Thematic | NBFCs | 15th April 2010

Indian NBFCs
Dreaming of bank licenses
NBFCs covered by Execution Noble
Since the Finance Minister’s announcement to grant new banking
IDFC, Buy IDFC.IN, 13% upside
licenses, various NBFCs have expressed their desire to apply for a Current price (Rs) 167
banking license. Given the existing issues surrounding asset-liability Valuation (Rs) 188
mismatch, ownership structures and regulatory requirements on CRR, Mkt cap -Rs m/ $ m 217,527 ($4,704m)

SLR and priority sector lending, not all NBFCs have equal chances or Shriram Transport SHTF.IN, valuation
equal inclination to become banks. Moreover, becoming a bank will Finance, Stance under under review
review
reduce ROE for most NBFCs with the exception of IDFC. Current price (Rs) 555
Valuation (Rs) Under review (last
The Government is ready to give new banking licenses published valuation is
Rs. 502)
In his budget presentation in February, the Finance Minister said that additional
Mkt cap -Rs m/ $ m 124,583 ($2,694m)
banking licenses will be allotted in India. Since then a number of NBFCs have
expressed their desire to become a bank. However, not all NBFCs have an equal LIC Housing Finance, LICHF.IN, 6% upside
chance of getting a banking license and not all NBFCs would benefit financially Buy
Current price (Rs) 892
from becoming a bank.
Valuation (Rs) 943
• Expression of interest: Within our coverage universe, both Shriram Mkt cap -Rs m/ $ m 84,637 ($1,830m)
Transport Finance (SHTF) and LIC Housing Finance (LICHF) have publicly
expressed their desire to apply for a banking license whilst infrastructure Other NBFCs mentioned in this report
financing company, IDFC, has said that it does not want one and would be Company Ticker Market Cap ($
name mn)
happy with an “Infrastructure NBFC” status since that would solve its
Reliance RCFT.IN 4,147
funding issues. (the RBI introduced a new “infrastructure NBFCs” category
Capital
on 12th February, 2010).
IFCI IFCI.IN 854
• Eligibility criteria: Whilst LICHF and IDFC have an edge over SHTF in terms Dewan DWHL.IN 392
of their ownership structure (directly or indirectly, the Government has a Housing
majority stake in them), SHTF scores over them in terms of its greater Srei Infra SREI.IN 201
experience in financial services and its lending focus to a credit starved Source: Bloomberg, Execution Noble
section of the society (a plus given the RBI’s goal of inclusive banking).

The economics of a banking license

Whilst a banking license would provide NBFCs access to cheaper sources of
funding and bring down their capital requirements, it would increase their
operating costs and lower the yield on advances (due to SLR-CRR requirements
and priority sector lending). It would also create asset-liability mismatch issues
for both LICHF and IDFC because of the long dated nature of their assets (5 to
10 years) vs the short term nature of banking liabilities (2 to 3 years).
Whilst purely on the basis of ROE expansion, a license would make most sense
Analysts
for IDFC (ROE would increase from 13% to 28%) as it would be able to raise
leverage to ~14x vs ~5x currently, ROEs for LICHF and SHTF would contract by Pankaj Agarwal, CFA
+91 (0) 22 4211 0923
530 bps and 320 bps respectively (as the decrease in cost of funds would be pankaj.agarwal@execution-noble.com
more than offset by increased opex and negative carry from the SLR-CRR Aditi Thapliyal
requirements and priority sector lending). +91 22 4211 0904
Aditi.thapliyal@execution Noble.com
However, for SHTF, inspite of the ROE hit, it still might make sense to pursue a
banking license in the interests of becoming a bigger business. Sales
Pramod Gubbi, CFA
Valuations +91 22 4211 0902
pramod.gubbi@execution-noble..com
Given that a banking license is still at least two years away, we are not factoring
in any financial implications of becoming a bank in our valuation models. We are Sarojini Ramachandran
+44 (0) 20 3364 6736
raising our estimates and valuation for LICHF by ~5% due to higher loan growth, sarojini@ execution-noble.com
lower NPA guidance from management and a more conducive environment for
home loans. We reiterate our “Buy” stances on LICHF (6% upside) and IDFC
(13% upside). We are putting our “Buy” stance and valuation “under review” for
SHTF in light of its outperformance (vis a vis the broader market) over the past
six months and its 18% rise since our 16th February note.

