AU Bank needs to fine-tune expenses as return on assets looks shaky

Trouble seems to be brewing on the net interest margin (NIM) front as the cost of funds continues to rise. After a moderate 10 basis point (bps) sequential decline in NIM to 6.1%, investors should brace for a higher decline in this metric in FY24.

Bank’s increased move to raise deposits will further increase the cost of funds, putting pressure on NIM. Cost of funds increased sequentially by 32bps to 6.29%. Moreover, the high proportion of fixed rate loan portfolio at 66% is an added pain for NIM. Hence, the management expects NIM to reduce by 30-40 bps in FY24. To be sure, management aims to reduce the proportion of fixed-rate loans in its portfolio to 50% over the next three years. But investors need to understand that the benefits of this move will accrue only gradually. Another concern is the trajectory of operating expenses (Opex). A key indicator, the cost-to-income ratio increased from 61.6% in the third quarter to 63% in the fourth quarter. This is primarily driven by the Bank’s increased investment in digital initiatives and expansion of business operations. Opex is likely to remain high in the coming quarters, but the management expects these investments to bear fruit from the end of FY24.

Still, analysts are cautious. Gyanada Vaidya, Research Analyst, Axis Securities, said, “While the management is confident of maintaining a return on assets (RoA) of 1.8% in FY24, given the higher opex levels and expected NIM compression, the RoA may further slide ” Clearly, in this backdrop, the bank’s solid year-on-year loan and deposit growth of 26% and 32%, respectively, is not enough to comfort investors. Add to this its expensive valuation multiple. “FY25E at 3x BV (book value), AU is costlier as its RoA is at par/less than peers including ICICI Bank, HDFC Bank and IndusInd Bank, which trade cheaper. While AU’s loan growth is high, it has a weak deposit profile and high opex yield resulting in a RoA that is at par/less than peers,” said analysts at Nuwama Research. Meanwhile, the bank has received an Authorized Dealer Category-I license from the Reserve Bank of India to offer foreign exchange related services, which is likely to be implemented in H2FY24. This bodes well for its long-term growth prospects, but for now, near-term concerns will remain and determine the stock’s performance.