IDFCFIRST BANK : Do we have a story here ?

BackStory:

On December 18, 2018, IDFC FIRST BANK was formed with the merger of CAPITAL FIRST, a retail focussed NBFC and IDFC BANK (Previously carved out of IDFC, a development finance institution [DFI] ). The purpose of the merger was to transform the bank by “Retailising” the book and bring profitability to the franchise.

IDFC Bank launched operations on October 1, 2015, with 23 branches and a state-of-the-art digital platform. As part of the demerger with IDFC, the Bank inherited the large infrastructure book of its parent IDFC Ltd. In order to diversify the balance sheet, the management focussed on building a retail banking franchise.

However, it was recognised that since the bank was converted from a large infrastructure finance institution, the Net interest margins were low at 1.7%. That resulted in low profitability, thus impeding their ability to invest in building the retail franchise. In view of this, it was deemed strategically vital for the Bank to expedite the building of retail assets and retail liabilities at scale, through an inorganic route. Capital First met all the strategic requirements and in fact turned out be a better cultural fit for the Bank. Capital First as a company, under the leadership of V Vaidyanathan, had built tremendous intellectual property over eight years and had a large retail franchise with a strong return on equity, and continuously growing profitability (net profit for FY17-18 was Rs.328 crore). However, the Company built its entire business model of retail lending on the basis of wholesale borrowing. This was risky in events of tight liquidity. To continue the growth momentum going forward, Capital First needed to diversify its liability base towards retail liabilities which could provide better pricing and sustainable availability of long-term funding. As per the regulatory guidelines, this was only possible under a banking platform which would have also enhanced the retail financing offerings of the Company. However, this would take time even if it came through. IDFC Bank, on the other hand, had a robust, technology-led, modern banking platform with high capital base for growth. With this merger, Capital First got the opportunity to continue growth on a banking platform. The merged entity continues to be lead by V. Vaidyanathan, a strong leader with a terrific track record to take the institution forward.

About Capital First

It is important to know the Capital First story in order to fully appreciate what’s currently happening at IDFC FIRST Bank. The charts below (Source – Annual report of IDFC FIRST BANK FY-19) highlight the growth story of Capital First;

The transformation of Capital first from being a nondescript loss-making NBFC back in 2008-09, to a highly profitable organisation by 2018, highlights the remarkable focus and ability of the management in creating a robust retail lending institution. It also gives a blue-print of the transformation that is taking place currently in the bank. You will see a similar trend unfolding consistently in IDFC First Bank, as reflected in the numbers below;

The following points are important to note;

The bank’s overall asset base hasn’t started to grow yet.
However, the asset mix has been steadily shifting towards the retail segment (up from 26.8% in 2019 to 45.6% in 2021). Retail assets, as a percentage of funded assets now stand at 67%. The CASA ratio share has steadily improved from 11.4% in 2019 to 51.75% in 2021)
A similar pattern is evident in the liabilities of the bank. Retail liabilities now stand at 46.4% in 2021 as compared to 29% in 2019. The bank has been focussed on replacing its wholesale liabilities with retail liabilities raised through CASA/TD.
This transformation is reflecting in the net interest margin (NIM), which has moved up from 2.37% in 2019 to ~ 5% in 2021.
The incremental cost of funds is at ~ 5% and incremental lending in retail is at over 14%. So the incremental spreads are very attractive at over 9% at this point in time. With a pristine retail loan book with GNPA of ~2% and NNPA of ~ 1% over the last ten years, the bank is now looking to expand customer segments to include prime home loans, the safest category of loans. With the bank lowering its interest rate, this can be pursued in a sustainable manner. The bank expects mortgage backed loans to form 40% of their loan book in due course.
As of June 30, 2021, the Bank has Rs. 27,936/- crore of liabilities at 8.66%. These are largely legacy borrowings of their DFI background(IDFC). When the Bank replaces this at say, ~5.0%, they would save ~ Rs. 1,000 crore per year on an annuity basis compared to today. This is a legacy issue on the liability side and is expected to go away with time as indicated by the trend in the last 3 years. (Source : Annual report 2021)
Going by the guidance issued by the bank, the retail loan book is expected to grow by 25% on a compounded basis over the long term. The bank has also guided an ROE north of 16% as they scale up. But what is not clear is the timeline within which this will be achieved. The credit events in the legacy corporate/infrastructure loan book have impacted ROE growth in the last couple of years. The ongoing issue with Vodafone (bank has exposure of ~2% of funded assets) may continue to put pressure on the profit numbers in the coming quarters.

The above analysis, leads us to believe that the bank is moving towards its stated goal of achieving profitability with scale in the long term. There may be some more headwinds arising out of legacy issues in its institutional loan book. However, if the retail story remains intact and the management continues to grow and retailise the asset & liability base, this may turn out to be a very profitable franchise for its shareholders over the next decade.

[ Disclosure : Author currently has an exposure of ~ 1% of his retirement portfolio in shares of IDFC FIRST BANK purchased on 25th August, 2021 @ Rs. 43.20/-]

Annexure:

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