IDFC First Bank: Decoding the business

Have you ever considered making a purchase in a promising but lesser-known bank? We often hear about the big players like HDFC Bank, ICICI Bank, and Kotak Mahindra Bank, but there are hidden gems in the banking sector that could be worth exploring.

One such bank that has caught our attention is the IDFC First Bank. You may not be familiar with it, but it's definitely worth getting to know. Recently, this bank has undergone some interesting changes. In one instance, it was announced in July that IDFC Ltd.and IDFC First Bank had decided to merge, which could have a big impact on their future expansion.

Also, IDFC First Bank intends to raise ₹2,000 crore in the form of equity capital during the second half of the current fiscal year, as reported on 20 July. This action demonstrates their belief in their own potential and growth opportunities.

The past three years have seen IDFC First Bank put a lot of effort into lowering its bad loan ratio and increasing deposit accumulation, which has greatly improved its fundamentals. Because of their upward trajectory, they have been able to easily attract institutional capital, the percentage of investors' investments is shown in the snapshot below ⤵️

Before getting into the bank's financials, let's understand the industry it operates in first.

Growth Opportunities

The Indian banking industry has a promising future, with significant expansion projected in the upcoming years. With $3.6 trillion in total assets, it is currently the third-largest financial institution worldwide. When converted to Indian ₹, it will be:

Oh boy, looks like I might’ve gone crazy with the zeros😵‍💫!

In addition, the Non-Banking Financial Company (NBFC) market is rising quickly, with assets expected to exceed $1 trillion by 2025. The popular Unified Payments Interface (UPI), one of the government's attempts to promote digital payments, has contributed significantly to the sector's growth. The chart below displays the composition of the Indian banking sector by their percentage for the Financial Year 2020.

With 12 public sector banks, 22 private sector banks, 46 foreign banks, 56 regional rural banks, and a wide network of cooperative banks totalling 96,000 banks across the nation, the Indian banking system is highly diverse. 

The banking industry is cyclical, which implies that the economy has a significant impact on it. Permit me to elaborate on how the economy has a significant impact on the operations of banks.

The economy has a strong impact on IDFC Bank's performance or banks in general. So when the economy is expanding, more banks see a rise in demand for loans and other financial services, which increases their revenue. But when the economy is contracting, there may be less borrowing and investment, which can result in reduced incomes and even a rise in bad loans as borrowers struggle to make their payments.

Banks therefore maintain their stability and long-term profitability by regularly monitoring economic trends and adjusting their policies to deal with the cyclical nature of the economy.

Now that we know that the industry has sufficient potential, let us get back to knowing, 

About IDFC FIRST Bank

In 2018, IDFC Bank and Capital First, a non-banking financial corporation (NBFC), merged to form IDFC First Bank, a privately owned bank.

This bank has led the way in a number of financial fields. For instance, it introduced the idea of monthly interest credit on savings accounts as the first universal bank, giving consumers a special benefit. Allow me to explain, it simply means that the bank will give you a small benefit each month based on the balance in your savings account. 

Additionally, IDFC First Bank was a pioneer by issuing the first lifetime free credit cards with no minimum spending requirements, setting them apart from the competition. The bank distinguishes out for offering customers dynamic and low Annual Percentage Rates (APRs), which make borrowing money when needed more reasonable.

Let's dive deeper into the workings of this remarkable bank and explore its business strategies further.

IDFC Bank

In 1997, IDFC Ltd. was known for funding infrastructure projects in India. In 2014, they got approval to start a new private sector bank, which began operating in 2015. However, they faced risks and low profits in infrastructure financing, so they decided to diversify. They started a retail banking business, specialised in lending to individuals, and sought a partner with experience in retail lending to merge with. And,

Capital First: 

Mr. Vaidyanathan established Capital First in 2010 with the goal of assisting consumers and small business owners who were neglected by conventional banks. Their goal was to become a universal bank, giving them cheaper access to a large pool of money to support their expansion.

