motilal oswal upgrades rating on idfc to 'buy

The good old 'new bank' story

IDFC

Detailed Report | 22 April 2015Sector: Financials

Vallabh Kulkarni ([email protected]);+91 22 3982 5430

Alpesh Mehta ([email protected]); +91 22 3982 5415

Ocean of opportunities

IDFC

22 April 2015 2

Contents

The good old ‘new bank’ story .................................................................................... 3

Milestones .................................................................................................................... 5

Banking Opportunity: Exciting model for the decade ................................................. 6

IDFC Bank – A Unique banking model ....................................................................... 12

Highly profitable Infra business to be the key enabler ............................................. 16

Transition expected to be smooth ............................................................................. 20

Higher leverage to drive higher sustainable RoE ...................................................... 24

Appendix 1: Comments by management in the run up to launch of IDFC Bank ...... 27

Appendix 2: Infrastructure Debt Fund ....................................................................... 29

Appendix 3: Key management for IDFC Bank ........................................................... 30

Financials and valuations ........................................................................................... 31

Investors are advised to refer through disclosures made at the end of the Research Report.

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

http://www.motilaloswal.com/Institutional-Equities�

IDFC

22 April 2015 3

The good old ‘new bank’ story A unique business model at play IDFC is well poised to build a unique banking business model, with the least cost to income ratio. RoE is expected to be healthy at 11-12% in the first full year of operation and then steadily rise to ~18% in the next four years. Post conversion into a bank, its balance sheet size is likely to be similar to YES and IIB, and the loan market share is expected to be just 80bp. In our view, cost optimization (cost to income ratio of 28-30% v/s sector average of 43%) and focus on “Bharat Banking” would be the key differentiators for IDFC Bank. We believe significant opportunity exists for IDFC Bank in the expanding profit pool of private banks (click here for our theme report, “Pool of Wealth”). With the banking business valued at 2x FY17E BV and 20% holding company discount, we upgrade IDFC to Buy, with SOTP-based TP of INR232.

Highly profitable Infrastructure lending business to be key enabler In the NBFC setup, IDFC made core PBT (ex capital gains and floating provisions) of 3.0% average assets over FY08-14. Under the banking setup, we believe the same business is likely to fetch a higher PBT as cross selling will pick up (higher fees, CA float, vendor financing etc.) and cost of funds is expected to decline. Pertinently, lending to Infrastructure segment (project loans) is exempted from regulatory requirements. With an expected higher share of this business over the medium term, IDFC Bank’s RoA is likely to be higher than peer private banks with higher exposure in corporate lending. Highly profitable Infrastructure lending business will partially compensate for regulatory requirements (CRR, SLR and PSL – reduced by infrastructure bonds), help set up non-infrastructure lending piece (to diversify balance sheet mix) and expand its network. Corporate business to dominate; expect RoA of 1.6%+ by FY18E The expertise and relationships built in Infrastructure lending will be used to grow non-infrastructure book (relationships with large corporate houses, customers in the supply chain of infrastructure developers among others). CA and fees buildup is likely to be faster due to dominance of corporate business and the low hanging fruits (getting CMS business, BG and LC business of existing customers). If executed well, we believe IDFC Bank will be able to create a niche in rural banking (“Bharat Banking”) over the long period (absence of legacy issues and use of technology to be key enablers). This business will have a high yield and with the aid of technology and lower network cost, profitability is likely to be healthy. Overall SA buildup is likely to take time due to limited brand recognition in the retail segment and expected cautious approach in growing brick and mortar setup (higher focus is likely to be on technology). Transition expected to be smooth IDFC has aggressively built floating provisions of INR18b and expects the higher provisions to continue till it transforms into a bank. Company has aggressively

Detailed report | Sector: Financials

IDFC CMP: INR167 TP: INR232 (+39%) Upgrade to Buy

BSE Sensex S&P CNX 27,890 8,430

Stock Info

Bloomberg IDFC IN

Equity Shares (m) 1,592.8

52-Week Range (INR) 188/108

1, 6, 12 Rel. Per (%) 2/14/19

M.Cap. (INR b) 279.2

M.Cap. (USD b) 4.5 Avg Val(INRm)/Vol ‘000 1334/8925

Free float (%) 100.0

Please refer to our sector report

“Pool of Wealth”

Shareholding pattern (%)

As on Mar-15 Dec-14 Mar-14 Promoter 0.0 0.0 0.0

DII 30.0 31.1 29.4

FII 47.4 47.7 52.6 Others 22.6 21.2 18.0

FII Includes depository receipts

Stock Performance (1-year)

100

125

150

175

200

Apr

-14

Jul-1

4

Oct

-14

Jan-

15

Apr-

15

I D F C

Sensex - Rebased

http://institution.motilaloswal.com/emailer/Research/FINANCIALS-20140303-MOSL-SU-PG076.pdf�

http://institution.motilaloswal.com/emailer/Research/FINANCIALS-20140303-MOSL-SU-PG076.pdf�

IDFC

22 April 2015 4

built an investment portfolio of INR250b (as of 9MFY15) v/s expected requirement of SLR securities of ~INR115b on being a bank. The impact of negative carry on CRR/ SLR is visible in current earnings. Further, any capital gains on treasury and strategic investments (not factored in estimates) will be utilized to account for bank’s setting-up cost and additional provisioning for certain infrastructure loans. In the first full year of operations, we expect IDFC Bank to clock an RoE of 11-12% and progressively increase it to ~18%. Our estimates on non-interest income and operating expenses remain conservative. Higher leverage to drive higher and sustainable RoE Under the past monoline setup, with a high ticket size and long gestation loan mix, rating agencies were uncomfortable beyond a leverage of 6-8x. Also, at the regulatory level (with Tier I of 12%), peak leverage would have been ~8x (assuming 100% risk weights and entire Tier I as CET I). Most private banks operate at 10-12x leverage, which in our view would be followed by IDFC Bank. On a sustainable basis, we believe that the RoE band (ex trading gains) is likely to rise by ~500bp (led by increased asset light revenue streams and leverage). Upgrade to Buy with SOTP-based target price of INR232 Value of the bank being set up is significantly higher (with higher retail deposits and loans), compared to the volatile and monoline Infrastructure lending setup of the past. Investors are likely to focus more on the expected improvement in business and higher and sustainable RoE, healthy Tier I ratio of 24%, strong management team and corporate governance. Foreign ownership level of ~26% post listing (significantly higher room than most private banks) will give IDFC Bank a shot in the arm. We estimate the banking business’ net worth to be INR162b by FY17E and assign a multiple of 2x (private banks’ average multiple). Upgrade to Buy with an SOTP-based target price of INR232. Challenges in transition to a bank Regulatory compliance (CRR, SLR and PSL) likely to be a drag on RoA (v/s

NBFC model), though the infrastructure bonds will provide relief. Building the granular Retail and SME business; in the near term, IDFC may

buy portfolios to build this business. Identifying talent to set up the banking entity. Scouting for locations to set up branches and technology related challenges.

Exhibit 1: IDFC Valuation - SOTP - FY17E based INR b USD b INR/sh Valuation Rationale IDFC Bank 288.7 5.4 182 2x NW for listed entity, 20% holdco disc IDF 17.4 0.3 11 1x Net worth Alternative Assets Management 12.8 0.2 8 8% of FY17E AUM NSE stake 10.7 0.2 7 5.8% stake, base price of last deal IB and Broking 7.6 0.1 5 1x FY17E NW Mutual Fund Business 16.4 0.3 10 3.4% of FY17E AUM Cash on balance sheet (Parent) 14.8 0.3 9 1x Cash Total Value 368.4 6.9 232 CMP (INR) 167 Upside (%) 39

Source: MOSL

IDFC

22 April 2015 5

Milestones

1997

IDFC formed with Mr. Deepak Parekh as founding Chairman

2000

Registered with Sebi as a merchant banker

2002

Sets up IDFC Private Equity as an investment manager for Private Equity funds

2003

Successfully raised USD200m for India Development Fund, first infrastructure focused private equity fund in India 2005

Raises INR13.7b through IPO (subscribed 10x) 2006

IDFC enters the capital markets business by acquiring 33% stake in SSKI

2008

Enters asset management by acquiring the AMC business of Standard Chartered Bank in India

2009

Company's loan book crosses INR200b, with more than 200 infrastructure projects being funded

2010

Classified as an Infrastructure Finance Company (IFC); raises INR4.8b in the first tranche of Infrastructure Bonds issue; Raises capital of INR26.5b through QIP

2013

Mr. Rajiv Lall appointed as Chairman; Mr. Parekh to be on the advisory board of IDFC

2014

RBI grants Universal Banking License to IDFC; Mr. Rajiv Lall to be MD & CEO of IDFC Bank

2015

Launch of IDFC Bank slated in October 2015

IDFC

22 April 2015 6

Banking Opportunity: Exciting model for the decade USD14t+ of savings pool over the next decade; underpenetrated economy Indian banking has been riding a strong growth curve, with business CAGR of 18%+

over the last two decades. However, in our view, there is a lot of impetus left, as an underpenetrated Indian economy and increase in savings will drive the next leg of growth.

