AU Small Finance Bank Limited (AUBANK) Earnings Call Transcript

Ladies and gentlemen, good day, and welcome to the AU Small Finance Bank Q2 FY '27 Earnings Conference Call. [Operator Instructions] I now hand the conference over to Mr. Prince Tiwari, Head of Investor Relations and FIC, AU Small Finance Bank. Thank you, and over to you, sir.

Thank you, Rupiya, and good afternoon, everyone, and welcome to AU Small Finance Bank Call for the second quarter of financial year '26-'27. We thank you all for joining the call this evening. On today's call from management, we have our Founder, MD and CEO, Mr. Sanjay Agarwal; our Executive Director, Mr. Vivek Tripathi; CFO, Mr. Gaurav Jain and IR team. CFO sir will start today's call with 15 to 20 minutes opening remarks, highlighting the bank's performance, positioning and outlook. We'll follow the opening remarks with the 40 to 45 minutes of Q&A from participating investors and analysts. [Operator Instructions] For any data keeping questions, you may kindly reach out to the IR team any time post this call. With that, I now request Gaurav to share his opening remarks.

Thank you, Prince. Good evening, everyone, and thank you for joining us for our Q2 FY '27 earnings call. Q2 was our 30th quarter as a commercial bank. And over the past decade, we have navigated a dynamic operating environment while strengthening our balance sheet, building multiple growth engines, investing in technology and talent and maintaining a sharp focus on risk management and governance. Q2 was another quarter where the bank demonstrated resilience and strong operating performance amidst a challenging macroeconomic backdrop. The operating environment in this quarter continued to be influenced by geopolitical risks and monetary policy tightening with MPC raising policy rate by 25 basis points to 5.5% and shifting stance to calibrated tightening. While domestic activity and credit demand remained healthy, we remain watchful of the implications on liquidity, deposit pricing, loan yield and demand. Now let me walk you through the key highlights of our performance in Q2. Our deposits grew strongly by 29% year-on-year and 8% quarter-on-quarter versus banking system growth of 18% year-on-year. This was despite not meaningfully participating in the strong SCNR inflows in the banking system due to our limited overseas footprint. We garnered around USD 230 million of FCNR deposits on a gross basis in Q2. CASA deposits continued to see strong growth at 29% year-on-year and 11% quarter-on-quarter with CASA ratio sequentially improving 70 basis points to 29.5% from 28.8% in Q1. Loan portfolio grew 25% year-on-year and 7% quarter-on-quarter against banking sector credit growth of 19%. Secured assets, which remain the foundation of our lending franchise grew by 26% year-on-year and 5% quarter-on-quarter. Unsecured businesses grew 23% year-on-year and 8% quarter-on-quarter led by micro finance and personal loans. Disbursement for the quarter was up by 33% year-on-year, driven by broad-based growth across businesses. This balance sheet growth translated into healthy operating performance. Net interest income increased by 32% year-on-year on the back of strong growth in loan portfolio and 33 basis points Y-o-Y expansion in margins. Sequentially, market declined by 9 basis points to 5.8%, driven by a hard share of investment total assets and seasonality. Sequential loan spreads remained broadly stable with declining loan yields of 9 bps, largely being offset by a 7 basis point decline in cost of [indiscernible]. All fee income grew by 16% year-on-year, driven by healthy business volumes. Treasury profits were lower on a Y-o-Y basis, leading to muted total other income growth of 8% year-on-year. Operating expenses increased by 26% year-on-year, driven by growth in disbursement volumes and continued investments in distribution, brand and technology. Operating leverage continues to play out on an underlying basis response to assets ratio, excluding guaranteed premiums improving from 4.1% in Q1 to 3.9% this quarter. We expect cost to assets ratio to improve year-on-year on a full year basis. Core PPOP grew by 31% year-on-year to INR 1,480 crores, whereas provisions declined by 25% to INR 359 crores, largely led by normalization in unsecured businesses. Asset quality metrics remained stable during the quarter. Pretax ratio improved on a year-on-year basis to 2.6% versus 3.3% a year ago supported by improvement in unsecured businesses, while slippages in the secured assets remain stable. GNPA ratio declined by 42 basis points year-on-year to 1.99%, and credit cost, including guaranteed premium declined by 45 basis points year-on-year to 0.8%. Profit after tax grew 53% year-on-year to INR 858 crores compared to INR 561 crores in Q2 FY '26. ROE for the quarter improved to 1.7% versus 1.4% in Q2 last year, and ROE improved to 16.1% versus 12.4% in Q2 last year. For the first half of FY '27, profit after tax improved by 45% year-on-year to INR 1,654 crores compared to INR 1,142 crores in H1 FY '26. Similarly, ROA and ROE improved to 1.7% and 15.8%, respectively, compared to 1.4% and 12.9% for the same period last year. In terms of other strategic updates, we continue to invest in our people, distribution, branding and technology to strengthen our foundation for the next phase of our growth. During the quarter, we added around 2,400 employees largely in customer-facing roles to support our increased distribution with 45 new deposit branches and 100-plus asset centers added in Q2. We also strengthened our senior leadership team with Mr. [ Anil Agarwal ], joining as Senior Executive Group Head, to lead our Commercial and Institutional Banking business. And Mr. [indiscernible] formally assumed the role of Chief Risk Officer. We've also stepped up our brand investments across television, trade and digital media with association with [indiscernible] being a prominent investment. This month, we also inaugurated our new corporate office in Mumbai, marking an important milestone in our journey. In the next few months, our entire senior leadership will be co-located in this office, bringing us even closer to the broader financial ecosystem. In terms of our credit ratings, on 1st October, [indiscernible] upgraded our credit rating outlook to positive from stable, while reaffirming our long-term rating at AA. Coming to our technology and AI initiative. As announced last quarter, our tech