IBSPECIAL

IDFC First Bank managing director and CEO V Vaidyanathan is probably feeling like a conqueror. The legacy bad loan issues are out of the way, the core operating profit has hit almost Rs 1,000 crore, the loan book is growing and the deposit base is healthy.

The take-off moment for IDFC First Bank has arrived. Exuding confidence after the fiscal first quarter performance, and speaking to analysts, Vaidyanathan said “it is frankly our read that our bank will never post a loss again in its life”.

If you are within the walls of the bank’s corporate office at Bandra-Kurla complex in Mumbai, you will get to sense this internal feeling of confidence among the staff. There is an air of expectation that the worst is over and scale-up is inevitable.

Vaidyanathan has been putting the pieces together for more than three years, ever since IDFC Bank and Capital First merged on December 18, 2018. These are in the areas of legacy stressed assets,  loan growth, low-cost deposits, profitability, incubating credit card business and developing fee-based income. By addressing these issues, he is building the pillars of the bank.  

Lumpy Assets

The prime task cut out for him was to deal with the lumpy assets that had gone sour. These inherited accounts included Dewan Housing Finance Corporation Ltd (DHFL),Reliance Capital, Future Retail, Cafe Coffee Day and some infrastructure loans. The bank had to make heavy provisions for these non-performing assets (NPAs), which impacted its profitability. All stressed legacy large-ticket wholesale exposures are now accounted for.

“We did not have a choice because there were just so many lumpy assets to deal with. We couldn’t push them under the carpet. So, one after the other, we have dealt with every one of these legacy accounts. I can tell you confidently there’s nothing left here,” said Vaidyanathan.

Keeping the flow into the NPA pool low had to stay as focus while leaving the lending tap open. Having sorted that out, the bank has guided credit loss for less than 1.5% and retail NPA for less than 2% this year.

“So, SMA-0, SMA-1, SMA-2, literally product after product, segment after segment and at the overall bank level, they're all lesser. Now naturally, if SMA is low, then flow into NPA will be lesser. The short point is that the asset quality numbers are looking quite good,” said Vaidyanathan.

For the quarter ended June 2022, the private sector lender reported gross NPA at 3.36% and net NPA at 1.3%. Excluding the NPA in the infrastructure financing book which will run down in due course, the gross and net NPA of the bank would have been 2.39% and 0.80%, respectively. For retail and commercial finance, which is the majority of the bank’s loan book, the gross NPA is at 2.12% and net NPA at 0.93%.

The bank is targeting gross NPA of 2%, net NPA of 1% and provisions of 2% on funded assets. 

Loan Book

IDFC First Bank’s loan book has not grown much, increasing by just 6% compounded three-year CAGR. But this is less of an issue as both IDFC Bank and Capital First, a non-banking financial company (NBFC), have a tried and tested model on the lending side that has been running for close to 10 years and compounding by about 30% for quite a long while. The loan book at merger was at Rs 100,000 crore with no retail deposits.

The lender is targeting to grow the loan book by 20-25% on a sustainable basis. As on 30 June 2022, the overall funded assets stood at Rs 1,37,663 crore, up from Rs 1,13,794 crore a year ago. Retail and commercial finance has seen a 3-year CAGR of 30% to touch Rs 92,477 crore as on March 2022 and subsequently to Rs 1,01,309 crore in June. The corporate (non-infrastructure) loan book has been stable at Rs 23,970 crore as of June 2022, from Rs 22,427 crore in March 2020.

The bank has brought down the legacy infrastructure financing portfolio from Rs 22,710 crore at time of merger to Rs 6,739 crore as on 30 June 2022. Infrastructure financing book now consists only 4.9% of the total funded assets, down from 22% at the time of merger.

The risk on wholesale banking has been cut even as exposure to corporate sector has declined to 17% from 29% in March 2019. Similarly, the bank has reduced its exposure to infrastructure sector to 5% from 19% in March 2019.

As part of the risk management strategy, IDFC First Bank has reduced its exposure to top 20 single borrowers from 16% to 9%. The exposure to top five industries has also been reduced from 41% in March 2019 to 23% in June 2022. 

Deposit Base

On the liability side, the bank has been able to raise deposits, even during tough times. As on 30 June 2022, the CASA (current account savings account) ratio is stable at 50.04%. The total customer deposits has grown by 3-year CAGR of 32% to Rs 1,02,868 crore.

“We even raised it during the period of Covid - over Rs 25,000 crore. So, that should give us some confidence. But the fact that we're continuing to raise strong deposits even after dropping interest rate is really heartening for all of us at the bank. Now with the deposits, let me say, that’s one of the foundational items for a bank to be able to raise deposits, which we are able to raise,” said Vaidyanathan.

The bank has reduced its high-cost borrowing by Rs 5,530 crore during the last one year. There is still remaining Rs 22,406 crore of high-cost infra bonds issued by the erstwhile IDFC Bank. When they are replaced at 5–5.5%, it is expected to add about Rs 750-800 crore to the net interest income on an annualised basis.

Operating profit main issue

The main problem has been the bank’s core operating profit, ex-treasury. When the second wave of Covid happened in the first quarter of FY22, for example, the bank had provisions but not enough operating profit.  But for the last three years, the bank has been investing in building various capabilities to grow its operating profit. That change became apparent in the June 2022 quarter when the bank’s core operating profit touched Rs 987 crore, showing a three-year CAGR of 36%.

This is a significant progress and provides a signal on where the bank is headed. There is now space for the bank to be able to take normalised provisions and be profitable. And this is no flash in the pan. The lender expects its core operating profit to rise by 45% in FY23 and by another 45% in FY24. 

“So, if the core operating profit starts compounding like this, I think it really augurs well for the bank. It gives us confidence that there is no one-timer sitting in this,” Vaidyanathan told analysts.

Vaidyanathan reads out four figures: Q2 of FY22, net profit at Rs 152 crore; Q3, at Rs 281 crore; Q4, at Rs 343 crore; and Q1 of FY23, at Rs 474 crore. Translating that into return on assets (ROA), he arrives at these figures: Q2 of FY22, ROA at 0.37%; Q3, at 0.64%; Q4 at 0.77%; and Q1 of FY23, at 0.97%.

“The ROA is moving so fast upwards. It gives us confidence that this story can progress up for a while,” said Vaidyanathan.

Credit card and fee-based income

On the credit card front, the bank has issued one million cards since starting this business in January 2021. The credit card book is worth Rs 2,315 crore as on June 2022, up 183% year-on-year. Though loss-making at this early stage, it is gaining market share.

The bank has also launched many fee-based products in the last three years. Being in the early stage of their lifecycle, they have the potential to grow.

As of 30 June 2022, the bank’s balance sheet size crossed Rs 2,00,000 crore.

So, where does this place IDFC First Bank? “While the bank has a relatively high cost structure which constrains its ROE (return on equity), it is also one of the highest growth banks in terms of both advances and PROP,” CLSA said in a note.

The analysts at CLSA also pointed out that there is credit risk of the retail book, which has been scaled up in the last 2-3 years. “Eventual asset quality may depend on the bank's underwriting and evolving macro outcomes. However, profitability could improve with the scale-up of CASA and fees, which could drive a rerating,” they said.

Until a year ago, IDFC First Bank was a liability gathering machine. Now the focus has started on the loan book and cross-selling of products.

“I think that we've come a long way and now we can quite confidently say that the foundation is well built for the bank,” said Vaidyanathan.