IDFC Bank, a part of the integrated infrastructure finance company Infrastructure Development Finance Corporation Ltd (IDFC Ltd), is a private sector bank. IDFC Ltd received a universal banking licence from RBI in July 2015 and started operations in October 2015. The lending business of IDFC Ltd was demerged and transferred to IDFC Bank. IDFC Ltd holds 53 per cent stake in the bank.
The bank serves corporate and private customers in India, including the infrastructure sector that IDFC Ltd specialised in since its inception in 1997. The bank offers fixed deposits, debit cards, savings account, cash management and other services. IDFC Bank plans to build a network of more than one lakh points-of-presence in the next 14 months to enable people across the country to transact digitally. The private lender plans to set up 30,000 micro ATMs and 75,000 Aadhaar Pay merchant points. While the micro ATMs function as a bank-in-a-box, most of the Aadhaar Pay merchants will be converted into business correspondents and will deliver basic financial services. As on December 31, 2017, the bank had a distribution network of 127 branches, 356 dedicated BC (business correspondent) outlets and over 13,070 micro-ATMs.
With a low credit growth scenario and the historical baggage of infrastructure loans with which the bank started off, it would have been difficult to grow organically. For this reason, IDFC Bank tried to strike a deal with Shriram Group last year, but the deal fell through.
The target customer segment of Capital First is complementary to that of IDFC Bank. Capital First targets largely the SME and MSME space, whereas IDFC Bank targets the rural population through its ‘Bharat Banking’ model and an affluent urban population.
DYNAMICS OF MERGER WITH
CAPITAL FIRST
With the merger with Capital First, IDFC may finally be able to shed its image as an infrastructure finance company. The merger could be a way for the bank to build its retail book, something it has been unable to do in the two-and-a-half years since becoming a bank.
Even as the deal with the Capital First may not give IDFC Bank the kind of scale which was expected from the deal with Shriram Group, Capital First’s retail-only focus and strong financials make up considerably for a smaller loan book. Shriram Group has a loan book of over Rs.80,000 crore, whereas, after the September quarter, Capital First had a loan book of about Rs.22,974 crore and gross nonperforming assets of 1.63 per cent.
The merger is expected to help IDFC Bank get closer to its target of 60 per cent share of retail loans by 2021. After the merger, the share of retail loans for the consolidated entity would stand at 45 per cent. Retail loans comprise merely 26 per cent of its total loan book.
The target customer segment of Capital First is complementary to that of IDFC Bank. Capital First targets largely the SME and MSME space, whereas IDFC Bank targets the rural population through its ‘Bharat Banking’ model and an affluent urban population. Capital First fills in the missing link, making the combined entity relevant to the entire spectrum of customers. T he combined entity will have assets under management of Rs.88,000 crore and will serve more than five million customers across the country. In addition, with the planned ramp-up of IDFC branches, the consolidated entity would have an enviable distribution network with almost 250 branches across 35 cities by March 2018; 2200 dealership points; about 360 dedicated BC (business correspondent) outlets and over 9000 micro-ATMs.
The merger is expected to be concluded in the next 9 to 10 months. Post the merger, IDFC Ltd’s shareholding in IDFC Bank will drop from the current 53 per cent to 38 per cent. According to regulatory requirement, IDFC would have to maintain at least 40 per cent shareholding in the bank. As a result, IDFC will look to buy shares from the market to get its shareholding back to 40 per cent.
CHANGE IN MANAGEMENT
IDFC had been looking for a retail head lately. Rajiv Lall, founder managing director of IDFC Bank, has agreed to pass on the mantle to V. Vaidyanathan, founder and executive chairman of Capital First.
Vaidyanathan, being a seasoned banker and a former executive director at ICICI Bank, is expected to bring the muchneeded expertise for building a strong retail portfolio.
LESS THAN EXPECTED REGULATORY DRAG
One of the ongoing concerns among the investors regarding the merger was the drag on profitability due to regulatory requirements on PSL, CRR and SLR. However, IDFC Bank’s management clarified that over 40 per cent of Capital First’s loans are PSL-compliant.
FINANCIALS 
IDFC Bank reported a 23.6 per cent dip in net profit for the third quarter mainly due to steep fall in its earnings from treasury operations. The net profit decreased to Rs.146 crore for the December quarter, as against Rs.191 crore in the same period last year. The treasury income after provisions and before tax fell 75 per cent to Rs.59.7 crore from Rs.241.7 crore in the December quarter last year. Its gross profit decreased 34 per cent to Rs.314.7 crore in Q3FY18 from Rs.476 crore in Q3FY17 since other income slipped 31 per cent to Rs.230.8 crore.
The provisions and contingencies fell 53 per cent to Rs.108.6 crore from Rs.231.8 crore a year ago. The bank had reversed its provisions of Rs.100.37 crore in September quarter. But 8.5 per cent higher operating expenses at Rs.411 crore made a dent in the company’s profitability.
The bank has seen sequential deterioration in its asset quality with gross bad loans ratio slipping to 5.62 per cent at the end of December quarter, compared with 3.92 per cent in the preceding quarter. The ratio was 7.03 per cent in the same period last year.
In absolute terms, the gross non-performing assets stood at Rs.2777 crore at the end of third quarter, as compared to Rs.2002 crore at the end of second quarter of FY18 and was Rs.3587 crore in the same period last year. The bank has a healthy capital adequacy at 19.5 per cent.
VALUATIONS
The bank maintained a PE ratio of 20.47x, as against its peer Federal Bank (20.45x). The bank has a return on equity of 7.23 per cent and a return on capital employed of 158.05 per cent. The bank has a debt-to-equity ratio of 6.16x and price to book value of 1.3x. The bank has been maintaining a healthy dividend payout of 22.81 per cent.
CONCLUSION
The two-and-half year journey of IDFC Bank has been marked with challenges. The bank has charted a clear course of action over the medium term and has even acquired a micro finance institution. It is expected that, post the merger, the capital base of the bank would be able to sustain its growth target of 20 per cent CAGR for the next two years without a need for dilution. Also, with the new and more experienced management at the helm, the bank would get another fresh start. We recommend our reader-investors to BUY the stock.
