Ambit AUSmallFinanceBank PreIPO MovingtothePremierLeague 28apr2017 PDF

AU Small Finance Bank
NOT RATED
PRE-IPO NOTE April 28, 2017
BFSI
Moving to the Premier League
Details of IPO
AU Small Finance Bank stands out among emerging SFBs given already
Current promoter holdings 36.0%
thriving secured retail assets business with superior profitability (avg.
RoE of ~24%; FY14-1HFY17). A 12-year transformation from HDFC - by Mr. Sanjay Agarwal 20.6%
Banks channel partner to diversified NBFC provided expertise in - by other promoters 15.5%
small-ticket asset-backed lending in underserved markets with Fresh issue Nil
controlled asset quality and operational efficiency. In transitioning to a Offer for sale 18.6%
bank, RoE could bottom at 15-16% vs single-digit RoE for other new
- by Mr. Sanjay Agarwal 0.9%
banks/SFBs. Comparing with vehicle/MSME lenders suggests valuation
of up to 4x BV is justified. Advise seeking clarity on whether AUSFB has - by other promoters 2.1%
people/systems for the demanding next phase of growth as a bank. - by other investors 15.6%
Promoter holdings post-IPO 33.1%
DNA of entrepreneurship
Source: Company, Ambit Capital research
Set up in 1996, AUSFB has undergone multiple transformations from being a
channel partner to HDFC Bank, an auto NBFC, a diversified retail NBFC and Key questions for management
now a small finance bank. The company also incubated a housing finance Current business
subsidiary, stakes in which were divested at 4.8x BV. Management thus shows What is the risk of larger banks pushing
willingness to successively take on bigger challenges with focused execution. loan pricing down in your customer segment
or forcing you to move into riskier segments
What differentiates AUSFB from peers? to protect yields?
Do you seek to deepen presence in existing
AUSFB compares well with peers on profitability (24% RoE) and has superior home states or expand to other states that
AUM growth (3-year CAGR of 31%). Secured small-ticket auto/MSME/SME could be more competitive markets?
lending (85% of AUM below `2.5mn ticket size) to low-middle income (LMI) Given average ticket size of `20mn-25mn in
customers in underserved home markets drives high yields (~17%). Despite rapidly growing SSF book (22% of AUM),
with exposure to construction finance and
lending to LMI segment, asset quality is healthy (FY12-1HFY17 credit cost of other NBFCs, what would be the impact of
70bps), and despite small-ticket lending, operations are cost efficient (cost- slowing real estate and uncertain informal
income ratio of 37-39%). A hybrid business model, imparting the best of bank economy on growth and asset quality?
and NBFC models, and conservative lending help asset quality. Use of
Evolution into an SFB
innovation and technology as business enabler boosts cost efficiency. Given the momentum in your assets
Bank transition would be least disruptive for AUSFB business, what sort of targets and strategy
do you have for the newly built bank team
Unlike other new banks/SFBs that are likely to record near single-digit RoE on liabilities and fee income?
during bank transition and face challenges on both sides of balance sheet, What key organisational, HR, and
AUSFBs RoE could bottom out at 15-16%. An already firing secured retail operational challenges do you face in the
transition from an NBFC to a bank? How
assets engine allows AUSFB to build liabilities with strategic focus on sticky will you do it differently from the earlier
customers and better cross-sell opportunities between two sets of customers. breed of new banks?
What is your choice between calibrated
Valuations: Peer benchmarking supports a valuation up to 4x BV organic growth over the long term and
AUSFB is among best-in-class on risk-adjusted profitability and growth vs retail opportunistic inorganic expansion to build
market share?
NBFCs, SFBs and small banks focused on MSME/trade. Bank license gives
What level of steady state RoE and loan
AUSFB an edge over NBFCs. AUSFB faces less disruption and low execution risk growth you aspire as an SFB?
than other SFBs during the bank transition. Compared to small banks, AUSFB
scores in terms of formidable assets franchise even as bank liabilities franchise
is yet to take shape. Comparison on risk-adjusted profitability shows SUF and Research Analysts
BAF as closest comparable peers (which trade at on average 5.8x FY17 BV). Ravi Singh
+91 22 3043 3181
Key financials
ravi.singh@ambit.co
FY13 FY14 FY15 FY16 1HFY17^
Total AUM (` mn) 37,043 44,490 55,677 82,213 93,684 Pankaj Agarwal, CFA
Net profits* (` mn) 694 725 1,395 2,472 1,685 +91 22 3043 3206
Credit cost (%) 0.43% 1.22% 0.88% 0.34% 0.52%

ravi.singh@ambit.co
RoE* (%) 16.8% 14.0% 20.4% 28.0% 24.8% Rahil Shah

Source: Company, Ambit Capital research; Note: *Before exceptional; ^credit cost and RoE are +91 22 3043 3217
annualised
rahil.shah@ambit.co
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
The DNA of entrepreneurship

Set up in 1996 by a first generation entrepreneur, AU Small Finance Bank
(AUSFB) has undergone several transformations. The initial company
received its first break as a channel partner of HDFC Bank in originating
vehicle loans and rechristened itself as Au Financiers (AuF) in 2005. In 2008,
AuF converted into an NBFC (focused on vehicle financing) to build its own
loan book. Supported by capital infusion from private equity since 2008, the
company scaled up its AUM by 56% CAGR (FY08-1HFY17) and diversified its
book away from vehicle finance to MSME/SME finance. Rajasthan accounts
for 56% of AUM. Having received the final bank license in December 2016,
on 19 April 2017 the company formally commenced its banking operations as
AU Small Finance Bank.
Exhibit 1: Timeline of the companys evolution
Event
1996 The company is set-up as L. N. Finco Gems Pvt. Ltd.
2000 The company is registered as an NBFC, acting as loan origination partner for banks.
2005 Name of the company changed to Au Financiers
2005 Becomes a channel partner of HDFC Bank to originate vehicle loans on risk-sharing basis
2006 Expands operation in Maharashtra
2008 Receives 1st round PE funding of `200mn from Motilal Oswal PE
2008 Began originating loans under its own book
2009 Expands operation to Gujarat
2009 Receives 2nd round PE funding from IFC (`350mn) and Motilal Oswal (`200mn).
2010 Launches MSME loan business
2011 Sets up a housing finance subsidiary - Au Housing Finance
2012 Receives 3rd round PE funding from Warburg Pincus (`1,500mn) and IFC (`330mn).
2012 Launches its SME loans business
2014 Receives 4th round funding of `1,245mn from existing investors.
2015 Received in-principle small finance bank (SFB) license from the RBI
February 2016 Divests 90.1% stake in Au Housing Finance to a PE consortium
December 2016 Receives final approval from the RBI to set up a small finance bank license.
April 2017 Converts into an SFB and renamed as AU Small Finance Bank
Genesis of the company

A first-generation entrepreneur, Mr. Sanjay Agarwal started this professional journey The original firm, set-up in 1996,
when he set up L.N. Finco Gems Pvt. Ltd in 1996. The firm operated as a fund managed began with asset
manager providing custodian services for funding received from HNIs of Rajasthan for financing in Rajasthan.
asset financing (vehicle loans), public issue management and merchant banking
services. The company managed AUM of `34mn at end-FY04.
Learning to walk under watchful eyes
As the business scaled-up and familiarity with asset financing in Rajasthan developed, Struck a partnership with HDFC
in 2005, the company changed its name to Au Financiers (AuF) and ventured into Bank for vehicle financing in 2005.
channel business with HDFC Bank and expanded its operations in Maharashtra.
Working with perhaps the best lender led to a steep learning curve for the small firm.
By end-FY08, AuF managed AUM of `2,122mn (implied CAGR of 181%, FY04-08)
Standing up on its own seeking the right partners
However, seeing the vast opportunity ahead of it and not being content with being a In 2008, AUF started its own
junior partner in the business-relationship, AuF decided to venture on its own. In journey.
2008, AuF converted into an NBFCAFC and entered into the lending business.
By 2008, the company was also facing the dilemma which most early-stage successful Capital infusion from PEs boosted
entrepreneurs face do they be content with their early success and continue on their the capacity.
April 28, 2017 Ambit Capital Pvt. Ltd. Page 2

