With its share price having doubled over the last year, IDFC First Bank is now amongst India’s top 10 most valued bank, by market cap. This has been a remarkable feat given the fact that IDFC got its banking license only in 2014.
The bank has exhibited phenomenal performance in a short period of less than a decade to have reached a point where it is now included in the MSCI India Index (which is a big deal). The single largest driver of this performance has been IDFC Bank’s merger with Capital First in 2018.
The strategy for IDFC First Bank, post merger, was to achieve a strong retail presence. And much to the street’s disbelief, within just 5 years, the bank delivered on its goal using a combination of (i) IDFC Bank’s banking license and access to low cost funding, and (ii) Capital First’s aggressive retail expansion experience, under the helm of CEO V. Vaidyanathan.
Recently, just days after the US$ 40 billion mega-merger between HDFC Bank with mortgage lender HDFC, came a much smaller but similar merger - that between IDFC First Bank, and IDFC. Post the merger, comments from the management indicated a target to grow at 25% on a compounded basis over the near to medium term.
If IDFC First Bank pulls off that kind of growth, its stock can very well continue to remain on the trajectory that it is now. But will it continue its winning streak?
IDFC First Bank has Already Turned Around
IDFC First Bank has undergone a massive turnaround from its earlier form, which was IDFC Bank. Before its merger with Capital First, erstwhile IDFC Bank had its own share of troubles, right from inception, until the merger in 2018.
Inherited infrastructure exposure: Erstwhile IDFC Bank was created by the demerger of the infrastructure lending business of IDFC Limited, a leading infrastructure financing company. Naturally, after IDFC Limited was granted a banking license by the RBI in 2014, the bank inherited a heavy skew on the infrastructure sector, which faced a slump
Focus on corporate lending: Additionally, the bank was primarily focused on corporate banking. In a drive to achieve breakneck growth, it ended up loosening its hold on prudent lending. Before long, the halls of IDFC Bank were filled with the stench of unpaid debt as loans worth thousands of crores to companies like Ruchi Soya, Essar and Lanco went bad
Bad loans and restructuring: By 2016, IDFC Bank knew it was in trouble. In a desperate attempt to clean up its balance sheet, it dumped Rs 5,000 crore of bad loans to asset reconstruction companies (ARCs). By March 2017 another two bad loans popped up on IDFC Bank’s portfolio. So IDFC Bank held a fire sale, offloading another Rs 4,000 crore of credit it carelessly extended to Essar Power and Unitech during the frenzied lending spree
A Strong Base Because of Capital First
The direction of IDFC Bank had been downward since its inception, and it is no wonder that its stock price plummeted by 50% between the 2016-18. The answer to its worries was a tilt to retail banking, which would accelerate if it found a credible partner to merge with.
After discussions with Shriram Group fell apart, the bank found itself a very successful NBFC - Capital First. Capital First was an ailing NBFC, which an ambitious leader from ICICI Bank, V. Vaidyanathan acquired in his personal capacity.
From there, with a sharp focus on retail and SME loans, Capital First saw a ballistic growth in its loan book from <Rs. 100 crore in 2011 to >Rs. 25,000 crore by 2018.
But as an NBFC, Capital First couldn't accept deposits or clear cheques, hindering loan book growth as it lacked access to low-cost deposits for lending. Also, RBI approval odds for a banking license seemed slim.
With IDFC Bank’s banking license, it could retain the same rigour, but with a renewed access to cheaper capital - the perfect recipe for what happened next for the combined entity.
A Dramatic Pivot
Over the last 5 years, since the merger between IDFC Bank and Capital First, IDFC First Bank has pulled off a massive turnaround. It highlighted its goal to become a retail bank. And within just 5 years, it transformed itself:
Retail loans in FY23, made up for 70% of the overall loan book of IDFC First Bank, miles away from the 27% of the mix it used to be at the time of the merger, with a steady CAGR of 31% from FY19-23
It achieved strong growth in retail deposits from around Rs. 13,000 crore to more than Rs. 1,00,000 crore (67% CAGR between FY19-23)
While deposits have grown, even the share of Current Account deposits in the total mix has changed, going from 13% of total deposits in FY19 to about 50% in FY23, creating a stable funding pool for further retail loan expansion
This transformation has also expanded the bank's geographical presence across India. With the combined entity having 242 branches in FY19, it has grown significantly to above 800 branches by FY23 (~3x in 5 years)
The result of the retail transformation of IDFC First Bank can now be clearly seen in the overall financial health of the bank. It has seen a massive improvement on all counts:
Setting the Stage for the next Leg of Growth
IDFC First Bank is clearly no stranger to tying the knot. Yet, after consummating a merger with Capital First in 2018, the company is now ready to walk down the aisle once more - but in a Game of Thrones-esque manner, with its own parent - IDFC Limited!
While some may raise eyebrows at yet another union so soon, IDFC First Bank sees it as a logical next step in its journey of growth and value creation.
With expectations of margin improvements to further close the gap to its larger private peers, an influx of about Rs. 600 crore in cash from the sale of its mutual fund business to Bandhan Bank, and a whole bunch of ownership efficiencies later, the latest merger is another move to be noticed in the big leagues!
This merger sets the stage for the next leg of growth, because of several advantages:
Simplify and Sanitize - The merger aims to consolidate the core banking and lending business under IDFC First Bank. This will help streamline operations, compliance, accounting, reporting, and governance by reducing duplication across different listed entities and enabling great synergy
Shareholder Value = Unlocked - The merger awards IDFC Limited shareholders 155 shares of the merged entity for every 100 shares owned, providing direct ownership of the high-growth IDFC First Bank instead of a shrinking portfolio. With IDFC First Bank trading at a higher P/ABV of 3x vs 1.4x for IDFC Limited., this is a valuation steal for IDFC Limited shareholders!
Improved Access To Capital - The merger between IDFC Limited and IDFC First Bank will result in the creation of India's 6th largest private-sector bank with a total market cap of Rs. 85,150 crore. The merged entity with a larger market cap can access equity more flexibly. Plus, the bank's enhanced size and liquidity could also enable inclusion in key stock market indices over time
Among various other big moves happening in the banking space, IDFC First Bank still manages to steal the limelight and be the investor darling. The robustness with which this company has changed its entire story over the course of a decade has been a testament to the potential it possesses henceforth as well.
With its robust retail franchise, expanding footprint, and focus on efficiencies, IDFC First Bank stands to finally be noticed for its efforts and possibly be ranked against its larger peers as the preferred choice for investors - but for now, an addition to your watchlist should suffice!
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