IDFC : Moving up the value chain

A 1994 report from Department of Economic Affairs, Ministry of Finance found a lack of specialised financial intermediaries offering funds for infrastructure projects. This lead to the birth of IDFC Limited (IDFC) on January 30, 1997.  In 1998, the company registered with Reserve Bank of India (RBI) as a non-banking financial company and in 1999, formally became a public financial institution. IDFC registered with the Securities and Exchange Board of India (SEBI) as a merchant banker and as an underwriter in 2000 and in 2001 as a debenture trustee.

The main product/service group and industry group of this company are ‘Infrastructure finance services’. Its businesses consist of lending and financing businesses, including project finance (fund-based and non-fund based), fixed income and treasury, along with other activities such as institutional broking, investment banking, asset management and an infrastructure debt fund, which are undertaken through a number of subsidiaries. Apart from these, it holds windmill operations, investments in non-regulated business entities as well as certain strategic investments. It is regulated by RBI as an ‘Infrastructure Finance Company – Non Banking Financial Company’ and is a systemically important non-deposit taking non-banking finance company.

In August 2005, the company’s equity shares were listed on the National Stock Exchange of India (NSE) and Bombay Stock Exchange (BSE) after an initial public offering.

APPROVAL FROM RBI

IDFC received the final approval for banking on July 23, 2015. The RRBI had granted a banking license to the  company making it the second lender after Bandhan Bank to enter the banking sector after more than a decade.

Bandhan Moves –

Bandhan started banking operations under Bandhan Bank from August 23, 2015, with the inauguration of 600 branches in 27 states along with 250 on-site ATMs.

Unlike a microfinance institution (MFI), which focused only on the poor, the bank will have four types of branches – Micro Branches, Rural Branches, Semi-Urban Branches and Rural Branches”

 IDFC started operation from October 1 with 20 branches. Of these, 15 are in tier-IV cities with rest of the branches in New Delhi and Mumbai.

STRUCTURE:

The demerger of BANK Undertaking from IDFC was to comply with RBI guidelines as follows

The RBI New Banking Guidelines specifically mandate that all new banks are to be set up through a non-operative financial holding company and will need to be categorically structured such that all businesses which a bank is permitted to carry out, will necessarily vest in the new bank and all other regulated financial services entities (regulated by the RBI or other financial sector regulators) will need to be held by such non-operative financial holding company. RBI Guidelines (RBI New Banking Guidelines) dated February 22, 2013, for Licensing of New Banks in the Private Sector, mandate that a non-operative financial holding company will, for a period of five years, to hold a minimum of 40% of the shareholding of the bank.

So, to comply with the central bank’s guidelines, IDFC FHCL was incorporated by the IDFC Limited aRBI guidelines. IDFC was incorporated with an initial capital of Rs 5 lakh  totally held by IDFC FHCL.

Between the date of filing of the scheme and the effective date, IDFC Bank issued shares to IDFC FHCL to meet the capitalisation requirements set out in the RBI New Banking Guidelines and to comply with the terms and conditions of the RBI In-Principle Approval granted to the IDFC Limited. Such issue of new shares shall be separately undertaken by the IDFC BANK to IDFC FHCL, prior to the effectiveness of the scheme and outside the purview and ambit of the Scheme, at an appropriate time as decided by the Board of Directors of the IDFC BANK

Thereafter in the process of the demerger, IDFC Bank will allot one share of IDFC Bank for every one share held by them in IDFC on October 1, 2015. IDFC Bank shares remained unlisted between October 1 and November 6, 2015.

So currently IDFC Bank Limited  is a subsidiary of IDFC Financial Holding Company Limited (IDFC FHCL), which in turn, is a wholly-owned subsidiary of the IDFC Limited. The Shareholding of IDFC Bank Limited at various stage is as follows:

1. The Post Demerger holding based on the stock exchanges on November 6, 2015
2. The Initial capital was at Rs 10 per share i.e. Face Value. Whereas figure for additional issue are not available with us, this might also be at face value.