own closely holding on to their firm OR seek external capital to boost capacity and let
go of some equity in exchange for strategic partnership? AUSFB chose the latter.
The company received capital infusion of `4.4bn over 2008-2014 from investors -
Motilal Oswal PE, International Finance Corporation (IFC) and Warburg Pincus. This
led to the shareholding of promoters declining to 36% by Feb-17. During these years
(FY08-FY14), AUM grew at a CAGR of 66%.
In FY13, AuF also incubated Au Housing Finance, whose AUM grew to ~`17bn by
end-FY16. In Feb16, after receiving a bank license, AuF divested 90% stake in the
HFC to a PE consortium for a consideration of `9.3bn, implying a valuation of 4.75x
FY16 BV.
IPO an offer for sale
In September 2015, AuF was one of the 10 entities that received in-principle small IPO is an 18.6% offer for sale with
finance bank licenses. After getting the final license in December 2016, AuF has no fresh capital raising.
converted itself into AU Small Finance Bank on 19 April 2017. Having filed its DRHP
in February 2017, the company is expected to soon launch its IPO as per media
reports (https://goo.gl/hzLlI0). This will be only offer for sale by investors for 18.6%
shareholding with no fresh capital-raising. The reported valuations imply a
valuation of 4.3x 1HFY17 BV (adjusted for pre-IPO capital infusion.
Exhibit 2: Key holdings pre- and post-IPO
% of total shares
Key shareholders Current Holding Offer for sale Post-IPO holdings
Promoters: 36.0% 3.0% 33.1%
Mr . Sanjay Agarwal 20.6% 0.9% 19.7%
Ms . Jyoti Agarwal 5.0% 0.8% 4.2%
Ms . Shankuntala Agarwal 5.0% 0.8% 4.2%
Mr . Chiranji Lal Agarwal 2.9% 0.5% 2.4%
MYS Holdings Pvt. Ltd. and others 2.7% 0.0% 2.7%
Non-promoters 64.0% 15.6% 66.9%
Warburg Pincus group 21.0% 5.2% 15.8%
IFC 10.7% 2.7% 8.0%
ChrysCapital 7.9% 4.0% 4.0%
Ourea Holdings (Kedaara Capital) 7.4% 3.6% 3.8%
SBI Life Insurance Co. 1.7% 0.0% 1.7%
Kedaara Capital AIF 0.3% 0.2% 0.2%
Others: 13.2% 0.0% 31.8%
Total Shares 100.0% 18.6% 100.0%
Promoters: 36.0% 3.0% 33.1%
Exhibit 3: Reported IPO valuation, as quoted in media reports*

Likely Valuation
Expected Issue size (` mn) 15,000
Expected valuation for AUSFB (` mn) 80,684
Expected issue price (`/share) 284
Net worth (1HFY17) 17,136
Pre-IPO capital infusion 1,715
Number of Shares (#) 284
Trailing BV (1HFY17, adj. for pre-IPO capital) 66.3
Trailing P/BV 4.3
Source: Company, Ambit Capital research;* https://goo.gl/Drx89t

What differentiates AUSFB?

We benchmark AUSFB with peers from vehicle financing NBFCs, business-
financing NBFCs, SFBs and small banks. Although smaller (AUM of `93bn at
end-1HFY17), AUSFB compares favorably on profitability (RoE of 24-25%) and
has superior AUM growth rate (31% CAGR in FY14-16). Using analytical
framework of IBAS (innovation, brand & reputation, architecture and
strategic assets) shows AUSFB has the sustainable competitive advantages of
a proven working model for small-ticket secured lending along with deep
knowledge of underserved home markets. High yields (~17%) in the chosen
market segment along with superior asset quality (credit cost of 40-50bps in
FY16-1HFY17) and controlled operational efficiency (cost to income of 37-
39%) support RoE. Further, capability to use technology/innovation as
business enablers is also a key competitive strength. However, there are
challenges too in building the brand further and managing a more
demanding scale-up as a bank than what the company executed in the past.
We believe the following key competitive advantages covered in our IBAS

framework have facilitated the companys journey so far and would help it execute its
strategy as an SFB in the coming years:
1. Retail focus on small-ticket secured lending.
2. Deep knowledge of operating in underserved markets in home regions.
3. Improving profitability driven by structural underlying drivers.
4. Healthy asset quality provided by conservative underwriting.
5. Track record and an organisation conducive to innovation/technology.
Using the same framework, key challenges in front of AUSFB in our view are:
1. Building a well-known brand beyond its niche geography and customer segment.
2. Protect the reputation while managing higher compliance and operational risk
benchmarks that become applicable as a bank.
3. Managing a more complex organization with addition of multiple assets and
liabilities products, newer geographies and bank functions.
As we detail out our discussion on the companys competitive advantages, we also
put forward key questions for the management in pre-IPO phase to have a better
clarity on how it is planning to meet key challenges ahead of it.

Exhibit 4: A comparison with peer NBFCs and banks

Latest as available AUSFB SHTF MMFS SUF MGMA CIFC SCUF BAF CAFL Equitas Ujjivan CUBK DCBB RBK
Loan book / AUM, ` bn 94 788 433 200 173 327 225 576 160 72 66 218 158 268
Loan/AUM breakup
Vehicle loans 51% 100% 100% 100% 71% 68% 6% 9% 9% 26% 4%
MSME/SME loans 49% 11% 3% 55% 31% 60% 21% 5% 51% 12% 18%
- MSME loans 28% 15% 13%
- SME loans 22% 16% 48%
Other retail 19% 29% 39% 55% 31% 53% 95% 19% 50% 14%
Agri 15% 18% 7%
Corporate 6% 14% 16% 62%
Retail 100% 100% 100% 100% 100% 100% 100% 94% 100% 100% 100% 86% 84% 38%
Non-retail 0% 0% 0% 0% 0% 0% 0% 6% 0% 0% 0% 14% 16% 62%
Du-pont (FY16)
Cost of funds 10.0% 10.9% 9.5% 9.7% 10.2% 9.8% 9.8% 9.2% 8.8% 11.3% 11.4% 7.6% 7.2% 6.5%
Yields on AUM 17.1% 16.7% 16.1% 11.7% 16.5% 14.0% 20.5% 18.2% 16.7% 20.0% 21.5% 10.4% 10.2% 8.5%
Spread 7.1% 5.8% 6.6% 2.1% 6.3% 4.2% 10.7% 9.0% 7.9% 8.7% 10.1% 2.8% 3.0% 2.0%
NIMs 9.5% 7.8% 9.1% 5.9% 6.7% 6.4% 13.2% 10.5% 5.3% 9.8% 10.4% 3.3% 3.5% 2.5%
Non-interest income 0.1% 0.1% 0.1% 0.9% 0.2% 1.2% 0.1% 1.1% 1.2% 1.6% 1.9% 1.4% 1.3% 1.5%
Total income 8.7% 7.9% 9.3% 6.7% 6.9% 7.6% 13.3% 11.7% 6.5% 10.8% 12.0% 4.7% 4.8% 4.0%
Total opex 3.4% 2.0% 3.3% 2.6% 3.3% 3.0% 5.6% 5.1% 3.3% 5.7% 6.1% 1.9% 2.8% 2.3%
Cost to income 38.6% 25.4% 36.1% 39.2% 48.2% 39.4% 42.3% 43.7% 50.7% 53.0% 50.8% 40.1% 58.4% 58.6%
Operating profit 5.4% 5.9% 5.9% 4.1% 3.6% 4.6% 7.7% 6.6% 3.2% 5.1% 5.9% 2.8% 2.0% 1.6%
Credit cost 0.3% 3.2% 3.0% 0.4% 2.0% 1.5% 3.3% 1.4% 1.6% 0.9% 0.5% 0.8% 0.5% 0.3%
RoA 3.3% 1.8% 1.9% 2.6% 1.1% 2.0% 2.9% 3.3% 1.1% 2.7% 3.5% 1.5% 1.1% 0.9%
Leverage 8.5 6.6 6.0 5.9 10.3 9.0 4.2 6.2 9.3 5.0 5.2 10.3 10.7 12.7
RoE 28.0% 12.0% 11.4% 15.2% 11.6% 18.0% 12.1% 20.9% 10.1% 13.3% 18.3% 15.5% 11.9% 11.2%
Operating performance
No. of employees 5,072 19,170 15,821 3,465 9,073 13,590 25,472 7,394 1,412 6,275 8,049 4,517 4,248 3,656
Branches 291 853 1,167 569 234 534 976 NA 222 549 469 525 198 193
Employees/branch 17.4 22.5 13.6 6.1 38.8 25.4 26.1 NA 6.4 11.4 17.2 8.6 21.5 18.9
AUM/employee (` mn) 16.2 38.0 24.0 51.6 20.0 21.9 7.7 59.8 113.6 9.8 6.7 46.6 30.4 58.1
Emp. cost/employee (` k) 366 307 372 614 336 190 203 1,011 1,425 373 260 480 645 1,039
Employee cost/AUM 2.1% 0.9% 1.7% 1.0% 2.5% 0.8% 2.7% 1.7% 1.0% 3.7% 3.9% 0.7% 1.4% 1.1%
Other opex/AUM 1.3% 1.1% 1.6% 1.6% 0.8% 2.1% 2.9% 3.4% 2.3% 2.0% 2.2% 1.2% 1.4% 1.2%
Cost to income 38.6% 25.4% 36.1% 39.2% 48.2% 39.4% 42.3% 43.7% 50.7% 53.0% 50.8% 40.1% 58.4% 58.6%
Asset Quality
Gross NPAs 0.64% 6.18% 8.00% 2.03% 8.05% 3.50% 3.57% 1.26% 1.07% 1.34% 0.15% 2.43% 1.52% 0.98%
Net NPAs 0.38% 1.91% 3.20% 0.90% 6.44% 2.10% 0.66% 0.29% 0.55% 0.94% 0.04% 1.53% 0.75% 0.59%
Credit cost 0.37% 4.92% 2.90% 0.47% 1.99% 1.55% 3.40% 1.92% 1.69% 1.17% 0.58% 1.16% 0.56% 0.59%
Capital position
Tier-1 22.5% 14.2% 14.6% 14.8% 14.6% 13.3% 23.8% 16.1% 14.5% 22.7% 22.4% 15.1% 12.8% 11.1%
CRAR 24.7% 16.6% 17.3% 18.4% 4.1% 19.7% 26.6% 19.9% 19.8% 22.7% 24.1% 15.6% 14.1% 12.9%

