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How safe is AU Small Finance Bank?


AU Small Finance Bank is in the news for all the wrong reasons. The stock is down -19% from its recent peak with high volumes. A series of high-profile resignations has raised questions on the asset quality of the lending book.

How safe is AU Bank? Should depositors be worried? Should investors be worried?

AU Small Finance Bank is one of the largest SFBs in India with a balance sheet size of 51,537 Cr. The bank has a deposit base of 37,014 Cr with 742 branches across India. It has commanded premium valuations due to the growth it had delivered in the past. However, the lender is facing its toughest challenge since its listing.

How safe is AU Small Finance Bank?

What is happening at AU Bank?

In the last six months, four key managerial people had either changed their roles or resigned from the company.

How safe is AU Small Finance Bank?

Such back-to-back exits have spooked investors. There is also a delay in reporting the news to the exchanges since Alok Gupta’s resignation was actually dated mid-July. Investors asked the obvious question: Why are senior risk/audit people resigning?

How good are the books?

The numbers look decent. There are pockets of stress, but manageable, at least according to the books.

Undoubtedly, Q1FY22 was a challenging quarter for the bank. The impact was more severe than Covid first wave. The bank had restructured 1.9% of the total loan book. Approx ~11% of advances had availed complete moratorium.

It had reported a GNPA of 4.3% & an NNPA of 2.3%. Not great, but not terrible.

In Nov 2020, the bank sold its remaining stake of 4.4% in Aavas for 570 Cr. It used these proceeds to make accelerated provisioning of 1233 Cr as of Q1FY22. Collection efficiency jumped to 114%, similar to pre-Covid levels.

How safe is AU Small Finance Bank?

What can go wrong?

Underreporting of NPAs

Restructuring/Moratoriums effectively mask the NPA numbers, and banks retain some flexibility if they grant moratoriums even in cases where situations are irrecoverable. If that is the case, the bank could eventually see larger provisions & write-offs in the coming years. This will in turn hurt the Tier 1 capital of the bank.

The bank currently has a Capital adequacy ratio of 23.1% & Tier 1 ratio of 21.6%. Both well above the RBI threshold of  15% & 7.5% respectively. Put another way, they would have to lose more than 8% of their book in totality (i.e. zero recovery) in order to breach regulatory limits, and that’s over and above the provisions they already have. While this seems unlikely, it’s one of the risks.

Run on the bank?

No bank can handle a situation where every depositor wants to withdraw his money at the same time. Such scenarios may create unnecessary panic and pushes RBI to impose moratoriums.

Let us look at the bank from an eye of a depositor, a new investor & an existing investor. What is the best course of action for each of them?

Are you a depositor in the bank?

You can continue your accounts. AU bank is a scheduled commercial bank, and RBI has rescued all depositors of all such banks – including Yes Bank and Lakshmi Vilas Bank recently. There’s enough of a capital buffer and then, there’s also a government guarantee; but more importantly, depositors in India in a scheduled bank haven’t seen losses.

The bank has total deposits of 37,014 Cr and loans of 36,635 Cr. It has a Tier 1 capital of 6172 Cr. It has investments of Rs 10,815 Cr of which G-Secs stood at 7780 Cr. They also have 1569 Cr cash balance with RBI & another 3212 Cr with other banks, which they can call at short notice.

In total, the bank has liquidity of approx 21,000 Cr. The remaining 16,000 Cr can be arranged via sale of assets (36,635 Cr) to an ARC at a discount of 55%. So even if things go south, the bank is in a position to pay back its depositors.

How safe is AU Small Finance Bank?As a depositor, we don’t think there’s significant risk and a need to take any action.

Are you an AU Bank shareholder?

Even if you are a long-term investor, there’s a lot here that is unknown. One way to deal with a fall like this is to follow a strict (trailing) stop loss. Things can go awry quickly, and whether the bank can be trusted or not is a bet that many people will be taking, and some will know more than you. If the bank’s shares continue to fall, there could be more to the story than we know. Unless you know everything about the bank, we just have to respect the price action. Bhav bhagwan che!

Let’s look at past instances. Yes Bank tanked 29% in a single day, on September 21, 2018, after RBI said they won’t allow Rana Kapoor to continue as CEO after January 2019. This sounds like a silly reason for a big bank – with 200,000 cr. in assets – to fall nearly a third in one day! Of course they would find a different CEO, no? But apparently, there was more to it. And when the stock showed some signs of recovery in the next month, it continued to fall afterwards, and trades at Rs. 11 now. You might have lost 30% then, but you would have saved yourself another 60% if you had continued to hold.

We wrote about Yes Bank: Are Yes Bank deposits safe? Will the stock price recover?

Yes Bank ChartAnother example: RBL Bank. Again, a decent bank, from the depositor’s point of view. But they only mentioned “some challenges in the near term” and the stock tanked 14% then. Since then, the stock has continued its fall, and a trailing stop would have been beneficial. The near-term challenges have actually not become long term problems for the bank – yet, it’s stock price doesn’t seem to have responded.

We wrote about why depositors didn’t need to worry but investors did: Why RBL Bank and IndusInd Bank may not be the next Yes Bank

RBL Bank Chart

In both the above cases, the underlying bank was stable – no depositor lost any money. Both banks have enough customers even today, and operationally, are forward looking as well (technologically speaking). Yet, the return made by shareholders has been abysmal since the advent of some bad news. The price reflected the problem. One simple way to participate is through a trailing stop loss – for example, sell if it goes below the “low” of the bad-news day. And buy back if it goes back to the “high” (assuming no further unfavourable news has come about).

Results for AU Bank will come in October, and that might provide more colour. There could be no problem at all, and if you do exit because of price action, you may have to reenter at a higher price, if things are actually in good shape. This is how markets are – there is no place for regret.

How safe is AU Small Finance Bank?

Au Bank 1 year Price chart


New Investors: Are you looking to buy the stock?

Probably not yet, because there are too many unknowns. Buying into a stock that is falling and falling hard typically does not end well. Particularly if it is a financial company. A lot of what happens is unknown, and knowing that you don’t know enough is the first thing to admit.

The valuations are stretched at 6 times Price to book. Any shocker in terms of increased NPA may trigger a de-rating. Bandhan, Ujjivan are examples where the market revised its view for the worse.

The company had a conference call to address all the issues raised by the investors. They reinforced that the exits are mainly due to personal reasons. They acknowledged the delay in public disclosure of resignation, due to retention discussions. 

We had seen circumstances in the past where investors had same apprehensions on banks like RBL, Indusind, IDFC First Bank etc. Sure, they may be having some risky assets. But they are likely to come out for the better, as a bank. As a stock, some of them continue to languish for years. Assigning parallels may be unwarranted at this point in time.

Overall, depositors in AU Bank can stay put. Equity investors should wait for more clarity before they take the plunge.

This article is for information only, and should not be considered as a recommendation to buy or sell any stocks.

How safe is AU Small Finance Bank? 


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