INITIATING COVERAGE 29 SEP 2017

AU Small Finance Bank

NEUTRAL
INDUSTRY Banks Expensive, but beautiful
CMP (as on 29 Sep 2017) Rs 567 AU Small Finance Bank (AU) was an NBFC till Mar-17. Key investment arguments
Its loan portfolio of Rs 108bn (Jun-17) is well- Diversified book: AUs loan book is diversified, with VF
Target Price Rs 530 diversified across Vehicle Finance (VF), MSME and contribution at 49%, and the balance coming in from
Nifty 9,789 SME loans. AUs lending is focussed on underserved MSME and SME segments. We expect AUM to grow at
Sensex 31,284 segments in urban, semi-urban and rural India, and 31% CAGR over FY17-20E, supported by new product
launches like Business Banking, Agri Allied, etc. Home
KEY STOCK DATA offers investors multi-year growth opportunities.
loans (AU sold its HF sub in FY17) will be re-started by
Bloomberg AUBANK IN While headline valuations appear stiff (5.6x FY20E 1QFY19.
No. of Shares (mn) 284 ABV), underlying business opportunities and Huge growth potential: AUs presence is largely in the
management strengths are strong. underbanked segments, with a small ticket size in VF,
MCap (Rs bn) / ($ mn) 161/2,471
MSME and SME. These underpenetrated segments,
6m avg traded value (Rs mn) - Initiate coverage with NEUTRAL and a TP of Rs 530
coupled with lower financial penetration in its main
STOCK PERFORMANCE (%) (5.2x FY20E ABV, 31x FY20E EPS). Faster growth and markets like Rajasthan, Gujarat etc., provide growth
52 Week high / low Rs 726 / 496 fund raising at high valuations are typically book opportunities, along with attractive higher yields.
3M 6M 12M
value accretive and rewarding for shareholders, as Liability franchise benefit is expected to be gradual, as
seen in lenders like Bajaj Finance, IndusInd Bank, AU has adopted a strategy of converting some asset
Absolute (%) - - -
Kotak, etc. However, with AU adequately capitalised branches into bank branches, and continuing with
Relative (%) - - - some asset centres. It is also opening pure liability
for the next two to three years (Tier 1 ~18.9%), this
SHAREHOLDING PATTERN (%) upside may not materialise immediately. branches in key locations in metros and urban areas to
Promoters 32.8 attract CASA and Retail deposits. We expect Retail
Despite AUs scorching 33% AUM CAGR during FY12- deposits (including CASA) to inch up to 20% in the
FIs & Local MFs 23.5
17, we believe it will deliver 31% CAGR over FY17- liabilities mix by FY20E.
FPIs 37.6
20E, given large underpenetrated credit segments Financial Summary
Public & Others 6.1
that it has mastered. Asset quality is underscored by Rs. Mn FY17 FY18E FY19E FY20E
Source : Company
a conservative lending approach and robust AUM 107,339 140,432 183,869 242,930
processes, along with collateral backing. AUM Growth (%) 30.6 30.8 30.9 32.1
NII 9,342 11,695 14,895 19,208
Meanwhile, AU has incurred capex of Rs 3.3bn on PPOP 5,813 5,588 7,253 9,851
technology and branch roll out for SFB conversion. In Adj. PAT 3,259 2,762 3,601 4,891
the near-term, C/I will rise by 19pp to 57.6% in ROAE (%) 21.72 13.00 14.93 17.46
ROAA (%) 3.1 1.6 1.6 1.7
Vishal Rampuria FY18E, and gradually taper off. ROA will drop 140bps P/Adj. BV (x) 8.3 7.6 6.5 5.6
vishal.rampuria@hdfcsec.com to 1.7% by FY20E, owing to CRR/SLR requirements P/E (x) 49.5 58.4 44.8 33.0
+91-22-6171-7325 and higher opex. Source: Company, HDFC sec Inst Research
HDFC securities Institutional Research is also available on Bloomberg HSLB <GO> & Thomson Reuters
 AU SMALL FINANCE BANK : INITIATING COVERAGE

AU started operations in
Diversified, secure retail lender
Rajasthan and expanded to
other adjoining states over a
period of time
VF loans comprise around
half of the total loan book
AU is a retail-focussed company with a diversified
product portfolio, currently operating in three
business lines i.e. Vehicle Finance (VF), MSME and
SME loans. As of 1QFY18, it has an AUM of Rs
107.6bn.
Founded in 1996 and headquartered in Jaipur, AUs
presence is largely in Rajasthan, Gujarat,
Maharashtra and Madhya Pradesh.
AU targets customers in urban, semi-urban and
rural India who are not catered to by formal banking
channels for various reasons like income
assessment challenges, low ticket size etc.
As on 1QFY18, Retail assets constitute 89% (VF-49%,
secured MSME- 31% and SME-9%), whereas
Wholesale assets (NBFC loans- 6% and Real Estate -
5%) comprise 11% of the total loan book.
AUs loan book has grown at a robust 33% CAGR
over FY12-17 to Rs 107.3bn, and disbursements at a
26% CAGR during the same period.
With its initial focus only on Vehicle Finance (VF),
AU later widened its base to include Housing
Finance, MSME and SME. It also forayed into the
Housing Loans category in FY11 through its
subsidiary AU Housing, which it divested in FY17,
resulting in a one-time profit of Rs 5.2bn.
Most segments offer high yields owing to small
ticket size and high operating costs.
It has built in strong processes and underwriting
capabilities over the years, which have resulted in
GNPA of 1.6% in FY17.
Currently, over 54% of the business is concentrated
in the home state of Rajasthan.

Vehicle Finance: In the Vehicle Finance (VF) business, AU extends loans to new, pre-owned vehicles (and also for
refinancing) across multi-utility vehicles, cars, small, light, medium and heavy commercial vehicles, tractors, three-
Entire retail book has
wheelers, two-wheelers and construction equipment. These loans are secured by the vehicles financed.
collateral backing
MSME: These loans are given to existing underserved customers primarily for business expansion, working capital and
equipment purchase. They are secured by immoveable property.
SME: AU extends loans to several types of small and medium-sized (SME) businesses, secured by immoveable
property and receivables.

