IDFC First the next HDFC Bank ?

Hello investors, in this article, we will talk about IDFC First bank as many people requested it, Now I will focus on only three points. That will help us understand if the company is expensive or not and I will compare this with HDFC Bank.

How a Bank Earns Money?

Let´s understand how a bank earns money. They make money from profitable investments, some banks have a very high fee income. I´m sure you have had to pay some heavy fees while doing some transactions but their biggest source is interest income. When the bank gives you a loan, they charge interest on it and that´s how they make money.

Now let´s talk about IDFC First bank. I´m sure you already know that IDFC First bank pays 7 % interest on savings account, this seems very high when we compare this with other banks because they are giving between 3 - 5 % plus they are reducing the interest rate but IDFC First bank is still paying 7 %. 

So why are they giving such huge interest because this is an expense for the bank?

When a bank gives you interest on savings account, it´s coming from the banks pocket, so it´s an expense for them. Let´s understand if this is good or not. As you may already know, IDFC First bank was formed when Capital First and IDFC bank came together. You might already know this but there is one point I would like to highlight.

Capital first was a financial company so they made money by charging interest on their loans but in order to lend money, first, they have to borrow money. Nobody gives you money for free so when you borrow money, you have to pay interest on it. Capital first used to pay an interest of 8.5 % on their borrowings. IDFC Bank had borrowings and they used t pay 8.9 % on them. So IDFC First bank got the borrowings from Capital First and IDFC bank. As of March 31, 2020, they had borrowings of 43 875 crores and they are paying 8.6 % interest on it.

Now you can see that is they are offering 7 % interest on a savings account, they are actually saving money because they have borrowings, where they are paying 8.6 % they are saving money every time they get money from the savings account.

I think this is a very big advantage for them. Let me explain why. When you run a bank, there are several costs involved and you need to keep opening more branches. IDFC First bank is very aggressive and they are opening many branches in a very short amount of time, so their cost is very high and you can actually see this with one metric, known as a cost to income ratio.

We will use Tijorifinance for this. We are going to check some data of IDFC First bank. We are going to skip the initial information, we are looking for the operational metrics. I will talk about the first 4 metrics later. Here you see the cost-to-income ratio of 68.72 %. This means that in order to get that income, the bank has costs of 68.72 %. This is very high and we can compare this with HDFC BANK, Kotak BANK and Bandhan bank. 

You can see in black that IDFC First bank has the highest cost-to-income ratio. HDFC Bank has 35 % and Bandhan has 27.9 % and Kotak Bank 47%.

 Let´s understand why.

As they are focusing on CASA ( current and savings account ), they have set up more branches in urban areas. Any bank can borrow funds in several ways and one of them is CASA. Banks give a lower interest rate on the savings account. As I mentioned earlier, they have borrowings of 8.6 % but they are paying 7 % on the savings account, it´s even better for other banks because they only pay 3 - 4 % interest on savings account and that´s why banks love CASA but IDFC is competing with several banks like Kotak and HDFC in urban areas and many people already trust these banks. If you don´t trust your bank, you won´t put your money there.

IDFC First bank just started so people don´t trust it as HDFC Bank, so they need to have something special and a higher interest rate on the savings account is helping them this is very high compared to other banks and that´s why I mentioned that this is an advantage for them, before we continue, if you are liking this article, please click the like button and let me know the topic for the next article in the comment section below.

 So then how does IDFC First bank give loans? 

For this, the branches are in rural areas. Let´s understand why rural. Banks like HDFC and Axis like to deal with big companies as they have a great track record and they are able to pay on time, they also have a retail business for customers like you and me but they don´t focus a lot on rural. I´m not saying that they avoid rural but the exposure is very little and if they don't, they tend to go for secured loans, which have a collateral home loan is an example of secured loan. If the customer doesn´t repay the money, you always have the collateral and that´s why banks like HDFC and Kotak like this business.

IDFC First bank also has a home loan business but they also go for unsecured loans, so there is no collateral involved, so if the customer doesn´t repay the money, the bank will lose money . This seems risky at first but IDFC First bank also has unbanked customers, so they don´t have any past record or bank accounts but is this risky? Let´s try to understand this. I´m sure you already know that you pay a very high interest ( more than 20 % ) on your credit cards.

So why do they charge such high interest? 

It´s simply because they have many customers who don´t repay the money and there is no collateral involved. That´s why they charge such a high-interest rate.

Let´s imagine they have 10 customers and they charge 25 %. If 2 of them don´t repay the money, there won´t be any problem because they will charge a very high interest to the rest 8 customers and something similar happens in IDFC First bank because they charge 14 - 16 % interest to their retail customers. Because banks like HDFC or Kotak would ever giver loans to these customers so they have a huge advantage but the business model is not perfect because it´s still risky just like the credit card business. But in this case, we can see the track record of Capital First because they are using the same platform.

ALSO READ: How to read the annual report of a company like HDFC AMC, ITC.