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Stock Exchange, Xetra, Virt-x and EuroNext.
The Government is ready to give new banking licenses…
During his Union Budget speech on February 26, 2010, India’s Finance Minster, Table 1 New banking icenses in the last
Pranab Mukherjee, stated that the RBI is considering giving additional licences to two decades
private players. NBFCs could also be considered said the FM, if they meet the RBI's
Year Name of the bank
eligibility criteria. Later RBI Deputy Governor, Usha Thorat, clarified that any
2004 Kotak Mahindra bank, Yes Bank
corporate or any other person or entity wanting to sponsor a bank will be subject to
1993 ICICI Bank, HDFC Bank, Axis
the eligibility criteria.
Bank, Global Trust Bank
The FM’s speech created lot of excitement as in the past the RBI has been very (merged with Oriental Bank of
Commerce), Times Bank
reluctant to give new banking licenses. Only eight new banking licenses have been (merged with HDFC Bank) and
given by the RBI over the last two decades. In fact over the past decade the RBI has IndusInd Bank.
issued only two new banking licenses which went to Yes Bank and Kotak Mahindra
Source: RBI, Execution Noble
Bank (see table 1). Our primary data sources tell us that the RBI has over last two
decades received around seventy applications for a banking license out of which
only eight have succeeded.

Since the Union Budget statement, CEO/CFOs of many companies have expressed
their desire to apply for banking licenses (see table 2). Whilst some of the potential
candidates are tight lipped about their interest in applying for a banking license
(Edelweiss Capital, India Infoline), IDFC has categorically stated that it is not
interested in a banking license.
Table 2 Expression of interest by various cotenders

CEO/CFO, NBFC Comnment

Sunil Godhwani, CEO & MD, Religare Enterprises “Any diversified financial player who has an interest in the space would be looking at it. We have to see
how it synergizes and adds value to the group. Capitalisation should not be an issue for us”
R R Nair, CEO, LIC Housing Finance "We are in-principle interested in the banking business but it is too premature to talk about it now. We
will wait for the Reserve Bank guidelines on the issue before taking a decision,"
Rajiv Lall, MD, IDFC “No, we are not. I am quite amused by the reaction of the market. The more important news for us was
the announcement of the infra-NBFC nomenclature. We are clearly focused on the regulatory category
of the Reserve Bank of India (RBI) and not on the banking license.” When asked whether IDFC is in line
for a banking license.
TT Srinivasaraghavan, MD, Sundaram Finance "We have no plan to apply for a bank licence or seek conversion of Sundaram Finance into a bank. It
is not part of our business plan. We believe what we are doing is fine. We strongly believe there is
relevance for NBFCs in India"

Ajay Srinivasan, Chief Executive - Financial
Services Aditya Birla Group
Sam Ghosh, CEO, Reliance Capital
"The Aditya Birla Financial Services Group is already a large non bank player. We will definitely apply
for a licence. The Aditya Birla Group is confident that we will meet any eligibility criteria that might be
set,
“The move will potentially open exciting new avenues of growth for Reliance Capital in the future. We
await further details and guidelines,"

R Sridhar, MD, Shriram Transport Finance
Sanjiv Bajaj MD, Bajaj Finserv
Uday Phadke, Mahindra's president for finance,
legal and financial services
Mr Hemant Kanoria, Chairman & Managing
Director, Srei Infrastructure Finance Ltd.
John Muthoot, Chairman and Managing Director, "At first we thought of doing that (applying for banking license). But, later decided not to apply for the
Muthoot Group
Atul Kumar Rai, CEO and MD, IFCI
Kapil Wadhawan, CMD, Dewan Housing
Source: Media, Execution Noble,
“We will be approaching the government and the RBI on this. We have been financing niche
segments which are not catered by any bank. The group would prefer a fresh license rather than a
conversion of one of the existing NBFCs”
“We will wait for the details before taking a decision,”
"We are interested in getting a banking license because we believe that Mahindra Finance has a
formidable footprint in rural and semi urban areas and we are, therefore, an ideal candidate for a
banking license. We are awaiting the RBI guidelines and will approach formally for various approvals
when that comes through,"
“We are particularly excited at the prospect of the RBI providing banking licenses to select NBFCs and
private entities in order to expand financial inclusion. This is an idea whose time has certainly come,”
banking license as we felt that there is a lot of untapped potential in the NBFC business,"
“We still have to wait for the final guidelines to come and the eligibility to be announced. As far as IFCI
is concerned, obviously IFCI would be a contender; there is no doubt about it. We missed the bus in the
90s, when fresh licenses were given, primarily on account of ownership issues. Those issues are not
there with us any longer and we have very strong financials, strong capital adequacy, and diversified
shareholding. So in some ways we are eligible."
"In the past too, we have made representations (to the Reserve Bank of India) and there is keenness
from our side,"

