The end-game for IDFC eventually is to convert to a bank. Banking is size-agnostic and as IDFC grows and reaches a critical size, its wholesale-funded model will pose a threat to its sustainability along with its ‘mono-line’ business. Hence, eventually, it needs to diversify both its asset as well as liability profile.
What is good for the management as well as the company over the longer term is not necessary good for the shareholders in the near term.
The issue is that the management can’t afford to take a 2-3 year view and, especially, in this case where the banking licence isn’t given every three years. The window of opportunity has opened after 20 years and no one wants to miss the boat.
The problem is that conversion to a bank would result in ROAs dropping down to 1% from the current 2.7-2.8% and ROEs would be down to single digits. The first 2-3 years will go in setting up the business, systems, recruiting people, etc. A considerable amount of management bandwidth will be spent in conversion to a bank and they would have no choice but to consolidate.
We would be very cautious of extrapolating IDFC's ability to return to its long-term current sustainable ROE of 16-17%. We maintain our ‘outperform’ rating on IDFC with a 12-month target price of R135.