Over the last two decades, Indian Banks have witnessed loan CAGR of 19% and loan-to-GDP has improved to ~54%. Based on nominal GDP growth assumption of 12% and multiplier of 1.4x, Indian Banks are poised to deliver a loan CAGR of 17% over the next 10 years and loan-to-GDP should increase to 82% by 2025.

India’s financial landscape presents a huge opportunity for innovators and nimble-footed players, as demonstrated in the last two decades. We believe NPBs (including new licensees) will be well poised to further marginalize state-owned banks and achieve loan CAGR of 20%+ over the next decade.

Indian landscape provides huge scope for asset generation The last few years have been one of the toughest periods for the Indian economy. GDP growth has slowed down to ~5%. Even amid such challenging times, the loan portfolio has expanded at a CAGR of ~15%. We believe this is a temporary phase and long-term prospects for the Indian economy and Financials are intact. Changing demographics in favor of younger population in India, rising disposable incomes and changing mindset of people in favor of consumption would be key drivers of growth, going forward. Focusing on the long-term opportunity and accordingly framing strategies to create differentiation/niches would be the key success factors for new players. Expect loan portfolio to increase 5x by 2025 India’s nominal GDP has posted a CAGR of ~14% over the last two decades, and bank loans have expanded at a CAGR of 19%. This has translated into average loan-to-GDP multiplier of 1.4x and loan-to-GDP of 54%, compared with ~19% in FY93. We build 1.4x as the long-term average in our base case assumptions, as the noise of excesses/lows will get harmonized, and the push to make India a manufacturing economy will increase the need for credit. Exhibit 2: Nominal GDP to expand 3.5x in 10 years

Source: MOSL, RBI

6 7 8 9 10 12 14 16 18 20 22 23 25 28 3237

4350

56 6578

90100

113127

142

159178

200224

250

280

314

352

394

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

FY17

E

FY19

E

FY21

E

FY23

E

FY25

E

Nominal GDP (INR t)

CAGR 10.0%

CAGR 14.8%

CAGR 14.4%

CAGR 12.0%

CAGR 15.8%

CAGR 14.0%

Despite the moderation in real GDP growth to an

average of 5%, loans grew 15% CAGR in the recent

years

Indian Financials’ growth to be driven by favorable

demographics, increasing middle class population,

under-penetrated retail and SME and infrastructure

development

Assumption of nominal GDP growth of 12% as compared

to ~14% over FY91-14

IDFC

22 April 2015 7

With long-term nominal GDP growth of 12% (real GDP growth of 7% and inflation of 5%) and average multiplier of 1.4x, the bank’s loan portfolio is likely to expand to INR323t by 2025, 5x FY15E loans and CAGR of 17% over FY15-25E. Loan-to-GDP of 82% will, however, remain lower than in some peer nations currently, indicating the tremendous opportunity that India provides. This further reinforces our view that strong asset creation would continue and India is nowhere near the saturation point.

Exhibit 3: Factored average multiplier of 1.4x (in line with long period average) – loan-to-GDP to rise gradually to 82%

Source: MOSL, RBI

Exhibit 4: Even in 2025, loan-to-GDP ratio in India would be lower than few peer nations (Loan-to-GDP, 2013 %)

Source: MOSL, World Bank

Exhibit 5: Loan portfolio could expand by ~5x over the next 10 years

Source: MOSL, RBI

Exhibit 6: Indian Banking will be world’s third largest by 2025 (total banking assets in USD b)

Source: Bancon Report

20 20 20 20 20 24 29 34 41 47 49 51 52 54 59 64 69 72 79 82

0.9

0.5

1.4

0.5

1.7

1.2

0.6

1.5

0.9 1.

6 2.2

1.8

3.0

1.3

2.2 2.

71.

71.

41.

41.

11.

11.

11.

21.

11.

2 1.4

1.4

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

FY17

E

FY19

E

FY21

E

FY23

E

FY25

E

Loan to GDP Loan to GDP multiplier 198

184

177

176

148

148

134

54

35

33

Hong Kong

US

Japan

Ukraine

Thailand

Korea

China

India

Indonesia

Phillipines

1.2

1.3

1.5

1.6

2.1

2.5

2.8

3.2

3.7

4.4

5.1

5.9

7.3

8.4

11.0

15.1

19.3

23.6

27.8

32.4

39.4

46.1

52.6

59.9

68.3

79.8

93.2

108.

812

7.1

148.

517

3.4

202.

623

6.6

276.

432

2.8

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

FY11

FY13

FY15

FY17

E

FY19

E

FY21

E

FY23

E

FY25

E

Loan (INR t)

CAGR 16.8%

CAGR 20.3%

CAGR 24.1%

CAGR 15.2%CAGR

15.8%

CAGR 15.6%

Loan portfolio could expand to INR323t from INR68t in FY15, more than 5x rise in

next 10 years

IDFC

22 April 2015 8

Where is the money? USD14t GDS by FY25 Bank deposits have seen a healthy CAGR of 18% over FY98-13, driven by a host of factors – acceleration in nominal GDP growth, rising savings rate, increasing proportion of bank deposits in total financial savings, and inflow of non-retail deposits. With an improvement in economic growth, we factor the savings ratio to rise steadily to 36%, translating into a cumulative decadal savings of over USD14t over FY15-25E, compared to USD3.6t during FY04-14. Further, if we assume the share of household financial savings to go up gradually to 45% in household savings by 2025 and the share of bank deposits to remain constant at ~75%, then the overall retail deposit CAGR over the next 10 years could exceed 15%.

Exhibit 7: USD14t of cumulative savings by FY25

20

25

30

35

40

0

40

80

120

160

FY90

FY92

FY94

FY96

FY98

FY00

FY02

FY04

FY06

FY08

FY10

FY12

FY14

FY16

FY18

FY20

FY22

FY24

Savings (INR t; LHS) Savings to GDPLinear (Savings to GDP)

Source: RBI, MOSL

Exhibit 8: Savings to increase 4x by FY25 (USD t)

Source: RBI, MOSL

Opportunity – Where would the growth come from? Retail Banking in India has had a strong run over the last decade, with 15% loan CAGR and 7%+ CAGR in number of accounts. The driving force has been private sector banks, which witnessed a CAGR of 23%+ in loans as well as number of accounts. We believe Retail Banking in India is still at the cusp of a new era. Consumer loan to GDP is still very low (in comparison with peer nations) at near 15%. Enabling factors are: (a) change in demographics, (b) access to credit, (c) rising income levels, (d) nuclear family concept gaining prominence, (e) dual income etc. Housing finance will be the key contributor to growth in consumer loans. Other contributors will be auto loans, shift from cash transactions to cashless transactions and increasing credit card penetration.

Exhibit 9: Indian middle class households to increase 3x+ over FY11-25

Source: NACER

Exhibit 10: Mortgage to GDP lower compared to peers (%)

Source: HDFC

0.7

3.6

13.7

FY92

-03

FY04

-14

FY15

-25

31 53114160

267

547

13 20 37

2011 2015-16 2025-26

Indian middle class household (m)Individual (m)Percentage of total population

8 15 2032 36 40 44 45

54

76 84101

Indi

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Chin

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Thai

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Mal

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Sout

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rea

Taiw

an

Hon

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Ger

man

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Sing

apor

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USA U

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Den

mar

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Mortgage to GDP

Nominal GDP CAGR of 12% and gradual increase in

savings to 36% of GDP could bring USD14t plus of savings

Despite an increasing retail loan share from 8% to 18%

in the last decade, retail credit to GDP remains at

near ~15% levels, one of the lowest in the world

IDFC

22 April 2015 9

India’s SME segment, which comprises 29.8m enterprises, employs 69m people and generates 45% of its industrial output, faces acute shortage of funding. An IFC study reveals immediate addressable need of INR9.9t even if unviable projects, sick units and companies without track record are excluded. This implies 19% of the existing bank loan portfolio.