Page | 2
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Loan Book Growth (%) Disbursement Growth (%)

AUM (Bn) Growth (%) - RHS Disbursement (Bn) Growth (%) (RHS)
270.0 48 52.5 160.0 66 72.5
45
47.5 140.0 62.5
220.0 42.5
120.0
32 37.5 52.5
31 31 100.0
170.0 32.5 42.5
AUM has grown at a CAGR 20
25
27.5 80.0 32
31 30
of 33% over the past 5 years 120.0 22.5 26
20 26 32.5
60.0
17.5 17 22.5
40.0 10
70.0 12.5

44.5

107.3

140.4

183.9

242.9
37.0

111.2

145.2
20.0 12.5

25.5

82.2

26.9

33.8

56.2

67.3

88.6
7.5

FY15 55.7

FY13 24.4
FY12 20.8
20.0 2.5 0.0 2.5
FY12

FY13

FY14

FY16

FY17

FY18E

FY19E

FY20E

FY14

FY15

FY16

FY17

FY18E

FY19E

FY20E
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

State-Wise AUM: West Dominates Strong Presence In The Semi-Urban/Rural Markets

Top four States contribute FY13 FY14 FY15 FY16 FY17 Metro
13%
90% to AUM Rajasthan 50% 54% 59% 58% 54%
Maharashtra 15% 15% 13% 13% 13% Rural
29%
Gujarat 27% 20% 14% 12% 12%
Madhya Pradesh 3% 5% 6% 8% 11%
Delhi 0% 2% 3% 5% 5%
Urban
Punjab 3% 3% 3% 3% 3%
25%
Chhattisgarh 1% 1% 1% 1% 1%
Haryana 0% 0% 0% 0% 1%
Himachal Pradesh 0% 0% 0% 0% 0%
Goa 1% 0% 0% 0% 0% Semi-Urban
Source: Company, HDFC sec Inst Research 32%

Source: Company, HDFC sec Inst Research

Page | 3
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Product Overview
Year of AUM as of
Ticket Size (Rs.mn) Tenure Yields
Commencement FY17 (%)
Most products enjoy high
Vehicle Finance 1996 50% 0.34 3-4 years ~20%
yield
SME 2012 20% 21.92 3-4years ~15%
MSME 2007 30% 1.08 4-5years ~19%
Source: Company, HDFC sec Inst Research

Granular Details Of The Loan Book

Rs. Bn FY12 FY13 FY14 FY15 FY16 FY17
VF 20.69 29.31 31.15 31.46 41.74 53.96
MUV 5.81 9.00 10.08 10.69 14.14 17.79
Cars 3.21 5.33 6.02 6.37 9.98 15.27
SCV 3.28 5.41 6.87 7.60 9.69 11.78
LCV 1.86 2.05 1.88 1.52 1.83 2.55
M&HCV 4.59 4.32 2.66 1.55 1.26 1.43
AU also provides wholesale
Tractors 0.43 0.62 0.71 0.82 1.36 1.75
loans to small NBFCs and
3W 1.22 1.84 2.20 2.06 2.09 2.06
real estate developers
2W - - - - 0.02 0.13
CE 0.20 0.27 0.22 0.17 0.31 0.58
Others 0.09 0.47 0.51 0.68 1.09 0.62
SME 2.29 2.12 4.23 10.46 18.29 21.22
SME BL - - 0.63 3.26 7.30 9.47
Construction Finance - 0.06 1.79 4.92 6.61 6.20
NBFC Finance 2.29 1.97 1.50 2.20 4.27 5.52
Others - 0.09 0.32 0.09 0.11 0.03
MSME 2.65 5.61 9.10 13.76 22.18 32.16
Total AUM 25.63 37.05 44.49 55.68 82.21 107.34
Source: Company, HDFC sec Inst Research

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 AU SMALL FINANCE BANK : INITIATING COVERAGE

Performance Snapshot
Loan Book Growth MSME And SME Portfolio Showing Strong Growth
Rs bn Rs bn VF MSME SME
120.0
107.3 60
Loan book has grown at a 54
CAGR of 33% over the last 5 100.0 50
yrs 82.2
80.0 40
32
60.0 55.7
30
44.5 22 21
37.0 18
40.0 20
25.6 14
9 10
20.0 10 6 4
3 2 2
- -
FY12

FY13

FY14

FY15

FY16

FY17

FY12

FY13

FY14

FY15

FY16

FY17
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research
Owing to a low base, MSME
and SME book have shown a Asset Mix Trend NIMs Have Improved
staggering CAGR of 65% and VF MSME SME %
56% respectively over the 100% 6%
10.0 9.4
9% 10%
last 5 years 90%
10% 15%
19% 22% 20%
9.0
80% 20% 8.8
70% 25% 8.0 8.1
27% 30%
60% 7.3
50% 7.0
40% 81% 79%
70% 6.0 6.5 6.4
30% 57% 51% 50%
20%
5.0
10%
0% 4.0
FY12

FY13

FY14

FY15

FY16

FY17

FY12

FY13

FY14

FY15

FY16

FY17
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

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 AU SMALL FINANCE BANK : INITIATING COVERAGE

Number Of Branches NPAs Trend

350 GNPA (%) NNPA (%)
291 301 1.80
300 1.64
1.60
Branch network more than
250 231 1.40 1.23
doubled during FY12-17 220
1.20
200 177 0.92 1.06
1.00
146
150 0.64
0.80
0.53
0.60 0.41
100
0.40 0.62
0.38
50 0.27 0.44
0.20
0.21
0 -

FY12

FY13

FY14

FY15

FY16

FY17
FY12

FY13

FY14

FY15

FY16

FY17
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

ROA ROE
% %
4.0 30.0 28.0
3.6
3.5
3.1 25.0
21.7
3.0 2.8 20.4
19.6
20.0
2.5 2.2 16.9
ROE dropped in FY17 mainly 2.0
1.8 15.0
14.0
2.0
owing to an increase in net
1.5
worth from the stake sale in 10.0
the housing subsidiary 1.0
5.0
0.5
- 0.0

