Detailed Rationale

CRISIL Ratings has reaffirmed its ‘CRISIL AA/CRISIL AA+/Stable/CRISIL A1+’ ratings on outstanding debt instruments of AU Small Finance Bank Limited (AU SFB).

 

CRISIL Ratings has taken note of the announcement by AU SFB on October 29, 2023, pertaining to the amalgamation of Fincare Small Finance Bank (Fincare) with and into AU SFB through an all-stock merger.

 

The scheme of arrangement has been approved by the board of directors of both banks. The merger is subject to approvals from shareholders, the Reserve Bank of India and the Competition Commission of India.

 

According to the terms, Fincare Business Services Ltd, the promoter of Fincare SFB, shall infuse Rs 700 Cr into Fincare SFB prior to the completion of the merger. Upon obtaining the required approvals, Fincare SFB shareholders shall receive 579 shares in AU SFB for 2,000 shares of Fincare SFB. Post merger, existing shareholders of Fincare SFB shall hold ~9.9% in AU SFB.

 

The merger is expected to expand the geographic footprint for AU SFB given their presence in north and north west India and Fincare’s strong presence in south India. With the merger, AU SFB’s portfolio will get diversified to include Fincare’s microfinance, mortgages, and gold loan businesses whereas Fincare SFB’s customers will get access to a wider range of products. Apart from this there will be technological, revenue and cost synergies to both the banks.

 

The merged entity will also leverage AU SFB’s strong product and digital capabilities to grow its deposits and lending franchise and Fincare’s distribution network in rural and semi-urban areas.  The combined entity is expected to have gross advances of over Rs 80,000 crore and deposits base of over Rs 85,000 crore. The share of microfinance book in the merged entity is expected to be ~7.5%.

 

In terms of timeline of the amalgamation, the effective merger date is February 01, 2024 and the amalgamation is expected to be completed in 3-4 months of receipt of RBI approval.

 

The rating continues to reflect AU SFB’s demonstrated ability to meet the expectations around improvement in asset quality and earnings profile and the sustenance in the bank’s overall performance in terms of capitalization and deposit mobilization. Given the size of AU SFB as compared to Fincare the existing performance of AU SFB is expected to sustain and improve from hereon.  However, these strengths are partially offset by lower share of current and savings account deposits as compared to peers. 

 

The bank has demonstrated its ability to manage its asset quality in the post-Covid scenario and maintain non-performing assets (NPAs) at a level which is lower than peers. Post Covid-19, the GNPAs peaked at 4.3% as of March 31, 2021 and remained at elevated levels on account of the pandemic’s second wave’s disruption. However, with gradual relaxation in lockdown restrictions and resumption in customer’s cash-flows led to improved collection efficiency, AU SFB’s asset quality has revived strongly. As of March 31, 2023, the bank reported an improved GNPA of 1.7% whereas NNPA stood at 0.4%. The GNPA remained range bound between 1.7% to 1.9% in the first half of fiscal 2024 and the same is expected to be sustained in the medium term.

 

Further, the bank has also maintained healthy profitability metrics, with stable return on assets (RoA) in last 2 fiscals. The NIM has declined slightly from 5.6% in fiscal 2023 to 5.4% in first half of fiscal 2024 due to the rising interest rate scenario. The operating expenses and credit cost have remained range bound between 4.4% to 4.6% and 0.1% to 0.3%, respectively.  The bank reported RoA of 1.7% as on September 30, 2023 and 1.8% in fiscal 2023 and fiscal 2022.The RoA is expected to inch up to 1.9% post amalgamation.

 

There has also been a sustained improvement in the bank’s overall liability profile marked by increasing share of deposits in the overall external liabilities and continued ramp up in retail deposit franchise. As on September 30, 2023 the overall deposits increased to Rs 75,743 crore from Rs 69,365 crore as on March 31, 2023. The depositor profile for Fixed Depsot (FDs) remains diversified with almost 60% of it being sourced from individuals, sole proprietors, partnership firms, among others. In terms of maturity profile of outstanding FDs, the share of deposits having a tenure of more than nine months increased from 76% in March 2019 to 88% as of March 2023. The bank is now attempting to increase focus on its retail deposit franchise and forgo a few wholesale accounts if need be, with the dual objective of reducing cost of funds and to attain higher granularity.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has taken a standalone view on the credit risk profile of AU SFB.