Exhibit 11: Incremental share of MSME loans on a rise (%)…

Source: RBI, Ministry of MSME

Exhibit 12: …yet, informal sources are a major funding source (INR t)

Source: IFC, SIDBI

Infrastructure Segment: India is an infrastructure-starved nation. While a lot of development has taken place, it is not comparable with peers. In the 12th Five Year Plan, the required investment in infrastructure is of USD1t. The way infrastructure story has unfolded in India makes this segment vulnerable and financiers would be shying away. However, it is important to note that the kick-start of policy reforms and compelling need for the Indian economy will bolster growth in the near future. Exhibit 13: Infrastructure investment under 12th five-year plan (INR t)

Source: Planning commission, MOSL

Rural Banking: Giving unorganized/underserved areas of the country access to financial services by leveraging technology and innovation is called financial inclusion. It is vital in the Indian context, as only 35% of the adult population has a bank account and only 68m of the 200m households have access to banking services. RBI has taken various initiatives aimed at financial inclusion: (1) opening of no-frills accounts, (2) relaxation of KYC norms, (3) simplified branch authorization norms and (4) engaging business correspondence. There has been some success, with bank branches in villages expanding to 40,800+, compared with 33,378 in FY10, and SA deposit mobilization increasing from INR44.3b to INR175b+ in three years.

6.7 6.6

9.0

9.2

11.2

12.311.4

13.014.3

21.3 25.7

67.7

19.9

42.1

33.58.6 29.8

25.0

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Share in overall Loans MSME Loan Growth

32.5

24.4

71.1

Supply Formal Sources Self-Equity Informal Sources

3.0 3.6 4.0 4.6 5.3 6.2 7.1 8.1 9.210.4

6.47.2 7.5

7.9 8.49.0 9.5 9.9 10.3

10.7

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Infra Investment Spend as a % of GDP

Of the overall SME funding requirement, only 22% is

met through formal sources

Structural opportunity remains high; however, strong policy measures

required to boost investments and funding

XIIth five-year plan estimates infra funding requirement of USD1t

Only 35% of India’s adults have formal banking

accounts; in rural areas, of the 138m households, only

41.6m have accessed banking services

IDFC

22 April 2015 10

While the scope to increase penetration is huge, developing an innovative and low cost business model is the key. Exhibit 14: Formal savings in India lower than rest of developing world and other BRIC economies (%)

Source: World Bank, MOSL

How Private Banks are capitalizing on this opportunity? Sensing the opportunity in semi-urban/rural areas, and led by RBI’s push, banks are venturing into the hinterland. Of the 49,096 branches added since FY09, 44%+ are in rural areas and 30%+ are in semi-urban areas. The breakeven period for semi-urban branches is typically 18-24 months+; however, as the Indian economy grows, these would be a strong source of business. Private Banks have been at the forefront of this expansion.

Exhibit 15: Private Banks accounted for ~30% of incremental branch additions since 2000

Source: MOSL, Company

Exhibit 16: Aggressive expansion of private banks into India’s hinterland (PBs Incremental branch mix %)

Source: Company, MOSL

12 918

2812

9

15720

24

9 7

India Other South Asia Rest of Developing World

Other BRIC Economies

Saved Formally Saved Using Other Methods Only Others

30 30 34 32 38 36 25 30 34 22 31 26 30 29 19 35

28

5 6 6 6 7 7 8

910 11

12 1314

15 15 16

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

PBs - Share in incr. branches Incr. MS over 2000-15 Private Banks MS

78 79 76 81 84 85 6753

62 57 53

39 3421

394822 21 24 19 16 15

3347

38 43 47

61 6679

6152

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Metro + Urban SemiUrban + Rural

The recent spurt in number

of branches in semi-urban and rural areas visible as other segments become

highly competitive

Private Banks gaining SA market share (%) 2003 2009 2011 2012 2013

SBIN 27 27 28 28 28

Nation-alized Bk

55 49 48 47 46

Pvt Banks 8 15 16 17 18

Others 9 10 9 9 8

IDFC

22 April 2015 11

Strong branch expansion has started yielding results. This is reflected in the number of savings accounts added in rural areas in the last three years – up from 60.2m to 100.8m. This, along with better underwriting practices, has resulted in an increase in Net profit market share for Private Banks (42% in FY14 from 17% in FY05). There remains huge scope for Financials to penetrate into the hinterland and bring around a shift from informal sources to the formal segment. Exhibit 17: Strong gains in PAT market share for Private Banks


9 12 15 15 14 8 11 12 13 13

47 43 44 41 43 47 47 42 36 29

17 20 21 22 21 23 25 28 32 42

27 24 21 21 23 22 17 19 20 17

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Foreign Banks Nationalised Banks Private Sector Banks SBI

IDFC

22 April 2015 12

IDFC Bank – A Unique banking model Corporate lending to dominate | Expect RoA of 1.6%+ by FY18E

Broad structure is in place – apart from the established Infrastructure lending, Non-Infrastructure corporate banking, “Bharat Banking” are likely to be the vital verticals for IDFC Bank.

Due to absence of legacy issues, if executed well, IDFC Bank will be able to create a niche in rural banking (“Bharat Banking”). This business will have a high yield and with the help of technology/lower network cost, profitability is expected to be healthy.

Expertise and relationship built in infrastructure lending will be used to grow non-infrastructure loans (relationships with large corporate houses, customers in the supply chain of infrastructure developers etc).

CA and fees buildup is likely to be faster due to dominance of corporate business and the low hanging fruits (getting CMS business, BG, LC business of existing customers).

Overall SA buildup is likely to take time due to limited brand recognition in retail segment and expected cautious approach in growing the brick and mortar setup (higher focus is likely to be on technology).

Broad structure in place; Infra and corporate business to dominate IDFC has four key lines of business – Infrastructure Financing, Investment Banking and Equities Broking, Alternative Asset Management, Asset Management and advisory and the Foundation. Large part of the Infrastructure Financing business will move to the bank. All the financial services companies will become the subsidiary of Non Operating Financial Holding Company (NOFHC), which in-turn will be a 100% subsidiary of IDFC Ltd (parent company). Thus, post setting up of NOFHC, IDFC Ltd (parent) will have only two subsidiaries: a) NOFHC (which in-turn will have all financial services) and b) IDFC Foundation.

Exhibit 18: IDFC’s proposed demerger structure


Existing shareholders

IDFC

Non-Operating Financial Holding Company

Bank AMC Securities AIF

Exisiting shareholders to get one share of IDFC and

IDFC Bank (47% stake)

Infra lending business to be transferred to the

bank

Weexpect ~INR140b NW to be transferred to

the bank

Foundation

IDF (49% holding)

IDFC

22 April 2015 13

Broadly, IDFC Bank’s lending business would be divided into five broad verticals – Infrastructure Lending (business transferred from IDFC), Non-infrastructure Corporate Lending, Commercial Banking (SME and Retail) and Rural Lending Business (Bharat Banking). Exhibit 19: IDFC Bank business verticals – Corporate and Infrastructure lending to dominate


Corporate banking business (Infrastructure + Non-Infrastructure) would dominate the balance sheet in the initial years. We expect IDFC Ltd to have a loan book of INR575b (as of 1HFY16), and of which INR525b to be transferred to the bank. Once the bank is formed, we factor a moderate growth of ~18% in the Infrastructure lending book. Share of this business is likely to remain dominant in the overall business and we expect 2/3rd of the loans and ~55% of customer assets to come from Infrastructure segment by FY21E.

Exhibit 20: Steady diversification of loan portfolio


Exhibit 21: Infrastructure loan book mix to remain largely same


Unlike other private sector banks, IDFC Bank will start with a loan market share of 80bp. Post conversion into a bank, it will be the seventh-largest private sector bank in the country in terms of loan size. Strong profitability from Infrastructure lending business will help IDFC Bank to build its non-infrastructure and branch banking business.

IDFC Bank

Infrastructure Lending

Non-Infra Corporate Lending

Commercial Banking

(Retail & SME )

Bharat Banking

(Rural)

529 627 742 879 1,041

88

82

7976

74

FY17 FY18 FY19 FY20 FY21

Infrastructure loans (INR b) % of loans

414 489 576 680 803

69 69 68 67 66


Project Infra loans (INR b) % of Infra loans

IDFC Bank’s lending business would be divided

into four broad verticals

Bharat Banking business to be the key PSL enabler,

going forward

Infrastructure loans expected to be 2/3rd of the

loans and ~55% of customer assets by FY21E

Post conversion, IDFC Bank will be the seventh-largest private sector bank in the

country by loan size

IDFC

22 April 2015 14

Exhibit 22: When did other players reach this balance sheet size


Exhibit 23: Post conversion, IDFC Bank will be the seventh-largest private sector player in the country (loans, INR b)


Expertise and relationship built in Infrastructure lending will be used to grow non-infrastructure loans (relationship with large corporate houses, customers in the supply chain of infrastructure developers among others). We expect an aggressive ramp-up (on a low base) in the non-infrastructure and commercial banking book, and it is expected to reach INR127b by FY20E. Share of this segment will increase to ~20% by FY21E from 15% at the starting of banking operations. CA and fees buildup is likely to be faster due to dominance of corporate business and the low hanging fruits (getting CMS business, BG and LC business of existing customers).

