Strengths *Healthy capitalisation Capitalisation is healthy, as reflected in Tier 1 capital adequacy ratio (CAR) of 13.28% and overall CAR of 13.29% as on December 31, 2019, despite moderation from 15.27% and 15.47%, respectively, as on March 31, 2019. The capital position is supported by sizeable networth of Rs 15,240 crore and healthy cushion against asset side risks with networth coverage for net non-performing assets (NPAs) of 14.2 times as on December 31, 2019.
Furthermore, with incremental growth coming from the retail portfolio coupled with scaling down of the wholesale loan book, capital consumption is expected to be at lower levels than seen in the past. In addition, the management has demonstrated ability to raise capital on several occasions in the past.
CRISIL believes the bank's capitalisation will continue to be healthy and will support the bank's credit growth over the medium term.
*Increased focus on retailisation of loan portfolio IDFC FIRST plans to be a retail-focused bank by significantly scaling up the retail book to 75% of the overall funded assets over the medium term. In line with this strategy, the retail portfolio has shown a healthy growth of around 42% in the past one year, to Rs 51,506 crore as on December 31, 2019, from Rs 36,236 crore as on December 31, 2018. Consequently, share of retail assets in total funded assets (advances + debt investments) increased to 49% from 35%. Furthermore, the management plans to leverage past expertise and track record and target small entrepreneurs and consumer segments to drive growth. The company has more than 90 lakh retail customers as of December 2019 and has demonstrated, in the past, ability to scale up its retail franchise profitably with steady asset quality.
In addition, to increase the granularity of the loan book, the bank is gradually scaling down its wholesale portfolio, leading to muted growth in the overall loan book. The wholesale funded assets reduced to Rs 42,951 crore as on December 31, 2019 from Rs 56,809 crore as on December 31, 2018. The bank's total funded assets remained flattish at around Rs 1,06,140 crore as on December 31, 2019 (Rs 1,04,660 crore as on December 31, 2018).
CRISIL believes IDFC FIRST will continue to focus on scaling up its retail portfolio, thereby improving the granularity of the portfolio. The bank does not plan to take on incremental exposure in the infrastructure segment and will focus on the relatively small-ticket, mid-corporate, and financial institution segments. Therefore, susceptibility to slippages in large exposures, which has impacted the bank in the past few years, will be reduced going forward.
*Expectation of significant improvement in earnings profile over the medium term The rating factors in expectation of significant improvement in earnings profile from current levels. The bank's profitability has been impacted in the past few quarters by multiple non-recurring factors including (i) accelerated provisioning on stressed assets amounting to ~Rs 3,500 crore; (ii) write-off of goodwill & other intangible assets created on merger amounting to Rs 2,599 crore; and (iii) markdown of existing deferred tax assets due to change in corporate tax rate amounting to Rs 751 crore. Further, with continued branch expansion, operating expenditure was high at around 3.2% (annualised) of total assets for the nine months ended December 31, 2019. Consequently, the bank reported a loss of Rs 2,936 crore for the nine months ended December 31, 2019, and a loss of Rs 1,944 crore in fiscal 2019.
Nevertheless, core earnings are already showing improvement, as reflected by pre-provisioning operating profit (PPoP) of Rs 1417 crore (1.2% (annualised) of average total assets) for the nine month ended December 31, 2019, compared with Rs 764[2] crore (0.5% of average total assets) for fiscal 2019. Pre- provisioning profits may be impacted over the next few quarters because of reduced retail disbursals on account of Covid-19 and consequent impact on income, but is expected to stabilise over subsequent quarters.
Further, incremental slippages from legacy wholesale exposures are expected to be limited going forward as bulk of the stressed assets has already been recognised and provided adequately (51% provision coverage on stressed assets as on December 31, 2019). Moreover, with planned ramp-up of the retail portfolio, credit costs are expected to remain under control over the medium term as asset quality is projected to be steady in the medium term. In addition, the net interest margin is expected to improve as the proportion of relatively high-yielding retail segment increases and reliance on high-cost wholesale borrowings decrease. However, operating expenditure is expected to remain elevated over the medium term due to ongoing expansion of retail banking operations.
Amidst the expectation of slippages due to Covid-19 related events, credit costs could increase impacting profitability in the near term with the bank potentially reporting losses in the two quarters post lifting of moratorium. However, the same could be offset to some extent by the banks improving pre-provisioning profits. Nevertheless, the ability to improve profitability on a sustained basis will continue to remain a key monitorable.
Weaknesses *Relatively low proportion of CASA deposits The bank's resource profile reflects a significant component of wholesale borrowings (fixed rate debentures, wholesale term deposits, and certificates of deposit) which formed 43% of overall resources (total borrowings including money market borrowings + total deposit) as on December 31, 2019. Therefore, cost of funds remained high at around 7.45% for the nine months ended December 31, 2019. However, the bank plans to reduce dependence on wholesale borrowings and scale up its retail liability franchise. Over the past few quarters, mobilisation of CASA deposits has improved significantly as reflected by increasing share of CASA deposits in overall deposits to 24.0%[3] (12.0% of overall resources) as on December 31, 2019, from 8.7% (4.1%) as on December 31, 2018. The bank has also grown retail deposits (fixed deposits plus CASA) by Rs 18,866 crore in last 12 months. Total retail deposits (retail term deposits and CASA deposits) improved to 43% of overall deposits as on December 31, 2019, from 17% as on December 31, 2018. Since the bank has not increased the overall loan book, this has been partly used to run down Corporate Term Deposits and Certificate of Deposits. Certificate of Deposits as of December 31, 2019 was Rs. 12,720 crores. Though CASA proportion is currently below industry average, it is expected to increase substantially over the medium term driven by efforts to grow retail liability franchise which has been successfully demonstrated so far. However, ability to scale up retail liability franchise to support credit growth will remain a key monitorable over the medium term. *Inherent weakness in asset quality in legacy wholesale loans; can be offset by demonstration of stable asset quality in newly built retail portfolio on a steady state basis Gross NPAs increased to 2.83% as on December 31, 2019, from 1.97% as on December 31, 2018, largely on account of slippages in the wholesale loan book. Furthermore, gross stressed assets ratio[4] increased to around 8.8% from 3.7%, driven by significant increase in stressed exposures in legacy wholesale loans identified by the bank. Moreover, gross NPAs of the retail portfolio, which will be the key driver for growth, stood at 2.26% as on December 31, 2019 (2.18% as on March 31, 2019). Most of the retail portfolio came from the erstwhile CFL where the management has demonstrated its ability to maintain stable asset quality. IDFC FIRST, as part of its retailisation agenda, is planning to enter new retail segments over the next few quarters. Also, the share of total wholesale portfolio (including stressed equity and security receipts), despite reducing, remained sizeable at around 43% as on December 31, 2019. CRISIL expects the gross non-performing assets (GNPA) levels to increase from current levels primarily due to slippages in the corporate segment and vulnerability of the key retail segment of the bank ' MSME borrowers to the economic slowdown and Covid-19. The bank's ability to manage asset quality in the newly built retail portfolio while scaling up operations and arrest slippages in the wholesale portfolio will remain key monitorables. |