FY12

FY13

FY14

FY15

FY16

FY17
FY12

FY13

FY14

FY15

FY16

FY17

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Page | 6
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Underserved segments key to growth

AU is focussed on underserved segments, a majority of resulted in a significant latent demand for credit in the
which depend on local money lenders and other informal MSME sector.
Underserved segments are
sources of credit. Potential demand and a greater number
huge in India. of formal channels are expected to drive growth. Financial Penetration In Key states Of Rajasthan,
Gujarat, Maharashtra and MP
Vehicle finance: NBFCs have increased their market
State Deposit Share (%) Credit Share (%)
share from an estimated 40% in FY 2011-12 to 47% in
FY 2016-17. The rise is partially owing to NBFCs Rajasthan 2.9 2.7
developing stronger risk management capabilities and Gujarat 5.7 5.2
a better understanding of their customers, and Maharashtra 20.1 29.0
consequently being able to serve those that banks do Madhya Pradesh 2.9 2.3
not have the risk appetite to cater to. Karnataka 7.3 6.6
Tamil Nadu 6.2 9.0
MSME: Micro, Small and Medium Enterprises (MSMEs)
Delhi 10.3 12.3
are a key section of the Indian economy. They account
Kerala 3.8 3.1
for an estimated 45% of Indias manufacturing output
and 40% of total exports for FY17. MSME credit grew at Andhra Pradesh 2.3 3.2
a CAGR of 11% between FY12 to FY16. The key growth UP 8.3 4.4
driver is the recovery of the economy, which has Punjab 3.1 2.6
Contribution from key states Source: RBI, HDFC sec Inst Research
to the overall banking
systems credit and deposit
is low,and offers huge
opportunity

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 AU SMALL FINANCE BANK : INITIATING COVERAGE

Growth rates to sustain, given presence in the underpenetrated segments

We estimate 31% CAGR AUM growth over FY17-FY20E.
A continued focus on underpenetrated segments and
launch of new products (Business Banking, Agri Allied,
We expect growth to be 31% Gold products etc) support our thesis of strong growth.
over the next 3 years
We believe the company has multiple levers for strong
and sustainable growth, namely, (1) Strong presence in
underpenetrated and financially underserved
segments, (2) Relatively low ticket size in the Vehicle
Finance segment as compared to peers, and (3) Foray
into relatively higher ticket size segments (Business
Banking, etc).
The share of current products is expected to be 87% by
FY20.

Loan Book To Grow At A CAGR Of 31% Loan Book Mix Will Evolve
AUM (Bn) Growth (%) - RHS VF MSME SME New
270.0 38 100%
32
Business banking like 31 31 31
33
90% 20% 17%
80% 16%
Overdraft, Business Loans, 220.0 15%
28 70%
Agri Loans, Gold Loans etc 30% 30%
60% 30%

242.9
170.0
have been launched, which 23 31%
50%
will also drive growth

183.9
120.0 18 40%
30%
140.4

13
50%
107.3

70.0 48% 45%

20% 41%
8
10%
20.0 3 0%
FY17

FY18E

FY19E

FY20E

FY17

FY18E

FY19E

FY20E
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Page | 8

AU is the only NBFC to
receive SFB license from RBI
SFB category is primarily
aimed at financial inclusion
AU SMALL FINANCE BANK : INITIATING COVERAGE
Conversion into Small Finance Bank: The implications
AU was one of the 10 applicants granted approval to Key regulatory and operational landscape
convert into a Small Finance Bank (SFB). This offered
the company opportunities for growth, with access
SLR/CRR norms applicable to commercial banks will
also be applicable to SFBs.
to CASA and retail deposits, along with the flexibility
to offer diversified products over the long term. SFBs have to preserve at least 75% of their loan book
for the priority sector (PSL), as against 40% for
List Of New Banks
universal banks. Within this, sub-targets have to be
NBFC Turned Banks Launch
met for: Agriculture (18%), Micro enterprises (7.5%)
Bandhan Aug-15
and weaker sections (10%), as defined for universal
IDFC (Infra Finance) Oct-15
Disha Apr-16 banks. Currently, AU meets the overall 75% PSL
Capital Local Apr-16 requirement, and the launch of Agri and Gold loans is
Equitas Sep-16 expected to help it meet its sub-segment targets too.
Suryoday Jan-17 Inter-bank borrowing is capped at 3x of net worth.
Utkarsh Jan-17 However, the current loan before conversion will be
Ujjivan Feb-17
grandfathered.
Au Financiers Apr-17
Janalakshmi Expected in 2017 At least 50% of the advances have to be lower than Rs
RGVN Expected in 2017 2.5mn.
ESAF Microfinance Expected in 2017
Source: Companies, HDFC sec Inst Research The total CAR for SFBs stands at 15%, with Tier I at
In Apr-17, AU commenced banking operations. The SFB 7.5% and Tier II at 7.5%. As compared to this, the CAR
category has been designed to improve the prospects requirement for universal banks is 11.5%, with Tier I at
of financial inclusion with higher priority sector targets. 10%.
Page | 9

