Markets
Increasing costs may take the wind out of AU Small Fin’s sails
Summary
In the past few quarters, it had been focusing on strengthening its key business segments such as vehicle finance and MSME. It is also diversifying its loan book to segments such as home loans, gold loans, and credit cards.Shares of AU Small Finance Bank Ltd have gained almost 30% from its 52-week lows seen in March. But further meaningful upsides could well be capped ahead in view of the expected net interest margin (NIM) compression, stiff competition for deposits and elevated operating costs (opex).
Sure, the continued credit (loan) demand in the market, particularly in the retail segment, bodes well for AU Small Finance. In the past few quarters, it had been focusing on strengthening its key business segments such as vehicle finance and MSME. It is also diversifying its loan book to segments such as home loans, gold loans, and credit cards.
Plus, the bank is expanding its geographical presence and digital footprint. It plans to open over 60 new branches in FY24. According to Motilal Oswal Financial Services, strong investments in the business and widening geographical reach will continue to aid business growth and further reduce geographical concentration.
Thus, the brokerage estimates loan growth to remain steady at about 28% CAGR over FY23-25. But expansion to new geographies and investments into its digital platform means opex would remain elevated. In the June quarter (Q1FY24), the cost-to-income ratio stood at 65%, but the bank expects to retain this ratio at 63% for FY24. The elevated funding costs is expected to be a drag on NIM in the near term. This is because about 66% of AU Small Finance’s portfolio is fixed book. This means, though deposits continue to reprice, the scope to pass on the increased rates is limited. The bank’s strategy of staying away from high-cost deposits and a stable interest rate environment could aid NIM. In FY24, NIM is expected to be in the range of 5.5-5.7%. In Q1, NIM fell sharply by 38 basis points sequentially to 5.7%.
Amid this, deposit growth is crucial to sustain the loan growth in FY24 given that most banks would be competing to raise deposits. In Q1, AU Small Finance’s deposits, while up 27% year-on-year, were flat sequentially as the bank used an excess liquidity buffer rather than raising high-cost deposits. It aims to focus on building granular deposits. To be sure, AU Small Finance’s stable asset quality metrics and benign credit costs are positive. Still, the operating leverage may take time to play out. Dnyanada Vaidya, research analyst-BFSI, Axis Securities, said, “Despite benign credit costs, NIM compression and elevated opex ratios will continue to hurt return on assets (RoA) in FY24. We expect RoA to contract to about 1.6% in FY24, before improving to about 1.75-1.8% by FY25E."