strategy is organized across 3 pillars of run, build and transform with dedicated teams and leadership for each area. Run and build capabilities are enabling the bank to scale faster while serving customers more intelligently at lower cost and in uniformity. Transform pillar is focused on ensuring AI adoption and scale and moving AI from individual use cases to an enterprise operating model. Our deterministic agency platform is a framework of responsibility human in the loop governance, model explainability, full auditability 0 truck security with real-time risk currently. This enterprise-wide automation is driving straight through processing and cross-sell. Our investments in data [indiscernible] house and [ Altec ] platform has started to show some traction. For example, across the platform, together with voice AI, enabled 5% of our total disbursement in Q2. Importantly, is automated customer coverage led to 50% operating cost savings led by voice AI disbursement. Additionally, the scorecard net underwriting model delivered INR 500 crore plus of disbursement in unsecured loans during the quarter. Agency AI LOS for gold loans is showing promise with over 2,500 loans disbursed till date, delivering faster turnaround times and superior customer service across 40 branches. Increasingly, the bank is focusing on scaling agency AI journey to beat, mortgages and commercial loans, while redesigning 5 priority back office and control functions as AI native outflows. Overall, our technology investments remain focused on delivering measurable business outcomes while creating a scalable foundation for sustainable growth and long-term differentiation. So let me provide some color on our key businesses, starting with deposits. Our [indiscernible] franchise is classified under 2 broad verticals, branch banking and commercial and institutional banking. Branch Banking forms around 60% of our total deposits and focuses on relationship-led customer acquisition and servicing. Commercial and Institutional Banking now comprises all other deposit verticals, including government banking, commercial and wholesale banking, FIG and capital markets, where the mandate is to build a stronger current account deposit franchise through deeper solution-led engagement across transactional banking, cash management, products and institutional banking. In Q2, total deposits grew 29% year-on-year, supported by a strong growth of 55% in car balances and 23% in [indiscernible]. On a daily average basis, car balances grew 60% year-on-year, whereas balances were up 24% year-on-year. New CASA count acquisition during Q2 also remained strong with 45% year-on-year growth in acquisition of premium accounts. During the quarter, bank also received heavy approval for providing UPI sponsorship services under the [indiscernible] and public issue. This will strengthen our capital markets and transaction banking proposition and help bank position itself as a banker to an issue for public market issuances. This strong deposit performance reflects several strategies coming together. Sharper segmentation, dedicated liability channels, wider distribution, stronger brand and an improved customer proposition. These capabilities built over several years are now translating into stronger acquisition and more granular broad-based growth. We are encouraged by the progress, but remain focused on sustaining it with the right mix, pricing discipline and quality of deposits. Moving on to our asset franchise. Retail secured assets comprising weeds, mortgages and gold loan from 66% of our portfolio and grew 22% year-on-year and 5% quarter-on-quarter. Within retail, we booked crossed the INR 50,000 crore milestone this quarter and grew 27% year-on-year and 6% quarter-on-quarter to reach INR 1,000 crores. Growth was driven by strong demand in the new vehicle segment as well as increasing disbursing traction across newer geographies. Gold loan business grew 102% year-on-year and 4% quarter-on-quarter to INR 4,700 crores. Mortgage business comprising micro business loans in affordable housing grew by 12% year-on-year and 2% quarter-on-quarter with growth largely being led by MBL and lab business where disbursements are up 17% year-on-year. As mentioned in the past, we are not looking to chase affordable housing loan growth given our cost of funds and the competitive intensity in the segment. Moving on to Commercial Banking. This business grew 39% year-on-year and 8% quarter-on-quarter to INR 35,300 crores with broad-based growth across some verticals. Transaction banking and ForEx income grew by 51% year-on-year, reflecting improving product penetration and stronger customer engagement. With gross remaining robust, focus in commercial banking is to become progressively self-funded with every lending supply chain and corporate banking relationship having a current account, CMS or collections and payments proposition attached. Now moving on to unsecured businesses. Our inclusive banking franchise, which primarily includes MFI, grew 23% year-on-year and 6% quarter-on-quarter. Collection efficiency was stable at 99.6% and 19% of the book is covered under the CGS guarantee scheme. Our digital unsecured portfolio also reported a strong growth of 23% year-on-year and 14% quarter-on-quarter. Personal loans grew by 81% year-on-year and 31% quarter-on-quarter off a low base, supported by anteed cross-sell and [indiscernible] new to bank acquisition. The credit card book saw a marginal growth with 1.5 lakh new cards issued in the quarter. To conclude, due to [indiscernible] continued progress across our deposit franchise, lending businesses and profitability. As we look ahead, our focus remains on building the institution ahead of its scale by strengthening governance leadership and organizational capabilities while simplifying processes and leveraging technology, data and AI to improve customer experience and productivity. While we remain watchful of the operating environment, the investments we have made in our businesses, teams and distribution provide us a strong foundation to pursue growth with disciplined brand and consistency. We remain confident in our ability to compound sustainability, deliver predictable performance and create long-term value for all our stakeholders. I would like to thank our teams for their commitment and all our stakeholders for their continued trust in us. With that, I'll now hand it over to Prince for Q&A.