AU needs to carefully craft a
strategy for garnering CASA
and retail deposits, given
high competition
PSL requirement will be
effective from FY19 and as
such it can generate higher
fee income in FY18 by selling
PSL certificates.
AU SMALL FINANCE BANK : INITIATING COVERAGE
Key Changes On Conversion To SFB AUs strategy for SFB
NBFC SFB AU has received RBI approval to open 431 SFB
Operation branches during FY18. They have opened 284 bank
branches, 119 asset centres and 251 ATMs spread
25% of the branches to
Branches No condition across 11 states and a Union Territory, as on 30-June-
be in URC
2017. AU will open new branches in under-banked
Asset areas to meet regulatory requirements. With the
Applicable. Negative Business Correspondent model allowed for the
Not carry on SLR of 350bps unbanked branches, it may opt for this route.
CRR & SLR
applicable and SLR 950bps at
current rates
AU has adopted the strategy of rolling out both bank as
No well separate asset and liability branches. Of 284
PSL requirement 75% PSL requirement. branches, 119 are separate asset and liability branches,
requirement
Not allowed to be a BC while the remaining are common bank branches. This
of a bank. However, has been crafted based on its assessment of existing
Can act as BC branches and potential to generate liability franchise.
BC model can capitalize on its PSL
for banks Further, these liability- focussed branches would also
strength through PSLC
and IBFS help generate leads for assets.
Liability Banking products: It plans to offer a wide range of
business banking products like Cash Credit, Overdrafts,
Bank Borrowing No cap 3x of the Networth
and also new loan products like Gold loans, Agri Allied
Scheduled bank status loans, and 2W loans etc.
Bulk Deposits Difficult will help faster
mobilization It plans to re-enter the housing segment in Tier 2 and 3
PSL benefit cities, and will benefit from the under-penetrated
available for affordable housing market.
Indirect PSL benefit Not available
on-lending Introduced an alternate distribution channel called
programme. Dost Banaye Dost, a referral programme.
Source: Company, HDFC sec Inst Research
Page | 10
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Current Product Portfolio As SFB

Asset Products Liability Products Other Products And Services
More products to be rolled Retail Assets : VF, MSME, SME, Gold Loans
CA Third party Insurance,MF
out over a period of time and Agri loans
Wholesale Assets : NBFC, Real estate groups
SA ATM and Debit cards
and Business Banking
Housing Loans (Will re-start by 1QFY19) TD and RD Lockers
Net banking, TAB Banking and Mobile
Banking
Source: Company, HDFC sec Inst Research

Retail Assets Dominated By Vehicle Finance Wholesale Assets

SME Business
10.1 Banking
0.2

Real Estate NBFC

MSME VF
group 51.6
34.3 55.5
48.2

Source: HDFC sec Inst Research Source: HDFC sec Inst Research
As on 30th June , 2017 As on 30th June , 2017

Page | 11
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Comparison With Small Finance Banks

Loan Book Comparison With Other SFBs (FY17) AUs AUM Is More Diversified Than Other SFBs
AU is superior to other SFBs Rs bn AUM Mix (%) Ujjivan Equitas AU
in most parameters 120.0 Micro Finance 97.5 46.0
107.3
VF 27.0 50.0
100.0 LAP 22.0
80.0
71.8 HF 1.5 3.7
63.8 Business Loan 1.0
60.0 Agri 0.4
MSME 30.0
40.0
SME 1.0 20.0
20.0 Source: Company, HDFC sec Inst Research

0.0
Ujjivan Equitas AU

Source: Company, HDFC sec Inst Research

GNPA Comparison (FY17)

%
4.0 3.7
3.5
3.5
3.0
2.5
Gross NPA is lower
compared to other SFB 2.0 1.6
1.5
1.0
0.5
0.0
Ujjivan SFB Equitas SFB AU SFB

Source: Company, HDFC sec Inst Research

Page | 12
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Success of Bandhan Bank in deposit
mobilisation
Bandhan Bank Ltd commenced operations in Aug- 15,
Bandhan has been very with the setting up of 501 branches across India. As of
successful in replacing bank Dec-16, Bandhans deposits stood at Rs 200bn, with
loans with deposits CASA comprising 26% of the total deposit. Deposit was
90% of total interest bearing instruments.
The bank operates through a network of 3,015
branches.
The success of deposit mobilisation can be attributed
to low financial penetration of banking products in
Eastern India
o Liability -focussed branches in business areas.
o Lucrative rates for bulk deposits; many co-
operative banks have reportedly parked funds.

Penetration Of Bank Branches Has Improved In The Last 5 Years

Number of Branches Estimated population* (in mn) Branches per 100000
Rural Rural
Rural
+ Urban + + Urban + Urban +
Total Total + Total
Semi- Metropolitan Semi- Metropolitan Metropolitan
Semi-urban
urban urban
2010 53,086 31,072 85,158 980 211 1,191 5.4 15.2 14.0
2015 82,358 43,716 1,26,074 1,061 233 1,294 7.8 18.7 9.7
Pan-India branch rollout by Source: RBI, HDFC sec Inst Research
the Industry has been
Trend In Deposit Accounts Across Different Segments
aggressive in the last 5 years Number of Individual Individual Saving Bank Deposits
Saving Bank Deposits Accounts Amount Outstanding Avg Balance
(mn) (Rs. Bn)
2006 2010 2015 2006 2010 2015 2006 2010 2015
Rural 104 167 384 962 1,703 3,601 9,250 10,198 9,378
Semi-Urban 85 136 320 1,124 2,155 4,470 13,224 15,846 13,969
Urban 68 97 186 1,246 2,381 4,541 18,324 24,546 24,414
Metro 71 100 180 1,838 3,731 6,476 25,887 37,310 35,978
Source: RBI, HDFC sec Inst Research

Metro And Urban Areas Have A Very Large Contribution To Overall Deposits
Category Deposit Amount (Rs bn) Share of Total Deposit
Rural 9,157 10%
Semi-Urban 13,173 15%
Urban 19,649 22%
Metro 47,243 53%
Total 89,221 100%
Source: RBI, HDFC sec Inst Research

Page | 13
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Cost pressure on conversion; to be paid off in the medium term

While the conversion to SFB offers the opportunity Cost/Income Ratio To Peak In FY18E
to build a diversified, stable and low-cost liability Cost to Income Ratio - LHS Employee exp % AUM
profile, efforts towards building the franchise will Other exp % AUM
inflate cost ratios. 70.0 3.5
Cost-to-Income ratio to peak The Cost-Income (C/I) ratio is expected to rise to 60.0 3.0
in 3QFY18/4QFY18 ~57.6% in FY18E, as against 38.7% in FY17. In our 50.0 2.5
estimates, we have factored in the launch of 434
40.0 2.0
bank branches. As per approval from RBI, AU will be
allowed to run unconverted branches as asset- 30.0 1.5
focussed branches. During 1QFY18, it has started 20.0 1.0
284 branches. Of these, 119 are separate asset and 10.0 0.5
liability branches, while the balance are common 0.0 0.0
bank branches. An additional 100+ branches would

FY12

FY13

FY14

FY15

FY16

FY17

FY18E

FY19E

FY20E
be launched by FY18 in the under-banked areas. We
expect an average opex cost of Rs 5 to 6mn per
Source: Company, HDFC sec Inst Research
branch.
Further, it has incurred capital expenditure of ~Rs
3.3bn, and is expected to incur Rs 400-500mn in
FY18 towards IT and other Infrastructure costs.