#1 Retail focus on small ticket secured lending

Almost AUSFBs entire assets book is secured lending against income-
generating assets. Starting with vehicle finance, the company diversified into
MSME, SME, NBFC and construction finance. The bank has a proven track
record in vehicle finance and MSME lending, where it outperforms peers on
growth and asset quality. While extending same conservative practices to
larger ticket lending in the SSF segment (SME, NBFC and construction
finance), growth has however been strong. The SSF loan book is perhaps yet
to be seasoned enough to provide conclusive comfort on asset quality.
The companys loan book consists almost entirely of small-ticket lending secured ~85% of the portfolio ticket size is
against income generating assets. As of now, ~85% of the portfolio ticket size is less less than `2.5mn
than `2.5mn (vs requirement of 50% for SFBs). Three key segments in the companys
loan book are vehicle finance, MSME loans and SSE (SME, NBFC and structured
finance). Since end-FY13, growth of the vehicle finance book has slowed and now
accounts for 51% of AUM (vs 79% at end-FY13). The MSME and SSF books have
grown faster and account for 28% and 22% of AUM respectively at end-1HFY17.
Exhibit 5: The book has diversified from vehicle finance Exhibit 6: Growth trends of SSF, MSME and vehicle books
100% Vehicle MSME SSF

9% 9% 6% 10%
90% 7% 19% 22% 22% 230%
10% 15%
80% 20%
70% 25% 180%
27% 28% SSF
60%
50% MSME
84% 81% 79% 130%
40%
70% Vehicle
30% 57% 51% 51% 80%
20%
10%
30%
0%
1HFY17
FY11
FY12
FY13
FY14
FY15
FY16
-20%
FY12 FY13 FY14 FY15 FY16 1HFY17
Source: Company, Ambit Capital research Source: Company, Ambit Capital research
Vehicle Finance flexible, nimble approach to the business

Small ticket focus: In its vehicle finance book, the company lends to customers in
the self-employed, first-time users/buyers and small road transporter (SRTOs)
categories. Focus customers are in the low middle to middle income segments.
Vehicle finance book is also highly diversified across categories (exhibit 7) such as
cars, UVs, CV/CE and three-wheelers. MUVs (multi-utility vehicles), cars and small
CVs account for 81% of total AUM (end-1HFY17). These are usually not vehicles for
personal use but predominantly used for income generating activities.
Exhibit 7: Within vehicle finance, the book is diversified across vehicle categories
100%
90% Dealers
9% 5% 3% 3%
80% 22% 15% CEs
70% 23% 22%
24% 3Ws
60% 22%
18%
50% 16% Tractors
20% 24% 26%
40% 18% 19% MHCVs
16%
30%
LCVs
20% 34% 34%
28% 31% 32% 33%
10% SCVs
0% Cars

The average ticket size is `0.3mn-0.6mn and loan tenor is 30-60 months. Loan yield
in the segment is ~18%. Loan amount is capped at ~`2.5mn.
Exhibit 8: Snapshot of vehicle finance products
average ticket Typical loan tenor
Target segment Security Typical yields
size (months)
Rural, Semi-urban & Vehicle +
`0.3mn-`0.6mn 30-60 ~18%
low income (urban) Guarantor
From CVs to PVs: As CV sales began to slow and the CV segment saw increasing Loan mix has moved from CVs to
delinquencies in FY13, the share of the MHCV book shrunk sharply from 22% at end- PVs
FY13 to 3% at end-1HFY17. MUVs, cars and small CVs have been the key drivers of
growth in the segment since FY14.
From new to old: The company has also moved towards the used vehicle segment and new to old vehicles
with ~35% of incremental disbursements now taking place in used vehicles. On a
blended basis, old vehicles form ~25% of total vehicle finance AUM.
Outperforming auto NBFC peers on growth and asset quality: While the
company slowed growth of its vehicle finance book, this trend was in-line with other
auto NBFCs as well (see exhibit 9). AUSFB outperformed peers on average growth in
vehicle finance during FY12-1HFY17 (see exhibit 10).
Exhibit 9: Vehicle finance growth rates have been volatile Exhibit 10: On average, AUSFB has outpaced vehicle
across auto NBFCs finance AUM growth
FY13 FY14 FY15 FY16 1HFY17 Vehicle finance AUM CAGR (FY12-1HFY17)
50% 35% 31%

40% 30% 26%
30% 25% 22%
20% 20%
15%
10% 15% 11%
0% 10% 6%
-10% 5%
-20% 0%
AUF SHTF MMFS SUF MGMA CIFC AUF CIFC MMFS SHTF SUF MGMA
However, the key outperformance of the company vs its auto NBFC peers was on
asset quality. The company continues to have one of the lowest NPA ratios among its
auto NBFCs peers.
Exhibit 11: AUSFB has outperformed its auto NBFC peers on NPA ratios
FY13 FY14 FY15 FY16 1HFY17
12.0% 11.0%
10.0% 9.2%
8.0% 6.6%
6.0%
3.8%
4.0%
1.6% 1.9%
2.0%
0.0%
AUF SHTF MMFS SUF MGMA CIFC
Source: Company, Ambit Capital research; This chart compares AUSFBs overall NPAs with overall NPAs of peer
companies. AUSFBs NPA in vehicle finance is closer to 2.5-3.0%, on 120DPD basis.

MSME Leading the diversification away from vehicle finance

Rapid scale-up of granular small-ticket MSME book: MSME as a segment was A highly granular MSME book
launched in FY11. It has grown at a CAGR of 58% in FY14-16, increasing its share of caters to similar a customer profile
total AUM to 28% as at end-1HFY17 vs 15% at end-FY12. Beginning as an offshoot as in the core vehicle finance.
of relationships built in vehicle finance, the company lends to MSMEs for business
expansion, working capital and equipment purchase. In almost all cases, self-
occupied residential/commercial property is the security (with average LTV of ~40%
at end-FY16). The average ticket size is `1.0mn and a typical loan tenor is 60-120
months. Its customers in the segment are businesses with annual turnover of `1mn-
10mn. Loan size is capped at ~`5mn. Average loan yield is ~18%.
Exhibit 12: Snapshot of MSME loan products
Average Typical loan tenor Typical
Target segment Security
ticket size (months) yields
Turnover > `1.0mn but self-occupied
~`1.0mn 60-120 ~18%
< `10mn residential/commercial property
Outperforming peers on MSME book growth and asset quality: A comparison AUSFBs MSME lending has faced
with NBFC and bank peers with significant presence in MSME lending shows that little competition from other
growing from a small base, AUSFB outperformed on growth and maintained better banks/NBFCs, so far.
asset quality. However, there is little distribution overlap with peer NBFCs and banks
in the MSME lending business as most of AUSFBs SME loan book is concentrated in
About 40-45% of AUSFBs
the very small ticket segment (~`1mn), where peers do not have much presence.
customers are new-to-formal
Most of AUSFBs MSME customers are first time customers to formal financial systems.
credit.
Thus, up to 40-45% of AUSFBs customers are new to credit, where AUSFB has strong
bargaining power in terms of yield and asset quality control.
Exhibit 13: MSME finance has in general been a growing Exhibit 14: On a low base, AUSFB has posted strong
segment for the industry (YoY AUM/loan growth) growth in its MSME book
FY13 FY14 FY15 FY16 1HFY17 MSME finance AUM CAGR (FY12-1HFY17)
100% 90%
77%
80% 80%
60% 70%
60%
40%
50% 45%
20% 39%
40%
0%
30%
-20% 17%
20%
-40% 10% 1%
-60% 0%
AUF SCUF CIFC CUBK DCBB AUF DCBB SCUF CUBK CIFC
Exhibit 15: AUSFB has performed well on NPAs compared to its peer MSME lenders
FY13 FY14 FY15 FY16 1HFY17
6.0%
5.0%
5.0%
4.0%
2.7%
3.0%
1.6% 1.8%
2.0%
1.0%
1.0%
0.0%
AUF DCBB SCUF CUBK CAFL
Source: Company, Ambit Capital research; This chart compares AUSFBs overall NPAs with overall NPAs of peer
companies. AUSFBs NPA in MSME is sub-1%, on 120DPD basis.