IDFC Limited shareholding:

Before the application to RBI Foreign institutional investors held 52 per cent stake in IDFC.

With application to RBI for the bank license, IDFC had to reduce FII holding to below 49% before starting of the banking operation. So IDFC was in talks with domestic mutual funds and insurance companies that hold 29.6 per cent which became prospective investors.

The sale or additional issue was necessary to comply with a RBI rule that mandates maximum foreign shareholding of 49 per cent in a private sector bank. The investors were interested in the tune of Rs 2,000 crore whereas the institution needed only about Rs 850 crore for the additional issue to adhere to RBI RB India requirement to reduce foreign holding to below 50 per. It decided to retain Rs 1,000 crore.

domestic institutional investors on September 19, 2014, introduced Rs 1,000-crore as qualified institutional placement (QIP). ICICI Prudential Life Insurance, ICICI Prudential Mutual Funds, Reliance Mutual Fund, SBI Life, Birla Mutual Fund, Tata Mutual Fund, Axis Bank and Aviva were the prominent investors in the QIP. The issue was priced at Rs 137 per share, an 8.6 percent discount to the stock’s close price on September 18 at Rs 150.05 on the BSE.

CONSOLIDATED PERFORMANCE (BEFORE DEMERGER):

1. During the three months to September 2015 or Q2FY16 of IDFC Limited i.e. before the demerger, the NBFC has booked exceptional charge during the quarter of Rs 2,600 crore. It posted a loss of Rs 1,460 crore in 2QFY16 primarily due to an exceptional charge booked during the quarter. The exceptional charge pertains to one-time specific provisions against stressed assets created from specific reserves i.e. stressed assets in coal and gas.The additional provisioning of Rs 2,640 made by the NBFC during the quarter ensures that the bank is fully protected against the stressed loan portfolio of Rs 8,800 crore as recognised by the management.
2. Apart from the provisions, there has also been a rise in bank related operating expenses viz. employee benefits and provisions and contingencies. The cost-to-income ratio excluding interest shot up to 22% in 2QFY16 as compared to 19% in the same quarter a year ago.
   Both these charges have led to the NBFC slipping into the red with a loss of Rs 1,470 crore during the quarter. Excluding the impact of the one-time provision, the NBFC posted a profit of Rs 1,170.
3.  Fall in loan Book :
   

   (Rs million)	2QFY15	2QFY16	Change
   Sanctions	737,930	542,930	-26.4%
   Disbursements	585,020	493,810	-15.6%
   D/S ratio	79.3%	91.0%
   Advances	548,510	468,890	-14.5%

4. Capital adequacy ratio stands at a robust 24.7% at the end of September 2015 (Tier-1 ratio of 24.1%).
5. IDFC’s Net Interest Margins (NIMs) have contracted by around 70 basis points to 3.1% due to interest reversal on loans that have turned bad. Its loan spreads reduced by 50 basis points to 2.2% during the quarter.
6. With more slippages in the power sector, the asset quality has declined further as reflected in the gross NPAs that rose to 3.2% at the end of September 2015 quarter compared to 0.6% in the same quarter a year ago. However, conservative provisioning by the NBFC has armed the bank with adequate provisions against the stressed loan book in future. Moreover, the bank will shift to the 90-day provisioning norm for NPAs from next quarter onwards and is also adopting a conservative practice of recognising interest income on stressed assets on a cash basis rather on an accrual basis. This prudent accounting norm is likely to shield the bank’s earnings against volatility.

REMAINING IDFC: 

With almost the full transfer of IDFC’s infrastructure lending business to the bank, IDFC Ltd has become the holding/investment company housing the non-lending businesses of asset management, investment banking, and  broking and consulting for alternative business segments.