Exhibit 24: Our assumptions on fee income remain conservative (fee income % of assets, FY17E)


Exhibit 25: CA buildup likely to be faster


76 95 144

170

357

364

444

406

480

638

646

666 2,

606

3,47

1

3,75

3

DH

LBK

DCB

B

LVB

CUBK

KVB

SIB

JKBK

VYSB FB IIB

KMB

YES

AXSB

HD

FCB

ICIC

IBC

IDFC will start here

0.60.8

1.1 1.21.3

1.51.6

2.3

FB IDFCB VYSB HDFCB ICICIBC AXSB YES IIB

20 32 46 6281

106

2.53.0

3.54.0

4.55.0

FY16 FY17 FY18 FY19 FY20 FY21

CA deposits (INRb)

CA deposits (% of Interest bearing liabilities)

CA and fees buildup is likely to be faster due to

dominance of corporate/Infrastructure

business

IDFC

22 April 2015 15

For a transition from wholesale entity to diversified liability mix, IDFC Bank would need to significantly increase its focus towards branch banking. Presently, IDFC is largely a corporate lender with minimum branch presence. To comply with 40% priority sector requirements, IDFC Bank can look towards portfolio buyouts or securitization in the initial stages. However, in the long run, it would need to build capabilities to source PSL eligible loans organically. IDFC Bank is expected take a different approach towards branch/rural banking with the use of technology.

Exhibit 26: Steep PSL requirements as IDFC converts into a bank (INR b)


Exhibit 27: We build a gradual increase in in-housing sourcing of PSL loans as Bharat Banking expands (% share of PSL requirements)


* Normally RIDF devolvement in case of non compliance of PSL targets takes place after a lag of 1-2 years. However, our estimates factor in from day one

Due to the absence of legacy issues, IDFC Bank will be able to create a niche in rural banking (“Bharat Banking”) over a long period if executed well. This business will have a high yield and with the help of technology and lower network cost, we believe profitability is likely to be healthy, if the risks are managed well. We expect IDFC bank to directly compete with NBFCs on the asset side for Bharat Banking. In our view, the success of branch and “Bharat Banking” business would be critical for the bank as a whole as it can enable organic creation of PSL, garner higher SA balances and quickly build the bank’s brand image.

233297

336373

418

82 89 84 75 63


PSL requirement RIDF devolvement

35 30 25 20 15

4540

3530

25

20 30 40 50 60


RIDF devolvement PTC/Securitisation In-house sourcing

Bharat Banking can be a key differentiator

“Bharat Banking” business will have a high yield and

with the help of technology and absence of legacy

issues, can have a lean cost model

IDFC

22 April 2015 16

Highly profitable Infra business to be the key enabler Infrastructure bonds to partially compensate for regulatory requirements In the NBFC setup, IDFC made core PBT (ex capital gains and floating provisions) of

3.0% of average assets over FY08-14. Under the banking setup, the same business is likely to fetch higher PBT as cross-

selling will pick up (higher fees, CA float, vendor financing among others) and cost of funds is likely to decline. Pertinently, lending to Infrastructure segment (project loans) is exempted from regulatory requirements.

With an expected higher share of this business, IDFC Bank’s RoA is likely to be higher than peer private banks having higher corporate exposures.

Highly profitable infrastructure lending business will partially compensate for regulatory requirements (CRR, SLR and PSL – partially reduced by Infrastructure bonds) and help set up the non-infrastructure lending piece (to diversify balance sheet mix) and expand its network.

Infra financing – a high RoA business; risk management remains a key Long gestation period and higher execution risk will lead to higher yields on infrastructure project loans. While the risk is high, we believe if managed well can provide strong risk adjusted returns for financiers. Higher ticket size, longevity, special skills set required for project evaluations (strong fee income opportunity) and lean cost structure make it a high RoA business. At the system level, while stress loans in infrastructure segment have increased to ~15%, IDFC, with its strong domain knowledge, managed to keep it low at 6.8%. Despite going through one of the worst period in infrastructure financing, IDFC managed to post core PBT of 3.0% of average assets in this business. Highly profitable infra lending piece to help build non-infra business Unlike other new generation private banks which had to build the balance sheet along with network expansion, IDFC has a strong existing profitable loan book, which can be used to build liability franchise and other non-infrastructure businesses. In our view, in the initial years, the bank’s focus is likely to be more on technology and less on brick and mortar expansion. Based on our calculation, the cost to income (C/I) ratio is likely to be 25-30% by FY16E-21E, aided by opex-light Infrastructure lending business (C/I ratio of <10%) and lower leverage on balance sheet. YES’ network expansion in its initial years (117 branches opened in first five years) was constrained by higher C/I ratio (average cost to income ratio of 67%). However, supported by a steady income from the Infrastructure business, network/infrastructure investment for IDFC Bank is expected to be higher/aggressive, without exerting undue pressure on opex ratios. We estimate IDFC Bank to open 525 branches by FY21E, resulting in buildup of SA deposits and comparatively better PSL capabilities in the first five years of operations (YES’ SA ratio stood at 1.2% in 2009). Overall SA buildup is likely to take time due to limited brand recognition in retail segment and expected cautious approach in growing the brick and mortar setup (higher focus is likely to be on technology). The bank is expected to start operations with 20-25 branches.

Higher ticket size, long duration book, strong fee

income opportunity (special skills set required for

project evaluations) and lean cost structure – key

drivers to growth and profitability

Aided by a steady income from the Infrastructure business, Infrastructure

investment for IDFC Bank is expected to be higher

/aggressive

IDFC

22 April 2015 17

Exhibit 28: Supported by Infrastructure business, we expect IDFC Bank to expand branches at a rapid pace (nos.)

* Year 1 ends in March 2017 Source: MOSL, Company

Exhibit 29: IDFC Bank would focus on top 20 centers in first five years (data for top 20 banking centers; INR b) Center Branches % share Deposits % share Credit % share

Greater Mumbai++ 2,338 1.9 14,523 17.6 14,636 23.2

Delhi++ 3,018 2.4 8,523 10.3 8,160 12.9

Bangalore++ 1,843 1.5 3,883 4.7 2,523 4.0

Chennai++ 1,647 1.3 2,524 3.1 3,203 5.1

Kolkata++ 1,425 1.2 2,301 2.8 2,291 3.6

Hyderabad++ 1,533 1.2 2,293 2.8 2,500 4.0

Pune 692 0.6 1,265 1.5 962 1.5

Ahmedabad++ 897 0.7 1,155 1.4 1,336 2.1

Lucknow 640 0.5 794 1.0 520 0.8

Bhopal 385 0.3 736 0.9 265 0.4

Patna 421 0.3 597 0.7 169 0.3

Gurgaon 365 0.3 583 0.7 313 0.5

Jaipur 583 0.5 575 0.7 760 1.2

Vadodara 371 0.3 528 0.6 450 0.7

Noida 290 0.2 526 0.6 228 0.4

Bhubaneswar 351 0.3 511 0.6 299 0.5

Chandigarh 355 0.3 504 0.6 584 0.9

Kanpur 460 0.4 495 0.6 145 0.2

Nagpur 362 0.3 417 0.5 319 0.5

Navi Mumbai 262 0.2 415 0.5 111 0.2

Total 123,184 100 82,736 100 63,179 100

++ Based on job openings posted on the website, we expect IDFC Bank to initially focus on these locations Source: MOSL, Company

Infrastructure bonds likely to boost profitability To boost the credit flow to Infrastructure segment, the Reserve Bank of India (RBI) exempted lending to the long term Infrastructure segment (project loans) from regulatory requirements (link to guidelines). At the time of conversion into a bank, IDFC’s >80% loan book is likely to be Infrastructure loans, and of which long duration Infrastructure loans are likely to be a majority (~75%). Based on the staggered factor (as prescribed by RBI in the guideline), IDFC would raise INR100-120b+ of infrastructure bonds every year. These bonds will not be a part of NDTL calculation for CRR and SLR. Even qualified loans will be exempted from PSL requirement. Thus, in our view, profitability of this business is likely to be higher under the banking setup v/s NBFC setup (lower cost of funds and more fee generating opportunities).