…but not everyone is invited to the party

Whilst the RBI has not yet published guidelines on eligibility criteria for NBFCs and
corporates to convert into banks, based on the RBI’s past record and the RBI top
brass’ public statements on this issue, not all the contenders have an equal chance of
getting a banking license.

The RBI has been reluctant in the past to give banking licenses to diversified
corporate groups The RBI’s deputy governor Usha Thorat’s statement immediately

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after the FM’s budget speech reiterated that the basic principles of ownership and
governance will remain unchanged while granting a banking license. This puts a
“The basic principles of ownership and
question mark on whether corporate groups like Reliance Capital, Bajaj Group, Aditya governance will remain unchanged.
Birla Group, Tatas etc. would make the cut when the RBI issues new licenses. They are sacrosanct. All the principles
The last two banking licenses granted by the RBI were to Kotak Mahindra (which had of ownership and governance will be
taken into account while evolving the
15 years of experience in financial services) and to the promoters of Yes Bank (who
new guidelines”. RBI’s deputy
were career bankers with significant experience in banking). Hence we believe pure governor Usha Throat immediately
play financial services firms like Shriram Transport, IDFC, LIC Housing Finance have a after the FM’s budget speech.
better chance of getting a banking license than firms like Reliance Capital and Bajaj
Finserve who are associated with big conglomerates.
Based on the parameters the RBI has issued while granting a banking license in the
past we have evaluated the chances of getting a license (see table 3) the three NBFCs
in our coverage universe.
Table 3 Applying the RBI's eligiblity criteria

Eligibility Criterion IDFC LICHF SHTF

Capital Adequacy Rs. 3 bn but likely to be All three NBFCs have much higher equity capital base than required by the regulator.
Requirement increased to Rs. 10 bn as per
media reports.
Diversified Holding Any single entity or group of Other than government, no LIC (which is owned by the Promoter have 43% stake in
related entities holding no single entity owns more than Indian government) owns 35% the company which can be
more than more than 10% 10% stake of the company negative issue
Association with a Should not be associated with Not associated with any Not associated with any Associated with the Shriram
corporate group a corporate group because of corporate group corporate group Group which has interests in
potential conflicts of interest businesses like insurance,
construction, technology etc.
Track Record in financial A track record in the financial Around 12 years of Close to two decades of Close to three decades of
services services industry experience in infrastructure experience in housing finance experience in truck finance
lending space. segment segment along with
experience in retail lending
business.
Presence in semi-urban No stated criteria but if the Mostly present in metros and Mostly present in metros and Large presence in semi urban
and rural areas NBFC has a presence in semi state capitals state capitals areas
urban and rural areas, the
chances of getting a banking
license would improve given
the government’s goal of
spreading banking services to
these areas.
Likelihood of passing
eligibility test
Source: RBI, Company filings, Execution Noble

- Relatively strong ; - Average ; - Relatively weak

IDFC: Whilst IDFC makes a cut in terms of capital requirements, ownership structure
and non-association with a corporate group, its shorter track record in financial Table 4 The RBI’s regulatory regime
services (with a focus on big ticket infrastructure loans) goes against the primary goal Banks vs NBFCs
of the RBI in granting new banking licenses (to spread banking to the unbanked Parameters NBFCs Banks
sections of the country).
Capital 12% (15%
LICHF: Whilst LIHF makes the cut on most of the parameters, its non presence in semi 9%
Adequacy ratio from FY11)
urban and rural areas can go against it.
Tier 1 Capital
SHTF: Whilst the high promoter stake (promoters have 44% in the company) and 6% 6%
ratio
association with the Shriram Group (which has businesses like insurance, construction, Cash reserve
technology, etc.) might go against SHTF, its 30 years of experience in retail financial 0% 5.75%
ratio (%)
services industry along with its lending focus to credit starved segments of the
Priority sector
economy can be a big positive for it given the RBI’s goals. Hence from an eligibility 0% 40%
lending (%)
perspective we find SHTF the best placed of the three firms.
SLR 15% of 25% of
Does it make financial sense to join the party? requirements (%) public all

