Shares of IDFC First Bank Ltd and RBL Bank Ltd have surged over the past one month, outperforming those of large peers and the broad Nifty. IDFC First Bank share price has gained a stellar 23 percent, while that of RBL Bank has climbed 9 percent. Gains for other large private sector lenders were in the 10-15 percent band.
At the outset, the first quarter performance of the lenders seems to have increased the optimism of investors. IDFC First Bank beat market expectations in its profitability metrics for the June quarter. Net profit of Rs 474 crore was above street expectations and loan growth of 21 percent was viewed as robust. What’s more is that the bank’s loan book growth was led by retail and small business loans even as it shed troubled legacy corporate loans. On asset quality too, the lender met expectations as bad loan ratios dropped and provisioning cushion went up.
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IDFC First Bank’s more-than-expected growth in core interest income and operating profit added credence to the management’s forecast of achieving a return on assets ratio of 2 percent in near term. The bank reported RoA of 0.97 percent for the June quarter. The accompanying commentary from the management also added to optimism. Managing Director and Chief Executive Officer V Vaidyanathan has assured that the bank would continue to hack through the legacy troubled accounts from its parent IDFC Ltd and boost the base of its low cost savings deposits.
That brings us to the two factors that should bother investors. IDFC First Bank’s operating expenses were far higher than its peers with cost to income ratio at 73 percent. Further, the bank’s cost of funds is higher compared with other lenders despite a 50 percent share of low-cost current and savings account deposits in the total deposit base. That is because the bank pays a higher interest rate of 4 percent on its savings deposit while its larger peers pay in 2.75-3.00 percent band. To be sure, the share of CASA in total deposits fell by 92 basis points year-on-year even though overall deposits grew by 21 percent. This shows that the bank is getting more high-cost term deposits and this does not augur well for margins. “Current RoE profile is burdened by high cost structure, loss in retail liabilities and credit card business,” note analysts at ICICI Securities Ltd in a report.
High operating expenses and a weaker liabilities profile is a common thread among new age IDFC First Bank and RBL Bank. Unlike IDFC First Bank, RBL Bank’s CASA ratio is lower. The lender showed improvement in the share of CASA deposits but it still comes up short against peers and even IDFC First Bank. “The bank has seen a meaningful improvement in the CASA ratio to 36%, while it plans to invest in franchisee network and building granular deposit base, which we believe will gain more importance in a rising interest rate scenario,” wrote analysts at Emkay Global Financial Services Ltd in a July 22 note. Besides these, RBL Bank’s top management transition has kept its share price depressed so far.
Yet another area of concern for investors is the fact that the retail loan book of both lenders is heavy on unsecured loans. Credit card outstanding and unsecured personal loans more than doubled for IDFC First Bank, while RBL Bank saw the share of such loans go up to 46 percent of its retail book in June quarter.
“Right now, unsecured lending is good for margins but slippages on these loans are normally higher than other categories. These are the first to show pain when the cycle turns,” said an analyst requesting anonymity.
That explains why despite the recent rally, shares of the two banks are still significantly down year-to-date. Fortifying the liabilities side and reducing the share of riskier retail loans could be just the ticket to keep the recent investor confidence in their businesses for these banks.
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