Business Segments

The image below ⬇️ shows the segments of IDFC FIRST Bank:

Now, turning our attention to the…

SWOT Analysis

SWOT analysis can be used to assess a company's health, so let's look at the:

Strengths

• The bank's strong asset quality and extremely low levels of bad loans are its greatest strengths. It has a strong capital position, as indicated by its 16.74% Capital Adequacy Ratio (CAR)
• In addition to giving the bank a competitive advantage, a robust capital base inspires confidence in depositors, members, credit rating agencies, and regulators, demonstrating the bank's stability to all of them. Below is the graph with the Capital Base Comparison:

• Over the past three years, they have been able to authorise sizable new exposures in corporate banking totaling ₹18,000 crore because of their effective credit review procedure.
• The bank increased CASA balances from ₹45,896 crore in FY21 to ₹51,170 crore in FY22 through the use of customer-friendly products, demonstrating their capacity to draw retail deposits with their respectable brand even though they cut savings account interest rates.

Weaknesses

• Compared to its competitors, IDFC First Bank has a smaller customer base. It has about 73 lakh customers as of March 2022, compared to far larger customer bases at its rival banks Federal Bank, IndusInd Bank, and Bandhan Bank.
• As of March 2022, IDFC First Bank has 641 branches in terms of branch network, whereas its competitors had a noticeably higher number.
• The bank carries a legacy liability of ₹25,181 Crore, which amounts to about 8.7% of its total expenses.
• Since December 2018, IDFC First Bank has added 464 new branches and 700 ATMs in an effort to increase CASA deposits and retail loans. Operating expenditures have increased as a result of this expansion, investments in digital initiatives, and the hiring of more workers.
• As the 9th largest private bank in India with a market share of just 1.14% in loans, the bank has difficulty negotiating favourable pricing with clients because of its tiny size. Its emphasis on consumer loans, which are less profitable than business loans, further reduces its pricing power.

Opportunities

• Beyond lending, the bank is pursuing a variety of ventures to diversify its revenue streams, including digital cash management, forex trading, wealth management, FASTag, toll acquiring business, credit cards, and current accounts for diverse consumer segments.
• Only $93 billion dollars, or about 18% of the country's GDP, of India's total consumer credit industry is made up of personal loans. Personal loans typically account for between 80% and 120% of GDP in developed nations, suggesting enormous growth potential in the personal credit industry in India.

Threats

• Established banks are competitors of IDFC First Bank.
• Loan demand falls as interest rates rise, which affects banks' profitability because deposit rates go up.
• For the bank, maintaining compliance and adapting to new regulations can be difficult.

Shareholding Pattern

Let’s look at the shareholding pattern:

Total Promoters’ Holding is 39.99% as of March 2023. Promoters of the company have not pledged any of their shares as collateral for a loan. This is a positive sign for investors, as it indicates that the promoters are confident in the company's financial health and future prospects.

About the Merger

IDFC First Bank’s board has given approval to the merger of IDFC Ltd, IDFC Financial Holding Company Ltd, and the bank. Currently, IDFC Ltd holds a 39.93% stake in IDFC First Bank through IDFC Financial Holding Company.

Post-merger, IDFC Bank will have complete public ownership, featuring diverse shareholders. When we look at the financial performance of the bank and IDFC Ltd, the bank currently has total assets of ₹2.4 lakh crores, while IDFC Ltd has total assets of ₹9,570 crores, which will be consolidated into a single entity after the merger. The bank has a turnover of ₹27,195 crores while IDFC Ltd has a turnover of ₹2,076 crores by FY23.

However, why didn't IDFC Ltd directly hold a stake in IDFC First Bank?

It is because, as per RBI's guidelines, highlighted in the picture below, promoters must not be conducting any financial regulated business directly under it. So it was mandated to hold the equity in IDFC First Bank only through IDFC FHCL.

Following the merger, the balance sheets of both entities will be merged into one, resulting in a 4.9% increase in the bank's book value. 

