Rating Rationale

Key Rating Drivers & Detailed Description

Strengths:

Adequate capitalisation

Capitalisation, adequate in relation to the bank's scale of operations, is supported by steady internal accruals apart from the bank's track record to raise need-based capital. As on March 31, 2023, the bank’s reported networth stood at Rs 10,977 crore as against Rs 7,514 crore on March 31, 2022, driven by a capital raise of Rs 2500 crore (Rs 2000 crore via QIP and Rs 500 crore by Tier II bonds) during the fiscal. The bank’s reported overall and tier 1 capital adequacy ratios (CAR) were comfortable at 23.6% and 21.8%, respectively as on March 31, 2023, and both these metrics have remained above 15% historically. Bank is expected to maintain adequate capitalisation with CAR at over 18% on steady state basis.

Sustained ramp-up in deposit franchise

The bank’s deposit base has registered a steady growth rate over the three fiscals alongside an increasing share of retail deposits (retail term deposits and CASA) as a proportion of total deposits and, of overall external liabilities as well. Registering a 3 year CAGR of 38.4%, the bank’s deposit base stood at Rs 69,365 crore as on March 31, 2023 which constitutes 92% of the total borrowings as compared to 84%, two years ago.

The deposit mix has been evolving, with higher focus on retail deposits. The aggregate share of CASA and retail term deposits (TD, of less than Rs 2 crore) in the total deposit base (including Certificates of Deposit) has been increasing consistently. As compared to 44% as on March 31, 2020, the proportion increased to 69% as of March 31, 2023.

Alongside growth in deposit base, the average cost of funds declined as incremental funds are being sourced in the form of low cost deposits and refinance from financial institutions. For fiscal 2017, cost of funds was 9.6%, which declined to 8.43% for fiscal 2018 and subsequently to 5.9% for fiscal 2022. However, it inched up marginally in fiscal 2023 and Q1FY24. It stood at 6.6% in Q1FY24.

Over fiscal 2019 and 2020, AU SFB had offered a higher rate as incentive to ramp up its retail deposit franchise after the banking sector faced volatility in the deposit base for a short period owing to market disruptions caused by some specific events at a few non-banks and banks. The second half of fiscal 2020 witnessed two major events - one in September 2019 pertaining to a co-operative bank and the other in March 2020 when moratorium was imposed on a large private bank - that had an impact of the deposits inflow for the banking sector. In the aftermath of both, the inflow of incremental deposits moderated for AU SFB for a short span; however, it corrected to its business-as-usual rate soon after.

Over the near to medium term, the bank’s ability to sustain improvement in its retail deposit franchise reflected by consistent increase in the share of retail deposits (retail TDs and CASA) in the total deposit and overall liabilities base, while maintaining competitive cost of funds, will serve as a key rating sensitivity factor.

Demonstrated track record of maintaining better than average asset quality metrics, even in a stress case scenario

AU SFB has sustained its asset quality over the past few years supported by strong focus on portfolio monitoring and collection practices. This is in addition to the sound understanding of the operating geography and borrower profile. Up until March 2020, the bank’s reported GNPA had remained below 3%. Post the outbreak of the pandemic, the bank's collection efficiency dipped with a sizeable proportion of the book in moratorium. However, as the restrictions were uplifted in stages and economic activity resumed in a staggered manner, the bank's business also picked up, both in terms of collections and disbursements. Thereafter, as the second pandemic wave broke out, a temporary impact was observed over April and May 2021 though, it corrected shortly after that. Reported GNPAs and NNPAs, after rising to 4.3% and 2.3% as on June 30, 2021, respectively started to decline on sequential basis and stood at 1.7% and 0.4% respectively on March 31, 2023.

The bank had a standard restructured portfolio of around 1.2% of gross advances as on March 31, 2023, down from 2.1% of gross advances as at the end of June 2022. Majority of these loans were restructured in Q4’FY21 and Q1’FY22. It was also noted that the bank extended loans under Emergency Credit Line Guarantee Scheme (ECLGS) to the tune of Rs 569 crore in fiscal 2021 and Rs 500 crore fiscal 2022. For some proportion of the portfolio against which ECLGS loans were disbursed, restructuring was also extended. Over the medium to long run, the pace at which the bank reinstates repayment discipline among its borrowers and maintains its resolution rate will remain a key monitorable.

As on March 31, 2023, the bank was carrying Rs 1,133 crore as provisions which forms 1.9% of its gross advances as on that date.

Over the past two fiscals, the bank has diversified its product suite and the SBL (Small Business Loans/loans to micro small and medium enterprises, MSME) book, in particular, has grown at a robust pace and now forms 31% of the total loan book. As the book is of relatively longer tenure and has grown at fast pace, the asset quality behavior here would be a key monitorable. Wheels (vehicle loans), which was the largest asset class with over 40% share in the gross advances until a few quarters ago, currently forms 32% of the gross advances.