Page | 14
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Liability franchise to deliver, but only in the long term

We believe conversion to an SFB strengthens the
business model, allowing access to a lower cost and
diversified liability mix to an already robust lending
franchise.
We underscore a noticeable improvement in AUs
Share of bank borrowings borrowing mix, with a decrease in the share of high
has been sharply cut
cost bank borrowings to 13% in 1QFY18 from 18% in
through issuance of Q4FY17. The share of debentures has fallen to 46%, as
debentures against 50% over the same period. The period
witnessed the conversion of AU into a bank.
Post conversion to a SFB in 1QFY18, AU enjoys lower
funding cost. Bulk term deposits are now 10% of the
borrowing mix, and with expected Scheduled Bank
Status over the next 2-3 months, the share of bulk
term deposits is likely to increase sharply, with
insurance companies, corporates and institutions
subscribing to them.
AU plans to open ~434 branches by FY18, ~284 of
which are already operational. With the current pricing
of term deposits at a premium (~20/30 bps) to the
incumbents, expect retail deposits, including CASA, to
be 20% of the total liabilities by FY20.
Savings accounts are also priced (6% for <Rs 0.1mn) at
a premium to peers. However, we believe the build-up
in CASA will be gradual, with SA estimated to
contribute 11% to total liabilities by FY20. As it plans to
disburse all loans through its own account, this would
also contribute to SA balances, with some float
available on these disbursements.
Over the last six to seven months, wholesale and
deposit rates have fallen sharply by 100-200bps. This
will provide a further boost to the spreads.

Liability Mix: High-cost Bank Borrowings To Decline Lower Blended Costs Of Borrowings To Fall
% 4QFY17 1QFY18
RTD+CASA % of Borrowing (%)
NCD 50 46
Refinance from FIs 21 16 Avg cost of borrowing (%)- RHS
CP 7 11 25.0 18.0
Drop in wholesale and Bank/NBFC 18 13 16.0
20.0
deposit rates would further Tier II Capital 5 4 14.0
boost spreads 12.0
Deposits - 10 15.0
10.0
Premium Deposit Pricing: To Provide Traction 10.0
8.0
FD Rate AU Equitas Bandhan 6.0
1 to 2 yr 8.00% 7.25% 7.50% 5.0 4.0
2-3 yr 7.50% 7.25% 7.00% 2.0
4-5 yr 7.00% 7.00% 7.00% 0.0 0.0

FY12

FY13

FY14

FY15

FY16

FY17

FY18E

FY19E

FY20E
Source: Company, HDFC sec Inst Research

Source: Company, HDFC sec Inst Research

Page | 15
 AU SMALL FINANCE BANK : INITIATING COVERAGE

SFB conversion: NIM to fall on regulatory requirement

Yields on Earning Assets and spreads would witness We expect Off-book asset mix to drop to 30% from the
optical pressure. Apart from regulatory costs of current 38% as AU starts getting lower cost of
CRR/SLR, some PSL shortfall in the Agriculture segment borrowing. NIM is expected to fall to 6.7% in FY20 from
would be weighed in. 8.8% in FY17.

Though NIM is dropping, it

will be superior to other NIM To Drop Owing To CRR/SLR Requirement AUM Mix: On Book And Off Book
Banks NIM (%) On-Book Off-Book
10.00 100
9.4 90
8.8 30 30
8.00 8.1 80 37 38 40 35
50 43
6.9 70
6.4 6.7 67
6.00 60
6.5
50
4.00 40
70 65 70
30 57 63 62 60
50
2.00 20
33
10
0.00 0

FY12

FY13

FY14

FY15

FY16

FY17

FY18E

FY19E

FY20E
FY14

FY15

FY16

FY17

FY18

FY19

FY20
E

E
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Page | 16
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Asset quality: To remain stable

Despite lending to low and middle income groups, Credit Cost To Remain At Current Level
AU enjoys strong asset quality. This is driven by Credit cost (%) GNPA (%) NNPA (%)
strong underwriting processes, supported by its 1.8
Recognition norm will move collection team. In the VF and MSME businesses, AU 1.6
from 120 days to 90 days as is focussed on disbursing loans primarily to business 1.4
a bank. assets, resulting in lower risk. 1.2
In FY17, owing to seasoning and demonetisaton, 1.0
GNPA increased to 1.6% as compared to 0.6% in 0.8
FY16. Credit cost for the company was 0.8% in FY17. 0.6
0.4
As an SFB, the companys NPA recognition norm
0.2
changed from 120 to 90 days, which will lead to an
0.0
increase in reported NPAs. We project GNPA to

FY12

FY13

FY14

FY15

FY16

FY17

FY18E

FY19E

FY20E
hover at 1.6% in FY18, and remain in this range as
the company would move to more secured lending.
Source: Company, HDFC sec Inst Research
Credit costs are expected to hover at 1.1-1.2% #Recognition norms will move to 90days in FY18 from 120days
range.

