IDFC First Bank Limited

[ishanagarwal89]

I acknowledge that the best way is to merge. If you read the concall transcript of IDFC Ltd for Q3FY21, Mr. Kakar conceded to the fact that there will be a discount for merger. Whether it will be 5%/10% or 20% is anyone’s guess. In my view, given the weakening vote share of IDFC Ltd, they will have to give into a larger discount for the merger to take place. Higher the discount, higher the book value for the bank.

Also the fact that IDFC Ltd has stopped holding concalls thereafter indicates something may not be going as per what was planned and shared with analysts in the past.

[nitin_jagtap]

Vodafone Idea stock surges on reports of government’s telecom relief package...

if this happens, then will solve Vodafone funded exposure issue for bank.

[sahil_vi]

@muruguselvank

in the AR

Annual report:
https://www.bseindia.com/xml-data/corpfiling/AttachLive/c7a18e1b-ca8f-4275-abe7-a0fe046dda57.pdf

FY21 AR notes

CEO’s note is so full of information that have to make a separate section for it. The investment thesis is handed to investor on a platter. Of course it is up to the investor whether they buy it, or not. Every individual must make their own decision.

1. What we are building at the core is a new age digital Bank which is agile and highly scalable.
2. Focus of analyst community is on the here and now. Analysts not focussing on strong fundamentals and incremental profitability. Comparison with banks built over last 2 decades unfair. Converting from DFI to commercial bank is hard (only ICICI succeeded).
3. Carrying 28k cr of borrowing at 8.66%. Incremental profitability to be large when these are replaced by low cost borrowings.
4. Aspiration: become bank of global scale & profitability, on the cutting edge of innovation, providing amazing customer service, highest levels of corporate governance, generate high return on equity, and enjoying international respect and admiration.
5. Product teams design products in a way that it is meant to be sold to our “near and dear” ones. We make products with transparent pricing and fees. Eg: Monthly credit of saving account interest Low, Dynamic APR for credit card revolvers, Cash withdrawal interest rates, Where there is a misunderstanding, instruction to the service team is “credit the customer first” then fix the root cause of the issue, No Fine Print Banking, We don’t pressurize employees to sell high margin products.
6. 40% of card holders do end up paying the revolving credit card rates.
7. We recently unveiled our new mobile and web app which have a large number of unique features like Google like search capabilities, Personal Finance Management, Pay-to-Contacts, one click FD creation, live mutual fund investing, risk-analyser
8. we have also developed specialization in financing artisans, large medium and small farmers, kirana shops, restaurants, automobile spare parts, tailoring, carpentry, salons, chemists, two wheelers, consumer durables, JLG in rural areas etc. The purposes of financing include business expansion, cattle purchase, water and sanitation financing
9. have financed over 30 million such loans till date in our combined experience. We have developed unique skills in this area with stable and high asset quality of Gross of ~ 2% and Net NPA of ~ 1% for over ten years.
10. On profitability, the issues in infrastructure and certain corporate accounts turned out to be more than expected because of the economic cycle
11. our CASA ratio has crossed 50%. this describes our capability to raise deposits, a key raw material for growth.
12. The deposit inflows were strong, more than requirements. So, to optimize the flows, we reduced our savings account interest rates. our new account opening continues apace. reducing our savings account interest rates had another positive benefit; can participate in prime Home loans profitably which has multiplied our market opportunities
13. we will easily surpass the fiveyear guidance of 1,00,000 crore retail assets given at the time of merger.
14. Infra financing: have brought down the loan outstanding to infrastructure from 22,710 crore at merger to 10,808 crore as of March 31, 2021.
15. On the Corporate Banking side, we have implemented good controls in our Bank and our recent portfolio performance is pristine. (some hints of incremental asset quality)
16. During COVID our retail NPA has increased, but we are confident of reverting to our pre-COVID GNPA and Net NPA around end of FY 22, based on the strong pickup in collections post COVID second wave. We should trust our skills, track record, experience and technology, and not doubt ourselves just because of a pandemic that came our way. We learn, adjust, refine, and move on.
17. We expect mortgage backed loans to form 40% of our loan book in due course
18. Credit Costs: Our provisions for FY 21-22 is expected to be only 2.5% of the average loan book which is quite reasonable by industry standards, of which a substantial portion has already been taken in Q1 FY22, hence you can expect to see successively reduced provisions in Q2, Q3 and Q4 FY 22. Going forward we expect to keep our provisions at below 2% of the average loan book.
19. 2- 1- 2 Formula: We will be targeting a 2-1-2 formula, i.e. Gross NPA of 2%, Net NPA of 1% and provisions of 2% on funded assets on a steady state basis.
20. Strong incremental profitability of retail lending business: Our incremental borrowing cost is less than 5% and incremental lending in retail is over 14% at this point of time. incremental spreads on retail is >9%. our credit costs (provisioning) are expected to be about 2% based on the combination of products we finance. our incremental ROE in the retail lending business is estimated at 18-20%
21. Strong incremental profitability of Corporate Lending business: Here, the estimated incremental business ROE is 14-15%
22. Higher cost of 1,000 crore from Legacy Liabilities currently: As of June 30, 2021, the Bank has 27,936 cr legacy loans at 8.66% interest rate. When our Bank will replace this at say, 5.0%, we would save about 1,000 crore per year on an annuity basis compared to today (todo: figure out when these liabilities are maturing)
23. Set up costs (OpEx) in retail liabilities because of investments as we are a new bank: Since merger to March 31, 2021, we have invested in 390 branches, 565 ATMs, added over 12,000 employees, invested and upgraded our technologies, launched or scaled up many new businesses like credit cards, Wealth Management, Fastag, Gold loans and scaled up many retail lending businesses like prime home loans and digital lending, all these are essential capabilities for building a large bank. These investments are giving us a negative drag today but this will become profitable with scale.
24. Incremental profitability in a table:
25. The comparison with Q1 FY22 was even better. Here the core operating profit was 601 cr which was 118% over the merger quarter, while the book grew only 9% over the merger quarter. This tells you that the incrementally, the operating profit on capital is disproportionately higher as compared to incremental capital consumed
26. We expect to grow the retail book by ~25% on a compounded basis for a long period of time. This is already playing out over the last 2 ½ years, as the NIM has already expanded from 1.84% pre-merger to 5.09% in Q4 FY 21 and further to 5.51% in Q1 FY 22
27. The negative drag because of high cost liabilities will go away as we will repay these liabilities on maturity. The negative drag because of investments will go away with scale.
28. Size of opportunity: the MSME, retail and rural and agriculture markets alone is about 65 lakh crore and growing. We are merely ~ 75,000 crore in this market, which is barely above 1% of this market. For us to grow at 25% is not a big deal.
29. VI Exposure: out of the total dues of the company about 1.5 lakh crore are owed to the government itself and hence they will be keen to solve this issue. if we have a strong and profitable model and go on for extended periods of time, then a one-off incident does not dent the long-term story.
30. announced a one-of-a-kind Covid Care scheme for employees by assuring them 4X their CTC, salary credit to nominee for two years, waiver of employee loan, extension of medical insurance for family for 24 months, scholarship up to 10,000 per month for two children until graduation, employment for spouse on merits or skill training allowance of 2 lakh and so on
31. We implemented a bank wide cost-rationalization program. We tightened credit criteria and launched new products. We accelerated our efforts for digitising the bank. Our senior management volunteered with salary and bonus cuts to lead austerity by example.