Thank you, Gaurav. [indiscernible], we can now open the floor for question and answers.

[Operator Instructions] The first question is from the line of Akshay Jain from Autonomous.

Two questions. First, on your margins. So I can see that our margins have declined by 9 basis points quarter-on-quarter, and you have attributed a higher investment as the reason behind it. So my question is on this liquidity, like you have seen a deposit growth of 8% Q-o-Q. And even if we adjust it for FCR, it is strong at 6.7%. So what's driving this strong deposit growth? Is it some one-offs? Or is it because the larger banks have we cut the domestic deposit space for FCNRB? So now what should be the sustainable deposit growth incrementally and also the margins?

Akshay, Prince here. So thank you for the question. I think on our overall deposit, we have been commenting in the summer time that as a bank, we have been investing heavily both in our distribution as well as technology and getting processes right, get -- make it easier for the customer to onboard themselves to bank with us. And what you are seeing is net-net, a result of that, right? I don't think there is any one-offs there. There could definitely be some transactional current account flows, which came through last quarter. But we are -- I would not say it's a one-off. It's something that we have been working upon as a bank. And we have started to see some bit of result of that. And that's why you see the CASA ratio in the quarter, going up by almost 70 basis points on a quarter-on-quarter basis. So -- and I think if you recollect our public guidance has always been that our deposits will continue to grow faster than or in line with our loan growth. And on the loan growth, given that this quarter, the loan growth -- because loan growth didn't have any FCNR component. So loan growth has grown at about 25% on a AUM basis, and deposits have just followed that. So there's nothing specific to call out there, I would say. It's more the granular work that the team is doing, and that puts us a lot more confidence going into this next cycle.

So what should be the sustainable deposit growth, but should we assume the current run rate of, say, 26%, 27% sustainable or should it cool down a bit incrementally and even on the CASA front?

