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
- As per my november post on OpEx, IDFCFB’s Opex/AUM is 5.4% and HDFCB’s OpEx/AUM is 3.3%.
- 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%.
- 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
- 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).
- 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.
- 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%.
- 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.
- 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
- Rate of growth of OpEx. Rate of growth of AUM. The larger the difference, the faster my fundamentals projections would be met.
- 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.
- 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.