Financial Institutions

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1 Financial Services Full Rating Report Ratings Non-Convertible Debentures Commercial Papers Outlook Non-Convertible Debentures Financial Data. 31 Dec 14 IND A+ IND A1+ Stable 31 Mar 14 Total assets (USDm) Total assets (INRm) 35,802 30,039 Total equity (INRm) 7,490 6,413 Net income (INRm) ROA (%) 3.5* 4.1 ROE (%) 16.4* 16.9 Tier 1 capital ratio Equity to AUM *Annualised Key Rating Drivers Strong Competitiveness in Rajasthan: India Ratings & Research (Ind-Ra) assigned Au Financiers (India) Ltd. s (Au Financiers) INR2.5bn non-convertible debentures (NCDs) an IND A+ rating with a Stable Outlook and its INR10bn commercial papers (CP) an IND A1+ rating in November The agency also withdrew the IND A1+(SO) rating on the company s INR400m CP as it was paid in full. Au Financiers early start, deep reach and local understanding provide it with a competitive advantage in Rajasthan. The company has by far the largest presence in Rajasthan than any other asset finance company. The state housed around half of the company s 220 branches and accounted for about half of its assets under management (AUM) in FY14. Nevertheless, its larger presence in the state also exposes to it to regional concentration risk. The company plans to continue expanding its franchise in other geographies while maintaining its competitive advantage in Rajasthan. To that aspect, it has developed material presence in Maharashtra and Gujarat. Reasonably Managed Asset Quality: The company s large presence in the western region coupled with better repayment track records than its peers has helped it in managing its asset quality in the current economic slowdown. Gross NPLs however more than doubled to 1.8% of AUM in vehicle financing (VF) in FY14, and credit costs rose to 1.8% of AUM (FY13: 0.7%). The credit costs in the portfolio of collateral-backed business loans have been modest though the portfolio is yet to face any stress scenario. The Reserve Bank of India s (RBI) updated guidelines are likely to impact credit costs additionally by about 15bp-20bp in the transition period. Strong Investor Base Supports Capital Requirement: Au Financiers has demonstrated a track record of bringing in strong investors to support its growth capital requirements. However, internal accruals should be largely sufficient to support its capital requirements as it moderates its expansion plan. The capital infusion in 4QFY14 has strengthened capitalisation of the company with comfortable equity to AUM of 14.2% in FY14. The company s capital requirement however may increase if the loan growth were to increase materially from projected. The recent guidelines by RBI to increase the minimum tier 1 capital to 10% in FY18 from the current 7.5% are unlikely to immediately impact the company as it has been operating at a higher capitalisation base. Average Funding Profile: Au Financiers mostly depends on banks for its funding requirement. Bilateral assignments and securitisation constitute about half of the total funding. Any disruption to off-balance sheet borrowings due to regulatory changes and the on-going push of banks for direct generation of priority sector assets could significantly impact funding cost. The company is gradually diversifying its borrowings, with borrowing from capital market constituting about 22% of its total funding in FY14 (FY13: 18.5%). Analysts Prakash Agarwal prakash.agarwal@indiaratings.co.in Priya Sunder priya.sundar@indiaratings.co.in Profitability Supported by Portfolio Sale Income: Au Financiers reported a comfortable return on average AUM of 2.3% in FY14. The company operates in a high yield segment, and interest income is supplemented by large off-book assets. The cost to income ratio at 33% is comparable to peers and should improve from economies of scale. 19

2 Rating Sensitivities Successfully Managing Franchise Expansion: Successfully and profitably managing growth with reasonable asset quality, diversified and stronger access to market funding, strong on balance sheet liquidity and comfortable capitalisation comparable to peers together with strengthened systems and processes could lead to a rating upgrade. Sharp Drop in Credit Costs Buffers: Any substantial rise in credit costs or sharp drop in the profitability, or lower capital buffers could lead to a negative rating action. Profile Au Financiers was set up in 1996 by a first generation entrepreneur. The company is a nonbanking finance company (NBFC) operating in the asset finance space, primarily offering financing for both new and used commercial vehicles (about one-thirds of AUM). In addition, the company started loan against property in 2011, which is about one 30% of its total AUM. The company has set up a housing finance subsidiary which had an AUM of INR4.1bn in FY14. The company has largely grown post FY08, during which the company received equity funding from its first PE investor (Motilal Oswal Private Equity) to the tune of INR0.2bn. Since then the company has received investments from International Finance Corporation, Warbug Pincus and Chrys Capital which has helped in significant expansion of its franchise. Figure 1 Shareholding on 31 March 2014 Motilal Oswal PE 11% ChrysCapital 10% Shares held by employees esop 2% Motilal Oswal Securities 1% Promoters 30% Source: Au Financiers International Finance corporation 19% Warbug Pincus 27% The company s management has hired several professionals from large banks in recent years. This has helped in bolstering the second line of management and reducing key man risk. These professionals bring strong experiences with them and are focusing on strengthening systems and processes, all this is critical to reach the next level of size. Starting with vehicle finance, the company has expanded its product suite to include propertybacked business loans (collateral based SME finance) in FY11. The company has also set up a housing finance company with a focus on affordable housing space. Apart from Rajasthan, which accounts for about 50% of its loan portfolio, the company has expanded into its presence in Maharashtra and Gujarat, which together constitute about onethirds of its portfolio. Strategy Applicable Criteria Financial Institutions Rating Criteria, 12 September 2012 Non-Bank Finance Companies Criteria, 12 September 2012 After high growth in the VF segment over the last few years, the company is looking to consolidate its portfolio in this segment in the face of weak environment and asset quality overhang. Growth in the new VF segment will be moderate, though it would continue to expand faster in the yield-accretive used vehicles segment. The loan portfolio growth will be driven by collateral-backed business loans. This segment, so far, has experienced modest credit costs 2