SME and structure finance (SSF) The chunkier part of the book
Separate segmentation to reflect nature of the book: The origin of SSF segment
lies in loans initially given to other smaller auto NBFCs. These loans were initially part
of the overall vehicle finance book. The SSF segment now has three sub-segments:
(1) SME, (2) loans to NBFCs/HFCs/MFIs, and (3) construction finance.
To differentiate against the MSME segment, this separate segment caters to SSF segment is relatively chunkier
businesses with turnover of more than `10mn. Average ticket size is `20mn-25mn portion of the overall loan book.
with maximum ticket size of `200mn. The lending is secured against property or
receivable with average LTVs of ~40%. Average loan yields are ~16%.
Exhibit 16: Snapshot of SME product
Target segment Security Average LTV Average ticket size Typical yields
Turnover > `10mn Property/Receivables ~40% `20-`25mn ~16%
This segment has scaled up primarily since end-FY13 (6% of AUM) and now accounts
for 22% of total AUM (at end-1HFY17). SME, NBFC and construction finance broadly
account for 40%, 30% and 30%, respectively, of the SSF book. As the company
transitions into a small finance bank, this division will shift to the wholesale banking
segment of the SFB.
Exhibit 17: Current estimated break-up of SSF book
30% SME
40%
NBFC
Construction finance
30%
Stable asset quality but recent strong growth indicates risk: From just `4bn at Recent rapid growth in SSF
end-FY14, the SSF book has grown by ~5x to `20bn (22% of AUM) at end-1HFY17. segment and external headwinds
While reported NPAs are reported to be low, rapid growth in recent years means a could test the asset quality in the
large part of the book is yet to be seasoned enough to have a last word on asset book.
quality. While the experience of scaling up secured books in vehicle finance and
MSME books with respectable asset quality provides some comfort, we are watchful of
the asset quality risks due to: (1) higher ticket sizes of `20-25mn in the segment vs
less than `1mn average ticket sizes in vehicle finance/MSME; and (2) weakness in the
real estate sector along with stress in the informal economy due to the Governments
crackdown on cash and tax non-compliance.
Key questions for management on lending focus
While the MSME segment is very similar to the companys core book and
customer segment in vehicle financing, loans in SSF segment are much larger.
What has led to building the SSF book that has grown ~5x in last three years to
account for 22% of total AUM? Do you see any risk to the asset quality in this
segment given the overall weak external environment for SMEs/developers and
small NFBCS?
What is likely to be the growth trends in the core vehicle financing book
considering the weakness in industry auto sales and increasing competition from
larger banks?
What are growth drivers in the MSME book? Is there any risk due to disruption
caused by the Governments ongoing crackdown on the informal economy?

#2 Deep knowledge of operating in under-served

markets in home regions
Starting its operations in Rajasthan, the expansion has largely been in
familiar geographies in the neighbouring states such as Gujarat,
Maharashtra, Madhya Pradesh, Delhi and Punjab. However, Rajasthan still
accounts for 56% of the AUM. The company has demonstrated a deep
understanding of regions of its core presence through scale-up and asset
diversification. Even when expanding to a new state, expansion usually
begins with contiguous areas (e.g. districts in Madhya Pradesh on Rajasthan
Border) before better understanding of the market allows further expansion.
In some cases, places with economic links with existing customer base (e.g.
Pune in Maharashtra due to its auto and allied industries links with vehicle
finance book) provide expansion opportunity. Given focus on the self-
employed and low middle income groups, these states have proven to be
fertile ground given dominance of rural and semi-urban centres and lower
formal credit penetration in these states.
Started from Rajasthan; calibrated expansion into familiar geographies: A calibrated approach towards
AUSFB started its journey in Rajasthan and built its business in the state in the first 10 geographic expansion has led to
years. Then it began expanding in the adjoining states, which allowed better control superior execution.
on its operations/strategy benefiting due to familiarity with the local economies in
these states. While expanding to new states, the company usually follows a strategy
to start from an area that is contiguous with an existing geography (e.g. a district in
Madhya Pradesh on the Rajasthan border). Once this allows better understanding of
the area, customer behavior and business potential, a wider expansion in the new
states takes place. AUSFB has expanded to Maharashtra (FY06), Gujarat (FY09),
Madhya Pradesh, Punjab and Goa (FY11), Delhi (FY13), Haryana (FY14) and
Himachal Pradesh (FY14). The top 6 states account for 95% of AUM with Rajasthan
accounting for 56% of AUM.
Exhibit 18: State-wise AUM distribution
Rajasthan Maharashtra Gujarat Madhya Pradesh Delhi Punjab Others
100%
80% 30% 27% 20% 14% 12% 12%

13% 13% 13%
60% 13% 15% 15%
40%
54% 54% 59% 58% 56%
50%
20%
0%
Lower credit penetration and dominance of rural and semi-urban centres in If executed right, key home
the home geography: AUSFBs key geographies of operation Rajasthan, markets provide good runway for
Maharashtra, Gujarat and Madhya Pradesh (MP) are marked by low penetration of the growth.
formal financial services and high share of rural and semi-rural centres (excluding
Maharashtra, where state-wise figures are impacted by metro centres such as
Mumbai). The exhibits 19 and 20 show that credit to GDP and CASA to GDP in
Rajasthan, MP and Gujarat are much lower than national averages. This, in our view,
reflects lower penetration of formal financial services. This provides a focused lender
with capital, stable process/systems and conservative lending practices a long runway
of strong growth.

Exhibit 19: AUSFBs key geographies have low credit Exhibit 20: However, CASA mobilisation is comparable to
penetration (measured as credit to GDP, end-FY16) the national average (CASA deposits to GDP, end-FY16)
140% 35%
120% 30%
100% 25%
80% 20%
60% 115% 15% 30%
25%
40% 10% 21% 19% 17%
20% 54% 39% 32% 28% 5%
0% 0%
Rajasthan
Rajasthan
All India
Madhya
All India
Madhya
Gujarat
Gujarat
Pradesh
Pradesh
Maharashtra
Maharashtra
Source: Company, Ambit Capital research; The figure of Maharashtra is Source: Company, Ambit Capital research; The figure of Maharashtra is
impacted hugely by metro centers, such as Mumbai impacted hugely by metro centers, such as Mumbai
This nature of AUSFBs markets is reflected in the higher share of non-metro/urban Branch network mix would stay
branches in the distribution network. As per AUSFBs branch plan for FY18, about largely rural and semi-urban.
62% of its total bank branches and 80% of its Rajasthan branches would be in rural
and semi-urban areas. This is also reflective of existing distribution network that
AUSFB maintained as an NBFC. These centres not only have lower competition from
large private sector banks but also provide the opportunity to grow the customer base
and loan book by taking market share from PSUs, co-operative banks and informal
financiers.
Exhibit 21: Proposed distribution of AUSFB branches by end-FY18
Metropolitan Urban Semi-Urban Rural Rural and semi
Total
Tier 1 Tier 1 Tier 2 Tier 3 Tier 4 Tier 5 Tier 6 urban
Rajasthan 7% 13% 11% 23% 10% 9% 28% 80% 100%

Maharashtra 21% 28% 12% 4% 4% 5% 26% 51% 100%
Gujarat 16% 36% 7% 11% 5% 4% 21% 48% 100%
Madhya Pradesh 10% 31% 14% 20% 4% 22% 59% 100%
Punjab 4% 50% 17% 8% 21% 46% 100%
Other states 33% 42% 9% 7% 0% 0% 9% 24% 100%
Total 13% 25% 11% 16% 6% 6% 24% 62% 100%
Key questions for management on geographical focus

What are your plans for reducing the concentration risk due to high exposure to
Rajasthan (56% of AUM)?
Do you plan to deepen your penetration in existing home states or expand in
other geographies which are highly competitive, e.g. south India?
With intensifying competition from both incumbent and new banks, are you
seeing rising competitive intensity in your home states that have so far been less
penetrated by the formal financial system?
How do you build teams in new geographies? What are usual profiles of your
new hires in terms of nature of prior experience, skills and age? How do you
build the brand awareness and client base in new geographies? What are key
observations on differences in customer and employee behaviors across different
states and how has that shaped your expansion?