Page | 17

Key risk factors
Transition entails execution risks: From an NBFC, AU
has now become a bank with a focus on both assets
and liabilities. As a bank, it is planning to roll out 431
Bank to garner CASA and branches by FY18 (284 operational as on 1QFY18). This
Retail deposits, and also has led to a huge increase in operating costs related to
provide fee income from IT, HR, risk management, compliance etc. Inability to
selling third party products scale up the business as a bank would entail an
elevated level of the C/I ratio and low profitability.
CASA and retail fixed deposits: Lower-than-expected
mobilisation of these may result in a higher cost of
funds than our expectations. We have assumed the
AU SMALL FINANCE BANK : INITIATING COVERAGE
share of CASA, including retail deposits to total liability
to improve to 20% by FY20.
Performance of other products: The bank has
launched new products like Agri. Allied, Two-wheelers,
Business banking products, among others, and plans to
launch more. Scaling up of new products remains a key
monitorable.
Geographic concentration: As of FY17, 54% of the loan
book stems from Rajasthan, and ~90% from only four
states- Rajasthan, Maharashtra, Gujarat, and Madhya
Pradesh, which poses the risk of concentration.
Page | 18
 AU SMALL FINANCE BANK : INITIATING COVERAGE

NII Growth Driven By AUM Growth Adj. PAT Trend

25.0 Rs bn
6.0
PSL requirement applies Rs. Bn
19.2 4.89
from FY19 and as such it can 20.0 5.0
generate higher fee income 14.9
15.0 4.0 3.60
in FY18 from selling PSL 11.7 3.26
certificates. 9.3 3.0 2.47
2.76
10.0
6.7
2.0 1.39
4.2
5.0
1.0 0.69 0.73
0.37
0.0 -

FY15

FY16

FY17

FY18E

FY19E

FY20E

FY12

FY13

FY14

FY15

FY16

FY17

FY18E

FY19E

FY20E
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

ROA And ROE To Drop Strongly Capitalised For Growth

ROAA (%) ROAE (%)
24.0 23.0
35.0
CAR (%)
28.0 22.0
30.0
21.7 20.0 20.5
25.0
18.0 17.3
20.0 14.9 17.5 17.7
13.0 16.9
15.0 16.0 15.7
ROAA to drop during 10.0 14.0
transition 5.0
3.6 3.1 12.0
1.6 1.6
1.7
0.0 10.0
FY16

FY17

FY18E

FY19E

FY20E

FY18E

FY19E

FY20E
FY15

FY16

FY17
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Page | 19
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Valuation
AU concentrates on the underserved market, with a shareholders, as seen in lenders like Bajaj Finance,
The IPO was only secondary
diversified lending book. It is far better placed than Indusind Bank, Kotak, etc).
fund raising
other SFBs, which are dominated by an unsecured
However, with AU adequately capitalised, it may not
lending book. We believe the company is a
need equity fund raising for the next two to three
structural growth story and provides good long-
years. The stock is quoting at 5.6x FY20 P/ABV and
term investment opportunities.
initiate with NEUTRAL view and a TP of Rs 530 at
Faster growth and fund raising at high valuations 5.2x FY20 ABV.
are highly book value accretive (and rewarding for

Key Parameter AU IndusInd Bajaj Finance Kotak Equitas Ujjivan

AUM FY17-19E CAGR (%) 31 26.5 33 19 20 23
Avg. ROE (%) (FY17-20E) 13.4 16.2 18.7 13.3 4.1 6.1
M. Cap (Bn) 158 999 1060 1010 52 38
FY19 P/B Multiple 6.5 3.78 5.68 3.98 2.28 1.95

Peer Valuations
Mcap CMP TP ABV (Rs) P/E (x) P/ABV (x) ROAE (%) ROAA (%)
Banks Rating
(Rs bn) (Rs) (Rs) FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E
AU 161 567 NEU 530 68 75 87 49.5 58.4 44.8 8.35 7.59 6.52 21.7 13.0 14.9 3.05 1.62 1.57
AXSB 1,221 510 NEU 510 197 220 255 33.2 21.2 13.2 2.59 2.32 2.00 6.8 9.9 14.4 0.65 0.89 1.23
BOB 319 138 BUY 220 88 102 144 23.1 16.8 10.9 1.56 1.36 0.96 3.8 5.1 7.4 0.20 0.27 0.39
CUB 108 164 BUY 197 53 56 66 19.6 18.4 15.9 3.12 2.92 2.50 15.2 15.3 15.3 1.51 1.56 1.56
DCBB 56 181 BUY 222 64 79 89 25.9 21.3 16.8 2.83 2.29 2.04 10.8 10.9 11.1 0.93 0.97 1.02
Equitas 51 152 NEU 150 63 64 67 32.2 94.2 38.2 2.42 2.37 2.28 8.9 2.4 5.7 2.00 0.54 1.11
FB 219 113 BUY 128 46 59 65 23.4 20.9 16.3 2.43 1.93 1.75 9.8 9.9 10.4 0.81 0.83 0.90
ICICIBC # 1,775 277 BUY 338 111 111 132 12.4 13.7 10.8 1.88 1.87 1.49 10.0 10.5 11.6 1.31 1.20 1.29
IIB 997 1,676 BUY 1,663 331 382 443 35.0 28.3 23.2 5.06 4.39 3.78 15.3 16.3 17.2 1.78 1.79 1.78
KMB # 1,834 1,001 BUY 1,109 136 181 205 46.1 36.3 30.0 6.29 4.62 3.98 13.2 13.9 13.3 1.68 1.89 1.89
SBIN # 2,193 254 BUY 348 109 117 157 13.1 12.8 9.4 1.58 1.47 1.13 6.8 5.8 7.0 0.42 0.37 0.44
Ujjivan 38 320 BUY 354 147 147 164 14.1 195.0 18.5 2.18 2.18 1.95 18.3 1.1 11.1 2.92 0.22 1.95
Source: Companies, HDFC sec Inst Research, # Adjusted for embedded value of subs