The key reasons behind the merger are,

1. The merger will simplify regulatory compliances for both IDFC Limited and IDFC FIRST Bank, leading to unification and streamlining.
2. It will help the bank with diversified institutional shareholders, like other large private sector banks, with no promoter holding.

Financial Performance

Over the past three years, the bank's Net Interest Income has constantly increased at a remarkable 26% rate, reaching ₹9,706 crore. It was more profitable than its rivals thanks to a Net Interest Margin (NIM) for FY22 of 5.96%, which was greater than the industry average of 4.84%.

Following the merger with Capital First, the bank saw two years of consecutively declining profitability before turning a profit of ₹483 crore in 2021. The net profit climbed to ₹2,485 crore in FY23, demonstrating the company's growing financial performance.

For the past four years, the bank has been attempting to lower its Cost to Income (C/I) ratio, which was 95%. However, it's still higher than its competitors. The C/I ratio is low for retail, commercial, and wholesale banking, but it's being affected by setup expenses, liabilities, and credit card segments.

They are generating interest income and encouraging business expansion by utilising its free cash flow to increase its loan portfolio and give credit to people, companies, and other organisations.

As mentioned earlier, they had substantial exposure to the infrastructure industry following the merger with Capital First, as mentioned above, which had an impact on its net profit due to non-performing loans. Since then, it has deliberately decreased its exposure to the industry and implemented risk management strategies.

Since the merger, CASA Deposits have increased dramatically, decreasing the bank's reliance on expensive borrowings from big lenders.

Below is the graph representing the Segment wise Break-up of the revenue for the bank:

Although the bank has a total debt of ₹52,962.5 crore, it generates a sizable amount of cash flow from its main business operations and is not overly dependent on outside funding.

The bank's free cash flow is less than the average of its peers. It represents the bank's continued expenditures in company development and expansion with possibilities of long-term success.

Peer Comparison

IDFC First Bank is a medium-sized bank in India, with total assets worth ₹52 billion. This places it on par with other mid-sized financial institutions like Bandhan Bank, IndusInd Bank, and Federal Bank. Since they are comparable in size, focus, and target market, these banks are appropriate peers to compare and assess IDFC First Bank's strengths and weaknesses. 

To learn more, have a look at the table below, which includes all of the essential variables that must be taken into account when assessing the performance of the banks.

	CASA	NIM	P/B	ROA	CAR
IndusInd Bank	42.72%	3.96%	1.52	1.26%	18.42%
IDBI Bank	56.79%	3.59%	1.35	0.84%	19.06%
AU Small Finance Bank	37.29%	4.80%	5.25	1.87%	21%
Bandhan Bank	41.61%	6.58%	2.85	0.10%	20.10%
Federal Bank	37.13%	3.06%	1.06	0.91%	15.77%
IDFC First Bank	48.41%	5.41%	1.17	0.08%	16.74%

In just 4 years, IDFC First Bank made a stunning transition from corporate to retail banking. The bank's emphasis on retail deposits increased significantly over the years, with a solid CAGR of 36%. The bank is well-positioned for loan book expansion thanks to a solid operational strategy and the opening of additional branches.

Check out IDFC First Bank's Business Model & Research Report to understand how the bank operates and grows.

The Bottom Line

There is long-term visibility for IDFC First Bank. With a solid capital foundation and few non-performing assets, it is in good financial standing. The bank's business has also been steadily rising in recent years, and it has a clear focus on boosting its retail banking division.

While many retail investors may favor the more well-known brands, looking into chances at smaller banks like IDFC First Bank may present some interesting prospects and the possibility of profitable investments. 

It's a bank that's on the move, and definitely worth keeping an eye on!

*Disclaimer: The stocks and companies discussed above aren't a recommendation from Insider by Finology and shall not be construed as a replacement for professional advice. Consult a professional or conduct the necessary research before making investment decisions.

Also, check out our IDFC First – Stock Analysis for detailed insights.