Yes. Yes, Akshay. [indiscernible]. I think the whole endurance of nation is to look for a sustainable deposit growth, right? And you've already commented that we want to relate it with the overall nominal GDP growth [indiscernible]. And there is the country is growing this year in the range of 10%, and we are expecting around [ 25% ] plus. So this half year, year-on-year, 29% growth can be a little bit more than what we expected. But I think the old architecture of building a deposit franchise has been really clearly laid down in the organization [indiscernible]. So we have a retail banking franchise, we have a commercial banking franchise, common banking franchise. So overall, we believe that from the last 9 years now, 38 quarters, we really have worked every day on a deposit line side and now is the time end is really paying in for us.

And also, if I can add say see the average balance is, I think we have given the daily average balance also for current account and savings account. And that also reflect, I think, Gaurav, covered it in his speech on a Y-o-Y basis, you're seeing both current accounts growing at about 60% on an average basis and savings account is also growing 24%, right? So that also tells you that this is more transactional money rather than any one-offs.

So our target is to grow in the range of 25% year-on-year. So -- but it will depend on the debt market and the overall conditions. So -- but we are very happy to see our growth irrespective of or not doing so well in our [indiscernible].

Understood, sir. And second question is on asset quality. So this quarter has been pretty robust on asset quality. But what would be the outlook in [indiscernible] given the El Nino and the uncertain macro, plus many of your peers have and of the impact of drought, especially in certain regions in Central India. So how should we expect asset quality to behave incrementally? And any change to credit cost guidance?

Yes. So of course, there are many vulnerabilities, which we are all going through but the silver lining is that our 6-month credit cost is around 73 bps or 74 bps. We have given a guidance of close to 90 bps. So we have enough room for any kind of vulnerabilities or one-off, but largely, some of the districts or states might be facing talented you drought or high oil prices and whatever, right? But the data has not shown any kind of stress till now. But yes, [indiscernible], let's see how quarter 3 behaves because whatever will be there, which will come in the quarter 3. I don't expect any surprises in quarter 4, to be honest. So -- [indiscernible] you want to add on something?

Yes. So largely what we anticipate, right? So, so far, until September, everything has been in line and what we anticipate that we would be within our guided range. We don't anticipate that we will be meeting in its -- so in terms of product, also, I would say, one of the most vulnerable product kind of very a wide COVID now 99% of that book is covered under CGF so we don't worry that much.

So is it safe to assume that your SME levels as well as the collection efficiency are still pretty robust, and you are yet to see any deterioration over there.

The next question is from the line of Jayant Kharote from Axis Capital.

Yes. Congrats on the good set of numbers. First question is on slippages. If you could help us understand which segments have seen in [indiscernible] Q2 versus Q1 in terms of slippages. That is first question. I'd like to come back with my second.

Jayant, both Q1 and Q2 sequentially is not comparable. Typically, it's not happen to open comparison but to have a right comparison you have to compare it with you last year, Q2. Because the tractor is a one product where you have a billing cycle twice in a year, right? So this quarter, you want a tractor billing and factor billing will have a little bit of impact on your overall right. So the right -- it has a seasonal because it's linked with the crop cycle. So in -- I would say if you look at the improvement area from last couple of quarters, that has largely been from the unsecured side. Our credit card and microfinancial giant has stabilized and is absolutely in shape. And on the secured retail assets or commercial assets, there has never been a challenge for us, right? So that's always has been the rainbow. So we don't see any sort of reason to ascertain that we change in the asset base. It's more of a seasonal and more of a tractor base.

Understood. Okay. Second was the insurance fee income impact, right? While there is some ROE impact to that tune. We have been guiding for this 1.8% ROA outlook consistently given that this could be maybe 7, 8 basis points of impact. What levers do you have to ensure that our ROA ROE profile remains stable going ahead? And why I'm asking this is, as I can see your shoring up deposits or liabilities as you scale up, that is going to weigh on your NIMs, right? And then probably right strategy to invest on the liability side from the medium-term perspective, but then how do you manage the ROE profile with this surplus liquidity on the deposit side continuing for the next 2, 3 years and then that insurance is coming?