75

150

225

325

425

525

17 40 67117

150214

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

IDFC Branches YES Branches

2/3rd of the loans are likely to be Infrastructure ones by FY21E, and of which project

loans are expected to be 2/3rd . Thus, 45% of the loan

book is expected to be qualified for Infrastructure

bonds by FY21E

http://rbi.org.in/scripts/NotificationUser.aspx?Id=9103&Mode=0�

IDFC

22 April 2015 18

Exhibit 30: Expect incremental Infrastructure bonds issuance of INR100b every year 1HFY16 FY16 FY17 FY18 FY19 FY20 FY21

Project Infra loans 367.5 385.0 431.2 495.9 570.3 655.8 754.2

Eligibility factor (%) 70 70 56 42 28 14 0

Eligible project Infra loans 110.3 127.8 225.4 341.5 467.4 604.4 754.2

Infrastructure bonds raised 100.0 120.0 202.9 307.4 420.6 543.9 678.8

% of Infra loans 27.2 31.2 47.0 62.0 73.8 82.9 90.0

Incremental bond issuances 100.0 120.0 82.9 104.5 113.2 123.3 134.8


Exhibit 31: We expect 150bp+ NIM benefit in Infrastructure book...

Bonds Deposits

Amount raised 100 100 Deployment in SLR 0 22 Deployment in CRR 0 4 Deployment in PSL (40% of 76%) 0 30 Deployment in Infra loans 100 44 Pro-forma P&L

Interest cost 8.8 8.0 SLR Interest income 0.0 1.7 CRR Interest income 0.0 0.0 PSL Interest income 0.0 2.4 Infra interest income 11.5 5.1

Total Interest income 11.5 9.2 Total Interest cost 8.8 8.0 Spreads (%) 2.8 1.2


Exhibit 32: …Resulting in incremental RoE benefit of 40bp+

Benefit

A Margin benefit of issuing these bonds 150bp B Proportion of Infrastructure and Affordable housing in overall loan book ~55%

C Margin benefit on overall book (A*B) 83bp D Loans as % of assets ~60%

E Pre-tax RoA benefit (C*D) 50bp

Tax rate 33%

F RoA benefit by 2020 ~33bp

Incremental RoA benefit per year ~6bp

Leverage ~7x

RoE benefit after full refinancing 230bp

Incremental RoE benefit per year 42bp


RBI in its recent policy has allowed banks to

participate in Infrastructure bonds - key hurdle resolved

Infrastructure bonds to substitute term deposits.

Thus, comparison on term deposits cost is a right indicator, in our view

IDFC

22 April 2015 19

Exhibit 33: Cost efficiency to be the key differentiator for IDFC Bank (opex % of assets)

* Year 1 ends in March 2017 Source: MOSL, Company

Exhibit 34: Operating expenditure (%) - technology related expenses to remain high in the initial years


Exhibit 35: Our employee cost assumptions remain conservative (INR m)


Exhibit 36: Technology costs would dominate overall expense in the initial years of operations (INRm)


Exhibit 37: We estimate IDFC Bank’s opex at INR12b in FY17E led by aggressive direct accounting of costs (details of peers when their opex was ~INR12b) Year Branches (nos.) Employees (nos.)

YES FY13 430 7,024

KMB (SA) FY10 249 8,804

VYSB FY13 546 9,758

IIB FY12 400 9,730

FB FY14 1,174 10,268

IDFCB FY17 150 3,750


1.1 1.1 1.1 1.2 1.2 1.2

2.2

3.53.9

3.3 3.3 3.12.6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

IDFCB Private Banks average YES, KMB (in initial years)

45 41 45 48 49 49

26 25 23 21 20 19

29 34 32 31 31 32

2HFY16 FY17 FY18 FY19 FY20 FY21

Employee Technology Other expenses

1.0 1.0 1.0 1.0 1.0

0.7


Cost per employee Private Banks average (FY14)

107

8169

61 57

30


Opex per branch Private Banks average (FY14)

Despite technology and branch expansion cost,

highly cost efficient Infrastructure business to

keep opex low

IDFC

22 April 2015 20

Transition expected to be smooth Pristine asset quality to continue | One-off gains - icing on the cake IDFC has aggressively built floating provisions of INR18b to cover the current stressed

assets book. We expect healthy profitability to leave enough room for the bank to continue making additional provisions in the future.

We expect asset quality to remain healthy as Infrastructure lending (benefit of 5/25 and extension of DCCO guidelines) and working capital loans are unlikely to high slippages in the near term. Conservatively, we factor higher stress in PSL and mid-corporate portfolio.

Company has aggressively built an investment portfolio of INR250b (largely G –Sec, in our view, as of 9MFY15) v/s expected SLR requirement of INR115b, when it converts into a bank. The impact of negative carry on CRR and SLR is already visible in the current earnings.

Further, any capital gains on treasury portfolio and strategic investments (not factored in our estimates) will be utilized to account directly the bank’s setting-up cost and additional provision on certain infrastructure loans.

In the first full year of operation, we expect IDFC Bank to clock RoE of 11-12% and progressively increase to ~18%. Our estimates are very conservative on non-interest income and operating expenses.

Stress loans adequately provided; unlikely to be a drag in banking setup Over the last few quarters, IDFC has aggressively built provisioning levels to take care of any large stress additions that may arise, post conversion to a bank, from the existing loan book. Total stress loans (GNPAs + RL) of the bank stands at 6.8% and IDFC carries the provisioning of 4% of loans. We expect it to build additional provisions till the conversion into a bank. Thus, risk adjusted RoA, post conversion into a bank, is likely to be high. Exhibit 38: We expect IDFC to build additional provisions till it converts into a banking setup


0.6 0.6 0.6 0.7

4.55.3

6.1 6.1

2.33.0

3.5 3.8

4QFY14 1QFY15 2QFY15 3QFY15

(% of loans) GNPA Restructured loans Outstanding provisions

Risk adjusted RoA, post conversion into a bank, is

likely to be high

IDFC

22 April 2015 21

Exhibit 39: IDFC Limited – Energy Sector Cumulative OS Approvals


Recently, RBI extended the flexible loan structuring guidelines for NBFCs. We expect IDFC to benefit with the incremental stress additions in Infrastructure portfolio being covered under these guidelines. Given the nature of working capital loans product, the stress in this segment is likely to be limited. By March 2017 (first reporting quarter for PSL loans), IDFC would require ~INR233b of Priority Sector Loans to meet PSL requirements. We expect much of it would be in the form of portfolio buyouts/securitization (thus minimal credit risk) and remaining as balance sheet loans (factor >1% slippage ratio). Overall, we expect the asset quality to remain healthy mainly led by lower risk profile of loan book and higher share of corporate and working capital loans.

Exhibit 40: Asset quality expected to remain strong


Exhibit 41: Dominance of corporate and working capital loans to drive healthy asset quality


IDFC’s stressed asset book stood at ~INR35b as of 3QFY15 (mainly gas related exposures). Over the last three to four quarters, IDFC has aggressively built floating provisions of INR18b to cover any eventualities. Thus, we expect provisioning to remain aggressive till the time IDFC converts into a bank.

1.221.15

0.92

0.75 0.760.83

0.93

0.37 0.350.28 0.23 0.23 0.25 0.28

1HFY16 FY16 FY17 FY18 FY19 FY20 FY21

GNPA (%) NNPA (%)

0.000.05

0.12

0.30

0.42

0.50

0.04 0.070.17

0.22 0.24

FY16 FY17 FY18 FY19 FY20 FY21

Slippages (%)

Credit cost (%)

RBI’s relaxation in terms of extension of DCCO, 5/25

structure will help IDFC in terms of asset quality

Asset quality to remain healthy mainly led by lower risk profile of loan book and

higher share of corporate and working capital loans

IDFC

22 April 2015 22

Exhibit 42: Aggressive provisioning since 2014 to cover for current stressed assets book


Strong treasury portfolio to provide relief on earnings IDFC has aggressively built an investment portfolio of INR250b (largely G-Sec in our view, as of 9MFY15) v/s the regulatory SLR requirement of ~INR115b, when it converts into a bank (based on our estimates). The impact of negative carry on CRR and SLR is already visible in the current earnings. We factor a higher G-Sec portfolio (INR160b), considering the LCR requirements as well. In our view, the company is sitting on higher MTM gains, and with a further fall in interest rates, treasury gains are likely to increase, which will help in providing for NPAs or direct technology cost. IDFC also has some strategic investments which will provide healthy trading gains. Exhibit 43: IDFC may choose to book gains on certain strategic investments

Investment Shares

(m) Book value

(INR m) Mkt value

estimate (INR m) NSE India Limited 2.4 601 16,375

STCI Finance Limited 3.5 540 582

ARCIL 27.2 1,138 2,344


Exhibit 44: Capital gains on treasury portfolio – another lever to aid earnings during transition (INR m)

