A World-class Bank in the making
It is a great pleasure writing to you once again. It has been two and a half yearssince the merger and during this period our Bank has made tremendous progress on layingthe foundation for a highly successful and megabank of the future. I would love to explainto you what we are truly building at our Bank. What we are building at the core is a newage digital Bank which is agile and highly scalable. Our pre-provisioning profits (PPOP)are low at this stage because of our DFI background with higher cost of legacyliabilities coupled with the set-up costs of a new bank but this is getting fixed at aquick pace because of our strong profitability on an incremental basis.
Chances are as a shareholder looking at quarterly results the underlying quality ofthe bank we are building is not entirely visible at this stage to you. Because the usualconversation from anchors are after any results are "So what is your exposure toVodafone Idea? How much more pain is yet to come on infrastructure? What is NPA in retailbecause of Covid? When do you see the situation normalizing?" If youre ananalyst chances are that to the above questions you will also add "Your ROE islow." I believe they are so focused on the here and now quarter and its comparisonwith other established banks that the power of incremental profitability is lost in thenoise. And the comparison is with banks who have already been there for 20-30 years orwith entities that were already profitable when they converted to a bank. What is notvisible to many is the foundation that has been laid and how quickly the picture ischanging. So much so that when I was pushed hard on some such subject by a journalist Iresponded instinctively "You ask Mr Kamath how hard it is to convert a DFI to acommercial bank to my knowledge he is the only one who has achieved this". (ReferFinancial Express in Press section)
Yes thats right. Our Bank was created from an infrastructure DFI which hadacquired a bank license. An infrastructure DFI by the nature of its business usuallyborrows long term funding from banks/ Bonds at market rates and usually lends tocorporate and institutions. So the margins and profitability are low and individualexposures are large. We are carrying Rs. 27936 crore of fixed-rate liabilities at 8.66%largely legacy and you can imagine the upsides when these are replaced by low costdeposits.
Thus to understand the future potential of our Bank you should understand the trueincremental profitability of our Bank. If you want to understand this please jumpstraight to Section 4 (Page 9) titled "The power of incrementalprofitability." I would now like to explain to you the vision of our Bank.
SECTION 1. VISION OF OUR BANK:
We have defined our vision as "To build a world class bank in India guided byethics and customer-first values powered by technology and be a force for social good."We find this line highly inspiring and are working towards it day and night. Let meexplain what each of these words in our vision statement mean for us.
(a) "To Build": To create a world class bank is an opportunity few peopleget in their lifetimes. Our employees could get opportunities to work in"world-class" organisations but "building" one is something else.
.a world-class bank": For a country as large and diverse asIndia and a country set to be worlds third largest economy by 2030 there are few"world-class" banks in India. And when we say world-class we mean banksof global scale and profitability on the cutting-edge of innovation providing amazingcustomer service highest levels of corporate governance generate high return on equityand enjoying international respect and admiration. We aspire to be on that list and arepassionate about building such a bank. We have already sown the seeds for such a bank.
For a country as large and diverse as India and a country set to be worlds thirdlargest economy by _ _ there are few "world-class" banks in India.
.with ethics and customer-first values": We advise our productteams to design products in such a way that it is meant to be sold to our "near anddear" ones. We make products with transparent pricing and fees. Working on the themeof Customer First we came up with many unique features as follows:
We advise our product teams to design products in such a way that it is meant to besold to our "near and dear" ones.
Monthly credits: We have started "monthly" credit ofinterest on savings accounts against the industry practice of Quarterly credits. So ourcustomers earn "interest on interest" monthly on their savings accounts. To thebest of our knowledge no large bank with a Universal Bank License has ever donethis.
Low Dynamic APR for revolvers: APR (Annual Percentage Rate) oncredit card revolvers has always been about 3.49% per month thats about 42% perannum. So if you carry forward any balances or if you miss your payment by mistake youpay at 42% per annum for that month. And by the way 40% of card holders do end up payingthese rates. Either customers are insensitive to APR or dont know about it.We think about this issue differently. We were the first bank to set dynamic and low ratesof 0.75% to 2.99% per month or 9% to 36% per annum based on several factors includingrisk rating. Check the APR on the credit card you have in your pocket right now chancesare you are paying more than our highest rates. If you apply you might get a ratesomewhere in between and chances are that you can benefit right away. And dontforget our many other such customer friendly features.