Yes. So look, when you speak about the ROE outlook for -- in the sort of say, medium term, right? So really, there will be some headwind from this insurance fee income, consultation paper, right? So we remain -- it tends to be seen what is the final shape in which this is ultimately passed, but irrespective of that, there will be some impact, right? But what I want to add is there are other line items within the other income line, which are growing on a secular basis. So we have ForEx business, which we started a couple of years back, that is gaining quarter-on-quarter. Also credit card issuance is something back. So that is also adding sort of my other income people -- we're also growing our trade finance business, right? So there are other people which will help offset some of the headwinds on the insurance side of things, right? In terms of other components of the ROA, we have been discussing extensively the operating efficiency as a key driver on a multiyear basis, right? When you look at our cost to assets ration of 4%, that will -- that compares with other midsized banks who are operating between, say, 2.5 to 3.5. So I feel confident that on a multiyear basis, we should be looking for sequential implements on this despite sort of continuing to invest in our franchise, right? And then on credit cost, we have said that long term, we should expect 90 to 100 basis points of credit cost on a cuticycle basis. So that will depend on how each year is playing out. So that's -- those are some of the key drivers. And the final one, again, this is -- I don't want to comment on quarter-on-quarter. But we have a deposit franchise which is gaining momentum and traction with each passing quarter, right? And Prince spoke about, as I mentioned in my opening remarks, how we are adding propositions, which are for differentiated segments, how we are investing in our distribution, in our technology and in our brand, right? So my deposit franchise will improve, which should help me lower the cost of differential versus other peer midsized banks over a medium-term outlook. So I think those are some of the things which will help, right? These are some of the own things, which we think we should have. And then there's always -- there are stuff which comes down on the good work, both on the negative side and positive side. So we remain hopeful that there are other stuff like the UPI MDR income line, et cetera, which will start to come into place. So multiple things to offset it.

[Operator Instructions] The next question is from the line of Kunal Shah from Citigroup.

So particularly on the deposit side from 2 contexts. One is we have grown at a pace faster at almost 28%, 29-odd percent and other banks are flushed with liquidity from FCNR. So what would be our deposit rate strategy would we continue with this 80, 90 basis points of premium on the term deposit side? Or given that banks, other banks would not be very aggressive, would we look at tweaking the deposit rate what would be our deposit strategy in the current environment?

[indiscernible] 89, 90, maybe 100 bps premium to other banks. We want to be on that strategy only because we haven't seen any rates coming down because of FCNR deposits. And it was largely on the, I would say, wholesale deposits, where some cut happened. And we also calibrated ourselves, and that is why our cost of money for quarter 2 has come down, right? So -- but in a larger sense, we need to build our deposit franchise. And we need to build with some kind of price and that we really want to be like this until we get a new platform and we settled on the new platform. So I think deposit franchise remains our top priority, and we will not play around with market-driven for sale or events, rather we want to be on our own path. And create more and more end customer and teach them holistically or serve them holistically so that in the long run, we are franchisee most stable and sustainable.

Okay. So in rising rate if other banks don't react in terms of increasing the rates, we might still react looking at maybe the growth profile and maybe our strategy, which is there. We will not be more market determined.

No. I won't -- I'm not saying this. I'm just saying this because we have a strategy, which is always based on some market data and all those things. But it's not driven by not many upticks number, right? We are pricing a 100 bps more or we are pricing with some other -- it's our own strategy where we want to leave our money. So that will continue. If money we have expenses, we need to add a franchise around that. our deposit side is now becoming more and more, I would say, visible, it's gaining the traction. We are building our franchise more in sense of that people are trusting us and knowing us more and more. So the cost of acquisition and the effort of [indiscernible] acquisition is now going down. So that's the way and it's clearly that what we have done around deposit franchise is one of the examples where how we can calibrate both the cost and the growth. So it's a balance of both sides. So let's not read too much. And I would say we go along with the requirement of the business.

Got it. And secondly, on OpEx to asset. So this quarter, again, we saw quite a significant jump on OpEx side, 7% quarter-on-quarter. And when we look at overhead cost that has gone up by almost like 11-odd percent quarter-on-quarter, 35% year-on-year. So currently, it's still in line with the overall AUM growth, and we kept talking about the OpEx efficiency. So when should we actually start seeing this efficiency, I understand we have added branches added employees over the past couple of quarters. But when ideally this operating efficiency would start to play.