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 September 30, 2023 the bank’s networth increased to Rs 11,763 crore from Rs 10,977 crore as on March 31, 2023 as against Rs 7,514 crore on March 31, 2022, driven by a capital raise of Rs 2000 crore via Qualified Institutional Placement (QIP). Additionally, Rs 500 crore raised via Tier II bonds during fiscal 2023. The bank’s reported overall and tier 1 capital adequacy ratios (CAR) were comfortable at 22.4% and 21.0%, respectively as on September 30, 2023, and both these metrics have remained above the regulatory requirement of 15% historically. The bank is expected to maintain adequate capitalization, post merger with Fincare.

 

• 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 deposits further grew Rs 75,743 crore as on September 30, 2023.

 

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 5.6% for fiscal 2023. However, it inched up marginally and stood at 6.4% in H1FY24 due to the macro economic scenario.

 

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

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%. Reported GNPAs and NNPAs, after rising to 4.3% and 2.3% as on June 30, 2021, respectively due to the pandemic started to decline on sequential basis and stood at 1.9% and 0.6% respectively on September 30, 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. Over the medium to long term, the pace at which the bank reinstates repayment discipline among its borrowers and maintains its resolution rate will remain a key monitorable.

 

Over the past two fiscals, the bank has diversified its product suite and the MBL (Micro Business Loans/loans to micro small and medium enterprises, MSME) book and it will further diversify its product suit by addition of MFI and gold loan portfolio on account of amalgamation with Fincare. The AUM has grown at a robust pace. 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

In first half of fiscal 2024, bank reported profit after tax of Rs 789 crore (RoA of 1.7%) and Rs 1428 crore in fiscal 2023 (RoA of 1.8%) as against Rs 1130 crore (RoA of 1.9%) in the previous fiscal. Net interest income has increased from fiscal 2023 onwards 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 0.3% in first half of fiscal 2024 and 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 to continued investment in credit card business and digital initiatives like QR and video banking. AU SFB will be acquiring the high yielding micro finance segment on account of the amalgamation which will push up the NIM’s and profitability of AU SFB.

 

In the medium term to long term, AU SFB is expected to enhance 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 branch expansion on account of amalgamation with Fincare. The ability of the bank to sustain its overall profitability, while scaling business across fast growing segments like MBL (MSME), Microfinance (MFI) and gold loans which will be acquired from Fincare will remain critical.

 

Weakness:

• 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, 56% 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 35.2% 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.

Liquidity: Strong

The bank reported an average Liquidity Coverage Ratio (LCR) of 139% for the quarter ended June 30, 2023, against regulatory requirement of 100%. Moreover, the bank had an adequate balance of excess SLR and other avenues of liquidity. It has also mobilized funds as refinance from NABARD and SIDBI.

 

ESG Profile

CRISIL Ratings believes that AU SFB’s Environment, Social, and Governance (ESG) profile supports its already strong credit risk profile.

 

The ESG profile of financial institutions typically factors in governance as a key differentiator between them. The sector has reasonable social impact because of its substantial employee and customer base, and it can play a key role in promoting financial inclusion. While the sector does not have a direct adverse environmental impact, the lending decisions may have a bearing on environment and other sustainability related factors.

 

AU SFB has demonstrated an ongoing focus on strengthening various aspects of its ESG profile.

 

AU SFB’s key ESG highlights:

• As part of its ESG strategy, the bank has identified certain environmental challenges and has been taking actions to make meaningful contribution. With that as the target, the bank has been promoting digital-first approach. By introducing digital visiting cards and digitalized operations through paperless onboarding and video banking platform, the bank has contributed towards reducing carbon footprint which in turn helped the bank save approximately 30,00,000 papers in fiscal 2022.
• The bank encourages the use of renewable energy. As on March 31, 2022, 9% of bank’s Wheels book is covered under green portfolio.
• To contribute towards building a responsible banking industry by serving customers across the socio-economic spectrum, the bank is furthering the cause of financial inclusion by making financial services accessible to the under-served. Last fiscal, over 1,93,000 customers were provided financial services under Jan Dhan Yojana.
• The bank has been using energy-efficient systems and sustainable infrastructure for its operations and follow the circular economy model for waste management. In fiscal 2022, the bank installed a 1.25 MW solar plant in Jaipur.
• With an intent to make meaningful contributions to the communities through its AU Foundation, last fiscal the bank contributed towards Covid-19 relief activities, focusing majorly on addressing the oxygen shortage during second wave, strengthening delivery system, providing safety equipment’s and trainings, community vaccinations etc.
• About 5-6% of the bank’s workforce comprised females and ratio of permanent employees to contract employees was 30.2 times for fiscal 2021. Number of women as part of the workforce were lower than peers, at 5-6% for fiscal 2021 and are estimated to have remained at similar level in fiscal 2022 as well.
• The strength of governance is reflected in the extensive experience of the board and management, over 80% of the board comprised independent directors. More so, there is a distinction between the Chairman and any executive role at the bank.
• In the past, there have been certain exits in key management positions (chief internal auditor and chief risk officer) in a short time window due to personal reasons/ internal movements. In the long run, stability in the senior management will remain a monitorable.