Cash withdrawal interest rates: If you withdraw emergency cash fromthe ATM on your credit card you normally pay Rs. 250 as one-time fee PLUS interest rate of42% p.a. from Day 1 of withdrawal. We felt this was rather high. We charge you Rs. 250 andcharge no interest till next Payment Due date. Yes you read this right no interest tillnext Payment Due date.
Customer First: Where there is a misunderstanding our instruction tothe service team is "credit the customer first" and fix the root cause of theissue.
No Fine Print Banking: We dont follow fine-print banking hopingcustomer wont notice certain terms or charges. We dont appreciate productmanagers who talk that language when designing products.
We dont pressurize our employees to "somehow" sellhigh-margin products to meet fee targets. The list of our "Customer First"features is long.
So what we are building is a bank thats clean from within. If you are wonderingat this stage if strong Customer First approach and great returns for Shareholdersis an "either-or" trade-off please jump straight to Section 4 (Page 9)on "Incremental Profitability" where we demonstrate the power of ourbusiness profitability.
and technology" India is building digital highways Aadhaar avast mobile network and UPI. We are coupling these with AI ML technologies data cloudAPI banking and are committed to investing in the latest technologies to continuously stayahead. We recently unveiled our new mobile and web app which have a large number of uniquefeatures like Google like search capabilities Personal Finance ManagementPay-to-Contacts one click FD creation live mutual fund investing risk-analyser and soon.
.and be a force for social good" To create social good is thepurpose of our existence. For example apart from lending to prime segments such as primehome loans and car loans we have also developed specialization in financing artisanslarge medium and small farmers kirana shops restaurants automobile spare partstailoring carpentry salons chemists two wheelers consumer durables JLG in ruralareas etc. The purposes of financing include business expansion cattle purchase waterand sanitation financing and so on.
We have financed over 30 million such loans till date in our combined experience. Wehave developed unique skills in this area with stable and high asset quality of Gross of ~2% and Net NPA of ~ 1% for over ten years. Similarly on the deposits investmentsinsurance or wealth management we can create many solutions for customers across crosssection of society that can create great social good.
To create social good is the purpose of our existence.
Propagating our vision statement: We first came up with the idea of a "seal"to capture our key themes to share with our employees. We then debated hours over multiplesessions about what should be on the seal. After much debate we settled in on threethemes:
Ethical Banking Digital Banking and Social Good. This also goes well with ourvision statement.
"Social-Good" is the purpose of our existence. Our business mustadd to larger social good. We exist to serve society- urban and rural rich and poorsalaried and self-employed cities towns and villages and manufacturing agriculture orservices.
"Ethical" is the means we want to use in dealing with everyone.There is no point becoming highly profitable if not earned the clean way.
And "Digital" is the medium we want to use. The seal looks asfollows:
After much debate we settled in on three themes: Ethical Banking Digital Banking andSocial Good. This also goes well with our vision statement.
Coding the DNA: By making this seal and sharing with employees we are attemptingto code the DNA of our employees. Thats because we are an early stage bank and theDNA code we build will affect the long term conduct of our employees. This also becomes aninternal check and balance among employees for good conduct as expected of them.
We are trying to code the DNA of our employees to align with the vision and mission bysharing the seal with them.
SECTION 2. EXPECTATIONS AT MERGER.
As compared to the original estimates at the time of merger we have outperformed onevery front but profitability. On profitability we would like to share that the issues ininfrastructure and certain corporate accounts turned out to be more than expected becauseof the economic cycle. This resulted in impact on our net-worth by about Rs. 2000 crore.Our Bank had also sold down loans worth Rs. 6448 crore to ARCs prior to the merger andnon-accrual of income from these exposures additionally affected operating profit. I wouldlike to share that we have substantially overcome the situation because of NIM increasingto 5.5% in Q1 FY22 which has resulted in Core Operating Profit crossing Rs. 600 crore inQ1 FY22. The core premise of attaching a well performing asset machine with a banksliability machine is well intact. We believe the Bank will head towards excellentprofitability in upcoming few years and we will cover lost time.