Page | 20
 AU SMALL FINANCE BANK : INITIATING COVERAGE

HDFC Bank Bajaj Finance

Stock prices (Indexed) 1-Yr Fwd P/B - RHS Stock prices (Indexed) 1-Yr Fwd P/B - RHS
300 5.0 1,600 CAGR 69% 7.0
CAGR 21%
1,400 6.0
250 4.0
1,200 5.0
Accretion in BV
200
3.0 1,000 by ~40% due to
Fund Raise 4.0
150 800
Bajaj Finance delivered 2.0 3.0
600
stupendous return 100 Accretion in BV by
2.0
~18% due to Fund 400
supported by fund raising 1.0
50 Raise Accretion in BV by 1.0
and ability to quickly deploy 200
~47% due to Fund Raise
that capital for growth at a 0 0.0 0 0.0

FY12

FY13

FY14

FY15

FY16

FY17

FY12

FY13

FY14

FY15

FY16

FY17
superior rate of return

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

IndusInd Bank Kotak Mahindra Bank

Stock prices (Indexed) 1-Yr Fwd P/B - RHS Stock prices (Indexed) 1-Yr Fwd P/B - RHS
450 Accretion in BV by
CAGR 69%
5.0 350 Accretion in BV by CAGR 25%
7.0
~53% due to Fund
400 300 ~28% due to Fund
6.0
Raise
4.0 Raise
350
250 5.0
300
3.0 200 4.0
250
200 150 3.0
2.0
150 Accretion in BV by 100 Kotak-ING Vysya Bank 2.0
100 ~57% due to Fund Raise 1.0 Merger
50 50 1.0
0 0.0 0 0.0
FY12

FY13

FY14

FY15

FY16

FY17

FY12

FY13

FY14

FY15

FY16

FY17
Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Page | 21
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Recent Performance
Rs Mn 4QFY17 FY17 1QFY18
NII fell owing to the impact Loan Book 107,339 107,339 107,590
of SLR/CRR, as it converted Interest Income 3,445 12,868 3,610
to an SFB in 1QFY18 Interest Expense 1,181 4,838 1,775
NII 2,264 8,030 1,835
Other Income 361 1,006 579
Total Income 2,625 9,036 2,413
Total Opex 1,178 3,664 1,169
Employee Cost 709 1,928 711
Cost-to-Income has Other opex 470 1,737 458
increased sharply, and will Cost to Income (In %) 45 41 48
increase further as more PPP 1,446 5,381 1,245
liability branches are rolled Credit Cost 264 652 291
out Gross NPA (90 days) 1.8% 1.3% 2.3%
PBT 1,183 4,730 954
PAT 779 3,259 618
ROA 3.18% 3.40% 2.25%
Source: Company, HDFC sec Inst Research
Credit cost and GNPAs have
been higher owing to a shift
in the recognition norms
from 120 days to 90 days

Page | 22

Corporate overview
Headquarted
The company got listed
recently in July 2017. The IPO
was only secondary offering
by existing shareholders
in Jaipur, AU Small Finance Bank was
incorporated in 1996. It lends largely to the
underserved segments catering to urban, semi-urban
and rural sections, with individuals in the low and
middle-income categories. Its products are Vehicle
(50%), MSME (30%) and SME (20%) loans among
others, with a total AUM of Rs 107bn as of FY17.
The company recieved the Small Finance Bank (SFB)
license from RBI on 20- Dec-16 to commence banking
operations, which it did in April-17 as a Small Finance
Bank.
As on 1QFY18, it currently has 284 bank branches and
119 asset centres.
The company operates in high-yield segments.
In FY17, the company sold its investments in its
subsidiary companies like AU Housing Finance Ltd,
Index Money Ltd and associate companies like M
Power Micro Finance Pvt. Ltd and AU Insurance
Broking Services Pvt. Ltd. The net profit (net of tax) on
sale of these investments was Rs.5.17bn.
The company was initially incorporated in the name of
L.N. Finco Gems Pvt Ltd by Sanjay Agarwal, the
Promoter and the Managing Director of the company.
He has over 21 years of experience in finance,
accounting, strategic planning and credit risk
management.
AU SMALL FINANCE BANK : INITIATING COVERAGE
Business presence is dominated in the home state of
Rajasthan, contributing 54% to the overall loan book in
FY17.
On the liabilities side, the borrowing mix is dominated
by NCDs and Term loans, contributing 50% and 33% to
the total borrowings respectively.
Adjusted ROA and ROE for FY17 was 3.1% and 21.7%
respectively.
Experienced and credible top management
Sanjay Agarwal (Promoter and Managing Director):
He holds a Bachelors degree in commerce from the
Government College, Ajmer. He is a qualified Chartered
Accountant with over 21 years of experience in
finance, accounting, strategic planning and credit risk
management.
Uttam Tibrewal (Whole-time Director): He holds a
Bachelors degree in commerce from the University of
Delhi. He has over 13 years of experience in the Non-
Banking Finance Industry.
For the SFB rollout, it has recruited many people from
the banking industry. Most of the key personnel have
been with the company for the last 6 to 10 years.
Page | 23
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Board Details
Date
Name Designation of Profile
Joining
He holds a Bachelors degree in commerce from the
Mannil Venugopalan Chairman and Independent Director 2011 University of Kerala. He has over 46 years of
experience in the Finance and Banking Industry
Board is chaired by Non- He holds a Bachelors degree in commerce from the
Executive Chairman Government college, Ajmer. He is qualified as
Sanjay Agarwal Promoter and Managing Director 1996 Chartered Accountant. He has over 21 years of
experience in Finance, Accounting, strategic
planning and credit risk management
He holds a Bachelors degree in commerce from the
Uttam Tibrewal Whole-Time Director 2013 University of Delhi. He has over 13 years of
experience in the Non-Banking Finance Industry.
He holds a Bachelors degree with honors in
commerce from Rajasthan University. He has over 26
Krishna Kant Rathi Independent Director 2008
years of experience working with various large
corporate in the fields of finance and accounting.
She holds a Bachelors degree in arts (economics)
from Lady Shriram college for Women, University of
Delhi and a Masters degree in Business
Jyoti Narang Independent Director 2015
Administration from the University of Delhi. She has
over 32 years of experience in senior leadership
positions in the hospitality industry.
He is a Qualified Chartered Accountant and has been
associated with the company since May 2010 as the
Deepak Jain Chief Financial Officer 2010 Chief Financial Officer. He has over 18 years of
experience in the fields of financial, treasury
operations and audit functions.
Source: Company, HDFC sec Inst Research

