AU Bank needs a fix on expenses as return on assets seen shaky

Headwinds are seen emerging on the net interest margin (NIM) front as cost of funds continue to inch up. After a moderate 10 basis point (bps) sequential decline in NIM at 6.1%, investors should brace for a higher fall in this metric in FY24.

With the bank ramping up on deposit mobilization, the cost of funds would rise further, exerting pressure on NIM. Cost of funds rose 32bps sequentially to 6.29%. Besides, a higher proportion of fixed-rate loan portfolio at 66% is an additional pain for NIM. So, the management foresees NIM compressing by 30-40bps in FY24. To be sure, the management aims to trim the proportion of fixed rate loans in its portfolio to 50% in the next three years. But investors need to understand that the benefits of this move would accrue only gradually. Another worry is the trajectory of operating expenses (opex). A key indicator , the cost-to-income ratio rose to 63% in Q4 from 61.6% in Q3. This is mainly driven by the bank’s increased investments in digital initiatives and expansion of business operations. Opex is likely to remain high in the coming quarters, but the management is hopeful of these investments yielding results from FY24-end onwards.

Even so, analysts are cautious. “While the management is confident of maintaining return on assets (ROA) of 1.8% in FY24, considering the elevated opex levels and expected NIM compression, ROA could take a hit going forward,” said Dnyanada Vaidya, research analyst, Axis Securities. 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 that, its expensive valuation multiple. “At 3x BV (book value) FY25E, AU is expensive because its RoA is equal to/lower than peers including ICICI Bank, HDFC Bank and IndusInd Bank, which trade cheaper. While AU’s loan growth is higher, its weaker deposit profile and higher opex yield an RoA that is equal to/lower than peers,” said analysts at Nuvama Research. Meanwhile, the bank has received an authorized dealer category-I license from the Reserve Bank of India for offering forex 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 linger and would dictate the stock’s performance.