AU Small Finance Bank’s resilient margins support strong loan growth and earnings outlook

Investment View and Valuation

Motilal Oswal Financial Services Limited’s July 26, 2026 results update says AU Small Finance Bank’s operating performance was in line and its business outlook remains steady. The broker reiterates its BUY rating and continues to identify AU Small Finance Bank as its top pick among mid-sized private banks, citing strong underlying growth, a high-yielding asset mix, resilient margins and contained credit costs.

The target price is Rs 1,275, based on 3.4 times FY28E book value, compared with the current market price of Rs 1,004.

1QFY27 Financial Performance

AU Small Finance Bank reported 1QFY27 profit after tax of Rs 7.96 billion, up 37 per cent year-on-year but down 4.3 per cent quarter-on-quarter. PAT was 6 per cent above MOFSL’s estimate, supported by in-line net interest income, lower operating expenditure and lower-than-expected credit costs.

The sequential contraction in net interest margin reflected the reversal of certain seasonal one-offs. Fee income declined 9 per cent sequentially amid seasonal effects, while lower treasury income contributed to the decline in other income. MOFSL expects operating expenses to moderate further, reducing the cost-to-income ratio to about 55-56 per cent over FY27E-FY28E.

Healthy Loan and Deposit Growth

Business growth remained healthy. Advances grew 26.2 per cent year-on-year and 3.2 per cent quarter-on-quarter to Rs 1,386 billion, while deposits increased 23.5 per cent year-on-year and 3.3 per cent quarter-on-quarter to Rs 1,577 billion. CASA deposits rose 21.9 per cent year-on-year and 4.7 per cent sequentially, taking the CASA ratio to 29 per cent. The loan-to-deposit ratio was 87.9 per cent.

Growth was broad-based across the key segments:

• Commercial banking: Up 33.8 per cent year-on-year and 5.9 per cent quarter-on-quarter.
• Retail secured assets: Up 22.5 per cent year-on-year and 4 per cent sequentially.
• Inclusive banking: Up 15 per cent year-on-year and 5 per cent sequentially, led by microfinance.
• Digital unsecured loans: Up 3 per cent year-on-year and 6.6 per cent sequentially, led by personal loans.

Asset Quality and Credit Costs

Asset-quality indicators softened modestly sequentially. Slippages increased 21 per cent quarter-on-quarter to Rs 7.98 billion, although they declined 22.3 per cent year-on-year. Gross and net NPA ratios rose 7 basis points and 2 basis points sequentially to 2.1 per cent and 0.76 per cent, respectively. Provision coverage was maintained at about 64 per cent.

Credit costs were 0.8 per cent, compared with 0.6 per cent in 4QFY26 and 1.36 per cent in 1QFY26, but remained below management’s guided range of 0.9-1 per cent. Provisions of Rs 3.7 billion were 6 per cent below MOFSL’s estimate and included a prudent Rs 230 million provision to strengthen policy for selected products.

MOFSL notes easing stress, recovery in unsecured loans and renewed growth in that segment, while recognising the seasonality of first-quarter asset quality.

Management Outlook and Earnings Estimates

Management expects loan growth of 2.0-2.5 times nominal GDP, translating into 22-25 per cent growth in FY27E. Growth is expected to be supported by expansion into newer markets and a pan-India franchise. Vehicle-finance growth should benefit from distribution expansion in South India, Uttar Pradesh and the East.

Management remains comfortable with return on assets of 1.7-1.8 per cent and targets about 1.8 per cent, helped by lower credit costs and improved other income. The move to the ECL framework is expected to be broadly neutral, with greater clarity from 3QFY27.

MOFSL marginally lowers its FY27E and FY28E net interest income estimates by 1.2 per cent and 2.5 per cent, respectively, but raises PAT estimates by 1.5 per cent and 1.1 per cent. It forecasts:

• PAT CAGR of 35 per cent over FY26-FY28.
• FY28E return on assets of 1.84 per cent.
• FY28E return on equity of 18.8 per cent.