IDFC bank (IDFCBK IN) (53% subsidiary of IDFC Ltd) reported its first quarter since inception. The bank’s P&L (profit and loss) is certainly cleaner with not only stressed loans being fully provisioned for but even interest income on the stressed loans accounted for on a cash basis only. While the P&L is cleaner and it’s still too early to judge the bank’s performance, the starting point of the P&L is a lot weaker as our calculated spreads at 50-60bps is very low and excluding treasury gains, core ROAs (return on assets) of the bank was ~60-70bps with zero credit costs.
While valuations at 1.1x Sep-17 book for the lending business has corrected significantly, we maintain our Neutral rating as: (i) As NPAs (non-performing assets) increase, IDFC bank’s spreads will be impacted over next 1-2 years and constrain ROA improvements. (ii) There will likely be high execution challenges to migrate a large balance sheet to a bank format. (iii) IDFC’s book growth over next five years will be <10% compound annual growth rate (CAGR) over private banks at 15-20% CAGR book growth.
What we liked—Cleaner P&L and Balance Sheet:
Just to recap, IDFC Ltd has R46 bn of floating provisions for R90 bn of declared stress loans. With +50% coverage on stressed assets, IDFC’s balance sheet is one of the cleanest among corporate banks.
In the third quarter of the fiscal 2016, IDFC has migrated to recognising only cash interest income on R90 bn of stressed loans. While that would have added to the NIM (net interest margin) pressure, this makes IDFC’s P&L also one of the cleanest.
Cleaner but weaker, in our view:
Spreads down to 50-60bps; Adjusted spreads lower than 80-90bps: We estimate IDFC’s spreads at 50-60bps in Q3FY16 v/s last declared ~120bps spreads before the demerger. While IDFC does maintain R150-160 bn of excess liquidity, even adjusting for that we believe IDFC’s spread is <80-90bps. While there is a 200bps spread between Bank’s base rate and G-Sec yields, IDFC is using the excess G-Sec holding for its CBLO borrowing and hence when it substitutes the excess investments with AAA loans, the net impact on spreads will be much lower than 200bps.
Treasury dependency too high: IDFC increased its investment book to R340 bn from R255 bn in Sep-15 leasing to excess G-Sec of R150 bn on its books. While IDFC booked R1.7 bn of treasury gains in 3QFY16, we have highlighted in the past that we do not see a reason for the bank to take such aggressive rate calls. This R1.7 bn was ~45% of IDFC’s PBT (profit before tax) in 3QFY16 and adjusted for that core ROAs would be 60- 70bps.
So while IDFC is starting with cleaner P&L and balance sheet, we believe starting spreads and ROAs are lower than street expectations.
Some 3QFY16 highlights:
Asset quality remained stable with Gross NPAs of 3.1% stable sequentially and the stressed book of R90 bn remained constant.
Balance sheet increased 16% quarter on quarter driven largely by further build-up in the investment book. Loan book increased 3% q-o-q.
IDFC has garnered R3.2 bn of CASA (largely CA) which is 50bps of its liabilities.
Fee income of R2.18 bn included R1.7 bn of treasury gains, excluding core fees which were Rs 0.48 bn.