#3 Improving profitability driven by structural

underlying drivers
AUSFBs RoE improved from an average of ~15% during FY12-14 to ~24%
over FY15-1HFY17. While asset quality has been stable, improvement in NIM
to ~10% and cost-to-income ratio (37-39%) has driven RoE expansion. NIM
expansion was led by (a) fall in cost of funds (from 12% in FY12 to 10.2% in
1HFY17 amid rating upgrades and benign liquidity in recent years); and (b)
AUM yields supported by pricing power in the chosen customer segments and
change in loan mix. Strong income traction with controlled operating
efficiency is behind the improvement in the cost-to-income ratio.
Exhibit 22: Average RoE of 24% (FY15-1HFY17) vs 15% Exhibit 23: led by improvement both in NIM and
during FY12-14 cost-income ratio
RoA (LHS) RoE (RHS) NIM (LHS) CI ratio (RHS)
4.0% 30% 12.0% 52% 60%

3.5% 25% 10.0% 45% 50%
3.0% 40% 37% 39%
20% 8.0% 35% 40%
2.5%
2.0% 15% 6.0% 30%
1.5% 9.5% 10.0%
10% 4.0% 8.1% 20%
1.0% 6.6% 6.8% 6.8%
0.5% 5% 2.0% 10%
0.0% 0% 0.0% 0%
FY12
FY13
FY14
FY15
FY16
1HFY17
FY12
FY13
FY14
FY15
FY16
1HFY17
Resilient pricing drove NIM improvement: During FY12-1HFY17, cost of Falling cost of funds
borrowings fell by 370bps (Exhibit 24). However, yields on AUM declined by only
150bps, leading to a 220bps improvement in spreads. NIMs have expanded by
340bps to 9.5%. Despite lower proportion of low-cost securitisation funding (from
71% of borrowing in FY12 to 40% at end-FY17), the fall in cost of funds was
driven by rating upgrades over the years and higher share of debentures/CPs in
the funding mix (from nil in FY12 to 35% of borrowings at end-1HFY17).
Change in AUM mix supported yields: Resilience in yields, in our view, is a along with resilient yields has
function of both change in AUM mix and pricing power that AUSFB enjoys in its driven NIM expansion
chosen customer segment. In recent years, the share of high-yielding used vehicle
financing has increased to about 28% of AUM in vehicle finance book. By vehicle
category, too, the share of the lower yielding CV book has declined. Scale-up of
the higher yielding MSME book (~18% yield) has more than offset mild dilution of
yields caused by the SSF book (~16% yields).
Pricing has been benign in AUSFBs chosen customer segment: Overall Both change in loan mix and
healthy yields across vehicle finance, MSME and SSF books are not very different pricing power have supported
from what focused lenders in the segment have derived in recent years. Less yields.
penetrated market, limited competition from larger private sectors and PSU
banks, and low price elasticity of the self-employed segment in the low and
middle income group have also supported NIM of players such as DCB Bank,
CUBK and SCUF.

Exhibit 24: Faster fall in cost of funds has led to expanding spreads/NIM
Yield on AUM Cost of Borrowing Spread (RHS)
20% 7.0%
6.5%
15%
6.0%
18.3%
17.9%
17.7%
17.5%
17.1%
16.9%
10% 5.5%
13.9%
12.6%
12.0%
11.4%
10.5%
10.2%
5.0%
5%
4.5%
0% 4.0%
1HFY17
FY12
FY13
FY14
FY15
FY16
Exhibit 25: AUSFB shifted its borrowing mix away from securitisation to bonds/CPs
Securitisation Banks Debentures CPs Sub. Debt
100% 0%
26% 17% 19%
80%
24% 28% 27%
60% 35% 29%
20% 20%
25%
40%
71%
20% 43% 48% 43% 35% 40%
0%

Exhibit 26: AUSFB has been upgraded by rating agencies over FY12-16
Year CRISIL CARE ICRA INDIA Ratings Brickwork
FY09 BBB-/Stable
FY10 BBB/Stable
FY11 BBB+/Positive A-
FY12 A/Stable A
FY13 A/Stable A A
FY14 A/Stable A A
FY15 A/Positive A+ A A+
FY16 A/Positive A+ A+ A+ AA-
Exhibit 27: Led by strong yields, AUSFBs spreads/NIMs are among the highest
FY16 AUSFB SHTF MMFS SUF MGMA CIFC SCUF BAF CAFL
Cost of funds 10.0% 10.9% 9.5% 9.7% 10.2% 9.8% 9.8% 9.2% 8.8%
Yields on AUM 17.1% 16.7% 16.1% 11.7% 16.5% 14.0% 20.5% 18.2% 16.7%
Spread 7.1% 5.8% 6.6% 2.1% 6.3% 4.2% 10.7% 9.0% 7.9%
NIMs 9.5% 7.8% 9.1% 5.9% 6.7% 6.4% 13.2% 10.5% 5.3%

Tightly controlled cost-to-income a key differentiator: A comparison with

peers shows that AUSFB is among the best on cost-to-income ratio. While the
company is not under-invested in terms of employee per branch, employee
cost per employee and overall cost to AUM, a superior income profile leads to
best-in-class cost-to-income ratio. Further, in the context of healthy asset quality
(discussed in the following section), the companys cost base has supported the
required sourcing, relationship management and recovery mechanism needed for
its business model.
Exhibit 28: Comparison of AUSFB on operational parameters
As at FY16 AUSFB SHTF MMFS SUF MGMA CIFC SCUF BAF CUBK DCBB RBK
Employees 5,072 19,170 15,821 3,465 9,073 13,590 25,472 7,394 4,517 4,248 3,656
Branches 291 853 1,167 569 234 534 976 NA 525 198 193
Employees/Branch 17.4 22.5 13.6 6.1 38.8 25.4 26.1 NA 8.6 21.5 18.9
Employee cost/employee (`) 365,744 307,293 372,312 613,532 336,373 190,366 203,030 1,011,291 480,001 644,978 1,038,936
Employee cost/AUM 2.1% 0.9% 1.7% 1.0% 2.5% 0.8% 2.7% 1.7% 0.7% 1.4% 1.1%
Other opex/AUM 1.3% 1.1% 1.6% 1.6% 0.8% 2.1% 2.9% 3.4% 1.2% 1.4% 1.2%
Cost to AUM 3.4% 2.0% 3.3% 2.6% 3.3% 3.0% 5.6% 5.1% 1.9% 2.8% 2.3%
Income to AUM 8.7% 7.9% 9.3% 6.7% 6.9% 7.6% 13.3% 11.7% 4.7% 4.8% 4.0%
Cost to income 38.6% 25.4% 36.1% 39.2% 48.2% 39.4% 42.3% 43.7% 40.1% 58.4% 58.6%
Key questions for management on NIM and operating performance

Has pricing competition intensified in your core segments of vehicle financing,
MSME and LAP?
Given your focus on small-ticket lending, can cost-to-income ratio and employee
productivity of your assets business see any further improvement?