1. The NBFC also holds 53% stake in the demerged banking entity that will be pared to 15% over a period of 10 years.
2. IDFC is expected to grow into a much larger entity as it will have exposure to both PPP as well as non-PPP infrastructure assets, currently, has operations only in the PPP projects.
3. Moreover, as IDFC will be funding projects that are operational, the element of risk faced from the delay or non-completion of under-construction projects is likely to be lower.
4. Since IDFC income will be tax-free, it will be in a position to offer competitive rates to borrowers.
5. Post demerger, it expects the NBFC’s business to generate a ROE of 15% over in future. IDFC presently has a Tier-I capital of Rs 4,400 crore that will be increased by Rs 1,500 crore in the coming quarter.
6. It received assets of Rs 700 crore post demerger and has market borrowings of Rs 300 crore. IDFC will raise more funds from banks and financial institutions.
7. Given the government’s strong focus on promoting infrastructure development in the country and with the deepening of the bond market, IDFC as an investment vehicle holds a lot of promise. Armed with a rich experiencing in funding infrastructure projects in the country, the IDFC business holds a lot of potential for the company in future.

IDFC BANK – (A NEW WAY FORWARD):

IDFC Bank will be a Universal Bank. It will have three business verticals namely

• Corporate (Wholesale) Bank,
• Consumer (Retail) Bank and
• Rural (Bharat) Bank.

Operation:

1. It will start with 20 branches mostly in rural areas. The RBI has stipulated that the new banks should have 25% of their branches in unbanked areas. Initially, it will be targeting the southern and west central parts of the country to launch branches in unbanked areas. By FY16, the bank wants to expand its network to 60 branches with a majority 45 in rural India. However, it might face challenges in building a retail franchise.
2. It aims to enroll 1.5 crore customers in next five years.
3. The primary focus will be Quality of Customer Service and Digital Banking. The dependence on brick and mortar branches will be lower as compared to existing banks. Even in rural banking, services will be delivered to rural communities using handheld devices. The project management team is working on the frontend design, mobile applications and on interaction with customers through social networks which will also cut costs.
4. Currently, it focuses on financing long-term projects, now it will operate in wholesale, retail and rural banking. This will help diversify its risk and yield better returns.
5. Experience in infrastructure lending business is likely to act as an anchor for the wholesale corporate banking operations of IDFC Bank. Utilising existing corporate relationships, the bank wants to penetrate the non-infra landscape and diversify its operations from term lending to lending for working capital management and cash management, transaction banking, foreign exchange reserves and other key services.
6. Revenues from ‘Wholesale & Commercial’ banking segments will be used for developing the retail and rural businesses where the bank will be starting on a clean slate and will be facing competition from established players.
7. In the retail loan segment, the bank wants to start out with affordable home loans and enter auto loans and credit cards later on.
8. The key will be to keep the cost to income ratio lower than the industry average. If the cost to income ratio of existing banks is in the 45-50% zone, we would like it to be in 35-40% zone as presently.
9. At present, the bank will have to function on borrowed funds since it will take a time to build up the deposit base, buy slowly the bank will be able to reduce its cost of funds and improve its spreads.

Financial: 

10. The bank will not require any incremental funding for the next six -seven years.
11. With a balance sheet size of Rs 70,000 crore, the bank will have a loan book of Rs 50,000 crore. At present, 90% of IDFC’s loan book comprises infrastructure loans to corporations.
12. SLR is the proportion of deposits that banks need to invest in government bonds and approved securities; it is currently 23.5%. Banks are required to channel 40% of their loans to small companies, agriculture, and other borrowers under priority sector norms.
13. The bank using the internationally recognized ‘CAMELS’ system. Under this system, banks are rated on the basis of five components namely Capital Adequacy, Asset Quality, Management, Earnings, and Liquidity.
    • IDFC Bank continues to remain adequately capitalized. Its’ Tier I capital adequacy ratio of 24% is well above the stipulated requirement.
    • On the asset quality front, the bank has been very proactive and conservative in recognising the risk of loan defaults from exposure to the power sector. Therefore, the bank has already provided for the entire stressed loan book including the restructured assets, NPAs and security receipts that account for more than 8% of the total loan book. The bank has gross NPA ratio of 3.5% at present which is fully provided for and the redeeming factor is that the bank is hopeful of a recovering the balance 40% of the stressed assets.
    • On the management quality front, IDFC’s pro-activeness in fortifying the bank by providing for stressed loans speaks volumes about its integrity and transparency. The provisions seem to be adequate for now and will ensure that the bank is able to focus on its operations without having to worry about the recovery of legacy assets.
    • The critical aspect of earning levels for the bank. The bank has a large treasury book constituting around 33% of the total balance sheet size. During the initial period, the bank will largely be wholesale funded with Rs 48,000 crore of infrastructure loans acquired from IDFC. As the bank works towards building its low-cost deposit base of Current Account and Savings Account (CASA) as well as complying with public sector lending (PSL) requirements, the yields and margins are expected to be low initially. As per the bank, its Return on Assets (ROA) is likely to be 1% at the beginning and improve over the next five years.
    • And on the liquidity front, the large treasury book will ensure that the IDFC bank is fully compliant with the CRR and SLR requirements.