The liquidity scare post the Lehman liquidity crisis exposed flaws in the wholesale deposits deposits

funded business models of India’s non-banking finance companies. In addition, over NPA Recognition 180 days 90 days
the years barring NBFCs operating in niche segments [where commercial banks either Source: RBI, Execution Noble
face a regulatory cap on lending (e.g. capital markets, real estate) or face borrower
segments that they are unable or unwilling to penetrate (infrastructure lending,
commercial vehicle and equipment finance, personal loans, etc)] the NBFC space in
India has gone through forced consolidation (as the regulator forced the NBFCs out of
the retail liabilities market). Few NBFCs have been able to gain access to sufficient

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capital to be able to scale their business (see table below). Thus NBFCs realise now
more than ever the need for a stable retail funding led liability base.
Table 5 Few NBFCs have been able to scale up over the years*

FY00 FY08
Asset size (Rs bn)
No of companies (% share in total assets) No of companies (% share in total assets)

Less than Rs 5bn 974 31% 318 5%

Above Rs 5 bn 22 69% 15 95%

Source: RBI, Execution Noble, * Note that NBFC here refers to deposit taking NBFCs
Although the contenders have given their own reasons for applying or not applying
for a banking license, the financial benefits of turning into a bank are not equal for all.
• Financial Impact: Whilst a banking license would provide NBFCs access to
stable, bigger and cheaper funds (~150-200 bps decrease in the cost of
Financial benefits of becoming a bank
funds) and bring down capital requirements (9% for banks vs 12% to 20% for
vary across NBFCs
NBFCs), it would increase the operating costs (~ 50 to 100 bps increase in
operating costs) and lower the yield on advances (due to SLR-CRR
requirements there will be ~70 to 100 bps impact). There would also be
further expenses in terms of skills and technology upgrades which these
NBFCs would have to incur in their initial years as banks.
• Priority sector lending: Once these NBFCs become banks, they will have to
meet the RBI’s priority sector lending norms (40% of total loans for a bank
have to go to the priority sectors). Whilst most of the lending done by SHTF
(second hand truck financing) and LICHF (housing loans below Rs. 2 mn)
comes under the RBI’s priority sector definition, IDFC would have to
separately meet these norms by extending credit to the priority sector or
subscribing to Rural Infrastructure Development Fund bonds which yield
between 4% to 5% (vs ~9.9% yield on advances on IDFC’s current loan book).
• Asset-liability mismatch: Given that both mortgages and infrastructure loans
are long duration assets (duration of around 5 to 10 years), both IDFC and
LICHF would face serious asset-liability mismatches if they are converted into
banks (given that the average duration of liabilities in the banking system is
only two years). Given that the average duration of SHTF assets is only ~ 3
years, it won’t face a similar asset-liability mismatch.
Table 6 Du-pont analysis (whole table is expressed as a % of assets)

IDFC IDFC Bank SHTF SHTF Bank LICHF LICHF Bank Comments
Interest earned 9.9% 9.9% 16.4% 16.4% 11.1% 11.1%
Interest expended 7.2% 5.9% 8.2% 7.4% 8.1% 6.6% Assuming 15% savings and 10% current deposits
base in steady state
Negative Carry ON - 0.7% - 1.4% - 1.0% As per the base rate calculation by the RBI
CRR and SLR working committee
NIM Impact from - 0.3% - 1.0% - 0.4% Assuming that priority sector lending would be
priority sector lending done at a blended yield of 9%.
Gross interest spread 2.6% 2.9% 8.1% 6.5% 3.0% 3.1%
Provisions and 0.5% 0.5% 1.5% 1.5% 0.2% 0.2% Though NPA recognition norms would change
writeoffs from 180 days to 90 days, the credit costs
won’t be impacted (since they are independent
of accounting norms).
Net Interest Spread 2.1% 2.3% 6.6% 5.0% 2.8% 3.0%
Operating cost 1.2% 2.2% 2.5% 2.9% 0.6% 1.6% Assuming a 100 bps increase in operating costs
for IDFC and LICHF and 40 bps for SHTF
Lending spread 0.9% 0.1% 4.1% 2.2% 2.2% 1.3%
Fee based income 2.5% 2.5% 0.3% 0.3% 0.3% 0.3%
Operating spread 3.5% 2.7% 4.5% 2.5% 2.5% 1.6%
Tax 0.9% 0.7% 1.5% 0.8% 0.7% 0.4%
Core ROA 2.5% 2.0% 3.0% 1.7% 1.8% 1.2%

