Why IDFC Bank May Be Chasing A Merger With Capital First 

IDFC Bank Ltd., according to media reports, is in talks to merge with non-bank lender Capital First Ltd. to boost its retail loan book after its bid to combine with the Shriram Group failed.

The banking arm of infrastructure financier IDFC Ltd. is in exploratory talks with Capital First, CNBC-TV and the Economic Times separately reported quoting people aware of the development. IDFC Bank refused to “comment on market speculation”. Emails to Capital First, 35.97 percent owned by private equity firm Warburg Pincus, remained unanswered.

IDFC Bank, which began operations in October 2015, is keen to expand its retail footprint over the next five years. It attempted to merge with the Shriram Group in a complex deal announced in July last year. Four months later, the two called off the merger after failing to agree on a share-swap ratio. IDFC Bank had then said its strategy to expand its retail business remained on track and it will continue to look for acquisitions to achieve that goal.

So far IDFC Bank’s loan book is skewed toward infrastructure lending, which contributed 47.5 percent of its total loans as of Sept. 30. This is the loan book that the bank inherited from its parent IDFC Ltd. when it received a banking licence from the RBI in 2014. It was one of only two entities (the other being Bandhan Financial Services) to get a banking licence.

Merger Rationale For IDFC Bank

• A deal with Capital First will help IDFC Bank expand its retail assets and add the non-bank lender’s 40 lakh customers to its base of 19.4 lakh.
• Capital First’s wholesale loans have been declining in absolute terms as well as percentage terms, complementing IDFC Bank’s wholesale-oriented book.
• Capital First lends to small businesses, entrepreneurs and consumers with a ticket size of Rs 15,000 to Rs 2 crore. Its assets under management rose at an annualised rate of 27 percent.
• Capital First also has relatively healthier asset quality. Its gross non-performing loans ratio stood at 1-1.5 percent in the past five years. IDFC Bank has reduced its gross non performing loans ratio to 3.9 percent after it sold off a chunk of bad loans to asset reconstruction companies in March 2017.

What’s In It For Capital First?

Capital First has never spoken publicly about banking aspirations. The lender, according to its website, sees a large opportunity in the micro, small and medium enterprises segment.

A potential merger with IDFC Bank may help it raise funds at a lower cost via current account and savings account (CASA) deposits. It will, however, not get that benefit immediately as IDFC Bank has not had much success its building its deposit base. It’s CASA ratio stood at 8.2 percent as of Sept. 30 – the lowest among its peers.

The combination of the two entities may also create a loan book which is spread across all key lending segments from large corporate and infrastructure to SME and retail

Capital First will, however, have to set aside funds to meet the central bank’s cash reserve ratio and statutory liquidity ratio requirements.

Shareholding Pattern

Warburg Pincus with a 35.97 percent stake is the largest shareholder in Capital First, according to exchange filings. IDFC with 52.84 percent stake is the biggest shareholder of IDFC Bank, while the Indian government owns 7.68 percent.

As in the case of the proposed IDFC-Shriram merger plan, the RBI’s restrictions on shareholding in private banks will play a role in the talks between IDFC Bank and Capital First.

Any acquisition of more than 5 percent stake in a banking company will require permission from the regulator. Non-regulated financial institutions are allowed to hold upto 15 percent in the bank while regulated and well diversified institutions are allowed to hold upto 40 percent. This is according to the revised ownership guidelines for private banks released in May 2016.