@sahil_vi

• 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%.

The thing which makes me happy is that i had actually modelled a lot of these things which are finding mention in AR21 earlier in year correctly. 2-3% Credit costs, 8% eventual NIMs, even the timeline (my calculation was 2.2 years and itll probably be safer to say 3 years. Bank says next 3 years will be best so far for the bank).

@Sanjeev_Bansal

While CASA ratio for the bank is going up at a fast pace, it may not be right to compare it with the likes of HDFC and Kotak, since they are doing it at a much lower RoI (3-3.5%) than IDFC (7%).

Hope investors would be happy to see stickiness of CASA despite cutting rates 200 BPS.

Disc: Invested, biased.

[sahil_vi]

RBI publishes credit card stats for each month on this website:
https://m.rbi.org.in/scripts/ATMView.aspx?atmid=115

Latest one available is for June here: https://rbidocs.rbi.org.in/rdocs/ATM/PDFs/ATM06210F02FA081F0147998F4EBD89AE2D26DA.PDF

I analysed IDFCF and several other banks. Here are the results. It’s quite surprising at least to me:

Raw data

Bank	PoS Transactions	Value of Transactions (in Lac)	Outstanding cards	Transaction / card	Value / Transaction	Spend / card
IndusInd Bank	3560605	257051	1569485	2.268645447	7219.306831	16378.04758
IDFCF	1247150	59461	386801	3.224267776	4767.750471	15372.50421
American Express	3603920	179357	1482771	2.430530406	4976.719794	12096.06878
HDFC Bank	40002494	1753372	14828277	2.697716936	4383.15671	11824.51609
Citi Bank	10369231	302718	2603989	3.982056376	2919.387175	11625.16432
ICICI Bank	28302499	1188705	11034268	2.564963892	4200.000148	10772.84873
SBI	31096314	1221507	12044135	2.581863621	3928.140808	10141.92385
Axis Bank	14465088	519105	7136582	2.026892986	3588.675022	7273.860232
Kotak Bank	4307469	150400	2355745	1.828495444	3491.609574	6384.392199
Federal Bank	32377	819	14803	2.187191785	2529.573463	5532.662298