#4 Healthy asset quality imparted by conservative

underwriting
The company stands out in terms of asset quality compared to peers (gross
NPA of ~2% on 90DPD norm). Better asset quality trends in its core vehicle
finance and MSME books than that of peers highlights the companys risk
management. Our discussion with management indicates that, distinct from
its direct NBFC peers, AUSFB has been able to strike a hybrid model, which is
a combination of bank-like verticals-based model and NBFC-like branch-
level accountability-led model. Experience of working with HDFC Bank in the
formative years came in handy. The company has also used CIBIL and micro-
level data analytics for a long time, setting itself apart from NBFC peers.
A hybrid model of a bank and an NBFC has worked: Besides focusing on small- AUSFB operates a unique hybrid
ticket secured lending for better control on asset quality, AUSFB has put in place model taking best of a bank and
credit underwriting processes appropriate for various lending segments and adopts an NBFC
the best practices of NBFCs (based on its own experience) and banks (based on
experience of working as a channel partner of HDFC Bank). Working with HDFC
Bank, for example, imparted a 90DPD NPA discipline right from the start of the
company.
Under this hybrid-model, similar to banks, the company has separate verticals for
sourcing, credit assessment, relationship management and recovery. On the other
hand, similar to NBFCs, the company also empowers its branch managers and holds
the sales/origination team accountable for credit quality.
Empowered branches with no outsourcing: As a guiding principle of its risk- No outsourcing of any function;
management, the bank does not outsource any of its functions. At the branch level, collaboration/accountability
the credit, sales and collection functions report to the branch manager. This wide promoted at branch level
collaboration allows no incentive to hide information for any function and no fitting
of an application to the policy. Until the last EMI is paid, the sales team has the
responsibility for repayments. As an example, penalty for an account turning 60DPD
in the first 6 months could be as high as 2x initial incentive for the sales. The
company has been using CIBIL since 2003.
Segment-specific credit management: As per the requirement of the customer Conservative and nimble credit
segment, credit assessment is decentralised for small-ticket vehicle finance and MSME management has served the
books while decision making is more centralised for the SSF segment. The company well
decentralised decision making has worked well for vehicle financing to low and
middle income customers, where nimble decision-making allowed the company to go
slow on vehicle finance book starting FY13 after early signs of stress began to
emerge in the industry.
Not being a captive lender to an OEM and conservative policies, such as not
participating in subvention schemes of OEMs, have allowed the company to even
fine-tune its exposures in different geographies across different OEMs and different
brands sold by an OEM.
Superior asset quality trends: Thus, overall asset quality trends have remained
healthy, with credit costs averaging at 40-50bps in FY16-1HFY17 after rising to
150bps (increase led by the CV book). Average credit cost, for FY12-1HFY17, thus is
at 70bps. The companys provisioning policies are also fairly conservative than
regulatory minimum requirements (exhibit 30).

Exhibit 29: Asset quality trends are healthy
Gross NPA Net NPA Credit cost (RHS)
2.0% 1.6%
1.4%
1.6%
1.2%
1.2% 1.0%
0.8%
1.6%
0.8%
1.2%
0.6%
1.2%
0.9%
0.4%
0.4%
0.2%
0.5%
0.3%
0.6%
0.4%
0.6%
0.4%
0.4%
0.2%
0.0% 0.0%
1HFY17
FY12
FY13
FY14
FY15
FY16
Exhibit 30: The companys provisioning policy in comparison with RBI rules
RBI Prudential norms for NBFCs Norms adhered to by AUSFB as NBFC* (Au Financers)
Standard 0.30%, 0.35% & 0.40% provisioning on standard assets by 0.30%, 0.35% & 0.40% provisioning on standard assets by
Assets Mar'16, Mar'17 and Mar'18 respectively Mar'16, Mar'17 and Mar'18 respectively
Overdue 6-18 months - 10% of total outstanding. Overdue 5-6 months - 10% of principal outstanding
Overdue above 18 months: Overdue 6-12 months - 40% of principal outstanding
NPAs - up to 1 year - 20% of the secured portion Overdue >12 months - 100% of principal outstanding
- 1 to 3 years - 30% of the secured portion 0.75% provision on assigned portfolio (at premium) and 0.25% on
More than 3 years - 50% of the secured portion par portfolio
Source: Company, Ambit Capital research; *Note: as of FY16
Key questions for management on asset quality

With stress in the real estate segment and the informal segment of the economy,
what are the risks of asset quality stress worsening over the next 6-12 months?
Is the NPA recovery process in the MSME/SME segment, now taking longer than
earlier, to conclude due to subdued real estate?

#5 Track record and an organisation conducive to

innovation/technology
Operating and penetrating a financially under-served segment need innovative
approaches by lenders. Key innovations for these lenders are in the areas of product
design, sourcing of customers, credit assessment and operations. We look at AUSFBs
track record of innovations to assess whether it can use this as a source of long-term
competitive advantage.
Exhibit 31: Some examples of using technology and innovation as business drivers
Example Description
Despite its customer segmentation focus on low-middle income group in rural/semi-urban areas, the company has used
technology as key enabler. It has used CIBIL scores since 2003. It has been using extensive SAAS-based MIS tools for
Focus on technology detailed branch-level, product-level, vintage level data analytics. The transition to bank has further given a fillip to
technology. In addition to rolling out its ~400 strong branch network for liabilities, the company is providing tab-banking
to all its FOS (feet on street).
In its assets business, driving cost efficiency is a key challenge given the small-ticket focus for lending. Thus, the company
has innovated on alternate channels, such as tele-calling teams, loan-referral programmes, employee-referral programme,
Alternate distribution
fintech partnerships, BC-like networks to maximise productivity. Over the years, the share of business sourced through
channels
these channels with controlled costs has risen. In addition to distribution, tele-calling, along with data analytics has been
useful in making recovery process more productive.
Launched in FY13, housing finance subsidiary scaled up to `17bn by end-FY16. This was an independent subsidiary with
Incubation and divestures
separate origination, risk management and operations. In February 2016, AUSFB divested 90% stake in this subsidiary to a
of home loan sub
PE consortium, as part of its SFB planning.
As per our discussion with the management, learning lessons from experience of other banks with very strong assets but
their limited cross-sell with liabilities franchise, the focus, right from the beginning, is to induce collaborations across assets
Assets team collaborating and liabilities team. Asset customers will be first port of call to build a retail deposits franchise given their decent savings
with liabilities team for potential (assets customers have typical EMIs in `15-20k). Further, assets team which are already well familiar with local
bank expansion markets have taken lead in sourcing properties for bank branches thus doing away with the need of real estate agents. The
management indicates significant savings in rentals by leveraging existing market intelligence within the organization to
build new business.
Key questions on new initiatives

How does the company assess the commercial impact of its investments in
technology and other innovations? How are employees incentivised to cross-
pollinate the best practices?
To what extent can existing data analytics and assets side innovations (e.g. in
distribution and recovery) be extended to a bank platform to drive assets cross-
sell and building the liabilities franchise?

What next as an SFB?

With a proven track record in building secured vehicle finance, MSME/SME
and housing finance businesses, AUSFB is looking to add products (e.g.
CC/OD and agri loans) to cross-sell to existing loan customers before it
begins to on-board new customers in a major way. The momentum on the
assets side would allow the newly hired liabilities team to build a granular
low-cost liabilities franchise with multi-year focus helped by sustainable
drivers like differentiated product design and customer proposition rather
than just high interest rates. Despite the near-term drag due to regulatory
costs and bank-transition related opex, RoE could bottom-out at 15-16%,
unlike the single-digit RoEs for new banks during the transition phase.
Near-term drag due to regulatory costs and bank transition related opex:
After becoming an SFB on 19 April 2017, AUSFB has many opportunities and
challenges before it. The key challenge is the near-term drag on profitability due to
negative carry of SLR and CRR as also increased opex for expanding the banks
distribution and investments in associated bank infrastructure. A representative
analysis of just the negative carry of SLR and CRR and some assumed near-term
investment in bank transition on current balance sheet shows RoE could trough at 15-
16%, before benefits of a bank platform kick in.
Exhibit 32: Near-term RoE could dip to 15-16% due to regulatory costs and opex
related to the bank transition
Scenario for trough RoE during SFB transition ` mn
Current position, As at end-1HFY17
Capital 17,136
Borrowings 62,809
Loans 63,445
On B/S assets 85,986
Off B/S assets 31,910
Total assets 117,897
1HFY17 RoE 24.8%
1HFY17 RoA 4.2%
Impact of SLR/CRR regulatory
Additional borrowing required to deploy SLR/CRR 15,389
Negative carry on these fund (post-tax) 281
RoE after negative SLR/CRR carry 23.2%
RoA after negative SLR/CRR carry 3.4%
Further impact of near-term branch transition related opex
Estimated opex for 430 branches as `3mn/year 864
Assuming 50% additional cost in bank transition related investments 432
Final RoE 15.6%
Final RoA 2.3%
Source: Company, Ambit Capital estimates
Long-term opportunities adding asset classes and improving liabilities An already firing secured retail
franchise: AU is uniquely placed as an SFB due to its track record in building secured asset engine is a key advantage
assets businesses. This is unlike most other SFBs that were MFIs, active primarily in
unsecured group loans. As an assets-financing NBFC, AUSFB had diversified across
vehicle financing and MSME/SME financing and had built a housing financing
business too. The key opportunities are: (1) launching new assets products such as
CC/OD (cash credit and overdraft) loans, business banking and agri loan on the
banking platform; (2) building a stickier and lower-cost retail liabilities franchise over
the long term; and (3) deepening penetration in existing geographies helped by
better brand equity and trust as a bank.