SECTION 3: OVERALL PERFORMANCE OF OUR BANK SINCE MERGER:
1. A strong Deposit Base:
We have always maintained that to have a strong and stable deposit base is the mostimportant foundation for building a great bank for the future. On this count we haveachieved the following progress:
a. Strong CASA Ratio: At the time of merger in December 2018 IDFC Bank was arecently formed Bank and thus did not have much CASA and Capital First was an NBFC withno CASA. On merger we had CASA ratio of 8.68%. At that time every analyst told us that thehardest issue to fix for you will be the liabilities side. We are happy to report that ourCASA ratio has crossed 50%. If anything this describes our capability to raise depositsa key raw material for growth.
b. Strong granular deposit franchise: During H1 FY21 markets were roiledexchanges were crashing across the globe there was crisis at one private sector bank andit felt the world was falling apart. The general experience in the banking system was thatthere was a flight of deposits to the top large banks. I am happy to report that preciselyduring that period of COVID chaos IDFC FIRST Banks granular customer deposits (Balancesless than or equal to Rs. 5 crore) grew by a whopping Rs. 6315 crore in Q1 FY 21 and byanother
Rs. 10565 crore in Q2 FY21! So the COVID ravaged quarter was our highest ever growthin granular deposits. Such is the confidence our customers bestow on us in a COVID yearand we know it is our job to live up to their trust. We thank them wholeheartedly.
Overall during FY 20-21 our granular customer deposits (balances less than or equalto Rs. 5 crore) grew by a whopping Rs. 33788 crore or 99% YoY. Today 82% of our customerdeposits are granular customer deposits (balances less than or equal to Rs. 5 crore) ascompared to 30% at merger.
|As on ||Mar 20 ||Jun 20 ||Sep 20 ||Dec 20 ||Mar 21 ||YoY Growth |
|Deposits balance upto Rs. 5 cr ||Rs. 34267 cr ||Rs. 40582 cr ||Rs. 51147 cr ||Rs. 60383 cr ||Rs. 68055 cr ||99% |
C. New account opening continues to be strong: The deposit inflows were strongand more than our requirements. So to optimize the flows we reduced our savings accountinterest rates. I am happy to share that our new account opening continues apace. On arelated note reducing our savings account interest rates had another positive sidebenefit; we can now participate in prime Home loans profitably which has multiplied ourmarket opportunities.
Reducing our savings account interest rates had another positive side benefit; we cannow participate in prime Home loans profitably which has multiplied our marketopportunities.
d. Reducing Concentration risk: Deposits from our Top 20 depositors have reducedfrom 40.0% of customer deposits at merger to only 7.7% as of March 31 2021. This is aconscious risk mitigation measure. You can rest assured your Banks deposit base isdiversified and super safe!
2. Maintaining strong Liquidity:
We always maintain liquidity more than regulatory requirements. We ended Q4 FY 21 withaverage LCR of 153% against regulatory LCR requirement of 100%. Again your Bank willnever ever take chances on this count.
3. Maintaining strong Capital:
We have always been and will always keep ourselves capitalized in excess of regulatoryrequirements at all times. In June 20 even while COVID first wave was raging we raisedRs. 2000 crore of equity. Again in April 21 the COVID second wave had just reared itshead we raised Rs. 3000 crore of equity. We enjoy support of long-term investors. Ourcapital adequacy is strong at 15.56% as of June 30 2021.
4. Excellent Retail Assets model:
This is the core engine of our Bank and is performing exceedingly well. We feel we willeasily surpass the five-year guidance of Rs. 100000 crore given at the time of merger.
5. Asset Quality:
a. Corporate Accounts: We have had a few issues from large corporate accountsincluding a housing finance company a financial conglomerate a Mumbai based Toll Roadcompany an Odisha based power account a telecom account and a few other such accountsbecause of downturn cycle in infrastructure financing in India and a few financialconglomerates going down. Barring our exposure to the telecom account we feel most of theissues are behind us.
b. Infrastructure financing is a difficult business because of dependence onregulatory approvals and dependence on ecosystems on which we have limited control. Wehave brought down the loan outstanding to infrastructure from Rs. 22710 crore at mergerto Rs. 10808 crore as of March 31 2021.
c. On the Corporate Banking side we have implemented good controls in our Bank andour recent portfolio performance is pristine.
d. Significant reduction in the identified stressed list: We have brought down theIdentified stressed asset list (Accounts that we consider stressed over and above thedeclared NPA) from Rs. 4138 crore as of March 31 2019 to Rs. 2264 crore as of March 312021. (further reduced to Rs. 1371 crore as of June 30 2021).