Conclusions

1. Indusind has highest spending per card. Something worth understanding and tracking. I dont track indusind specifically. Specially impressive is their spend/transaction. How are they able to incentivise users to make such large average transactions?
2. Citi bank has highest average transactions per month at around 4 but value per transaction being low it is somewhere along middle on spend per month per card.
3. IDFCF ranks second overall due to its second rank in Transactions per card per month (3.2) and third rank in value of each transaction (4800 Rs per transaction). Specially the high transaction value shows that client base is very similar or all the banks (perhaps except. federal).

Caveats

1. I only considered june data. Ideally we would consider for several months or a full year to account for seasonality. Since IDFCF only recently started scaling up this biz, existence of that data will take time.
2. IDFCF credit card program is new and probably not yet stable. The “leadership” position could be temporary. Better to look at it a year from now instead of getting to excited. Still very interesting statistics.
3. This only talks about volume and value data not credit quality.

[TejasW]

Hi,
It appears that IndusInd ran a voucher scheme in the month of June.

Source: https://www.cardexpert.in/indusind-credit-card-offer-june-2021/

Looking at the annual fees of some of their cards, it seems that they have a healthy arsenal of premium segment cards.

Credit Cards – Compare and Apply for Credit Card Online | IndusInd Bank

Your caveat 1 is on the mark, I believe that there is some seasonality to such data due to the nature of the partnerships with retailers and schemes these banks provide, it would be worth looking into data over longer periods and identify MoM trends or avg. monthly transactions for a year or so.

[diffsoft]

Disc: No investments

I wanted to point out an area of caution, esp in a banking business.

Understandably, a rapidly growing business needs equity capital (via issuing new shares). This is particularly true of a banking business, because there are limits on how much you can grow with existing equity capital. These limits arise, in effect, because of rules that force a bank to get more equity to grow faster than its intrinsic rate (basically via various ratios to be maintained). This is unlike, at the other extreme, US tech firms that operate on negative equity, and which constantly engage in buybacks. Equity capital is also required to fund sudden losses that arise out of mis-steps while growing rapidly.

Thus it is highly likely that a firm, esp a bank, grows really rapidly but issues a lot of new shares in the process. That should be a real watchout for an equity investor. Just as an illustation, if the earnings of a firm grows 3x in 5 years, management will write about the wonders it did, but it does no good to an investor who finds that his share of profits are substantially lower because the company issued lots of new shares (say 100%) to reach these levels. In other words EPS grew much slower (1.5x) than earnings.

In other words an investor has to be cautious of equity shares inflation!

With this understanding in mind let’s look at the equity issuances of IDFC First and how it compares. The table below shows new shares issued with respect to shares at the end of Dec 31, 2016:

We see that IDFC First has issued 83% additional shares since end of Dec 2016, compared to 8% by Kotak Bank and HDFC Bank.

So, a rupee earned by IDFC First is now watered down by 44% for an investor since Dec 2016, vs only 7% for Kotak / HDFC Bank!

Over long periods such repeated equity issuances eat away earnings for a long term investor. This is illustrated by another bank that was a star at one point: IndusInd Bank. From the beginning of FY 2009 until end of FY 2021 as below. (please bear with my formatting)

1. IndusInd Bank issued new shares continually such that end of March 2021 shares outstanding were 2.42 times those at the start of FY 2009

2. IndusInd Bank grew fantabulously over this period. Its earnings in FY 2021 were 19 times what it earned in FY 2009 (a CAGR of ~ 28%). Earnings are in Rs crores.

3. However its EPS grew by only 7.9 times and CAGR lower by about 1/3rd because of such continuous equity issued.

4. As an aside do note that this EPS will often be lower than reported EPS because reported EPS is averaged in a year for such issuances.

We may be tempted to ask, is it such a big deal. Yes it is. Look at how 27.9% and 18.8% compound in that time frame

To sum, earnings growth is great for management. It is equally great for an investor if his share of earnings grow at the same rate or faster (via buybacks). To that extent when a CEO says I will grow really rapid, assess how much equity will he issue along the way.