In Capital First, their Net NPA was below 1 %. If the financial company doesn´t recollect the money in 90 days, it´s known as Gross NPA or non-performing asset, the company will keep some money aside to be safe and this is known as provisions, so let´s imagine there is a Gross NPA of 100 crores and there are provisions of 20 crores the ending 80 crores will be Net NPA. I like this to be below 1 %.

In the case of Capital First, it was around 1 % always. So this tells you that they were able to control the risk. So how did they keep the Net NPA so low? The biggest reasons is technology as they have millions of customers and this helped them scale the business. 

So which factors are inside this technology?

The biggest one is cash flows so they check your income and expenses because if you have a good source of income, you will be able to repay the money. So in the case of Capital First, out of 10 customers, 4 would get rejected due to bad cash flows and there are legal reasons and personal interviews and if you pass these filters, they would approve your loan.

Other banks have been able to control their moratorium numbers as it´s less than 10 %. In the case of IDFC First bank, it´s 28 %. Retail is 23 % and wholesale if 35 %.  This is very high compared to other banks.

Advantages and Disadvantages.

Other banks have included some complicated steps so their customers don´t take the moratorium or if their customers don´t meet some requirements, they didn´t give the moratorium, but in the case of IDFC First bank, they have given moratorium to everyone who requested for it, of course, it´s not perfect because we never saw this moratorium at scale but they have given it to nearly everyone who wanted it.

So why did I say that this is an advantage and disadvantage at the same time?

It´s an advantage because there customers will be happy as they don´t have to pay for some time and they will stay with the bank and they might take future loans and if they are happy, they will recommend the banks to their friends and family.

There is one more advantage. Many of their customers have just restarted the business again, if they are earning money now, they can save it as they don´t have to pay for some time. When the business will do well, they will have more money and they won´t have problems to repay the money to the bank, so it won´t be a problem for the bank in the future. Please remember that the bank will still charge interest in the moratorium so it´s not a big deal but this is a disadvantage because now their investors are worried as 28 % is very high even though the management has said that this will be below 10 % and the moratorium can change your habits because you will start thinking that it´s not necessary to repay the money to the bank as you didn´t have to repay anything in the moratorium and this is not good for banks, so we don´t know the real impact but the good thing is that the bank raised money recently but we already know that the NPA´s will be higher. You will see the real impact of NPA´s after some time, of course in the lockdown period, the demand was ow and nobody wanted a loan so banks were able to control their cost.

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IDFC First bank was able to decrease their cost by 20 % compared to the last quarter, despite that, they were able to grow their CASA numbers mainly thanks to article KYC but before, I want to explain if IDFC First bank will become the next HDFC Bank or not because if not, people will say that I wrote that in the title but I didn´t answer. It will never be the next HDFC Bank because the business model is totally different.

HDFC Bank started with big companies and they used to do business with them because they wanted to become profitable from day 1, they didn´t start retail because they knew that you need branches and you need money for that. Plus Mr Aditya Puri had experience in corporate sector and once they were profitable, they started the retail segment but they were opening branches in phases and they weren´t aggressive.

In the case of V. Vaidyanathan, his experience in retail so he wants to focus on that and they are very aggressive with their branch expansion, so of course their profits won´t be so good for a while but once the expenses are done, the profit will grow at a very fast rate.

 So is the bank expensive or not? 

In the case of banks, free cash flows don´t help you because the business model is different and I teach this in my course, where I talk about the business model of a bank and NBFC and how to value them, you have to check other metrics such as Return on Assets, Return on equity and NIM but they just posted profits recently so we can´t actually look at these metrics, but if you compare them with other banks, it looks very cheap but there are two main reasons behind this the first reason is there retail loans, which are growing rapidly but these retail loans are not profitable yet and it's the same even in the last quarter. So they are growing rapidly but they are not profitable mainly because of high provisions, so even if they generate good revenue, they create more provisions so the bottom line is always negative and the second problem is their wholesale loans because they only give loans to medium quality companies, so the quality is not good if we compare them with HDFC Bank for example and that´s why they created so many provisions in the past and that´s why they never showed profit until recently & personally, I don´t like their infrastructure book. Let me explain why.

We will continue with Tijorifinance. I´m on the page of IDFC First bank below, you can see the NPA break-up.

So when the bank gives a loan and they don´t recollect the money in 90 days, it´s known as NPA, so Tijrofinance actually shows you where the NPA is coming from you can see 21% is from infrastructure transport and 4 % is infrastructure energy. So approximately 25 % of their NPA´s are from infrastructure. So now you know why I don´t like this segment because the risk is very high. I would like to mention as a disclosure that I have IDFC First bank in my portfolio. Please don´t take this as a recommendation and it´s a small position because I still think there are some risks involved. 

So why did I invest? 

When this bank started, the management guided that in 5 years, 70 % of their book would be retail, it´s already more than 61 % of their book, they also guided that the CASA would be more than 30 % and it´s already 33 %, they said their margins would be more than 5 % and they already have 4.5 %. So they have already achieved a lot according to their guidance and that´s why I like it, so if you would like to know the stocks in my portfolio or why I like them or if you want many reports on several companies, you can check out our official website www.wodsofficial.com, where you will find everything. So, don´t forget to subscribe for more articles. 

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