Branch expansion seeking to differentiate beyond just the high deposit giving room to the bank to focus
rates: As per our discussions with management, AUSFB is looking to convert ~185 of on sustainable acquisition of sticky
its ~300 assets branches into bank branches and open another ~250 bank branches customers
to reach ~430 bank branch network by end-FY18. While, the SFB in all likelihood
offer higher rates on deposits than the market average, it will also try to achieve
differentiation through simple product designs and defined customer propositions to
get customer stickiness. For example, core principles while designing liabilities
products are have very few variants; simple to communicate; and ensure easy
proposition with only 3 top-of-mind USPs for each product.
Hiring for bank operations has received good response with talent coming from
larger private sector and foreign banks. All sales personnel in the frontline cadre will
be equipped with tab banking to amplify physical reach with technology.
Exhibit 33: Representative internal layout of a branch (view Exhibit 34: Striving to give a modern feel to the branch
from the branch managers cabin) decor
Exhibit 35: Self-service kiosks at the entry of branch Exhibit 36: Artwork at branch designed to give a local feel
Key questions for management on SFB transformation

Given that the company has momentum on the assets side, what are the
timeframes/targets for the newly hired liabilities team? What are targets for
cross-sell of new loan products, CASA mobilisation and fee income generation for
bank branches?
How will the effectiveness of branch rollout and newly hired employees be
measured?
Once the bank transition related costs are fully absorbed and investments in bank
transition reach break-even, what level of steady-state RoE can be expected on a
bank format vs current RoE of ~25%.

Valuation: Best of both worlds deserves a

premium
AUSFB does not have direct peers but can be compared with either retail
asset financing NBFCs, SFBs or small banks focused on the MSME and trade
segments. Among these, NBFCs are the closest peers in terms of customer
focus and assets mix. A comparison with NBFCs on risk-adjusted profitability
shows that AUSFB compares well with SUF and BAF. While AUSFB is smaller
than these companies, it also has an advantage of superior growth
momentum in the near-term and advantage of sustainable earnings in the
long term due to a bank license that allows it to expand to other assets and
build a superior liabilities franchise. Benchmarking with these peers, we
believe a multiple of 4x current BV (FY17) can be justified.
No direct valuation peer
AUSFB does not have a direct comparable peer for valuation benchmarking. While Retail NBFCs, other SFBs and small
the companys recent track record has been as a retail-focused asset financing NBFC, banks are peers in general, but are
it had built a diversified book across vehicle financing and MSME/SME financing. It not directly comparable.
has, however, turned into an SFB, which would cause some near-term drag on its
erstwhile NBFC profitability due to regulatory costs and investments needed for bank
transformation before medium- to long-term benefits of addition asset classes and
lowering cost of funds kick in.
Other SFBs and small banks not the right comparables yet
However, AUSFB is also unique among SFBs as most SFBs were earlier MFIs with little Other SFBs are different due to MFI
experience in secured lending and are battling growth and asset quality headwinds to focus; incumbent banks operate in
their MFI books. Banks with predominantly small-ticket secured MSME/trade lending different customer segment.
in self-employed customer segments are DCB Bank and City Union Bank. But even
these banks customer profiles appear to be of higher income than AUSFBs customer
profile. Further, these banks are much ahead in terms of having built a
predominantly retail deposits franchise.
Retail asset financing NBFCs peers are the best valuation benchmarks
Thus, among the three groups of peer companies (retail asset financing NBFCs, SFBs Retail NBFCs are relatively closer
and small banks), retail asset financing NBFCs are the best benchmarks given similar peers.
customer profiles and asset mix. Transition of AUSFBs liabilities mix towards a retail-
deposit-led one would take time. Among the diverse group of retail asset financing
NBFCs, we compare AUSFB on risk-adjusted profitability to understand the warranted
valuation (see exhibits 37 and 38).
Peer benchmarking supports a valuation of 4x BV
Exhibit 37 shows a comparison of income profile and asset quality of asset financier AUSFB benchmarks closely with
NBFCs. Given the link between higher yielding lending and asset quality, the SUF and BAF on risk-adjusted
companies above the lines show those which have maintained superior asset quality profitability.
(low average credit cost) despite high yield lending. On this metric, AUSFB compares
with best-in-class NBFCs like BAF and SUF. The bubble size represents valuation; the
bigger bubbles for companies above the line indicate premium valuations accorded
to better risk underwriting. The average multiple for SUF and BAF is 5.8x FY17E BV
and represents a benchmark. Their valuations, in our view, cap the valuation
expectation for AUSFB.
These companies are, however, much larger and have longer track records than Though smaller currently, AUSFB
AUSFB. However, compared to these companies, AUSFB has an advantage of enjoys growth momentum in near
superior growth momentum in the near term and advantage of sustainable earnings term and bank-linked longevity in
in the long term due to the bank license that allows it to expand into other assets and the long term.
build a superior liabilities franchise. Thus, a multiple of 4x BV appears fair.

Exhibit 37: On risk-adjusted profitability, AUSFB appears Exhibit 38: RoE vs P/B superior profitability supports the
among the best-in-class NBFCs such as SUF and BAF premium valuation
4% 9% 14% 19%
9
0.0%
Avg. credit cost (FY15-1HFY17)
8 BAF
0.5% SUF AUSFB 7
6
P/B (FY17E)
1.0%
CIFC 5
1.5% BAF SUF
4 CIFC
2.0% MGMA 3 AUSFB
MMFS SCUF
2.5% 2 SHTF
SHTF MGMA
MMFS SCUF
1
3.0%
0
3.5% 10% 15% 20% 25%
Avg. total income as % of assets (FY15-1HFY17) Average RoE (FY15-1HFY17)
Source: Bloomberg, Ambit Capital research; Note: we have taken average of Source: Bloomberg, Ambit Capital research; For sake of comparison, we
FY15-1HFY17; the bubble size represents PB on FY17x multiple. For sake of have used valuation multiple of 4x FY17 BV for AUSFB.
comparison, we have used valuation multiple of 4x FY17 BV for AUSFB.

Summary Financials
Balance sheet
Year to March (` mn) FY12 FY13 FY14 FY15 FY16 1HFY17
Net worth 3,817 4,419 5,978 7,665 10,007 17,136
Borrowings 6,543 24,821 21,300 28,783 47,826 47,420
Other Liabilities 1,211 1,889 2,308 3,351 4,897 6,042
Total Liabilities 11,571 31,128 29,586 39,799 62,730 70,598
Cash & Balances with RBI & Banks 1,688 3,760 2,034 2,029 1,234 1,704
Investments 309 7,387 1,136 1,398 2,316 3,618
Advances 9,141 18,432 24,560 34,040 56,208 63,445
Other Assets 434 1,549 1,856 2,332 2,972 1,831
Total Assets 11,571 31,128 29,586 39,799 62,730 70,598
Off Balance Sheet loans 16,403 18,612 19,930 21,638 26,005 31,910
Income statement
Year to March (` mn) FY12 FY13 FY14 FY15 FY16 1HFY17
Net Interest Income 1,265 2,135 2,779 4,050 6,517 4,399
Total Non-Interest Income 8 24 58 24 50 19
Total Income 1,274 2,159 2,838 4,074 6,567 4,418
Total Operating Expenses 661 965 1,134 1,515 2,538 1,526
Employees expenses 386 527 697 945 1,577 748
Other Operating Expenses 275 438 437 570 960 778
Pre Provisioning Profits 612 1,194 1,704 2,560 4,029 2,892
Provisions 58 168 607 487 257 250
PBT 554 1,027 1,097 2,073 3,772 2,642
Tax 181 333 371 679 1,301 958
PAT , before exceptionals 373 694 725 1,395 2,472 1,685
Exceptional items (Income)/expense 0 0 0 0 0 -5,168
PAT, reported, after exeptionals 373 694 725 1,395 2,472 6,853
Ratio analysis
Year to March FY12 FY13 FY14 FY15 FY16 1HFY17*
Cost / Income ratio (%) 51.9% 44.7% 40.0% 37.2% 38.6% 34.5%
Cost/ AUM (%) 3.1% 2.5% 2.3% 2.7% 3.4% 3.2%
Non-int. inc. / total income (%) 0.7% 1.1% 2.0% 0.6% 0.8% 0.4%
Non-int. inc. / average assets (%) 0.04% 0.06% 0.12% 0.04% 0.07% 0.04%
Credit costs (%) 0.27% 0.43% 1.22% 0.88% 0.34% 0.52%
NIMs (%) 0.0% 5.6% 5.8% 7.6% 9.0% 9.5%
Leverage (x) 7.8 9.4 9.5 8.1 8.5 7.0
Source: Company, Ambit Capital research; *Annualised

