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IDFC: Building the arsenal for banking operations - Views on News from Equitymaster
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IDFC: Building the arsenal for banking operations
Aug 3, 2015

IDFC declared its results for the first quarter (1QFY16) of the financial year 2015-16 (1QFY16). The institution reported a 4.9% YoY increase in its income from operations for 1QFY16. However, the profits declined by 47.2% YoY for 1QFY16. Here is our analysis of the results.

Performance summary
  • Consolidated income from operations increased by a tepid 4.9% YoY in 1QFY16 due to a 1% fall in project loans. The disbursements to sanctions ratio was down at 78% in 1QFY16 as compared to 84% in 1QFY15.
  • Overall asset management revenues increased by 14% in 1QFY16, total asset under management (AUM) stands at Rs 692.7 bn at the end of June 2015. The investing banking and broking business income increased by 36% YoY during the quarter.
  • Net interest margins (NIM) contracted to 3.2% in 1QFY16 from 4% in the year ago quarter.
  • Other income fell by 99% YoY during 1QFY16 primarily due to higher interest income on tax refunds earned in the year-ago quarter.
  • The cost to income ratio (excluding write-back of depreciation) shot up to 35% in 1QFY16 as compared to 16% in the year ago quarter mainly due to bank related expenses. The bank expenses jumped to Rs 850 m in 1QFY16 from Rs 50 m in 1QFY15.
  • Net profit declined by 47% in 1QFY16 on a steep jump in operating expense mainly due to write-back of depreciation in the year-ago quarter and higher bank related expenses.
  • Capital adequacy ratio stands at a robust 23.8% at the end of June 2015 (Tier-1 ratio of 22.6%).
  • Net NPAs rose to 1% at the end of June 2015 (0.4% at the end of June 2014).

Consolidated financial performance snapshot
Rs (m) 1QFY15 1QFY16 Change
Income from operations 21,225 22,259 4.9%
Interest expended 13,021 15,194 16.7%
Net Interest Income  8,205 7,064 -13.9%
Net interest margin 4.0% 3.2%  
Other Income 666 9 -98.6%
Operating expense 550 2,423 340.5%
Provisions and contingencies 2,039 625 -69.4%
Profit before tax 6,282 4,026 -35.9%
Tax 1,416 1,290 -8.9%
Effective tax rate 22.5% 32.0%  
Share of profit from associates 3  (124)  
Minority interest 51 70  
Profit after tax/ (loss) 4,817 2,542 -47.2%
Net profit margin (%) 22.7% 11.4%  
No. of shares (m)   1,594  
Book value per share (Rs)*   110.0  
P/BV (x)   1.4  
* (Book value as on 30th June 2015)

What has driven performance in 1QFY16?
  • IDFC's profitability and asset quality have been hit due to the twin effects of its transition towards a banking entity and no change in the risk surrounding the coal and gas assets held by it. Although credit offtake has improved with each of the gross loan approvals and disbursements registering growth of 26% YoY during the quarter but the cumulative disbursements to sanctions ratio continued to remain lower as compared to last year.

    Significant slowdown in sanctions
    (Rs m) 1QFY15 1QFY16 Change
    Sanctions 688,190 720,270 4.7%
    Disbursements 580,300 559,040 -3.7%
    D/S ratio 84.3% 77.6%  
    Advances 538,480 533,590 -0.9%

  • As IDFC remains overinvested in risk-free SLR securities in its migration towards the banking business, its average loan spreads have reduced by around 40 basis points. This coupled with interest reversal on loans that have turned bad have eroded NIM by 80 basis points to 3.2% for the quarter.

  • The asset quality has declined further with the gross NPAs rising to 1.5% at the end of June 2015 quarter as compared to 0.6% in the year-ago period. However, conservative provisioning by the NBFC has ensured that the net NPAs are lower at 1%. As per the NBFC, its overall stressed assets remain stable at around Rs 85 to 88 bn constituting 8.4% of the overall loan book. As 80% of the stressed assets pertain to the coal and gas assets whose chances of recovery still remain uncertain, the NBFC has decided to increase its provisioning by Rs 25 bn in addition to its existing provisioning of Rs 25 bn that were adequate as per regulatory norms. The extra provisioning is being done to ensure that the bank starts with a clean balance sheet and its profits are insulated from the overhang of the legacy assets.

  • The additional provisioning will cover 50% to 60% of IDFCs stressed assets and is likely to be provided from non-distributable special reserves after requisite approvals. This will result in reduction in IDFCs networth by Rs 16 bn.

  • On the banking front, the final license has already been received from RBI on 23rd July 2015. The NBFC would be filing with Registrar of Companies and the banking operations are expected to be launched on 1st October 2015 when the demerger of the financial undertaking from IDFC into the bank becomes effective. The allocation of shares of the bank to the existing shareholders of IDFC and the listing of the bank are likely to be completed in the first week of November.

  • The bank will have an initial capital of Rs 130 to Rs 135 bn with a Tier I capital adequacy ratio of over 15%. The initial loan book will have a size of Rs 400 to 500 bn pertaining to wholesale and large corporates. The NBFC will utilize its existing relationship with corporate community and diversify in to non-infrastructure banking segments. The success of the wholesale banking operations will be utilized to build on the retail and rural banking segments. IDFC Bank will initially start out with 20-25 branches out of which 15 will be in rural India mostly in districts of Madhya Pradesh and the rest in urban India. As per the management, the bank will have an initial ROA of 1% due to start-up costs and wholesale funding. But the management is confident of expanding its ROA over the next five years by utilizing its existing corporate relationship and technology expertise.
What to expect?
At the current price of Rs 150, the stock is valued at 1.2 times our FY17 adjusted book value.

IDFC remains well poised in terms of capital adequacy and prudent and conservative management skills to transition into a bank with a strong and clean balance sheet. The NBFCs high focus on protecting the bank from the risk of legacy assets through high provisioning score high on the governance. This will indeed go a long way in enabling the bank to concentrate on growth and new business development and bodes well from the shareholders perspective.

We have factored in muted growth in loan book and risks to margins and asset quality in our assumptions. The near term hiccups stand imminent as the company transitions into a bank. While negative sentiments towards the infrastructure sector may prevail in the near to medium term, investors should reap the benefit of steady long term players like IDFC. Although ROE has fallen to 8.3% at the end of June 2015 quarter, we believe that these are initial expenses required to set up a sound and efficient banking entity. While we continue to reiterate our buy view on the entity, investors must ensure that the stock does not comprise more than 5% of their overall portfolio.

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