AU Small Finance tumbles 5% in 4 sessions; what should investors do?

Last week, reports claimed that the Reserve Bank of India has raised concerns about the rapid rise in advances at AU Small Finance Bank

Shares of AU Small Finance have tumbled 5.3 per cent in four trading sessions after reports, last week, claimed that the Reserve Bank of India (RBI) had called the lender's management for two meetings last year, raising concerns about the rapid rise in advances.

The benchmark S&P BSE Sensex, and S&P BSE Bankex, meanwhile, added 1.1 per cent and 1.4 per cent, respectively, during the period.

"The bank was told that its growth was not in line with what other banks in the system were reflecting. The RBI is concerned whether this signifies high incentives for achieving growth, along with a dilution of underwriting standards, risk management, and risk model," said a report by BQ Prime.

Analysts believe the regulator's concerns are justified as such a rapid pace of loan book expansion may lead to asset quality concerns going ahead.

"In recent times, we have seen a bank, and an NBFC going through a massive crisis mainly due to aggressive lending, which resulted in big compromises on asset quality," said G Chokkalingam, founder and head of research at Equinomics Research.

AU Small Finance Bank, Chokkalingam added, has posted 26 per cent year-on-year (YoY) growth in advances in the January to March quarter (Q4FY23), around 1,000 basis points higher than the industry credit growth. Yet, it maintains one of the lowest net non-performing assets (NPAs) ratio (0.4 per cent in Q4FY23) despite such aggressive growth.

"While it would be unfair on part of any analyst to express any doubt, the regulator monitoring such development would be good for all players concerned, including AU SFB," he added.

On its part, the lender refuted the report around regulatory rebuke on credit growth during the earnings call on Tuesday.

During Q4FY23, advances grew 5 per cent quarter-on-quarter (QoQ) to Rs 59.2 crore, led by wholesale (up 60 per cent YY), while retail advances grew 25 per cent YoY.

Deposits, too, accelerated in Q4, registering a growth of 32 per cent YoY/13.5 per cent QoQ. That said, cost of finance (CoF) jumped by 30bps QoQ to 6.3 per cent, leading to a 10bps decline in net interest margin (NIM) to 6.1 per cent.

Going ahead, analysts remain divided on the growth outlook as they remain watchful of operating profits, margin and credit growth trajectory vis-a-vis the stock's expensive valuation.

"As we proceed into FY24, we see operating profitability facing a few challenges, primarily on the margin front. This would be a result of a shifting loan mix, peaking out of yields and rising cost of funds," said analysts at Kotak Institutional Equities.

They, further, added that while AU SFB continues to position itself as a franchise for the long term, valuations remain high. The brokerage has, therefore, downgraded the stock to SELL from REDUCE.

Those at Nuvama Institutional Equities, too, maintained their 'REDUCE' rating on the stock as they believe, at 3x book value (BV) FY25E, AU SFB is expensive because its return on asset (RoA) is equal to/lower than peers including ICICI, HDFC Bank and IndusInd Bank, which trade cheaper.

"Its weaker deposit profile and higher opex yield an RoA that is equal to/lower than peers. We retain ‘REDUCE’ as we find better risk-reward elsewhere," they said.

Chokkalingam of Equinomics, however, said that AU SFB would be able to justify  the premium valuations if the RBI doesn’t find any scope for compromise on asset quality.

Over the medium-term, brokerage firm Sharekhan said that outlook for the lender remains stable to positive as it has demonstrated its ability to execute, and deliver strong performance.

"Accelerated investments in uplifting the franchise will sustain growth, and expand more streams of revenue and activities, with the eventual goal of becoming a universal bank. The objective should be to maintain a strong credit filter, and granular growth in assets and liabilities along with sustaining stable spreads, all of which should bode well for sustainable future earnings growth," they said. The brokerage has a 'BUY' rating on the stock with a target price of Rs 800.