There are also other distortions with issuing new equity capital, but this one issue merits a mention

[sreered]

IDFC and Capital First merger happened in Dec 2018, and hence the big spike in the outstanding shares…it is wrong to take this event into consideration… if you take that as the base, the incremental increase is not much, considering a relatively new bank like IDFC First… in the long term, once it matures, the numbers are likely to be similar to what Kotak and HDFC are in the current period…

[sahil_vi]

@diffsoft

To sum, earnings growth is great for management. It is equally great for an investor if his share of earnings grow at the same rate or faster (via buybacks).

For a bank, broadly speaking most investors track book value per share compounding which roughly equates to ROE over time (if there are enough growth opportunities and assuming 100% reinvestment).

Point well taken over equity dilution for banks (which is only a problem if bank wants to grow book faster than ROE). For a low ROE bank (which IDFCF was for last K years) there is literally no other option, if they want to grow.
At same time, comparison of a 2.5 year old bank with 10 or 20 year old banks is not a fair one. Imagine if a 2.5 year old baby ran a race with a 10 or 20 year old human: no prizes for guessing the results of that comparison. Specially since this bank was an erstwhile DFI, one of the most gruesome lending businesses (high borrowing rate, low lending rate, chunkiness, high rate of default). I’d be more interested in tracking the equity raise post 2023 (5 year establishment period mentioned in each communique). Of course if an investor is not comfortable with the transitionary period equity raises, they always have option to invest elsewhere , especially all the wonderful banks mentioned by you.

[sanjeev_thakur]

Wonderful summary @sahil_vi. Looking forward for your research on #22 but here is something I found (copied/paraphrased).

1. Core Retail Deposits as a proportion of Total Deposits and Borrowings is increasing and currently stands at 33% (Aug 2022). It was at 21.78% as on 31 Dec 2019. Plan is to take this to 50% within the next 5 years (2024?).

2. With the growth in retail deposit base, IDFCFB has been reduced its high cost borrowings (FY21: INR50.47billion; FY20: INR37.39 billion). The management expects the same to reduce further post FY24, as the legacy long-term and infrastructure bonds start maturing. As a part of the reducing wholesale borrowings, IDFCFB has also reduced its certificates of deposits by 75% yoy in FY20 and 16% yoy in FY21.

References:

1. India Ratings and Research Private Limited : India's Most Respected Credit Rating and Research Agency : India Ratings Affirms IDFC FIRST Bank’s Debt Instruments at ‘IND AA+’/Negative

2. https://www.idfcfirstbank.com/content/dam/IDFCFirstBank/PDF/Commentary-for-Q3-FY20-results-for-IDFC-FIRST-Bank-Final.pdf

[diffsoft]

@sahil_vi

For a bank, broadly speaking most investors track book value per share compounding which roughly equates to ROE over time (if there are enough growth opportunities and assuming 100% reinvestment).

Book value per share can grow even with negative ROE, if equity is freshly issued at market price that is much higher than book value - even as earnings are negative. Consequently book value will be seen to be growing, even with losses!!! And growth in book value is then touted as (or mis-led as) economic performance of the firm.

I had some time ago shared an example of Fairfax here - Quess Corp - Human Resources Company - #9 by diffsoft

In any case, to be clear, my post is not a comment on the value IDFC First. It is to show a certain kind of caution to be exercised.

[sahil_vi]

@diffsoft

Book value per share can grow even with negative ROE, if equity is freshly issued at market price that is much higher than book value - even as earnings are negative. Consequently book value will be seen to be growing, even with losses!!

I was talking about a steady state bank which is making > 10% roe.

Anyway, for a bank which is still trying to get over its dfi mess, judging it based on equity dilution is a bit like judging a fish by its ability to climb a tree. We won’t end up with a useful number

The broader concern is well received, but imo only applies once ROE crosses a certain threshold and we can say that erstwhile IDFC mess is over. I’d say post 2023.

[rohit_mahajan]

In the case of growth in book value by diluting equity … one can also look at EPS growth in tandem to understand actual effect of dilution of equity…

[Parth_Mehta]

Thanks alot for such an extensive coverage. Much appreciated.

Just had one general question regarding the 27936 crores of legacy liabilities raised at 8.66%, I believe they should mention the date or atleast year when these liabilities will mature, a.k.a when the 1000 crore savings will start. I didn’t exactly find that in the annual report. Isn’t it a poor form of financial reporting to not indicate this?

Please let me know if I’m missing something.

