Credit Cost in micro finance segment stood at around 3% for 1HFY25; with a major part of it coming in 2QFY25. Based on ground assessment, the bank feels that October'24 was better than Sept'24. The credit cost in the segment might go up in 2HFY25.
• Net Credit Loss for the bank in the secured segment has not been more than 20-25bps for years.
• Will build contingency buffer in micro finance only when the credit cost goes beyond 3%.

Valuation and strategy:

Despite the slowdown in micro finance lending and calibrated approach in credit card portfolio, the bank expects gross loan portfolio to grow by around 25% YoY in FY25. Expecting FY25 cost of funds to be in the range of 7.10-7.15% (vs. earlier guidance of 7.20- 7.25%). Cost of Funds remained stable sequentially at 7.04% in 2QFY25 (vs. 7.03% in 1QFY25). All components of fee income to report strong growth in 3QFY25 and 4QFY25. Despite operating expenses being seasonally higher in 2HFY25, the bank expects cost to income ratio to remain at around 60% for FY25 (vs 63.6% in FY24 and 63.0% in FY23). We recommend Buy AU Bank for price target of 870 with Est forward EPS for F.Y 2025 to 38.39 for current EPS 22.21.