Du-pont analysis
Year to March FY12 FY13 FY14 FY15 FY16 1HFY17*
NII / Assets (%) 6.0% 5.5% 5.6% 7.3% 8.7% 9.2%
Other income / Assets (%) 0.04% 0.06% 0.12% 0.04% 0.07% 0.04%
Total Income / Assets (%) 6.0% 5.6% 5.7% 7.3% 8.7% 9.2%
Cost to Assets (%) 3.1% 2.5% 2.3% 2.7% 3.4% 3.2%
PPP / Assets (%) 2.9% 3.1% 3.4% 4.6% 5.4% 6.0%
Provisions / Assets (%) 0.3% 0.4% 1.2% 0.9% 0.3% 0.5%
PBT / Assets (%) 2.6% 2.6% 2.2% 3.7% 5.0% 5.5%
Tax Rate (%) 0.9% 0.9% 0.7% 1.2% 1.7% 2.0%
ROA (%) 1.8% 1.8% 1.5% 2.5% 3.3% 3.5%
Leverage 7.8 9.4 9.5 8.1 8.5 7.0
ROE (%) 13.7% 16.8% 14.0% 20.4% 28.0% 24.8%
Source: Company, Ambit Capital research; Assets include on-balance sheet and securitized assets; *Annualised

Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Ambit Capital Private Limited (022) 30433174 saurabh.mukherjea@ambit.co
Pramod Gubbi, CFA Head of Equities (022) 30433124 pramod.gubbi@ambit.co
Research Analysts
Name Industry Sectors Desk-Phone E-mail
Nitin Bhasin - Head of Research E&C / Infra / Cement / Home Building (022) 30433241 nitin.bhasin@ambit.co
Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 aadesh.mehta@ambit.co
Abhishek Ranganathan, CFA Retail / Consumer Discretionary (022) 30433085 abhishek.r@ambit.co
Anuj Bansal Consumer (022) 30433122 anuj.bansal@ambit.co
Aditi Singh Economy / Strategy (022) 30433284 aditi.singh@ambit.co
Ashvin Shetty, CFA Automobiles / Auto Ancillaries (022) 30433285 ashvin.shetty@ambit.co
Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 bhargav.buddhadev@ambit.co
Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 deepesh.agarwal@ambit.co
Dhiraj Mistry, CFA Consumer (022) 30433264 dhiraj.mistry@ambit.co
Gaurav Khandelwal, CFA Automobiles / Auto Ancillaries (022) 30433132 gaurav.khandelwal@ambit.co
Girisha Saraf Home Building (022) 30433211 girisha.saraf@ambit.co
Karan Khanna, CFA Strategy (022) 30433251 karan.khanna@ambit.co
Mayank Porwal Retail / Consumer Discretionary (022) 30433214 mayank.porwal@ambit.co
Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 pankaj.agarwal@ambit.co
Paresh Dave, CFA Healthcare (022) 30433212 paresh.dave@ambit.co
Parita Ashar, CFA Cement / Metals / Aviation (022) 30433223 parita.ashar@ambit.co
Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 prashant.mittal@ambit.co
Rahil Shah Banking / Financial Services (022) 30433217 rahil.shah@ambit.co
Ravi Singh Banking / Financial Services (022) 30433181 ravi.singh@ambit.co
Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 ritesh.gupta@ambit.co
Ritesh Vaidya, CFA Consumer (022) 30433246 ritesh.vaidya@ambit.co
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritika.mankar@ambit.co
Sagar Rastogi Technology (022) 30433291 sagar.rastogi@ambit.co
Sudheer Guntupalli Technology (022) 30433203 sudheer.guntupalli@ambit.co
Sumit Shekhar Economy / Strategy (022) 30433229 sumit.shekhar@ambit.co
Utsav Mehta, CFA E&C / Infrastructure (022) 30433209 utsav.mehta@ambit.co
Vivekanand Subbaraman, CFA Media / Telecom (022) 30433261 vivekanand.s@ambit.co
Sales
Name Regions Desk-Phone E-mail
Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7886 2740 sarojini.r@ambit.co
Dharmen Shah India / Asia (022) 30433289 dharmen.shah@ambit.co
Dipti Mehta India (022) 30433053 dipti.mehta@ambit.co
Krishnan V India / Asia (022) 30433295 krishnanv@ambit.co
Nityam Shah, CFA Europe (022) 30433259 nityam.shah@ambit.co
Punitraj Mehra, CFA India / Asia (022) 30433198 punitraj.mehra@ambit.co
Shaleen Silori India (022) 30433256 shaleen.silori@ambit.co
Singapore
Praveena Pattabiraman Singapore +65 6536 0481 praveena.pattabiraman@ambit.co
Shashank Abhisheik Singapore +65 6536 1935 shashankabhisheik@ambitpte.com
USA / Canada
Ravilochan Pola CEO Americas +1(646) 793 6001 ravi.pola@ambitamerica.co
Hitakshi Mehra Americas +1(646) 793 6002 hitakshi.mehra@ambitamerica.co
Achint Bhagat, CFA Americas +1(646) 793 6752 achint.bhagat@ambitamerica.co
Production
Sajid Merchant Production (022) 30433247 sajid.merchant@ambit.co
Sharoz G Hussain Production (022) 30433183 sharoz.hussain@ambit.co
Jestin George Editor (022) 30433272 jestin.george@ambit.co
Richard Mugutmal Editor (022) 30433273 richard.mugutmal@ambit.co
Nikhil Pillai Database (022) 30433265 nikhil.pillai@ambit.co

HDFC Bank Ltd (HDFCB IN, SELL)
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
Apr-14
Jun-14
Aug-14
Oct-14
Dec-14
Feb-15
Apr-15
Jun-15
Aug-15
Oct-15
Dec-15
Feb-16
Apr-16
Jun-16
Aug-16
Oct-16
Dec-16
Feb-17
HDFC Bank Ltd
Source: Bloomberg, Ambit Capital research

Explanation of Investment Rating

Investment Rating Expected return (over 12-month)
BUY >10%
SELL <10%
NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation
UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock
POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs
NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs
* In case the recommendation given by the Research Analyst becomes inconsistent with the rating legend, the Research Analyst shall within 28 days of the inconsistency, take appropriate measures (like
change in stance/estimates) to make the recommendation consistent with the rating legend.
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AU Small Finance Bank

Credit cost (%) 0.43% 1.22% 0.88% 0.34% 0.52%

RoE* (%) 16.8% 14.0% 20.4% 28.0% 24.8% Rahil Shah

The DNA of entrepreneurship

Genesis of the company

April 28, 2017 Ambit Capital Pvt. Ltd. Page 2

Exhibit 3: Reported IPO valuation, as quoted in media reports*

April 28, 2017 Ambit Capital Pvt. Ltd. Page 3

What differentiates AUSFB?

We believe the following key competitive advantages covered in our IBAS

April 28, 2017 Ambit Capital Pvt. Ltd. Page 4

Exhibit 4: A comparison with peer NBFCs and banks

April 28, 2017 Ambit Capital Pvt. Ltd. Page 5

#1 Retail focus on small ticket secured lending

100% Vehicle MSME SSF

Vehicle Finance flexible, nimble approach to the business

Source: Company, Ambit Capital research

April 28, 2017 Ambit Capital Pvt. Ltd. Page 6

50% 35% 31%

FY13 FY14 FY15 FY16 1HFY17

April 28, 2017 Ambit Capital Pvt. Ltd. Page 7

MSME Leading the diversification away from vehicle finance

FY13 FY14 FY15 FY16 1HFY17

April 28, 2017 Ambit Capital Pvt. Ltd. Page 8

Source: Company, Ambit Capital research

April 28, 2017 Ambit Capital Pvt. Ltd. Page 9

#2 Deep knowledge of operating in under-served

Rajasthan Maharashtra Gujarat Madhya Pradesh Delhi Punjab Others

80% 30% 27% 20% 14% 12% 12%

Source: Company, Ambit Capital research

April 28, 2017 Ambit Capital Pvt. Ltd. Page 10

Rajasthan 7% 13% 11% 23% 10% 9% 28% 80% 100%

Key questions for management on geographical focus

April 28, 2017 Ambit Capital Pvt. Ltd. Page 11

#3 Improving profitability driven by structural

RoA (LHS) RoE (RHS) NIM (LHS) CI ratio (RHS)

4.0% 30% 12.0% 52% 60%

April 28, 2017 Ambit Capital Pvt. Ltd. Page 12

Yield on AUM Cost of Borrowing Spread (RHS)

Securitisation Banks Debentures CPs Sub. Debt

Source: Company, Ambit Capital research

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Tightly controlled cost-to-income a key differentiator: A comparison with

Key questions for management on NIM and operating performance

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#4 Healthy asset quality imparted by conservative

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Exhibit 29: Asset quality trends are healthy

Gross NPA Net NPA Credit cost (RHS)

Key questions for management on asset quality

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#5 Track record and an organisation conducive to

Key questions on new initiatives

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What next as an SFB?

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Key questions for management on SFB transformation

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Valuation: Best of both worlds deserves a

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