G-sec portfolio as on 3QFY15 250,000

AFS portfolio (assumed) 30.0%

Total AFS portfolio 75,000

Indicative yield of the portfolio (%) 8.25

Current Gsec yield (%) 7.8

Duration (Avg. of Banking sector duration as on 3QFY15) 3.2

Total unrealized gains (current) 1,080

Total unrealized gains (further 50bp decline in Gsec) 2,280


63 164

73 400

199

148

341,

151

242

424

702

445

515

487 94

539

963

197

883

81,

026

305

518 1,

647

592

501

365

4,82

52,

039

2,81

21,

532

1Q20

08

3Q20

08

1Q20

09

3Q20

09

1Q20

10

3Q20

10

1Q20

11

3Q20

11

1Q20

12

3Q20

12

1Q20

13

3Q20

13

1Q20

14

3Q20

14

1Q20

15

3Q20

15

Total provisions (INR m)Provisions for stress in existing loan book to be

provided before conversion into a bank

Treasury gains are likely to help in providing for NPAs

or direct technology cost

IDFC

22 April 2015 23

Infrastructure financing profitability higher under banking setup Post conversion into a bank (removing regulatory cost), Infrastructure financing business’ profitability is likely to improve with a) CA floats (currently it is not allowed to accept deposits) and b) higher fee-based income (BG, LCs, CMS business among others). Importantly, lending to Infrastructure segment (project loans) is exempted from regulatory requirements, which can significantly improve its profitability in the banking setup as well. Further, under the banking setup, leverage allowed on this business is likely to increase as rating agencies will have higher confidence on the liability side. Thus, with improved RoA and higher leverage, RoE is likely to be much higher in the banking setup. Exhibit 45: 70% of IDFC’s loan book can be refinanced using regulatory exempt bonds


4.5 7.614.8 15.8

24.3 25.8 28.7

70

IIB HDFCBC YES VYSB FB ICICIBC AXSB IDFC

Project Infra and Housing Loans (% of loans)

CA float, higher fees and reduction in cost of funds to

drive RoA. Leverage levels are expected to be higher

under the banking setup

Regulatory exemptions on ~50% loan book would lead

to structurally higher RoA for IDFC Bank

IDFC

22 April 2015 24

Higher leverage to drive higher sustainable RoE Strong execution track record of management | Quality demands premium

Value of the bank’s setup is significantly higher as it provides stability to business (with higher retail deposits and loans) v/s significantly volatile and monoline Infrastructure lending setup, which is also highly cyclical and lumpy in nature.

On a sustainable basis, in our view, RoE band (ex trading gains) is likely to move up by ~500bp led by high asset light revenue streams and leverage.

Investors are likely to focus more on the expected improvement in business and higher sustainable RoE, healthy Tier I ratio of 24%, strong management team and corporate governance. Foreign ownership room of ~26% post bank listing (significantly higher room than most private banks) will work in its favor.

Our positive view is derived from management’s execution track record, especially on asset quality in a highly constrained Infrastructure lending space.

We expect the banking business’ net worth to be INR163b by FY17E and assign a multiple of 2x (private banks’ corporate lender average multiple). Upgrade to Buy with an SOTP-based target price of INR232.

Under the monoline setup, with high ticket size and long gestation loan mix, rating agencies were not comfortable beyond a leverage of 6-8x. Even at the regulatory level (with Tier I of 12%), peak leverage would have been ~8x (assuming 100% risk weights and entire Tier I as CET I). Most private banks operate at 10-12x leverage, which in our view would also be followed by IDFC Bank. On a sustainable basis, in our view, RoE (ex trading gains) band is likely to move up by ~500bp, led by high asset light revenue streams and leverage. In the erstwhile NBFC business, IDFC’s ability to earn fee income was constrained by non-availability of a bouquet of products, including LCs, Guarantees among others. Management’s focus on targeting suppliers/customers in existing Infrastructure client’s value chain would enable the bank to garner higher exposure to fees in the lucrative mid-corporate segment. Exhibit 46: Leverage of IDFC Bank will increase gradually to ~9x by FY21E; however, will remain lower than peers… (leverage multiple; FY14)


8.79.7 10.1 10.1 10.7 11.3

15.3

VYSB ICICIBC IIB AXSB FB HDFCBC YES

IDFC Limited (4.8x)FY17 IDFC Bank (7.9x)

FY21 IDFC Bank (9.4x)

Leverage ratios bound to go up with better liability

profile

IDFC

22 April 2015 25

Exhibit 47: …However, RoE to be similar to peers led by higher core profitability (%)


Exhibit 48: Improvement in RoE to be largely led by higher fees and leverage (RoE %)


IDFC stock price performance v/s Bankex IDFC has been an underperformer v/s most private banks and NBFCs despite having a wholesale business model, which should do well in benign liquidity, improving outlook on growth and fall in interest rates. Investors are still grappling with the issue of expected transition to a bank and the hit on earnings in the near term. In our view, post conversion into a bank, RoE is likely to be at least 11-12% and the transition is expected to be smooth.

Exhibit 49: IDFC has significantly outperformed Bankex since listing…


Exhibit 50: …However, uncertainty on converting to a bank has led to underperformance over the last year


In our view, the expected improvement in RoE (~18% by FY21E), post conversion to a bank, will drive valuations higher v/s the earnings trajectory. IDFC is likely to be the most cost efficient bank in the system, with a C/I ratio of 25-30% on a sustainable basis, due to higher corporate loans (chiefly infrastructure) and absence of legacy issues.

1.6 1.6 1.7 1.8 1.9

11.213.6 14.5

16.217.8


RoA RoE

7.9 8.5 9.0 9.2 9.4

Leverage

11.2

17.8

2.6

2.7 0.9 0.1 0.7 1.3

4.1

FY17

E RO

E

Mar

gins

Fees

Ope

x

Trad

ing

inc

Prov

isio

ns Tax

Leve

rage

FY21

RO

E

0

500

1000

1500

Aug

-05

Feb-

06A

ug-0

6Fe

b-07

Aug

-07

Feb-

08A

ug-0

8Fe

b-09

Aug

-09

Feb-

10A

ug-1

0Fe

b-11

Aug

-11

Feb-

12A

ug-1

2M

ar-1

3Se

p-13

Mar

-14

Sep-

14M

ar-1

5

Bankex (rebased) IDFC (rebased)

100

120

140

160

180

Mar

-14

Apr

-14

May

-14

Jun-

14

Jul-

14

Aug

-14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Bankex Rebased IDFC Rebased

IDFC

22 April 2015 26

Exhibit 51: IDFC: one-year forward PBV


Exhibit 52: IDFC: one-year forward PE


Exhibit 53: IDFC’s target price sensitivity to valuation multiple of the banking business (INR b)

Target price

Upside % FY17E Banking

NW (INR b) Banking

multiple (x) IDFC Bank

valuation (INR b) Value of other

business (INR b)

Fair Value (20% HoldCo

discount INRb) 195 14 161 1.6 258 80 311 214 24 161 1.8 291 80 340 232 35 161 2.0 323 80 368 250 46 161 2.2 355 80 397 268 56 161 2.4 388 80 426 323 88 161 3.0 484 80 513 413 141 161 4.0 646 80 657 504 194 161 5.0 807 80 802


Exhibit 54: IDFC’s target price under various scenarios (multiple for Banking Business – x FY17E BV)


Exhibit 55: SOTP - FY17E based INR b USD b INR/sh Valuation Rationale IDFC Bank 288.7 5.4 182 2x NW for listed entity, 20% holdco disc IDF 17.4 0.3 11 1x Net worth Alternative assets mgt 12.8 0.2 8 8% of FY17E AUM NSE Stake 10.7 0.2 7 5.8% stake, base price of last deal IB and Broking 7.6 0.1 5 1x FY17E NW Mutual Fund Business 16.4 0.3 10 3.4% of FY17E AUM Cash on balance sheet (Parent) 14.8 0.3 9 1x Cash Total Value 368.4 6.9 232 CMP (INR)

167

Upside (%)

39 Source: MOSL

1.4

4.9

2.0

0.80.0

1.5

3.0

4.5

6.0

Aug

-05

Jan-

07

May

-08

Oct

-09

Feb-

11

Jul-1

2

Nov

-13

Apr

-15

PB (x) Peak(x) Avg(x) Min(x)

13.2

39.6

15.1

6.6

3

13

23

33

43

Aug

-05

Jan-

07

May

-08

Oct

-09

Feb-

11

Jul-1

2

Nov

-13

Apr

-15

PE (x) Peak(x) Avg(x) Min(x)