3 though it is yet to go through a stress scenario. The company s product mix in VF has witnessed some transition where the proportion of MUVs and cars, a segment which has a lower cyclicality, expanded to 42% of total VF AUM in FY14 from 35% in FY12. Simultaneously the proportion of HCV and LCV has decreased to 10% from 20% in the same period. The company plans to continue to expand faster in Cars and MUVs. Rajasthan would remain the focus area for the company to expand, though it is looking towards diversifying its portfolio. Majority of incremental branches would continue to come in Rajasthan. The company would remain focused on the high-yield segment for its portfolio growth and increase its geographical reach to generate additional business. The geographic expansion of the company is planned to be gradual. Figure 2 Assets Under Management (INRbn) 50 On book Off book FY11 FY12 FY13 FY14 Source: Au Financiers Credit Risk/Stressed Loans Most of the company s borrowers are in the earn and pay category where the borrowers earn from the vehicles financed and pay back the company in instalments. The slowdown in the economy has resulted in reduced freight availability for commercial vehicles operators, leading to lower earnings and impacting the asset quality of CV financiers. Some of the stress visible in the VF segment has also been driven by high competition among lenders for a market share which has pushed LTVs up. Higher LTVs result in lower borrowers equity, reducing incentives for borrowers to hold on to an asset in the event of stress. This has been aggravated by the large discounts offered by manufacturers, depressing the resale price of vehicles and resulting in higher credit costs in the event of defaults. Credit losses in collateral-backed business loans have been low till now. However, the segment is still to see any material stress scenario. Collateral-backed business loans are largely collateral driven and any correction in property prices could result in building up of stress. Nevertheless, property prices are still holding up despite the macroeconomic slowdown. Majority of Au Financiers borrowers are however generally small businessmen with small ticket sizes and in rural locations and have limited alternative sources of financing. Also, the loans have been primarily generated through in house teams and have moderate balance transfer cases. Having said that, the segment also has a sizeable portfolio of large ticket size loans, including loans to commercial real estate. This portfolio however is likely to reflect greater cyclicality. Au Financiers loan portfolio has come under cyclical pressure due to the economic slowdown. The pressure is higher in the portfolio of outside Rajasthan partly because of the company s lower competitive strength in outside geographies. In addition, its portfolio outside Rajasthan has been concentrated into products which have come under greater pressure in the current slowdown. 3

4 The gross non-performing assets on AUM increased to 1.3% in FY14 from 0.7% in FY13 as the asset portfolio came under cyclical pressure. Also, gross NPLs in VF increased to 1.8% in FY14 from 0.7% in FY13. Delinquencies in collateral-backed business loans portfolio are low (180dpd), though the early signs of higher delinquencies are visible. In addition, the portfolio is largely unseasoned and the true credit cost is likely to be reflected only with a lag. The company s reported delinquencies as well as credit costs will increase on the updated guidelines from RBI on 90 days past due NPLs recognition norms. While NPLs in vehicle finance could double, credit costs could increase by as much as 20bp in the transition phase. The load availability of truck operators is likely to improve with the expected improvement in economy. Also, the softening of fuel prices is likely to improve the operating metrics of truck operators. Withdrawal of discounts offered by manufacturers should have a stabilising effect on used vehicle prices. These factors are likely to help strengthen the asset quality of the company. Market Risk Au Financiers market risk is low. The company s investments are primarily into its subsidiaries and own originated pass through certificates. Interest rate risk is moderate as a sizeable part of the total funding is through off-balance sheet. The interest rate risk primarily emanates from its on-book borrowings which are on floating rate of interest, while the corresponding lending to VF is fixed Operational Risk Au Financiers faces moderate operational risk as it mostly collects cash on its loans and has informal credit appraisal processes and systems. The company however has reasonable systems in place. In addition, cash balances are distributed over several collectors and individual size is small. Individual discretion is restricted as the company has various levels of credit appraisal. Funding and Liquidity Au Financiers remains largely dependent on banks for its funding needs, with almost half of the funding originating through off-balance sheet bilateral assignments and securitisation segment. The on-book funding lines are spread over multiple banks, though HDFC Bank is the largest banking partner. The company has been looking to expand the resource profile and to that extent increased capital market funding in FY14 to about 22% from 2% in FY13. The new guidelines by RBI counting RIDF investments as priority sector lending could reduce banks appetite for purchasing these loans. Au Financiers however has been able to sell its loans to public sector banks without much of a challenge. In addition, demand for agri loans is likely to grow further because of the new guidelines. According to the management, 25%-30% of the company s loans are eligible to be classified as agri loans where demand remains high. The company s asset-liability tenors are largely matched. Its ALM is supported by its proportion of securitisation as it offers matched funding. Also, the company s on-book funding is majorly through term borrowing which results in a matched ALM portfolio. Capitalisation Au Financiers has raised equity at regular intervals, improving its capitalisation levels. The company s reported tier 1 ratio was 17.5% in FY14, though it is supported by a large bilateral assignment portfolio and is unadjusted for credit enhancements (provided under earlier regime where credit enhancements were allowed). Equity to AUM increased to 14.2% in FY14 from 12.4% in FY13. The lower capital difference between equity to AUM and Tier 1 ratio despite the large balance sheet is because of the guarantees provided by the company to its subsidiary 4

