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IDFC First Bank – Struggling with high cost-to-income ratio

Company Name – IDFC First Bank Limited (IDFC First Bank)

Current Share Price – INR 82.7 (Jan 30, 2024)

Market Cap – INR 58,453 cr


1. What is interesting about the stock?

IDFC Limited and IDFC First Bank Limited plan to combine into a single entity, as approved by the board of IDFC First Bank. To streamline its corporate structure, IDFC has completed all stages of "Corporate Simplifications" including the closing of IDFC Projects and the sale of AMC business. The amalgamation with IDFC First Bank is expected to be finalized by the end of FY24, subject to regulatory approvals. This merger scheme allows public shareholders of IDFC to have direct ownership in IDFC First Bank, which will enable them to unlock the value of their investments that are currently held by IDFC Limited. The merger is expected to benefit IDFC First Bank shareholders by creating a diversified institution with both public and institutional shareholders, similar to other successful Indian private-sector banks. Additionally, raising equity capital from a diversified set of shareholders will become easier for the institution.

A bit of background on IDFC First Bank ..

What are the most common issues customers face with modern banks in India? These include high hidden charges and penalties, lack of transparency, high credit card interest rates, and ATM usage charges for non-bank ATMs. Even major banks such as HDFC Bank, ICICI Bank, and Kotak Mahindra Bank are known to engage in such practices. However, IDFC First Bank is one of the few players in the industry that seeks to address these problems and set itself apart from the rest.

IDFC First Bank is a pioneer in the industry, offering unlimited free ATM transactions from all ATMs in India, no penalty for breaking fixed deposits for senior citizens and children, no additional charges for issuing checkbooks, lifetime free debit and credit cards, monthly interest credit to savings accounts, and credit card interest rates as low as 9% per annum. However, all of these perks come at a cost, as the bank's inflated cost-to-income ratio can be as high as 73% (9MFY24), while other banking industry leaders such as HDFC Bank and ICICI Bank is around 40%.

Moreover, the bank faces challenges such as a high percentage of non-performing assets, legacy high-cost borrowings, and the burden of rapid expansion into new regions. Recently, the issues regarding high NPA and legacy high-cost borrowing have started subsiding. Whether IDFC First Bank can emerge as the "Next HDFC Bank" remains to be seen and only time will tell.

IDFC, a major infrastructure lending company, transferred its infrastructure finance assets and liabilities to a new entity called IDFC Bank in November 2015. Later, in 2018, IDFC Bank merged with Capital First, a leading NBFC founded in 2012 by V Vaidyanathan. Capital First had established itself as a top lender for small entrepreneurs, MSMEs, and Indian consumers, with a unique model based on new technologies. The goal was to finance India's 50 million MSMEs and emerging middle class.

However, a challenge arose during the merger as IDFC and Capital First were experts in wholesale and retail lending, respectively, and had limited deposit book-building experience. Despite this, under the leadership of the new CEO/MD Vaidyanathan, the bank increased its deposit book almost 5x from INR 38,455 cr in December 2018 to INR 1,76,481 cr in December 2023, with a CASA of around 50%.

Bank has been able to reduce dependency on high-cost borrowing over the years:

As of December 31, 2023, the bank has a funded loan book of INR 1.90 lakh cr:

Bank has been able to reduce exposure of Infrastructure Finance book:

The Bank today has 4 major product segments for the retail segment which are:

  • Consumer & MSME Loans - Home loan, Loan Against Property (LAP), Auto loan, Personal loan, Micro Enterprise loan

  • Wealth Management

  • Credit Cards: Over 22 lakh cards issued since the start of the division in Jan 2021.

  • Cash Management Solutions

Why invest in IDFC First Bank?

  • Willing to break set norms in the industry - The Bank’s biggest strength is its willingness to sacrifice tried and tested revenue sources for greater customer satisfaction and brand building.

  • Through Capital First, the Bank has extensive experience in the SME lending sector, one of the fastest-growing segments of the banking industry.

  • The Company leadership is well-led by the MD/CEO V Vaidyanathan who has extensive experience working across various banking and financial segments in ICICI Bank, ICICI Prudential Life, and Capital First.

2. Key Historical Financials

  • Bank has grown its revenue at a CAGR of 20% in the last 5 years with PAT growing at 23%.

  • Other Key Operating Metrics for the Bank are:

  • Net Interest Margin - 6.4% (Q3FY24)

  • GNPA - 2.04%

  • NNPA - 0.68%

  • Cost to Income Ratio - 72.8%

  • The NIM is a healthy 6.4%, which is near the industry standard. Bank still has a very high cost-to-income ratio mainly due to the additional burden of opening new branches very fast and low fees based income.

3. What is my view on Company valuation?

IDFC First Bank's share has jumped 40% in the last 1 year on the back of improved performance.

The bank currently trades at a P/B of 2.1x vs 2.8x of HDFC Bank, 3.3x of ICICI, 3.2x of Kotak Mahindra Bank, and 1.6x of SBI.

Historical RoE for IDFC First Bank has improved to ~11% but is still lower than its private sector banking peers.

Based on the improving numbers of the past 3 years and the promise shown by the accelerating digital operations of the Bank, I expect IDFC First Bank to maintain a ~20% revenue CAGR for the next two years. Management has guided towards ~20% income growth and ~30% profit growth annually for the next 5 years.

Bank will need additional external capital to fund this growth, so simplification of shareholding helps. During the first week of October 2023, the bank raised INR 3,000 crore from via qualified institutional placement (QIP) at an issue price of INR 90.25 per share.

At its current valuation, the bank can appear to be a bargain vs the rest of the industry but it has a difficult road to deliver results (reducing the Operating Cost to Income ratio and building loan book with low credit cost) in the next few years. Valuation is looking a bit stretched in that context.

4. What are the risks to the investment analysis?

Risks to the analysis are:

  • The bank's generous policies towards its customers and its extensive marketing efforts come at a steep cost-to-income ratio of ~70%, compared to its direct competitors HDFC Bank & ICICI Bank, who maintain ratios of ~40%. This poses a significant risk as it suggests that the bank is less efficient in its earnings compared to its rivals.

  • Intellectual property and patents are not widely recognized in the banking sector, making it easy for competitors to replicate and provide similar services. Even unique offerings that set IDFC First Bank apart from the competition may not remain differentiating factors for long.

  • The financial services industry is highly competitive, with other banks like HDFC Bank, NBFCs like Bajaj Finance, and new-age competitors like Navi Technologies and Paytm all vying for a share of the Indian Financial Services market. To keep up with the competition, the bank must maintain its technological momentum, or risk falling behind in this ever-intensifying race.


About the Author

Life Long Student of Equity Markets.


I have no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.

I am not a SEBI registered advisor. This article is purely for educational purposes and is not to be construed as investment advice. Please consult your financial advisor before acting on it.

I have used publicly available information while writing this article.



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