Merged entity to focus on branch expansion, cross selling products: Capital First

Warburg Pincus has had a dream run with Capital First over the last five years and would not like stay on as a larger shareholder in the merged entity, said Vaidyanathan.

"The regulation is subject to RBI discretion, a single investor can own between 5-10 percent," said Lall.

Vaidyanathan also clarified that post the approval of the merger, his stake in IDFC bank will not really be impacted and that his appointment as CEO of the combined entity will have to be approved by the regulator.

Talking about the synergies of the combined entity, Vaidyanathan said they would be carrying capabilities of creating retail assets, while Lall said besides complete alignment in strategy, they would offer huge number of customers that are in the segment that are more potentially liabilities' rich.

The combined entity together would hold 195 branches of IDFC Bank, said Vaidyanathan, adding that the focus will be on branch expansion, getting customers and cross selling produces.

In the same interview they spoke on various aspects of the synergies through the merger if it goes through.

Below is the verbatim transcript of the interview.

Latha: What are the regulatory requirements, now IDFC's stake in the merged entity will be at 38 percent, right?

Lall: Thereabout.

Latha: Does the law require that you have to be at 40 percent till 2020?

Lall: We don’t intend to seek regulatory dispensation. I don’t think there will be a big deal for IDFC to actually claw back to 40 percent. So that is the intent at this time.

Latha: So the combined entity will issue more shares?

Lall: No, IDFC would buy in the market.

Latha: What about Warburg Pincus, what do the rules require in terms of Warburg’s, it has to be 5 percent or below in the new entity, so would they have to sell out?

Vaidyanathan: The current stake holding is about 36 percent. Through this deal they will come to a little more than 10 percent, maybe about 10.3 or 10.4 percent, and to that extent they probably have to come down to 10 percent. Now the norms are at 5 percent, but I think the system is hopeful based on the synergies we want to demonstrate and the future long term path we want to show, I think they are hopeful that they will get an approval for 10 percent.

Latha: There will be regulatory dispensation request?

Vaidyanathan: They should probably give them a window to deal with that situation.

Nisha: You are also saying that Warburg Pincus wants to stay on as a larger shareholder in the merged entity, they are not looking at monetising after the merger as well.

Vaidyanathan: That is absolutely true. Warburg Pincus as you know has had an absolutely dream run with Capital First over the last say five years. They really believe in the business model, they back the management very strong. So, the sense that we have from this is that they will continue to back the story for many more years to come and they are very much in.

Latha: So much depends on Reserve Bank of India (RBI) allowing them to stay at 10 percent?

Vaidyanathan: Allowing them to get to 10 percent. As I said, we cannot pre-judge the regulator, we got to respect their view on this.

Latha: But there are precedents.

Vaidyanathan: There are precedents, for example they had a 10 percent stake in Kotak Mahindra Bank.

Lall: If I were to just add, the regulation is that subject to RBI discretion, a single investor can own between 5 and 10 percent. So it is their discretion.

Nisha: You also will land up owning a very small minority stake in the merged entity by way of your stake in Capital First. So as the CEO, as per the regulations, you will have to let go off that and also your CEO position will have to be approved by the RBI.

Vaidyanathan: That is correct, even my position has to be approved by the regulator. We are hopeful for that. As far as stake holding is concerned, say about 3.5-3.6 percent or somewhere in that zone, I don’t think that should be any bother at all for anybody, certainly not, and in fact it actually demonstrates I guess both the investors that I am personally also as committed to this institution for the growth in the long run.

Latha: There is no regulatory rule against owning, regulation wise you just have IDFC having to buy 2 percentage point from the market and Warburg getting an approval.

Vaidyanathan: That is about it and I stay where I stay.

Latha: Now to come to synergies. What do you perceive as synergies?

Lall: Synergies are, there are several levels, so I will come to the financial ones in a minute, but they start in the software domain. So, one there is complete alignment in terms of strategy. Our stated strategy is aggressive retailisation. This merger offers exactly that.

Latha: But only in assets.

Lall: Correct, but it offers a huge number of additional customers, 3 million customers that are in a customer segment, that are actually more potentially liabilities rich. How do you actually generate liabilities from customers, you can do that, you can try and build a liabilities business that is completely disjointed from the asset side, but actually the customer does not see a bank like that. The customer would like to have a holistic relationship with the bank. So if you offer a product on the asset side that they really appreciate, there is every chance that you will actually be able to generate liabilities from the same customer base. So that is strategic fit.

Second there is intent and that is very important between the two of us which is build the institution.

Latha: How many customers do you promise in terms of liability, 3 million retail customers you said, 3 million bank accounts?

Vaidyanathan: Actually it goes a little deeper than that. It is not 3 million customers alone, it is the capability to originate 3 million customers and it is very important. In 2010 we had just Rs 94 crore retail book and today we are Rs 23,000 crore. Every month we are adding a large number of customers in the retail space. So, when you carry this capability to the new institution and on that platform you scale it up.

Secondly, in lending as you know, it is not about lending alone, you got to get it back, so we have developed some very special capabilities of doing two things. One access a particular part of the banking system which is currently not addressed, it is important, and two, do it in a very high quality way where NPAs are low. It is seven years running, our net NPA is 1 percent -- that says something.