195

232

268

80

130

180

230

280

Jan-

14

Feb-

14

Mar

-14

Apr-

14

May

-14

Jun-

14

Jul-1

4

Aug-

14

Sep-

14

Oct

-14

Nov

-14

Dec

-14

Jan-

15

Feb-

15

Mar

-15

Apr-

15

May

-15

Jun-

15

Jul-1

5

Aug-

15

Bear case (1.6x) Base case (2.0x) Bull case (2.4x)

IDFC

22 April 2015 27

Exhibit 56: IDFC bank DuPont Y/E MARCH 2017 2018 2019 2020 2021

Net Interest Income 2.62 2.66 2.71 2.83 2.99

Fee income 0.81 0.90 0.99 1.10 1.17

Fee to core Income 22.60 24.25 25.64 26.88 27.19

Core Income 3.43 3.56 3.69 3.92 4.16

Operating Expenses 1.07 1.08 1.14 1.18 1.20

Cost to Core Income 31.27 30.28 30.89 29.98 28.84

Employee cost 0.44 0.49 0.54 0.58 0.59

Emp. to total exp (%) 41.18 45.06 47.61 49.30 48.86

Technology 0.27 0.25 0.24 0.23 0.23

Others 0.36 0.35 0.36 0.36 0.38

Core Operating Profit 2.36 2.48 2.55 2.74 2.96

Trading and others 0.13 0.14 0.15 0.15 0.15

Operating Profit 2.49 2.62 2.70 2.90 3.11

Provisions 0.17 0.17 0.23 0.25 0.26

NPA 0.02 0.04 0.10 0.14 0.16

Others 0.15 0.13 0.14 0.11 0.10

PBT 2.32 2.46 2.47 2.65 2.85

Tax 0.77 0.81 0.82 0.88 0.94

Tax Rate 33.00 33.00 33.00 33.00 33.00

RoA 1.56 1.65 1.65 1.78 1.91

Leverage (x) 7.22 8.24 8.76 9.11 9.33

RoE 11.24 13.57 14.50 16.18 17.84


IDFC

22 April 2015 28

Appendix 1: Comments by management in the run up to launch of IDFC Bank

Why get into a banking business?

Banking business is a better regulated business. As a NBFC, access to liquidity related flexibility is limited. During the GFC, bond markets access vanished for a few non-banking entities. Secondly, as a banking entity, we can take higher leverage resulting in high levels of sustainable profitability to benefit all the stakeholders.

Long term strategy

We are looking at a nine-year time frame, where the first three years would be about consolidation, stability and investment. The next three years would be about growing, and the final three years would be about acquiring scale. It is not a one-year thing. We would need five to seven years to establish ourselves. It is a marathon, not a sprint!

New structure of IDFC group

IDFC Limited which is the listed entity today would be the promoter of the bank. As per the bank regulations for new banks the promoter of the bank has to set up the bank through a non-operating financial holding company (NOFHC). So under IDFC, we will have a 100% owned NOFHC. That NOFHC will need to own all the financially regulated businesses of IDFC. So the bank will be subsidiary of the NOFHC. We expect the NOFHC to hold 53% of the bank. The balance 47% will be owned directly by shareholders of IDFC. So as we have said for every share that a shareholder owns in IDFC he or she will get one share in the bank and the shareholding will therefore be, we expect, 53% owned by the NOFHC, 47% owned directly by the shareholders

IDFC has four subsidiaries – Corporate Investment Banking, Alternative Asset Management, Public Market Asset Management and the Foundation. IDFC, the parent, will be the holding company. It will have one subsidiary directly, which will be the Foundation. It will then have a non-operating finance holding company, under which there will be four subsidiaries, three existing ones and the fourth is the bank. Through the scheme of re-organisation, assets and liabilities will move from the IDFC balance sheet to the bank, such that on the very first day of its operations, the bank will also be listed.

Branch network expansion

IDFC is would meet the RBI mandate that banks must have 25% of their branches in tier V and tier VI towns. Over the next decade, going by the 80-20 rule, 80% of our business will come from 20% of our branches, located in the top 60 cities. We expect to start operations with 20branches, 5 in the Tier I cities and rest in Tier IV to Tier VI cities.

Client acquisition strategy

Our strategy, at least in the beginning, will be to build on the strength that we have in the corporate market, which is one extreme of the client universe. Next, seek to get our share of urban India and simultaneously reach out to the base of the pyramid. Both on the consumer bank and the corporate bank, we will start at the upper end of the client spectrum. Simultaneously, we will attack the other extreme of the client spectrum. We have this narrative inside IDFC when we talk about dealing with the two extremes of India and Bharat at the same time, and then over time we will fill the middle. Our starting strength is in the high end. We see a huge opportunity in the low end. So, we want to attack that first. Over time, then we will fill in the blank spaces.

Profitability We are targeting a cost-to-income of 35% as opposed to the current norm of

45%. Lending to infrastructure using infrastructure bonds would lead to higher margins led by exemptions of CRR, SLR and PSL.

Investments in technology In order to ensure we don't get stuck with legacy technology in the future, we are

looking to develop a flexible, open, plug-and-play system. We aim to upfront technology investments to the initial years of operations

PSL lending

If all goes according to plan, we will more than meet the PSL requirement within the first three years off roll out. In the initial phase, it may buy into the priority lending portfolio of existing banks, but in the long run, IDFC Bank intends to develop its own expertise. We believe priority sector lending would be our greatest challenge. We have to develop capabilities in this area as part of our strategy.

IDFC

22 April 2015 29

Appendix 2: Infrastructure Debt Fund

We expect loans of INR50b and net worth of ~INR16b to be transferred to Infrastructure Debt Fund (IDF). We believe the following attributes of an IDF-NBFC lend predictability and stability to its business profile:

Regulatory guidelines

Clear and focused business model

Initially IDF-NBFCs were allowed to do takeout financing only in public private partnership (PPP) infrastructure projects, with a minimum operating track record of one year and tripartite agreement. In the FY15 monetary policy RBI also allowed, with minimum operating track record of one year, non-PPP projects and PPP project without tripartite agreement. This will ensure that projects that an IDF-NBFC lends to, do not carry any construction risk, and are generating cash flows

Protection available to asset quality

Regulations mandate that IDF-NBFCs invest only in projects that have a signed tripartite agreement between the project authority, project company, and IDF-NBFC

In the event of financial default by the project, the tripartite agreement will provide credit enhancement to the IDF-NBFC by providing (i) the right to terminate the concession agreement, (ii) priority access to termination payment from the project authority, and (iii) well-defined timelines for completion of the termination process

This robust credit enhancement mechanism provided by the tripartite agreement significantly strengthens the IDF-NBFC’s asset quality, as the quantum of termination payment will always be adequate to cover the IDF-NBFC’s outstanding dues

Regulations are awaited for Non-Tripartite PPP projects and non PPP projects Limited asset-liability mismatches and foreign currency risks

The regulation allows IDF-NBFCs to raise only long-term funds with a minimum five-year maturity

This will align the duration of IDF-NBFCs’ liability profile with the long term characteristics of infrastructure projects, thus ensuring minimal asset-liability mismatches

The regulation mandates infrastructure finance companies to hedge at least 75% of their foreign exchange borrowings

IDFC

22 April 2015 30

Appendix 3: Key management for IDFC Bank

Name Responsibility Total experience Past experience

Mr Avtar Monga

Chief Operating Officer

~32 years Bank of America (25yrs) – MD for global offshore delivery center of expertise

GE capital – CEO, Transport financial services business and Card business (JV with SBI)

Mr Pavan Pal Kaushal

Chief Risk officer

~30 years Ernst and Young – leading the risk function for financial services division

ANZ – Head of Commercial Credit risk for Asia Pacific region, followed by CRO for India

Citibank – Senior leadership roles for Corporate, Investment and Consumer bank

Mr Sriraman Jagannathan

Chief Digital and Data Officer

~25years Airtel – Spearheaded launch of first mobile payment platform

Citigroup (20yrs) – leading e-commerce and digital build out in India and Japan

Mr Ajay Mahajan

Head – Financial markets group

~25 years Bank of America (14yrs) – MD & Country treasurer for financial markets, balance sheet mgmt and Capital market business

YES (founding team member, 4yrs) - Group President of Financial Markets, Institutions and Investment Management

UBS (6yrs) – MD to build banking operations R-Square advisors (2yrs) – Entrepreneurial venture

Mr Ravi Shankar

Head of Bharat Banking

~30years Fullerton India – Head of Business and Marketing, Rural and Urban Financing

