IDFC First Bank - Business Model & Research Report

How would it be to have the operational efficiency of a bank and an established retail loan segment combined in a single banking entity? Let's discover...

Well, IDFC First is the bank that we are talking about! In recent times, one thing that we have understood for sure is that the banking business is no joke! You have to be very careful before investing in the banking sector, or you might just end up losing your money.

It becomes imperative that you understand the business model, operational efficiency, financials, and the prospects of a particular company before putting your hard-earned money in it!

So, what's so special about IDFC First? How is it different? Should you invest? This article will come in handy to clear the fuss and answer all your questions.

Welcome to a detailed fundamental analysis of IDFC First Bank. 

IDFC First Bank Ltd - An Overview

IDFC First Bank came into existence by the merger of IDFC Bank and Capital First on December 18, 2018. To fully understand the merger and its reasons, it is crucial to understand the history of both these companies.

IDFC Bank - IDFC Limited was basically into financing Infrastructure and wholesale loans, which were used to finance massive projects. In 2015, IDFC Bank was created by the demerger of infrastructure, the lending business of IDFC to IDFC bank.

CAPITAL FIRST - Capital First, founded in 2012,  was an Indian NBFC providing debt financing to small entrepreneurs, MSMEs (Micro, Small, and Medium Enterprises), and Indian consumers.

But here, the main question is... Why would a Bank merge with an NBFC?

Well, this merger was a win-win situation for both parties. IDFC Bank, which had a loan book mainly consisting of infrastructure and wholesale chunk loans with low margins, looked for a retail finance institution with the adequate scale, profitability, and specialized skills. Capital First had a strong presence in the retail segment with a robust retail loan book which would help IDFC bank diversify its loan book and increase its margin or spread.

On the other hand, Capital First was looking to transform into a “universal bank” so that it can access a large pool of funds at a low cost for growth. And with its product mix and customer profile, it would fit well into the banking fold. 

But you might be thinking, why are these “Retail loans” so important? Let us understand the matter with this image.

So, now you know?

That way, IDFC First  Bank has had a complete turnaround since the merger. With a strong focus on the retail segment,  It now has a customer base of around a whopping 7.3 million people, a strongly funded asset base of more than ₹1,17,127 crores, with about 63% in the retail segment. IDFC FIRST has a total of 580 branches all over the country.

Till now, you must have got a brief overview of the bank. Let us now look at the business model.

The Business Model of IDFC First Bank

IDFC First has been very aggressive in the retail segment. The bank aims to be predominantly a retail bank. Although It has not entirely shifted its focus from corporate banking, it has trade, forex, cash management, salary accounts, treasury, and related businesses.

The main focus of the bank is to use Capital First’s tried and tested model of financing small entrepreneurs and consumers on a bank platform (which is IDFC bank). With IDFC’s strong branch network and rural presence, the company aims to use the advantages offered by both these companies and use them to expand in the retail segment.

IDFC bank used to earn a spread of only 1.7% before the merger, Which has seen a drastic turnaround, which can see an upside of up to 5-6% in the future because of the retail segment business that came with Capital First.

Let us have a look at the product portfolio of IDFC First Bank:

The bank also offers Working Capital Loans and Corporate Loans for Business Banking and Corporate Customers in India. But majorly, it focuses on the retail segment. 

While looking at banks, we need to analyze how the bank is lending its money. The strategy for IDFC First is not to increase the loan size but to change the product mix.

As you can see, the company is constantly trying to increase the retail funded assets rather than increasing the total funded assets. And you know why.

Now, let’s talk about the raw material for the bank, i.e., the liabilities side of the bank. The strategy for the bank is quite simple, i.e., to increase the deposits from customers as they are one of the cheapest sources of funds for the bank. To increase these deposits, IDFC First started providing a whopping 7% interest on the savings account, due to which the bank saw a high increase in the customer’s deposits.