Nisha: A lot is riding on you, in fact the market is really looking up to you for the retail growth of IDFC Bank. Now you have really originated a kind of business which will give a lot of cross-selling opportunities and the retail portfolio and assets to the bank. However, as far as getting deposits are concerned, Kotak Mahindra Bank, Yes Bank, at higher rates are also struggling at this point. What is your strategy there and what is the timeline and the target you are looking at because markets are very keenly watching out for these targets.

Vaidyanathan: I think it is an absolutely good question and I think probably one of the very most important questions. In my opinion, when you look all around us, at the grassroot level, you see shopkeepers, you see people, you see employees, etc. you just see there is so much opportunity. Everybody needs to keep the savings somewhere. Number two, if you see the Indian economy’s growth over the next 10 years, I just read a report that Morgan Stanley report talks of 6 trillion economy and we are 2.3 trillion today. Now where is the extra 5 trillion going to be financed from and where the savings are going to come from?

They are going to park it somewhere. So, if we develop a product where customers have confidence in us, we have a relevant product, and we open branch structure that can allow customers to come and put the money with us and have a digital strategy, I have no doubt in my mind that we will raise deposits. It is a big play on the India story.

Nisha: Will it require another inorganic play from your part?

Vaidyanathan: Not necessarily at all. In fact I would say this whole merger has to be seen as a bigger picture. The bigger picture is that Indian economy is going to become say a 7 trillion in 10 years, okay, 5 trillion to be created, I have a big piece on that. We are not the last bank to be created in the country, maybe there are 40 banks here, maybe there are 40 on the liability side, but 100 more to come. So it is a very big story to play out for.

Latha: Let me come to the other regulatory requirement, cash reserve ratio (CRR) and statutory liquidity ratio (SLR). How much more should the combined entity get in rupees crore terms to get to 4 percent CRR?

Lall: Broadly speaking, we need Rs 6,000 crore. However, we already have little over Rs 2,000 crore in excess SLR, CRR sitting with us. So we need about Rs 4,000 crore.

Latha: So you will have to raise it.

Lall: We will raise it in the market. We have a very accomplished treasury operation. So, we should be able to do it.

Latha: But that will tell on margins, won’t it?

Vaidyanathan: These things are marginal in the scheme of things in the initial run.

Latha: Initially you start with a tough margin problem.

Vaidyanathan: It will always be a tough job in initial phases on many fronts for that matter. Fixing your liabilities over a three year story, of course is not going to be an easy job, I recognise it is important, it is difficult, but it can be done. I recognise that there may be a few other challenges along the way but the issue is what do we look from a three year standpoint of view. So, we should not get really worried about.

Latha: I take your point, I am just looking at the current three years because the share price will reflect, maybe nine months down the line kind of entity, share price may not look at three years down the line kind of entity.

Vaidyanathan: I cannot pre-judge the share market, but all I can say is that I got to do what I got to do. If I got to put 500 branches, I got to go and put it, and the results will come when they come.

Latha: That was the next question, how many of your current offices can straightaway be added as branches you think?

Vaidyanathan: We think that combined together at existing branch network, we will probably have 195 branches. However, the long story, let me say a little longer term story, is not to stay where we are. If we get very focused on the quarter-on-quarter profits, we will never invest and we will forever be stuck in a funk, our feet will be in clay. If we got to open branches, we got to do it.

If it costs expenses, we got to do it. We should focus on what we can get out of those branches, how we can cross-sell to our customers, and how finally we can improve the value proposition for our customers in a composite way. If we achieve that, value will come, investors will reap the rewards.

Nisha: Synergies and retail growth is what market is banking on, but in the medium term, while you achieve that target, the key question here is the margin depression. Here I would like to come back, apart from SLR, CRR, as well as the priority sector lending (PSL) requirements, there is also the credit cost because you have a certain criteria of NPA which is on the lower side. However, when it comes and merges with the bank, will it really depress the margins as well?

Vaidyanathan: I have to answer this question very specifically. I just take you to Capital First. When we started, we were posting Rs 5 crore a quarter of profits; not long ago, five years ago, Rs 5 crore a quarter. At that point of time, if I got stuck saying that growth is only Rs 5 crore, I cannot invest, it would not have been Rs 75 crore a quarter profit today. I got to do what I got to do.

So here to your question therefore, I am not really focused about what the first quarters profits are going to look like, am I going to be down, am I going to be up, that is not the way to think and we can never build big institutions with that thinking. So your question, I will not focus on the immediate margin this quarter, one year. I will start building the organisation, and build the infrastructure, get the organisation, get the products right, and grow the organisation, and the results will fall in place when they fall in place.

Latha: Just to continue that, priority sector, how much of your loans will already qualify for priority sector? Will the merged entity meet?

Vaidyanathan: Yes, I think we will add to the priority sector because we are in excess of 40 percent as our priority sector. So in fact our priority sector drag to the process is zero. In fact we are a contributor for priority sector to this contribution.

Nisha: By how much?

Vaidyanathan: We are excess of -- about 45 percent of our book is priority sector.

For full interview, watch accompanying video...