5 HFC which have been reduced from its tier 1 calculation. As the company moderates its growth plans, the incremental capital injection requirement is likely to decline because internal accruals should be sufficient to support its capital needs. Also, although the capital requirement may increase with higher growth, strong investors may support the company. Figure 3 Equity to AUM (%) FY10 FY11 FY12 FY13 FY14 Source: Au Financiers Profitability Au Financiers profitability is reasonable (return on AUM: 2.3% in FY14). The company operates in the high yield segment and its interest income is supported by the large income from the off-balance sheet portfolio. The company s operating efficiency has improved with its cost to income ratio declining to 33% in FY14 from 39% FY13. Nevertheless, the credit costs increased in FY14. Figure 4 Return on Avg AUM (%) FY11 FY12 FY13 FY14 Source: Au Financiers The company s interest income may improve as it increases the proportion of used assets in its portfolio. Its higher focus on collateral-backed business loans is also likely to support interest income as the company operates in the high yield segment. Nevertheless, its ability to manage credit costs will be the key driver of profitability. 5

6 Au Financiers Ltd BALANCE SHEET ANALYSIS 31-Mar Mar-14 As % of Assets 31-Mar-13 As % of Assets 31-Mar-12 Year End Year-End Year-End Year-End USDm INRm INRm INRm A. Loans and Advances , , ,894.7 Secured Loans Unsecured Loans Hire Purchase Assets Financial Leases , , ,877.2 Loans to related parties Bills Discounted B. Other Interest-bearing Assets , , ,263.0 Other Interest-bearing loans , ,957.5 Investments , Operating Leases C. Loan Loss Reserves D. Total Earning Assets , , ,157.8 E. Fixed Assets F. Non-Earning Assets , , ,327.2 Cash , , ,169.8 Others , Total Assets , , ,638.0 G. Short-term Funding , , ,747.9 Unsecured , Secured , , ,747.9 H. Long term debt due within a year , , I. Long term Funding , , ,971.4 Long term borrowings , , ,821.4 Public Deposits Subordinated Debt , , J. Other Non-interest bearing liabilities , , K. Provisions L. Tangible Net Worth , , ,918.8 Total Liabilities and Equity , , ,

7 Au Financiers Ltd INCOME STATEMENT ANALYSIS INCOME STATEMENT ANALYSIS 31-Mar-14 As % of Average Earning Assets 31-Mar-13 As % of Average Earning Assets 31-Mar-12 Au Financiers Ltd Year-End Year-End Year-End INRm INRm INRm Interest earned 5, , ,407.0 Interest expended 2, , ,037.2 Net Interest Income 2, , Other Operating Income ,079.8 Personnel Expenses Operating Expenses Pre-Provision Operating Profit 2, , Provisions for Losses Operating Income after Provisions 1, , Other Non-operating Income Prior Period adjustments Pre-tax Profit 1, , Taxes Net Profit RATIO ANALYSIS A. PROFITABILITY (%) Net Income/Equity (avg.) Net Income/Total Assets (avg.) Non-interest Expenses/(Net Interest Income+Other Operating Income) Net Interest Income/Total Assets (avg.) Pre-provision Operating Profit/Total Assets (avg.) Operating Profit after Provision/Total Assets (avg.) Interest expended / Total Borrow ings (avg.) B. CAPITALIZATION (%) (Net Profit - Dividends)/Prior Period Equity Equity/Total Assets Equity/Loans Tier - I Capital Ratio Tier - II Capital Ratio Debt/Equity (x) Short term borrow ings incl. LT debt due in 1 year /Total Borrow ings C. ASSET QUALITY (%) Provision for loan losses/loans (avg.) Provision for loan losses/pre-provision operating Profit Gross NPLs/Gross Loans Loan loss Reserves/Gross NPLs 24.3 Net NPLs/Equity

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