AU Small Finance Bank – Small, pricey yet beautiful
“AU Small Finance Bank” that commenced its commercial operation from 19th April 2017 transitioned to its banking avatar after running a successful and highly profitable retail focused NBFC (Non-Banking Finance Company) for over twenty years.
At a time when ‘large banks’ are grappling with severe challenges of non-performing assets and slow credit growth, the IPO of a “Small Finance Bank’ (SFB) gives investor an opportunity to participate in the growth opportunity of the largely underbanked but lucrative segment of the market.
“AU Small Finance Bank” that commenced its commercial operation from 19th April 2017 transitioned to its banking avatar after running a successful and highly profitable retail focused NBFC (Non-Banking Finance Company) for over twenty years. AU is one of the first ten entities that received the nod from RBI to start a Small Finance Bank.
The company is coming out with an “Offer for Sale” of 53.4 crore equity shares (18.8 percent of its paid up capital). Promoters are selling 9 million shares and the rest of the offer comes from private equity investors like Warburg Pincus, ChrysCapital, Kedaara Capital and IFC. Post issue, the promoter holding will stand reduced to 33 percent from 36 percent. The issue is open for subscription between June 28th to June 30th and is offered in the price band of Rs 355 – Rs 358 per share. At the upper end, the value of the offer works out to Rs 1912 crore.
AU – the story
AU commenced its journey from Jaipur, Rajasthan in 1996 and got registered as an NBFC in 2000. In the year 2005, the Company became a commercial associate of HDFC Bank for originating and servicing vehicle loans and this relationship aided in developing robust systems and processes early. From a single product (Vehicle Finance), the Company expanded its portfolio in 2007 to include MSME (Micro, small & medium enterprises) loans. It added housing finance in 2011 and SME (small & medium enterprises) loans in 2012. Currently 50 percent of the portfolio of Rs 10,734 crore comes from vehicle finance whereas 30 percent is from MSME and 20 percent from SME. Close to 99 percent of the portfolio is secured.
So what’s going for this entity focused primarily on serving low & middle income individuals and businesses that have limited or no access to formal banking and finance channels?
Robust track record: The Company has reported robust financials as it penetrated into the underserved markets. While reporting a CAGR (compounded annual growth rate) of 29 percent in disbursement and 30 percent in assets under management in the past four years, the revenue has risen by 37 percent and profitability has grown by 47 percent .
The entity is extremely well capitalised and reports one of the best return ratios in the industry.
Diversification with a focused expansion strategy: Thanks to its lending history of twenty years, the Company has decent operating experience in rural and semi-urban markets of India and as of March 31, 2017, 146 of its 301 NBFC branches were located in such markets. Over the years, the company has focused on customers in such markets, particularly those without a credit history, that offer significant growth opportunities and customer loyalty. AU has adopted a strategy of contiguous expansion across regions and has presence across ten states and one Union Territory with significant focus in Rajasthan, Gujarat, Maharashtra and Madhya Pradesh.
Robust Risk Management Framework: The Company has a robust and comprehensive credit assessment and risk management framework to identify, monitor and manage risks inherent in operations. This is critical to maintain asset quality in a business where most borrowers do not have proper documentation. AU focuses on cash flow of the borrowers, limits the exposure to small ticket size and lends only to revenue generating assets. The company also prices the risk adequately. Consequently AU has maintained a healthy asset quality with gross NPA on 90-day overdue basis at 1.9 percent .
Stable funding mix: The Company has been diversifying its funding mix. As of FY17, 50 percent of the borrowings was from NCDs (Non convertible debentures), 32.9 percent from term loans, 6.8 percent from Commercial Papers (CP), 4.7 percent from subordinated debt and 5.6 percent from working capital facilities. The Company has successfully brought down its cost of funding from 12.6 percent in FY13 to 10.13 percent in FY17, thanks to the improvement in credit rating to A+ (stable) from top four rating agencies.
Small Finance Bank: The transformation is underway. As per the guidelines of the regulator, the SFBs will have to maintain CRR (cash reserve ratio) and SLR (statutory liquidity ratio) as their commercial banking counterparts. They are also required to have 25 percent of the branches in unbanked rural areas and have a priority sector lending portfolio at 75 percent of net bank credit (much higher than 40 percent of commercial banks. At least 50 percent of their loans and advances should constitute advances of the size up to Rs 25 lakhs.
While as an SFB AU will have access to low cost liabilities in the form of CASA (Current account & savings account) deposits, the business will undergo a shift with significant up fronting of costs. The Company will add 162 branches in FY18 and will also add employees and IT platforms.
On the asset side, in addition to the NBFC products, it will offer personal and business banking products. So while banking lends a long term credibility to the business, margins and hence return ratios might moderate.
PSU banks losing market share: While banking prima facie looks to be a crowded place, the crisis in the corporate banking space that has impacted public sector banks significantly has created headroom for new efficient entities in the market. Thus despite competition, smarter entities especially banks with smaller Balance Sheet can look forward to scaling up businesses profitably if they have their eyes and ears on the ground.
Expensive valuation: AU Finance is being offered at a valuation which leaves little on the table for the investors in the short-run.
While the valuation premium might sustain if the growth trajectory doesn’t disappoint in the future, we expect returns to map earnings growth closely in the future. For long-term investors, reposing their faith in the scaling up of this SFB into a meaningful entity in the Indian financial system, the issue offers an interesting opportunity.