Therefore the newly formed IDFC Bank ranks reasonably well with respect to parameters such as soundness, management quality, and profitability.

MARKET MOVEMENT: 

IDFC slumped 60% at Rs 60 on BSE after the demerger scheme takes effect on 1^st October 2015, when financing undertaking of IDFC gets transferred to IDFC Bank. The pre-demerger market cap of the company was R 22,523.51 crore.  Post-demerger, the book value of IDFC will fall to Rs 100 per share. Post demerger, the book value of each IDFC Bank share will be Rs 39 per share.

The market capitalisation of the both companies after the demerger is approx Rs 29,600 crore which includes the 53% holding by IDFC into IDFC BANK of approx Rs 11,000 crore, so the net market capitalisation of the both the companies is approx. Rs 18,600 crores trading at a discount compared with pre-demerger.

HDFC BANK:

HDFC is the largest private sector bank in India by market capitalisation (approx. 2.71 lakh crore) and according to the Brand Trust Report 2014, HDFC was ranked 32nd among India’s most trusted brands and this has been achieved through various services and leader to provide services even not heard in India and through acquisition & merger

HDFC, a private sector bank promoted by housing Development Corporation Ltd. (HDFC), a premier housing finance company.

1. On March 1995, HDFC Bank launched its IPO of Rs50 crore and got listed on BSE – 19^th May 1995 and listing on NSE – 8^th Nov 1995.
2. Within three years of established it had over 19000 deposit account and was adding 2500 new account per month
3. Branch network touched 50 in 1998
4. Entered into agreement with NSDL for DEMAT, with this in 1999 depository participant business witnessed phenomenal growth and total investors touched 50,000
5. In 1999, it also launched online real-time net banking and first international debit card in India.
6. In 2000 acquired and merged Times bank and became the first bank in India to launch mobile banking in India.
7. Focussed offering to NRI customers and went to list on New York Stock Exchange in 2002.
8. Credit card launched in 100 cities in 2004 and special women debit card launched in 2006.
9. In 2008 Centurion bank of Punjab merged with the company.
10. In 2009 Tie up with postal departmental to extend rural reach.
11. In 2011 First bank to retail silvers bars in India.
12. In 2013 it had approx. 3300 branches and reached 20 lakh household and approx. 12000 ATM in 2022 cities

“Through various innovative product for every customer and using the technology to its best for expansion and acquisition has helped the HDFC bank to reach Market cap. Of Rs 2.71 lakh crore in span of  20 years of its establishment”

CONCLUSION:

The key operational parameter in banking is the net interest margin: the difference between the average cost of deposits and the interest earned on loans. To keep the ratio healthy, it is essential for a bank to get hold of as many low-cost savings and current account deposits as possible. Intense competition for savings account deposit and limited branch presence will limit its ability to quickly ramp up the savings account franchise.

Keeping costs under check will be the other big task for the management as high costs could prove to be a drag on profitability whereas IDFC Bank will have to front-load a lot of technology and marketing costs. The world is moving to smartphones; so, the focus on technology design will be a phone. The idea is you should be able to do everything on a smartphone; you don’t have to go to a bank branch. You should be able to get your queries answered 24×7; you should be able to withdraw cash in places that are more ubiquitous than automated teller machines.