AU Small Finance Bank shares fall 8% after flagging margin pressure post Q2 results

Shares of AU Small Finance Bank Ltd. fell more than 8% on Monday, October 26, even as the lender reported a 53% year-on-year increase in second-quarter profit for FY27. While lower provisions and strong operating performance supported earnings, pressure on margins, rural stress and a decline in the provision coverage ratio remain key concerns.

Net profit rose to ₹857.7 crore from ₹561 crore a year earlier. Net interest income (NII) increased 31.5% year-on-year to ₹2,820.1 crore from ₹2,144.4 crore.

Gross non-performing assets (GNPA) improved to 1.99% from 2.10% in the previous quarter. However, net non-performing assets (NNPA) edged up to 0.81% from 0.76%.

Provisions stood at ₹359.4 crore, compared with ₹371.5 crore in the previous quarter and ₹480.8 crore in the year-ago period.

AU SFB: Management commentary and outlook

The bank is targeting deposit growth of around 25%, while aiming for overall business growth of approximately 2.5 times nominal gross domestic product (GDP) growth.

For FY27, management expects credit costs to be around 0.9%, compared with 0.73%–0.74% in the first half of the year. Its long-term credit cost guidance remains at 0.9%–1%.

Net interest margin (NIM) declined by 9 basis points quarter-on-quarter to 5.8%. Management expects margin pressure to persist amid competition for deposits and liquidity conditions.

The cost-to-assets ratio is expected to improve year-on-year in FY27 despite continued expansion.

On asset quality, the bank flagged higher slippages linked to seasonal stress in tractor financing. However, its unsecured portfolio is showing improvement.

Management identified El Niño, deficient rainfall and elevated oil prices as key risks to monitor. The third quarter will be important in assessing the impact, although the bank said it had not seen material stress through September.

Growth in gold loans moderated following a correction in gold prices, while the loan-to-value ratio remained stable at 75%.

The bank mobilised only $230 million through FCNR(B) deposits, citing its limited overseas presence.

Proposed changes by the Insurance Regulatory and Development Authority of India (IRDAI) to insurance distribution could weigh on fee income. The bank expects foreign exchange, cards and transaction banking to partly offset the potential impact.

Kotak Institutional Equities has a 'Reduce' rating on AU Small Finance Bank, with a target price of ₹950 per share.

The brokerage noted that the bank reported a return on equity (RoE) of 16% and 50% year-on-year earnings growth in the second quarter of FY27. The performance was supported by a sharp decline in provisions and strong growth in pre-provision operating profit (PPoP).

Asset quality remained broadly stable, with the net non-performing loan ratio at 0.8%. Slippages stood at 2.5%, while credit costs were at 1%.

NIM declined by 10 basis points quarter-on-quarter, according to the brokerage.

Despite the margin pressure, Kotak Institutional Equities said AU Small Finance Bank is well positioned to deliver strong returns on equity and growth over the medium term.