Adequate profitability despite costs linked to SFB transition and heightened provisioning requirement post Covid-19

AU SFB's profitability has remained adequate over the last 3-4 years. As anticipated earlier, after commencement of banking operations, return on average assets (RoA) declined from 2.7% (adjusted for exceptional income) in fiscal 2017 to 1.5-2.0% for the succeeding fiscals on account of shrinkage in net interest income (NII), investments in lower-yielding securities in compliance with statutory liquidity ratio (SLR) requirement and other technology and head office costs. As the bank has been able to replace legacy institutional borrowing by low-cost deposits, leading to decline in overall cost of funds, benefits were passed on to the customers as well by the mode of reduction in yield. As a bank, it has more avenues to increase other income on account of aspects like increased customer and distribution network, increase in income from priority sector lending certificates (PSLCs) and cross-sell of products to customers.

In fiscal 2023, bank reported profit after tax of Rs 1428 crore in fiscal 2023 (RoA of 1.79%) as against Rs 1130 crore (RoA of 1.87%) in the previous fiscal. Net interest income increased in fiscal 2023 on account of growth in business volumes, partly impacted by increased cost of funds. Recoveries from write offs, classified under other income, had also increased during the period. Credit cost declined to 0.2% in fiscal 2023 as against 0.6% in previous fiscal. Operating costs inched up to 4.3% in fiscal 2023 from 4% in previous fiscal, primarily due continued investment in credit card business and digital initiatives like QR and video banking.

In the medium term to long term, AU SFB is expected to sustain its net interest margin driven by strong market position in core territories and product segments, which allow it to price in the risks suitably. Operating expense ratios should remain at current levels given there are no major expansion plans in the medium term apart from the regular branch expansion. The ability of the bank to sustain its overall profitability, while scaling business across fast growing segments like SBL (MSME), and housing will remain critical.

Weaknesses:

Moderate, though improving, scale of operations and geographic concentration in business

Scale of operations, though improving, remains moderate in relation to private banking peers despite higher-than-industry-average growth. Gross advances stood at Rs 59,158 crore as on March 31, 2023, marking a growth of 26% over the year. The bank leverages on its strong presence in the retail asset segment with a diversified product profile. After converting into a bank, AU SFB has diversified into asset segments such as home loans, agricultural-SME loans, gold loans, personal loans and credit cards, business banking, working capital, and overdraft facilities in addition to its businesses of Wheels and SBL. As a strategic call, the bank has curtailed its exposure to corporate segments like lending to non-banking financial companies (NBFCs), builder loans against property (LAP), etc. over the last few quarters.

In terms of gross advances mix, over ~78% of the book is deployed in retail loans with Wheels forming the largest portion at 32% followed by SBL, which accounted for 31% of the book.

Geographically, though it has a strong track record of operations in Rajasthan, Maharashtra, Madhya Pradesh and Gujarat, AU SFB’s portfolio is concentrated across the four states to the extent of 76%, with Rajasthan alone accounting for 35% of the advances

Over the medium term, diversity across product suite and geographical base is not expected to change materially as the bank continues to focus on increasing its penetration in these states and product segments, and does not have plans to grow aggressively in newer domains.

CASA, though improving, remains low as a proportion of overall liabilities in comparison with larger private banks

While AU SFB has demonstrated its ability to ramp-up deposit base in the initial phase of its banking journey and continues to do so gradually, its CASA – though improved over the last fiscal – remains lower than that of other larger private banks.

While the share of CASA plus retail deposits rose to 69% as on March 31, 2023 from 44% as on March 31, 2020, share of bulk deposits still remains higher than a number of other private banks. Bulk deposits, as opposed to retail deposits, are inherently rate-sensitive and not sticky. However, 55% of AU SFB's bulk term deposits are reported to be non-callable. Nevertheless, they pose inherent challenges in managing asset liability maturity mismatches, particularly when the liquidity environment is tight. Consequently, building a granular deposit profile with a solid share of CASA is critical.

The share of CASA, though improved, was lower than that for larger private banks at 34.9% of total borrowings (deposits plus other borrowings) and 38.4% of the total deposit base (including certificate of deposits) as on March 31, 2023. Fiscal 2020 witnessed disruptive events at two banks - one in September 2019 and the other in March 2020 that had an impact on deposit inflow for a number of private banks. In the aftermath of both, the inflow of incremental deposits moderated for AU SFB for a short span before correcting to business-as-usual rates soon after.

In the medium to long term, AU SFB’s ability to sustain this improvement in CASA such that its share in the total deposits and overall borrowings of the bank increases and demonstrates sustainability, will be a key rating sensitivity factor.