Disc. Invested

[gmysore74]

I recall reading in one of the credit rating reports that the liabilities run until 2025-26. In any case, there isn’t much to get too excited over it. At time of merger, bank had 60000 cr of such liabilities, which now have come down to 27000cr. The benefits of the reduction seem to have just gotten absorbed into the endless credit losses the bank has seen so far in last 3 yrs…

[Puch]

This information has publicly been disclosed and already discussed on this forum earlier, you can find the details here - IDFC First Bank Limited - #1503 by Puch

[jockaayush]

If we see this, IDFC INFRA BONDS have a maximum maturity of 4 Years 8 Months.

[gmysore74]

I personally hold IDFC infra bonds that I bought in 2012 which mature in 2022.

[sahil_vi]

@gmysore74

endless credit losses the bank has seen so far in last 3 yrs

It’s actually a mixture of credit losses and operating expenses (due to branch expansion, employee hiring, and business mix change).

1. The thing about credit losses is, you can actually track where they came from. Last many many years of credit losses came from corporate and specially infra book: DHFL, reliance capital etc. Now Vodafone Idea is another potential credit loss from same corporate book. Good thing is that all of these are legacy loans. This is a clean up which was necessary. This is the cost capital first paid for a banking license.
2. The retail credit losses seen now are actually due to pain of last lock down. Modern lending is cashflow based. Now if you take away that cashflow and literally stop the economy, of course some % of people are bound to not pay up. If bank actually achieves it’s guidance of 2.5% credit losses in retail in one of the toughest adversarial setting known, imo it would show the strength of the retail book. In any way even in a normalised scenario 2% credit loss is expected. Key thing for investor to do here is closely track actual credit losses in fy22 and see if they remain around 2.5%. Have they actually front ended the credit losses as they said in Q1 or is this all just a hogwash? Remains to be seen. Of course any wave 3 throws the guidance out of the picture and credit losses will increase if there is a wave 3.

[Rushil]

There has been a wave 3 even in countries having 60 percent plus double vaccinations.
IMO that will seriously dent small banks. This + VI going down will give long term investors a good chance to invest later on.
Given wave 3 and other issues with IDFCFB can’t really see them keeping their guidance at all.

Really don’t like Vaidyanathan’s guidance every quarter-just say I don’t know how the credit picture will pan out -like how HDFC Bank had accepted sometime ago- though it helped us investors since he raised capital at rs 57 which is a great deal

@sahil_vi - agree with your logic there but seeing Kerala’s numbers(yes they had lower sero positivity) I am not so optimistic. Wave 3 will affect those not exposed to delta variant- plus sero positivity doesnt mean immunity won’t wane)Hope to be wrong.

[sahil_vi]

@Rushil

countries

That’s not how reality works. Let me demonstrate why such “it happened there it will happen here” reasoning has high potential to fail. In essence you’re inverting the causal relationship (A causes B, B does not cause A). Only reasoning which works is first principles reasoning.

1. What caused wave 3 in all these countries? It was India’s wave 2 which caused wave 3 in these countries: namely : delta variant. Delta variant invades immune response, is 2-3x more transmissible than alpha variant. So it shouldn’t come as a surprise that developed countries had a wave 3. I had predicted back in April that all developed countries will have wave 3 after personally battling with delta variant.
2. Despite wave 3, Britain has remained open. Despite wave 3, Britain has not seen high deaths. The vaccination really works and helps keep bad outcomes down which takes away necessity of imposing lock downs. Because healthcare system is not under risk of collapsing
3. Recent sero survey results have shown around 60% indians having covid antibodies. This shows the extent of our underdetection. But it also shows our extent of damage already done. Same variants simply cannot do same type of damage again.

So really, the question is not so much whether a wave 3 but rather: will there be a more dangerous variant than delta which invades immunity we’d built after delta variant. That, yes that could cause a third wave. I shudder to think what such a variant would look like. Can it happen, definitely. Is that a bygone conclusion? Most definitely not.

In conclusion: I really do hope there are no more dangerous variants. And frankly if there is a 3rd wave (caused by a new variant), the extent of the human trajedy will far exceed a few percent points of NPA on a banks balance sheet.

@Rushil

Kerala’s numbers(yes they had lower sero positivity) I am not so optimistic.

That is precisely the reason Kerala is having high cases , they did better first time around. But now, they’re slowly getting delta variant. The more they vaccinate the more they become immune. The key risk is not a new wave it is new lockdowns. Both of below need to happen for that to happen:

1. New variant more dangerous than delta
2. Low vaccination.

Point 1. Is probabilistic. Point 2. We are actively fighting again. More lockdowns is not a bygone conclusion. It’s a risk. But that is why valuations are low. Otherwise it’d be at > 2x book.