The idea was to increase the deposits from retail customers and lend them in retail loans, which help to earn high-interest rates, thereby increasing the spread.

What is its moat?

1. Advantage of Capital First’s retail presence and penetration

IDFC First has got the advantage of already established retail penetration of Capital first’s business. It is now in a position to disburse loans at higher interest rates due to its retail network. If IDFC manages to lower its borrowing cost with increased retail deposits, it can earn an extra 2-3% spread, which is very difficult for other banks as they don’t have a strong retail presence.

2. Tech-savvy Business Model

IDFC First, with its latest operational techniques, has architectured its design and technology in a very open and flexible manner.

However, these are not very strong moats. The bank is currently young and will take time to develop a strong moat.

What is good?

1. Increasing retail deposits constantly which helps to reduce the costs.

2. Reducing the infra and wholesale loans drastically and increasing retail loans percentage.

3. Focusing on restructuring loans rather than increasing them exponentially.

4. Advanced digital operational techniques help in increasing operational efficiency and flexibility.

What is bad?

1. Wholesale loans of the bank are still high at 37%

2. High cost to income ratio due to the high operational expenses

3. Low fee-based income

4. ROA and ROE are not encouraging but are expected to grow.

5. The cost of liability for the bank stood at 8.35%, which is relatively high.

Financials of IDFC First Bank

CASA Ratio

CASA (Current & Saving Account) ratio is a very cheap source of funds for a bank as these deposits carry comparatively lower interest rates. Thus, the higher the ratio, the better it is for the bank.

CASA ratio for IDFC First stands at 51.75% and has seen a consistent increase over the years which is a good sign for the bank as it decreases the cost of funds. IDFC first is focusing on becoming a Retail focused bank, due to which we can see a further high increase in CASA ratio for the bank. 

Net Interest Margin (NIM)

After the merger with Capital First, the company has witnessed an increase in NIM because of the rise in the retail loan segment. 

The current NIM stands at 5.09%  and is expected to grow further as the bank is focused on decreasing the wholesale chunk and infra loans, which are low yield loans and increasing the CASA ratio, which will reduce the cost.

Non Performing Assets (NPAs)

Most of the NPA’s are witnessed by the bank in wholesale and infra loans, but IDFC First has improved its Net NPA over the years. As mentioned earlier, the bank is reducing the infra and wholesale loans in its product mix,  which used to account for the majority of NPA for the bank. The bank has done an excellent job maintaining its balance sheet clean and is aggressive in recognizing NPA’s. We can expect the percentage to reduce further in the future.

Capital Adequacy Ratio (CAR)

The CAR of the bank stood at 16.32%. The bank raised additional equity capital of Rs. 3,000 crore was raised through QIP on April 6, 2021, which shows that the bank is trying to improve its CAR. But,  Excluding the capital raised, the capital adequacy as of March 31 would have been 13.77% which is relatively low and may concern the investors.

Financial Statements

The bank is trying to keep its balance sheet as clean as possible. To increase the granularity of the loan book, the bank is gradually scaling down its wholesale portfolio, leading to muted growth in the overall loan book. On the liabilities side, the bank has been focusing on building a granular retail deposit franchise and increasing the CASA ratio in the percentage of total deposits.

A glance over the P&L will tell you that the interest earned by the bank has improved over the quarters, which is a good sign for the bank. Operating expenses have decreased over the quarters, and PAT was at Rs 324 crore for December 31, 2020.

(Source of info: ticker.finology.in)

Conclusion

If we look at the bank from a broader perspective, the bank has shown an improvement in all aspects over the quarters. With its focus on the retail segment and improvement in product mix, the bank is also expected to enhance its NIM. Opex has decreased, and as the bank matures, the loan book is also likely to increase.

But as always, before deciding on whether to buy shares of a company or not, you must do thorough research about the company and see if it fits with your investment objectives.

Happy Investing!

Anyway, what's your opinion on IDFC First Bank? Tell us in the comments.