e. Large borrowers exposure As a risk mitigation measure we have reducedexposure on large borrowers. Our top 10 borrowers as a percentage of total exposure hascome down from 12.8% as of December 31 2018 to 5.9% as of March 31 2021.
f. Retail Assets quality: On the retail side our asset quality has been pristineat Gross NPA of ~ 2% Net NPA of ~ 1% for over 10 years through stress tests ofDemonetisation GST implementation and economic slowdown. During COVID our retail NPA hasincreased but we are confident of reverting to our pre-COVID GNPA and Net NPA around endof FY 22 based on the strong pickup in collections post COVID second wave. We shouldtrust our skills track record experience and technology and not doubt ourselves justbecause of a pandemic that came our way. We learn adjust refine and move on.
g. Expanding customer segments to cover Prime Home Loans: Because we have droppedour interest rates we can sustainably pursue prime home loans the safest category ofloans. We expect mortgage backed loans to form 40% of our loan book in due course.
We expect mortgage backed loans to form % of our loan book in due course.
h. Credit Costs: Our provisions for FY 21-22 is expected to be only 2.5% of theaverage loan book which is quite reasonable by industry standards of which a substantialportion has already been taken in Q1 FY22 hence you can expect to see successivelyreduced provisions in Q2 Q3 and Q4 FY 22. Going forward we expect to keep our provisionsat below 2% of the average loan book.
i. 2- 1- 2 Formula: We will be targeting a 2-1-2 formula i.e. Gross NPA of 2% NetNPA of 1% and provisions of 2% on funded assets on a steady state basis.
We will be targeting a _->-_ formula i.e. Gross NPA of _% Net NPA of >% andprovisions of _% on funded assets
SECTION 4. INCREMENTAL PROFITABILITY OF OUR BANK:
Please read the following notes on our incremental profitability to understand theprofitability of our incremental business.
a. Strong incremental profitability of retail lending business: Our incrementalborrowing cost is less than 5% and incremental lending in retail is over 14% at this pointof time. So our incremental spreads on retail is over 9%. We have specialization in thesesegments and our credit costs (provisioning) are expected to be about 2% based on thecombination of products we finance. Thus our incremental ROE in the retail lendingbusiness is estimated at 18-20%.
b. Strong incremental profitability of Corporate Lending business: Here theestimated incremental business ROE is 14-15%.
But you are not yet seeing this profitability in our books because of the following twopoints.
c. Higher cost of Rs. 1000 crore from Legacy Liabilities currently: As ofJune 30 2021 the Bank has Rs. 27936 crore of liabilities at 8.66%. These are largelylegacy borrowings of our DFI background and these are the challenges of converting a DFIinto a bank. When our Bank will replace this at say 5.0% we would save about
Rs. 1000 crore per year on an annuity basis compared to today. This is a legacy issueon the liability side and will go away with time.
When our bank will replace this at say . % we would save about Rs. >crore per year on an annuity basis
d. Set up costs in retail liabilities because of investments as we are a new bank:Since merger to March 31 2021 we have invested in 390 branches 565 ATMs added over12000 employees invested and upgraded our technologies launched or scaled up many newbusinesses like credit cards Wealth Management Fastag Gold loans and scaled up manyretail lending businesses like prime home loans and digital lending all these areessential capabilities for building a large bank. These investments are giving us anegative drag today but this will become profitable with scale.
e. Incremental return on capital. Now let me tell you something amazing about ourprogress. Please study the following table:
| ||Q3 FY 19 (merger quarter) ||Q4 FY 21 ||Increase % |
|Funded Assets ||Rs. 104660 cr ||Rs. 117127 cr ||11.9% |
|Core Income (NII plus Fees) ||Rs. 1495 cr ||Rs. 2616 cr ||75.0% |
|Core Operating Profit (NII plus Fees less Opex excluding trading gains) ||Rs. 276 cr ||Rs. 460 cr ||66.9% |
So when we compare the merger quarter with Q4 21 the funded assets grew only 11.9% intwo years but at the same time the Core Income grew by 75% and Core PPOP grew by 67%.The comparison with Q1 FY22 was even better. Here the core operating profit was Rs. 601 crwhich was 118% over the merger quarter while the book grew only 9% over the mergerquarter. This tells you that the incrementally the operating profit on capital isdisproportionately higher as compared to incremental capital consumed. Thats thepower of strong increase in Net Interest Margins to 5.5%. Numbers in Q4 FY 21 excludeimpact of interest on interest reversal of Rs. 55 crore.