Page | 24
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Shareholding Good Credit Ratings

Public and Agency Ratings
Promoter holding is 32.8% others Brickwork BWR AA (Stable)
6.1 Promoters
32.8 India Ratings and Research IND A+ (Positive)/IND A1+
CRISIL CRISIL A+ (Stable)
Care Ratings CARE A+ (Stable)
ICRA ICRA A+ (Stable)
FPIs
37.6

FI and Local
MFs
23.5

As of July 7, 2017
Source: Company, HDFC sec Inst Research

Page | 25
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Income Statement - Standalone Balance Sheet-Standalone

(Rs mn) FY17 FY18E FY19E FY20E (Rs mn) FY17 FY18E FY19E FY20E
INCOME STATEMENT SOURCES OF FUNDS
Interest Earned 14,170 21,230 27,738 34,728 Share capital 2,843 2,843 2,843 2,843
Interest Expended 4,828 9,534 12,843 15,521 Reserves and surplus 17,153 19,650 22,905 27,444
Net Interest Income 9,342 11,695 14,895 19,208 Shareholders' funds 19,996 22,492 25,748 30,287
Other Income 135 1,480 1,829 1,871 Total Deposits - 68,500 111,900 180,425
Total Income 9,477 13,175 16,724 21,078 CASA 7,000 11,900 20,425
Total Operating Exp 3,664 7,588 9,471 11,227 Total Borrowings 76,887 84,576 67,661 60,048
PPOP 5,813 5,588 7,253 9,851 Other Liabilities, provisions 1,293 1,552 1,862 2,235
Provisions & Contingencies 767 1,435 1,837 2,497 Total 98,176 177,120 207,171 272,994
PBT 5,046 4,153 5,416 7,355
Ex. Item 6,703 - - - APPLICATION OF FUNDS
Provision for Tax 3,322 1,391 1,814 2,464 Advances 66,080 84,173 120,110 170,671
PAT 8,427 2,762 3,601 4,891 Investments 21,503 71,319 63,683 80,304
APAT 3,259 2,762 3,601 4,891 Fixed assets 2,758 5,517 5,793 6,082
Source: Company, HDFC sec Inst Research Other Assets 7,835 16,111 17,585 15,936
Total assets 98,176 177,120 207,171 272,994

Disbursements 67,305 88,634 111,240 145,151

AUM 107,339 140,432 183,869 242,930
Source: Company, HDFC sec Inst Research

Page | 26
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Key Ratios
FY17 FY18E FY19E FY20E FY17 FY18E FY19E FY20E
VALUATION RATIOS ASSET QUALITY
EPS 11.5 9.7 12.7 17.2 Gross NPLs (Rsm) 1,072 2,188 3,060 4,073
Earnings Growth (%) (79.6) (15.3) 30.4 35.8 Net NPLs (Rs man) 693 1,270 1,491 1,846
BV 70.3 79.1 90.6 106.5 Gross NPLs on AUM (%) 1.3 1.6 1.7 1.7
ABV (100% cover) 67.9 74.7 86.9 102.0 Net NPLs (%) 1.06 0.90 0.81 0.76
RoAA (%) 3.1 1.6 1.6 1.7 Coverage Ratio (%) 35.3 42.0 51.3 54.7
ROAE (%) 21.7 13.0 14.9 17.5 Provision/Avg. AUM (%) 0.8 1.2 1.1 1.2
P/E (x) 49.5 58.4 44.8 33.0
P/ABV (x) 8.3 7.6 6.5 5.6 ROAA TREE
Dividend Yield (%) 0.14 0.18 0.19 Net Interest Income 8.8% 6.9% 6.5% 6.7%
Non Interest Income 0.1% 0.9% 0.8% 0.7%
PROFITABILITY Operating Cost 3.4% 4.5% 4.1% 3.9%
Yield on Advances (%) 15.0 14.7 14.4 14.1 Provisions 0.7% 0.8% 0.8% 0.9%
Cost of Funds (%) 7.5 8.3 7.9 7.7 Tax 1.7% 0.8% 0.8% 0.9%
Core Spread (%) 7.4 6.4 6.5 6.4 ROAA 3.1% 1.6% 1.6% 1.7%
NIM (%) 8.8 6.9 6.5 6.7 Leverage (x) 7.11 8.02 9.52 10.19
ROAE 21.7% 13.0% 14.9% 17.5%
OPERATING EFFICIENCY Source : Company, HDFC sec Inst Research
Cost-Income Ratio (%) 38.7 57.6 56.6 53.3
Cost/Avg. Asset Ratio (%) 3.9 6.1 5.8 5.3

BALANCE SHEET STRUCTURE

RATIOS
Loan Growth (%) 30.6 30.8 30.9 32.1
Deposits Growth (%) 63.4 61.2
Equity/Assets (%) 20.4 12.7 12.4 11.1
Equity/Loans (%) 30.3 26.7 21.4 17.7
Source : Company, HDFC sec Inst Research,

Page | 27
 AU SMALL FINANCE BANK : INITIATING COVERAGE

RECOMMENDATION HISTORY
Date CMP Reco Target
AU TP
700 29-Sep-17 567 NEU 530

650

600

550

500
Rating Definitions
BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period
Sep-17

Sep-17
Aug-17

Aug-17
Jul-17

Jul-17

NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period
SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period

Page | 28
 AU SMALL FINANCE BANK : INITIATING COVERAGE

Disclosure:
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has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific
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Any holding in stock No
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Page | 29
 AU SMALL FINANCE BANK : INITIATING COVERAGE

HDFC securities
Institutional Equities
Unit No. 1602, 16th Floor, Tower A, Peninsula Business Park,
Senapati Bapat Marg, Lower Parel, Mumbai - 400 013
Board : +91-22-6171 7330 www.hdfcsec.com

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