IDFC First Bank: can it boom in the midst of gloom and doom?

RBI’s 21st Financial Stability Report (FSR) released on July 24, 2020 has sent shivers down the spine of economists, policymakers, market experts and investors. Macro stress tests for credit risk indicate that the GNPA ratio of all SCBs may increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 under the baseline scenario. If the macroeconomic environment worsens further, the ratio may escalate to 14.7 per cent under very severe stress, FSR reads.

There’s a clear message for the entire banking system and all its stakeholders to recognize the COVID-inflicted slowdown to its truest potential and create buffers within the system to tide over the pandemic situation.

But there’s a blessing in disguise! Some banks are turning around even under the tough market conditions thereby passing through perhaps the toughest litmus test.

IDFC First Bank is one such turnaround story which is unfolding in the private banking space during the pandemic times. After posting losses for 6 consecutive quarters, IDFC First Bank has reported profits in the past two quarters—i.e. in Q4FY20 and Q1FY21.

Should you bet on turnarounds?

Yes, you should, if they are promising enough. But investing in a turnaround story requires a lot of patience and one must have realistic expectations as well.

In the business world, the term turnaround is used to convey a financial recovery of a company which was doing poorly earlier. If you are investing in a turnaround company, you must pay attention to the quality of the turnaround and evaluate if its performance can sustain.

IDFC First Bank: has it taken the first step right?

If you remember, IDFC First Bank was established through the merger of IDFC Bank and Capital First in December 2018. For the last one and half years, it’s been dealing with the legacy issues on the wholesale loan book. The bank took a big knock on three corporate accounts—DHFL, Reliance Capital and Vodafone Idea. But that’s the past. The bank seems to be dealing with asset quality problems with a resolute.

The loan book of the Bank hasn’t shown much growth over the past two years. Nonetheless, the book composition has changed clearly in favour of retail loans which now account for 54% of the book, from 35% at the time of merger. This shift in the loan book composition has offered immediate benefits by way of improved Net Interest Margins (NIMs). At the time of the merger, the bank clocked the low NIM of 2.9%. In Q1FY21, IDFC First Bank has reported an NIM of 4.5%.

At the time of merger, the bank had guided that it aimed to achieve a retail loan book composition of 70% over a period of 5 years (i.e. by FY2024). Looking at the progress it’s made so far on this front, it appears to be on track to achieve its targeted loan book composition.

Business model seems to be changing for better…

Apart from the growing dominance of retail franchise, the transformation of the business model is evident from the changing borrowing mix as well. The bank has cautiously reduced its dependence on Commercial Papers (CPs), long term as well as money market borrowings. This has helped it reduce its market dependence and thereby fluctuations in the borrowing cost as well.

Here’s what CRISIL said about IDFC First Bank in its update:

CRISIL believes IDFC FIRST will continue to focus on scaling up its retail portfolio, thereby improving the granularity of the portfolio. The bank does not plan to take on incremental exposure in the infrastructure segment and will focus on the relatively small-ticket, mid-corporate, and financial institution segments. Therefore, susceptibility to slippages in large exposures, which has impacted the bank in the past few years, will be reduced going forward.

Going by the restructuring of loan book and changing mix of borrowings, it appears that IDFC First may not lend at the lower end of the yield curve where there’s intense competition. It means, it may not go aggressive on home loans or even in big-ticket corporate loans. IDFC First’s focus is likely to be the retail customer and MSME. Simply put, IDFC First Bank is attempting to replicate the time-tested lending model of Capital First in a bank format.

During the pandemic quarter, IDFC First raised Rs 2,000 of CET-1 (Common Equity Tier-1) capital quite comfortably. With this, the bank’s Capital Adequacy at 15.5% stands way above 10.9% as required under RBI guidelines.

The management has clarified that there’s no intent to use it up to mitigate losses. So, the newly raised capital can help accelerate growth when the economic environment improves. The presence of some high-profile investors among shareholders is a sentiment booster for the bank and shows the faith of institutional investors in the prospects of IDFC First Bank.

Can we expect a replica of Capital First from IDFC First Bank?

Between FY10 and H1FY19, Capital First grew its loan book at a massive 52% compounded annualised rate from Rs 935 crore to 32,622 crore. As on June 30, 2018, i.e. just before the merger of Capital First with IDFC Bank, the GNPA of Capital First was 1.6% and NNPA was 1.0%.

This couldn’t have been possible without rigorous underwriting and strategic thinking of the then management. As per the company records, only about 38 applications reached the disbursal stage for every 100 logged in at Capital First.  Low credit score, insufficient cash flow/documentation, unsatisfactory response at the personal interview were the primary reasons for the rejection of applications.

That said, barring demonetization (and the implementation of GST to an extent), there weren’t major disruptions. Factors such as the credit environment and the growth expectations were never so negative between 2010 and 2018, as they are at present.

It’s always darkest before the dawn

The on-going pandemic is forcing banks to take risk management function seriously and up their defences against unforeseen challenges. But for some banks such as IDFC First, the clean-up drive has begun much before the coronavirus outbreak hit the economy.  If it continues to deliver on its guidance, IDFC First Bank is likely to come off with flying colours in the post pandemic world.

Disclosures: This post is only an attempt to shed light on the fundamental aspects of IDFC First Bank and shouldn’t be construed as a recommendation in itself. That said, On July 26, 2020, Ventura Securities has given a conditional buy recommendation on IDFC First Bank (click here to watch the recommendation video), which is purely technical in nature. If you are following it, you may want to stick to the technical levels mentioned therein.

You may also like to read: Will Indian banks pass the COVID-stress test?

 

 Disclaimer: 

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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