Guidance on Profitability:
a. As explained above our retail lending business is immensely profitable. Weexpect to grow the retail book by ~25% on a compounded basis for a long period of time.This is already playing out over the last 2 years as the NIM has already expanded from1.84% pre-merger to 5.09% in Q4 FY 21 and further to 5.51% in Q1 FY 22. We expectprofitability to increase as we expand the loan book.
b. The negative drag because of high cost liabilities will go away as we will repaythese liabilities on maturity. The negative drag because of investments will go away withscale. Thus the highly profitable retail and wholesale businesses will shine the results.
c. Basis the above you can expect to see a significant pickup in NII ROA and ROEat the Bank from here on as this phenomenon plays out. We feel comfortable guiding forReturn on Equity of upwards of 16% as we scale up our business based on our experienceand incremental unit economics.
I believe it is only matter of time and not a question of whether this will happen.
SECTION 5: OPPORTUNITY FOR SCALE UP.
For our business the market opportunities are practically unlimited for our lines ofbusinesses. The credit outstanding in the country including banks and NBFCs is about Rs.120 lakh crore and as per CIBIL TU report the outstanding for commercial loans > Rs.50 crore is Rs. 54 lakh crore (Source: June 21 MSME report). Thus the MSME retailand rural and agriculture markets alone is about Rs. 65 lakh crore and growing. India ismoving from unorganized to organized underserved to served and technology is supportingthis change. We are well positioned to ride the technology wave. We are merely ~Rs. 75000crore in this market which is barely above 1% of this market. For us to grow at 25% isnot a big deal. There is no dearth of opportunities in our great country and we have thenecessary capabilities.
SECTION 6. VODAFONE IDEA EXPOSURE:
I would now like to directly address the concerns that some of you would have about ourexposure to Vodafone Idea. Let us hope the government supports the industry; out of thetotal dues of the company about Rs. 1.5 lakh crore are owed to the government itself andhence they will be keen to solve this issue. In any case we have a lot of growth capitalby our side. We will peruse the matter through law of the land.
With a strong liability base consisting of low-cost CASA of 50%+ we get good marginsin our business. We can compound our advances continuously by about 25% for a long timeand we can build this book to any size of our desire in our lifetimes it could be Rs. 2lakh crore Rs. 5 lakh crore Rs. 10 lakh crore or more. We will ride it through withoutimpacting our long-term future and build a great bank from here. So we will keep our eyesriveted on the longer story. We have experienced such situations earlier and have alwayslearnt that if we have a strong and profitable model and go on for extended periods oftime then a one-off incident does not dent the long-term story.
SECTION 7. DEALING WITH COVID
On dealing with COVID I would like to say that were overwhelmed with the way ouremployees stayed motivated throughout the wave one and wave two of COVID. They werevolunteering to run their branches and to assist customers. We announced a one-of-a-kindCovid Care scheme for employees by assuring them 4X their CTC salary credit to nomineefor two years waiver of employee loan extension of medical insurance for family for 24months scholarship up to Rs. 10000 per month for two children until graduationemployment for spouse on merits or skill training allowance of
Rs. 2 lakh and so on. Our employees appreciated this greatly. We implemented a bankwide cost-rationalization program. We tightened credit criteria and launched new products.We accelerated our efforts for digitising the bank. Our senior management volunteered withsalary and bonus cuts to lead austerity by example. I thank them all.
SECTION 8. CLOSING NOTE.
I believe we are on to something very special here. We have set up a strong platform.Dont underestimate the power of the 50% CASA Bank with a powerful and tested lendingmachine attached to it. We are a mid-size bank today but I believe we have all theingredients of becoming a mega bank of the future with themes of ethics digitalsocial-good and customer first. I also believe our best-ever three years are coming up forus.
Dont underestimate the power of the % CASA Bank with a powerful and testedlending machine attached to it.
I express our sincere thanks to our regulator the Reserve Bank of India who haveconstantly guided us on our approach and supported us throughout. Our Board members areeminent people with rich experience have great intellect highest levels of integrity andhave constantly guided the Bank with strategic inputs and towards very high standards ofcorporate governance.
I sincerely thank our customers for banking with us. I also sincerely thank each one ofour shareholders for your support and confidence even in trying times. Our employees areexceptional and I thank them all.
Managing Director and CEO