IDFC First Bank Limited

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I have been thinking about how to project when IDFC First bank can come back to a respectable RoA, something which would lead to reasonable valuations. Here is my attempt at doing that

Data from old posts

  1. As per my november post on OpEx, IDFCFB’s Opex/AUM is 5.4% and HDFCB’s OpEx/AUM is 3.3%.
  2. From my October post on understanding NIMs and Provisions, a reasonable estimate for provisions and write-offs for IDFCFB seems to be capital first’s pre-merger number of 2%. Of course in the interim while they clean up balance sheet the provisions would be high (even for Covid, bank has created ~2.5% of AUM provisions). The FY20 Provisions+Write-offs were 4%.
  3. From the same post, the NIMs for IDFCFB were 5.4% in FY20 and were 8%+ in CapF days. It is now clear why the RoA is negative or marginally positive. All the NIM (5.4%) goes away in OpEx (~5% in FY21 and 3-4% in FY20) and Provisions+Write-offs (4% in FY20 and possibly 3-4% in FY21).

Putting it all together

  1. I think in a steady state, it is reasonable to assume that IDFCFB would have 2-3% Provisions+Write-offs (assuming similar asset quality as CapF).
  2. The Opex as % of AUM has to come down to 3% from the current 5% (4% is a reasonable interim projection for the bank). This would happen as the bank disburses more loans from each newly opened branch and the OpEx scales much slowly than the AUM growth.
  3. Assuming OpEx growth of 5% and AUM growth of 20% we get this equation which means that after 2.2 years, OpEx/AUM could become 4%.
  4. The NIMs would expand back from 5.4% to 8%+ as the % of retail in the loan book and the liabilities increases. This would be supported by both a increasing CASA (taking cost of borrowing from 10% to <7%) and increasing retail loan disbursements. (The NIMs are already at 6.5% in H1FY21). Assuming that the expansion to 8% happens in 2 years time.
  5. This means that in 2 years time, the PTRoA would be = 8-(2.5+4) = 1.5%. This means the RoA would be 1.1%.

One might ask, why I am doing this. The reason is to create key monitorables which can enable me to track the story and understand whether it is proceeding like I want it to proceed.

Key monitorables

  1. Rate of growth of OpEx. Rate of growth of AUM. The larger the difference, the faster my fundamentals projections would be met.
  2. Provisions+Write-offs in a steady state. I have modelled for 2.5% average (2-3% range). If they are much higher, it would spoil the party. Much lower would enable faster profitability.
  3. NIM expansions: key sub-monitorables are Gross Yields and the Retail CASA+TD ratio. Gross yield should expand as retail as % of loan book increases and Retail CASA+TD growth would reduce interest expended line item.

I would wait for these key trends to play out in next 2 years or so and if they do not, then that would be a clear exit criteria for me.

Disc: Invested, Full PF here. I am positively biased. This post is for educational purpose only. Would request all investors to make their own informed decisions, discussing with their financial advisors.

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