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For IDFC Bank, that was granted the universal bank licence, building its retail portfolio has been critical. After the much talked about IDFC-Shriram group merger being called off, IDFC Bank’s merger announcement with non-banking finance company—Capital First, is yet another attempt to ramp up its retail franchise. While the synergy—of access to high yielding retail loan portfolio—is obvious, it is likely to pay off only over a period of time. Near-term integration issues and the recent run up in stock prices of both companies, provide little upside for investors.
In arriving at a swap ratio of 139:10 --- 139 shares in IDFC Bank for every 10 shares of Capital First—the bank has valued the NBFC at nearly Rs 9,300 crore, a premium of 12 per cent to the current market cap. The deal thus values Capital First at 3.6 times FY18 book value. This given the size of the company, its growth and other financial metrics seem fair and leave less scope for a sharp re-rating.
Synergies that may pay off
When IDFC Bank started its banking operations on October 1, 2015, its gross loan book stood at about Rs 46,381 crore. As of the latest September quarter, its outstanding credit stood at Rs 90,598 crore. In a bid to build its mass market focus, the bank, a little over a year back, had acquired Grama Vidiyal Micro Finance (now renamed IDFC Bharat Ltd).
The merger of IDFC Bank with Capital First can result in synergies in as far as building retail loan portfolio goes.
Capital First that started off with wholesale financing, shifted its focus to retail financing businesses, in 2012. Diversifying into retail business paid off, evident in the company’s consistent growth in loans and earnings over the last couple of years. Between FY15 and FY17, the company’s loan book grew by 28 per cent annually and profits by 44 per cent. The asset quality has also been under check. The RBI in 2014 tightened the NPA recognition norms for NBFCs to bring them on a par with banks by March 2018. Migrating to 90-day norm, Capital First’s gross non-performing assets still remains stable at 1.6 per cent of loans. A niche player in the MSME space, the company has also diversified its loan portfolio into consumer durables and two wheeler financing over the years.
The merger will give IDFC Bank access to Capital First’s high yielding retail portfolio. Currently 27 per cent of IDFC’s loan book (funded) is retail (Rs 18,064 crore as of Sept 2017). Capital First’s assets under management stood at Rs 22,974 crore as of Sept 2017.
Limited upside
While synergies are apparent, integrating diverse lending businesses could see some challenges. IDFC Bank’s profitability is already under pressure owing to regulatory costs and expenditure on building its retail side of the business. IDFC Bank’s return on asset (ROA) stood at 1 per cent and return on equity (ROE) at 7.2 per cent in FY17. This is already lower than ROA and ROE of 1.8-2 per cent and 15-18 per cent respectively of leading private banks.
The deal that values Capital First at about 3.6 times its FY18 book value, also leaves little scope for a sharp re-rating. Other retail focussed NBFCs such as Cholamandalam Investment and Finance trade at 4 times, Shriram City Union at 2.4 times (asset quality concerns have impacted earnings). Bajaj Finance a leading NBFC player in consumer finance, SME and commercial and rural lending, trades at a premium to others at 6 times. Size, strong return ratios, low delinquencies and robust growth in earnings have helped the company command premium over the years.
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