 

There is growing importance of ESG among investors and lenders. AU SFB’s commitment to ESG will play a key role in enhancing stakeholder confidence, given high share of foreign investors as well as access to both domestic and foreign capital markets

Outlook: Stable

CRISIL Ratings believes AU SFB will sustain its asset quality metrics and profitability at above average levels while scaling up the loan portfolio. The build-up of the bank’s liability franchise driven by an increasing share of CASA and retail term deposits – in total deposits and overall borrowings - is also expected to continue.

Rating Sensitivity factors

Upward factors

• Continued increase in share of CASA and overall deposits as a proportion of total borrowings in line with other mid-size private sector banks
• Scale-up of operations while maintaining asset quality with GNPA below 3% and, profitability at above RoA level of 2.5% on a steady state basis.

 

Downward factors

• Deterioration in asset quality reflected in rise in GNPA to over 4% and weakening of earnings profile evidenced by RoMA remaining below 1.5% for a prolonged period, resulting in moderation of capitalization
• Inability to sustain and improve the momentum of traction is overall deposits and CASA declining to and remaining below 30% of total deposits.

About the Banks

AU SFB (formerly Au Financiers (India) Ltd) was incorporated in 1996 as an NBFC, promoted by Mr. Sanjay Agarwal, with 28+ years legacy of being a retail focused institution. AU SFB started its banking operations in April 2017 and listed its shares on Bombay Stock Exchange and National Stock Exchange in July 2017. AU SFB has an established market position in Rajasthan, and has expanded operations to Maharashtra, Gujarat, and other states over the years. AU SFB's main focus is retail asset-financing segment, primarily in the vehicle financing segment (around 32% of gross advances) alongside Small Business Loans to MSMEs (29%). Other segments include housing, gold loans, personal loans, overdraft, and commercial banking products.

 

AU SFB’s liability product offerings include the entire gamut of current account, savings account, recurring and term deposits, transaction banking, bouquet of third-party mutual funds and insurance covers.

 

As on March 31, 2023, AU SFB had established operations across 1027 banking touchpoints while serving 38.6  Lakh customers in 21 States & 3 Union Territories with an employee base of around 28,320, employees.

Key Financial Indicators

For the year ending March 31,	Unit	H12024	2023	2022
Total assets	Rs Crore	95,977	90,216	69,078
Total income	Rs Crore	5,730	9,240	6,915
PAT	Rs Crore	789	1,428	1,130
Gross NPA	%	1.9	1.7	2.0
Overall capital adequacy ratio	%	22.4	23.6	21.0
Return on assets	%	1.7	1.8	1.9

 

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue size (Rs crore)	Complexity  levels	Rating assigned with outlook
INE949L08418	Tier II Bonds	30-Nov-18	10.90%	30-May-25	500	Complex	CRISIL AA/Stable
NA	Tier II Bonds^	NA	NA	NA	50	Complex	CRISIL AA/Stable
NA	Certificate of Deposits	NA	NA	7-365 days	1100	Simple	CRISIL A1+
NA	Fixed Deposits	NA	NA	NA	40000	Simple	CRISIL AA+/Stable
INE949L08426	Tier II Bonds	3-Aug-22	9.30%	23-Aug-32	50	Complex	CRISIL AA/Stable
INE949L08434	Tier II Bonds	3-Aug-22	9.30%	13-Aug-32	100	Complex	CRISIL AA/Stable
INE949L08442	Tier II Bonds	3-Aug-22	9.30%	3-Aug-32	450	Complex	CRISIL AA/Stable

^Yet to be issued