Hi Everyone,
I have a lot of interest in banking industry. I have a question regarding banking and not on IDFC bank so, please don’t mind.
The over all question is that how do I calculate the net profit which a bank is capable to make out of the money it is going to raise by diluting its equity.
I am going to take a scenario below with few assumptions. Please try responding within that scenario.
Suppose a bank has 250cr outstanding shares and it is planning to dilute it further by 40cr shares. The bank is raising 700cr from these 40cr shares.
The total outstanding shares comes out to be 290cr.
Now I want to calculate the net profit which can be earned from this 700cr.
Suppose they disburse this 700cr as advances
Assumptions taken.
1 The bank has a track record of 2% slippage on advances and 75% of provisioning. So the provision comes out to be 10.5 cr
2 The bank has an average yield on advances of 8% so the net interest earning is 56cr because there is no interest expense.
3 Tax rate is 25%
4 Operating cost is something I am unable to calculate. Please do let me know if any other cost needs to be deducted apart for depreciation.
How do I compute the operational cost for this 700cr of advances. or please do let me know if there is any other way through which I can calculate net profit from this 700cr.
The reason I am getting confused at operational cost is because BANK has two major activity getting deposit and giving advances. All other activity come under these 2 activity.
Since this 700cr has been raised via dilution it goes through only 1 activity that is giving advances. So how do I compute the operational cost here so that I can arrive to net profit.
My way of calculating might be wrong please do correct me there as well.
Please don’t mind my question. It might look silly
The most practical way of arriving at incremental annual profits that can be arrived at by this incremental equity raised, is to apply the marginal Return on Equity on this equity capital. This could be simplistic in a bank that is undergoing a lot of changes in its A & L profile, operational activities etc. They can be arrived at as adjustments.
Marginal ROE will probably be the latest quarter ROE pre raising of this equity capital. So if the last quarter annualized RoE is say 15%, then you could say this adds Rs 105 crores of PAT on Rs 700 crore of equity capital.
You can then make adjustments based on the specific context…maybe capital is raised to cover for anticipated provisions, to cover for CAR for new Basel rules, or to expand credit faster that internal accruals will allow while maintaining CAR.
Also from your query it appears that you seem to indicate that only capital raised as equity is what you will be able to disburse. It will of course (and better be) be much more as pointed out by @Pradeep_Jadhav
Raising equity also allows the bank to raise liabilities, i.e. deposits and the deposits + equity + other liabilities will be used for generating assets, most of which will be advances. So it is not just one activity. It is both - on the liability side as well.
Bank raises equity to lend more without lowering CAR. Suppose CAR is 20%, bank can lend 3500 cr not only 700 cr. Now on this 2800 cr, bank will pay interest to depositors. Deduct this interest as cost, consider interest income from 3500cr not 700cr, you will get the answer to your query. If bank has solid business model, this capital raise will increase earnings more than ROE and every capital raise will increase share price. If bank is struggling to maintain balance sheet/assets, this capital raise will turn into one more equity dilution just for survival.
Hi. Can someone please guide me if they follows a minimum profit margin filter as well, below which one would not touch a bz whatsoever be the earning growth. Meaning lets say, a bare min 5% OPM or 3% net margin filter.
Because I came across this co ‘Redington’, everything seems decent but 2% NPM is too thin for me, and makes very difficult to infer moat, if any.
Good question. I don’t think there is anything specific for banking. Just like any other business, as per Indian income tax regulations, losses from a specific business can be set off against future profits generated by that specific business (only!). So a bank can carry forward losses like any other business.
Now because a bank has past losses to carry forward, that means, tax wise, they will be able to generate profits but their final taxable profit would be after the previous year’s carry forward losses have been set off. This gain in bottom adds to the final Return on Assets number that a bank generates, and because Return on Equity is essentially Return on Assets * Gearing, it also has exponential gain on return on equity, specially for a leveraged business. Exemplifying how leverage boosts your profits:
Quote from Devil take the hindmost, A history of Financial Speculation by Edward Chancellor, pg: 207
Corporate leverage operates in a similar manner to the speculator’s margin loan. For exam-ple, if a company has earnings before interest of $100 million and interest payments of $90 million, then its net profits before tax are $10 million. A 10 percent increase in earnings to $110 million will produce a 100 percent rise in pre-tax profits to $20 million. Insull and other holding company operators in the 1920s enhanced the effects of corporate leverage by creating a pyramid of cross-shareholdings between heavily indebted companies
Here’s a snapshot of Consolidated P&L of IDFC First Bank for FY2021 (source: AR for FY2021 pg: 269)
