IDFC Bank is betting on expanding its retail presence

The near collapse of merger talks between IDFC Group and Shriram Capital seems to have been cheered by shareholders on both sides, even though the management thought it was “a marriage made in heaven”.

IDFC Bank shares rose 5.18 per cent to Rs 58.90 apiece since its close on October 30, when the exclusivity clause in merger talks was called off. In the same period, IDFC Ltd rose 2.11 per cent to Rs 62.90 on the Bombay Stock Exchange, while Shriram Transport Finance and Shiram City Union Finance Ltd went up 9.34 per cent and 1.45 per cent, respectively.

But the end of the prospect hunting raises one important question. How will IDFC Bank now take care of its impaired balance sheet and grow at the same time? The strategy so far seemed to outgrow the legacy-induced cost pull by expanding the balance sheet rapidly enough. Surely, IDFC Bank management doesn’t have any qualms in admitting that. In an interview with Business Standard in July, after announcing the exploratory merger talks with Shiram, Rajiv Lall, chairman and managing director of IDFC Bank, said, “You have to find a balance between the luxury of building something at a leisurely pace and diktats of the market. It would have been impossible to satisfy a very strong group of stakeholders by doing it completely organically,” Lall said.

Working on that strategy, the bank snapped up one of the largest microfinance institutions in South India, Grama Vidiyal Microfinance Ltd in July 2016, just a few months after IDFC Bank started operations in October 2015. After integrating Grama Vidiyal’s 3,500 staff and in the process acquiring 1.2 million customers and Rs 1,500 crore in assets, IDFC Bank management became ambitious.

To cut its legacy drag from “six years to three years” straight, Lall went ahead with a merger proposal with a company whose balance sheet was larger than IDFC Group. While Shiram Group’s loan book was about Rs 80,000 crore in June, IDFC Ltd and IDFC Bank’s total loan book was about  Rs 60,000 crore.

 

“It was ambitious, no doubt. But it was worth trying. Had we not tried it, we would have repented why we didn’t,” said Lall in another interview to this paper on October 30, the day it called off the merger talks citing non-cooperation from Shriram Group’s four shareholders. Lall stressed that the period of exclusivity had ended, not necessarily the chances of a deal. Shriram founder R Thyagarajan said the same.

But, “human nature is such that it is difficult,” Lall said. For sure, the bank will start hunting for new assets soon. “We are aggressive people, we won’t rest.” 
 

Why the hurry for mergers, barely two years into operation? IDFC Bank started its operations with an impaired balance sheet, but with a solid capital base. The two banks that acquired licences in 2015, IDFC Bank and Bandhan Bank, had diametrically opposite asset profiles. IDFC Bank’s balance sheet was corporate-only, while Bandhan Bank’s asset base was entirely retail, thanks to its microfinance background. Now, private sector banks strive to create more retail assets as the yields are high and ticket sizes low, which translate into less bad debts.

Therefore, IDFC Bank, like its peers, wanted to be retail focused. And for that, the bank needed to expand its branch network aggressively, but the bank’s cost structure didn’t allow that.

The bank’s legacy burden creates a drag on its profit and loss accounts for two reasons: there is a legacy bad asset stock of  Rs 3,700 crore for which the bank is incurring a cost of Rs 175-200 crore a year. Then, Rs 36,000 crore of bonds were contracted for a coupon of 8.9 per cent. This is a net negative drag (netted for the amount the bank would have paid if the bonds were contracted at the present rate) of around Rs 400 crore a year. This pre-tax Rs 575-600 crore of drag translates into 0.35 per cent hit on the return on assets.

“I should open up 200-250 branches a year for the retalisation of accounts to take place, but with this kind of a drag, how can I?” said Lall, adding, the bank could not add about 100 branches in the last two years because of this skewed cost structure.

What’s next? The drag will ease up but that will take time, about three to 3.5 years, the bank management told analysts in a conference call. The bonds start maturing in 2021 and the pressure should lessen too.  

The bank is now focusing on diversifying its credit growth, particularly away from infrastructure — towards retail, loans to the small and medium enterprise, mid-size corporations and large corporate houses outside of the infrastructure segment. 

The bank also seems to be managing its bad debts well. Gross bad loans as a percentage of total loans were at 3.92 per cent at the end of September quarter against 5.96 per cent a year earlier and 4.13 per cent in the June quarter. However, profit fell 40 per cent to Rs 234 crore compared with Rs 388 crore earlier.

Going forward, the plan is to list some of the units under the holding company structure, and the bank is now aggressively building up its asset management team, Lall revealed in the interview. “I have told my staff to continue with this quarter’s performance for the next eight quarters,” he said. The idea is to keep up the aggressive pace of growth to outgrow its challenges.

Analysts, however, have mixed feelings. Out of 13 analysts tracking IDFC Bank, six have ‘buy’ calls on the stock, five recommend ‘hold’, while two say ‘sell’, according to Bloomberg. Similarly, in IDFC Ltd, out of six analysts, five have ‘buy’ call, one recommends ‘hold’ and another has a ‘sell’ call.  

“We have a ‘neutral’ call on the bank stock. The management has given a clear guidance of a turnaround, but that seems to be too far away. But we are happy that they did not want to hide the stress,” said an analyst with a foreign brokerage.

According to an analyst with a rating agency, the bank’s profitability is not an issue and investors should not have any problem with liquidity as well as capital adequacy. In fact, the tier-1 capital ratio is 19 per cent, much higher than what is required. Rating agencies have ‘AAA’ rating on the bonds issued by the holding company and being serviced by the bank.

“As far as the business case is concerned, there are headwinds. But it is not that the bank has to grow inorganically to remain relevant. Organically also, the bank is doing well, but it needs to improve visibility, which we understand would not be possible immediately,” said the analyst with the rating agency, who also requested anonymity.

Contours of IDFC-Shriram merger

• Plan was to create a ‘mass retail bank’ focused on the underserved

• Post merger IDFC Ltd was to be the holding company

• Shriram City Union was to merge with IDFC Bank

• Shriram Transport was to be delisted