So look, there are 2 impacts. When we look at the year-on-year increase in cost, right? So there is an underlying cost, which is supporting the existing business and then there is investment which is going for improving the platform, be it through technology, distribution or branding. So the 25% is a net result of that, right? But if you look at on a cost income ratio or on a cost-to-asset ratio, we are either stable or improving on that. So on an ROE basis, I think we improved on a Y-o-Y basis when you look at Q2 numbers.

Next question is from the line of Nitin Aggarwal from Motilal Oswal.

Congrats on the results. I have 2 questions. One is on the gold loan growth, like we have been earlier reporting pretty strong growth, 100% plus, but this quarter, there's a little outlier in that strong growth context. So anything to read into this from this quarterly growth perspective? And the second is, again, going back on the margin, in general, there has been a concern about the fixed rate nature of the bank and how the rate cycle is playing out. So what levers do we see to maintain margins? And is there any risk that we are looking at that can play out on the margins of the competition for deposit items going forward and because the book will take some time to replace. So how is the management looking at that?

Listen, and we just comment on margin and then ask Sanjay to comment on gold loans. So margins, I think you see our margins this quarter, loan spreads have been similar, right, if we compare quarter-on-quarter basis. While the cost of funds have gone down by about 7 basis points, we have also seen some decline in the yen because the mix change, right? That's what we had articulated last time as well. So I think the larger part of the NIM decline has been coming from the higher liquidity that we have made are basically the higher investment book that we have run as a percentage of total assets. And then there has always been the day count impact which keeps altering between quarters. So this quarter, I think there was an extra day count. So that had impacted the 3, 4 basis point side. But if I go forward and if I look forward, then I think a couple of key components to the NIM. One is obviously on the cost of funds. On cost of funds, as we articulated this quarter, the cost of funds benefited from transactions, current account balances, which have gone up significantly, right. As you -- somebody has said in the call earlier that the system liquidity is drying up from the FCNR, there was a lot of system liquidity that also helped. But I think that has started to dry up and the rates have started to go up, right? Especially in the short term, you can see we see rates going up. So this probably will put tapping in to further improvement in our cost of funds, right? So going forward, it will be more a function of liquidity and deposit competition, which will determine the trajectory of cost of funds. I think an answer to earlier question that we peg our deposit cost to the midsize banks, right? So if they react, we will necessarily be forced to react given the platform at disadvantage that we currently have, right?

Now [indiscernible] as far as of advances is concerned, I think that was your question that our book is floating rate and 70% is fixed rate. So this 30% floating rate book, the recent rate [indiscernible] has happened of 25 basis points, that gets transmitted over the next 3 to 4 months. It typically takes about 3 to 4 months or 1 full quarter. So full impact will be visible linked quarter, but it will start happening from this month onwards, right?

In case any future rate hikes happen, then that will further go on to support the yield on this 20% of the book, right?

As far as the 70% of the book is concerned, which is the strength, right? I think there we'll have to just go with the market. And if there could be any pickup in the disbursement yields in the market, then I think that should start reflecting at our end as well. We'll follow that pot pressure, right? And otherwise, it's a function of the asset mix is going to be. And as you know that this time, we think unsecured book is also available to us, which was not really there last time, and it has started to come off the cycle and started to do well. So if I -- if you ask me very point line question that are we better prepared compared to the last interest rate cycle, the answer is yes, right? And why I say that? I say that because of 2 or 3 reasons. And I think we talked about some of them on the call. One, the floating rate book, which is now 30% provides some cushion, right? Second, the overall -- if you look at the deposit rate tenure itself, what we have done is we had elongated our deposit retail deposits and the peak rate from 18 months to 36 months. So that should also help. But the biggest point that I want to highlight or the second bigger point is the interest rates in the system hasn't gone down to the extent the report cut has happened. If you look at the last 3 quarters, since December quarter last year, even though the RBI cut the reported by 125 basis points, the deposit rates haven't really related that strongly, right? And we do believe that when the rates start to go up, probably that some of that is already baked into the market price. And the last point, I think as a deposit franchise, we are in a much better position than we were in 2022 when the last centered cycle keeps, right? The franchise is much bigger, investing in our branches. We have a Pan-India franchise. And obviously, there could be a tailwind from the platform transition as well, right? So I wouldn't say all in all, we do think that we are in a much better position to tenor this in cycle as compared to where we were last time.