TNS India Pvt ltd - SVP and Head stakeholders mgmt, automotive, Finance and technology sectors

To head commercial banking and consumer banking unit our discussion with the management suggest that two senior people within the IDFC group is expected to be appointed

IDFC

22 April 2015 31

Financials and valuations

Exhibit 57: Balance sheet details (INR m) Y/E March 2016 2017 2018 2019 2020 2021 Comments Share Capital 33,815 33,815 33,815 33,815 33,815 33,815

Bank would be well capitalized for future growth. We factor initial net worth of INR140b

Reserves & Surplus 114,342 127,667 145,368 166,434 192,901 226,145

Net worth 148,157 161,481 179,182 200,249 226,716 259,960

Deposits 39,000 108,030 196,074 308,490 451,167 633,439

Change (%) 81.5 57.3 46.3 40.4

CA 19,500 32,409 45,751 61,698 81,210 105,573 IDFCB is expected to capitalize on strong corporate relationships for CA growth SA 1,875 6,563 14,766 29,859 50,761 78,381

Borrowings 741,000 972,270 1,111,089 1,233,962 1,353,502 1,478,024 Based on Infrastructure bonds guidelines, we expect IDFC Bank to raise ~INR120b p.a. bonds on an average over next 5years

Change (%) 31.2 14.3 11.1 9.7 9.2

Infra Bonds 110,000 196,200 307,368 430,608 568,094 722,389

Other borrowings 631,000 776,070 803,721 803,354 785,408 755,636

Other Liabilities & Prov. 30,000 36,000 43,200 51,840 62,208 74,650

Total Liabilities 958,157 1,277,781 1,529,545 1,794,541 2,093,593 2,446,073

Current Assets 32,157 38,981 48,205 60,553 66,737 65,885

Investments 333,700 506,560 566,040 602,708 636,091 672,166 Treasury book transfer expected to be ~INR175b

Change (%) 51.8 11.7 6.5 5.5 5.7

G Sec 200,000 260,000 286,000 314,600 346,060 380,666 We factor in higher G-Sec in the balance sheet

RIDF and PTC 83,700 186,560 208,040 201,708 186,351 167,084

Other investments 50,000 60,000 72,000 86,400 103,680 124,416 Entire equity investments to remain in holdco.

Loans 559,300 692,640 867,780 1,074,256 1,322,335 1,625,907 ~INR525b of loans to be transferred to the bank (of which project loans are INR350b)

Change (%) 23.8 25.3 23.8 23.1 23.0

Infra loans 460,000 529,000 626,520 742,054 878,935 1,041,118 We factor 18% CAGR over FY16E-21E

PSL loans 9,300 46,640 89,160 134,472 186,351 250,626

Non Infra loans 90,000 117,000 152,100 197,730 257,049 334,164 Non Infra corporate loans to dominate initially; Commercial banking (Retail and SME) contribution to rise with a lag

Other Assets 33,000 39,600 47,520 57,024 68,429 82,115

Total Assets 958,157 1,277,781 1,529,545 1,794,541 2,093,593 2,446,073

IDFC

22 April 2015 32

Exhibit 58: Customer assets mix (%) Y/E March 2016 2017 2018 2019 2020 2021 Comments

Loans 80.7 73.7 75.6 78.9 82.0 84.8

Infra 66.4 56.3 54.6 54.5 54.5 54.3

Eligible for Infra bonds 16.6 23.2 29.8 35.1 39.1 41.9

Others 49.8 33.1 24.8 19.3 15.4 12.4 We build in a gradual pickup in organic PSL capabilities PSL loans (in-house) 1.3 5.0 7.8 9.9 11.6 13.1

Other loans 13.0 12.5 13.3 14.5 15.9 17.4

Investments 19.3 26.3 24.4 21.1 18.0 15.2

PSL related 12.1 19.9 18.1 14.8 11.6 8.7

PTC + Securitization 6.7 11.2 10.4 8.6 6.9 5.4 RIDF would be a major drag on profitability in the initial years RIDF 5.4 8.7 7.8 6.2 4.6 3.3

Non SLR (Bonds etc) 7.2 6.4 6.3 6.3 6.4 6.5

# Loans + Investments (ex G Sec) Source: MOSL

Exhibit 59: Liability mix (%) Y/E March 2016 2017 2018 2019 2020 2021 Comments

Deposits 5.0 10.0 15.0 20.0 25.0 30.0

CA 2.5 3.0 3.5 4.0 4.5 5.0

Access to horizontal and vertical value chain of existing Infra clients will enable faster buildup of CA book

SA 0.2 0.6 1.1 1.9 2.8 3.7

Retail term + Bulk 2.3 6.4 10.4 14.1 17.7 21.3

Infra bonds 14.1 18.2 23.5 27.9 31.5 34.2 We expect aggressive expansion in branch network (YES had 117 branches after five years)

Other borrowings 80.9 71.8 61.5 52.1 43.5 35.8 Branches 75 150 225 325 425 525

* as a percentage of interest bearing liabilities Source: MOSL

Exhibit 60: P&L statement details (INR m) Y/E March 2H2016 2017 2018 2019 2020 2021 Comments

Interest Income 45,119 101,981 122,247 146,095 173,267 205,707

Interest Expense 29,382 72,655 84,891 101,081 118,347 137,931

Net Interest Income 15,737 29,326 37,356 45,014 54,920 67,777

Spreads are expected to be lower; high capitalization to drive margins higher

Change (%) 27.4 20.5 22.0 23.4

Non Interest Income 5,350 10,500 14,600 18,880 24,294 30,118

Change (%) 39.3 29.3 28.7 24.0

Net Income 21,087 39,826 51,956 63,894 79,214 97,894

Change (%) 88.9 30.5 23.0 24.0 23.6

Operating Expenses 3,838 11,986 15,125 18,962 22,851 27,222

We factor high technology costs and branch expansion cost. Low CI ratio of Infra bus. to keep CI ratio lower at >30%

Change (%) 212.3 26.2 25.4 20.5 19.1

Pre Provision Profits 17,249 27,840 36,831 44,932 56,363 70,673

Change (%) 32.3 22.0 25.4 25.4

Provisions (excl tax) 1,355 1,878 2,341 3,884 4,793 5,896

Credit Cost (%) 0.5 0.3 0.3 0.4 0.4 0.4

PBT 15,894 25,962 34,490 41,048 51,570 64,776

Tax 5,245 8,568 11,382 13,546 17,018 21,376

Tax Rate (%) 33.0 33.0 33.0 33.0 33.0 33.0

PAT 10,649 17,395 23,108 27,502 34,552 43,400

ROAs expected to rise from 1.6% (FY16) to 1.9% (FY21)

Source: MOSL

IDFC

22 April 2015 33

Exhibit 61: Key ratios Y/E March 2017 2018 2019 2020 2021 Comments

Spreads Analysis (%)

Avg. Yield-Earning Assets 9.7 9.3 9.4 9.5 9.7

Avg. Yield on loans 11.6 11.1 11.0 10.9 10.9

Avg. Yield on Investments 6.8 6.5 6.5 6.6 6.7

Avg. Cost-Int. Bear. Liab. 7.8 7.1 7.1 7.1 7.0

Interest Spread 1.9 2.2 2.3 2.5 2.6 Sharp drop in FY17 spreads led by regulatory req.

Net Interest Margin 2.8 2.8 2.9 3.0 3.2 Initial lower leverage to keep NIMs healthy

Profitability Ratios (%)

RoE 11.2 13.6 14.5 16.2 17.8

Expect sustainable ROE to be ~500bp higher than erstwhile NBFC business

RoA 1.56 1.65 1.65 1.78 1.91

Int. Expense/Int.Income 71.2 69.4 69.2 68.3 67.1

Fee Income/Net Income 22.6 24.3 25.6 26.9 27.2

Non Int. Inc./Net Income 26.4 28.1 29.5 30.7 30.8

Efficiency Ratios (%)

Cost/Income 30.1 29.1 29.7 28.8 27.8 Low CI infra business key enabler of lower overall low CI ratio

Empl. Cost/Op. Exps. 41.2 45.1 47.6 49.3 48.9

Cost per Empl. (INR m) 1.6 1.5 1.4 1.3 1.3 Employee strength (ex infra) to increase from 2,250 in FY16E to 12,000 employees in FY22E ex-Infra bus. (INR m) 0.9 1.0 1.0 1.0 1.0

NP per Empl. (INR m) 5.8 5.1 4.3 4.1 4.3

Source: MOSL

IDFC

22 April 2015 34

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motilal oswal upgrades rating on idfc to 'buy

Economy & Finance

play idfc

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expected higher share

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