Leverage (x) 5x 14x 9x 14x 12x 14x

ROE 12.4% 27.6% 26.9% 23.7% 21.7% 16.4%
Incremental priority YES NO NO
sector lending
ALM mismatch YES NO YES
Source: RBI, Company filings, Execution Noble,

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Our Du-pont analysis of these NBFCs shows that ROE would contract for both SHTF
and LICHF. For IDFC there would be expansion of ROE primarily because the company
would be able increase its leverage from current 5x to 14x post conversion to a bank.

IDFC: Based on our assumptions, IDFC would benefit the most if it converts into a
bank. Whilst ROA would fall to ~2.0% from 2.5% (due to increased operating costs IDFC benefits the most in terms of
and negative carry from SLR and CRR and priority sector lending), its ROE would ROE if it converts into a bank,
LICHF and SHTF lose out on both
expand (from ~13% to around 28%) as it would be able to increase leverage to ~14x
ROA and ROE.
compared to the current leverage of ~5x (IDFC has constraints on leverage because
of fears of downgrades from rating agencies). However, IDFC will face issues related
to asset-liability mismatch as most of its assets are long dated assets (5 to 10 years)
whilst banking liabilities are of shorter nature (2 to 3 years).

LICHF: LICHF’s ROE would contract by 5% points from ~21.7% to 16.4% as the benefits
from lower cost of funds (~150 bps) would be more than offset by ~140 bps negative
carry from SLR and CRR and additional priority sector lending requirements and ~ 100
bps increase in operating costs. The benefits of increased leverage would be marginal
as LICHF already has leverage of ~12x.

SHTF: SHTF’s ROE would contract by 3.2% points from ~26.9% to 23.7% as the benefits
from lower cost of funds (~180 bps) would be more than offset by ~140 bps negative
carry from SLR and CRR and additional priority sector lending requirements and ~ 40
bps increase in operating costs. SHTF would also gain from increased leverage from its
current ~9x to ~14x. The major benefit for SHTF to turn into a bank would be from
access to funding which would make its business model scalable.

Conclusion: The only winner in ROE terms appears to be IDFC, a firm which has said it
does not want a banking license whilst LICHF & SHTF lose out both on on ROA & ROE.
However, for SHTF particularly it might still make sense to pursue a banking license in
the interests of becoming a bigger (albeit a less profitable) business.

Despite a fall in ROE after converting into a bank, the reason behind NBFCs pitching
for a banking license is that it gives them access to a bigger and more stable liability
base which enables them to grow their revenues faster. E.g. Whilst Kotak Mahindra’s
ROE has remained in low teens since it became a bank in 2003, it has grown at a much
faster pace after getting a banking license (balance sheet grew 20x between 2003 and
2009). This has been rewarded by shareholders’ with Kotak’s share price
outperforming its banking peers during the period.

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LIC Housing Finance Ltd. (LICHF, Buy, 6% upside)
We do not think that the rewards to LICHF of becoming a bank are particularly
significant as LICHF already has one of the lowest cost of funds amongst NBFCs
with continuous access to funds (even during the post Lehman liquidity crisis) due
to the implicit backing from its parent company LIC.

Whilst LICHF’s stock price has gone up by 23% since our initiation on 24th February,
2010, we continue to remain positive on the stock on the back of its long term
competitive advantages on both sides of the balance sheet. Based on higher loan
growth and lower NPA guidance from management and a more conducive
environment for home loans, we are upgrading our earnings estimates for FY10,
FY11 and FY12 by 4%, 1% and 5% respectively and raising our valuation by 5%.

In our meeting with the CEO, R Nair, we clarified certain concerns which have been
raised by investors repeatedly.

• Management continuity: On management continuity, the CEO stated that

whilst the top management of LICHF is deputed from LIC for around 3
years, the period can be extended if the person concerned is critical for the
operations of the company. E.g. the head of recovery division (deputed
from LIC) has been with LICHF for the last 18 years.

• NPAs on a rapidly growing loan book: Management stated that the

company has not relaxed its credit appraisal mechanism to pursue higher
loan growth. In fact, says the CEO, maintaining lower NPAs is the highest
priority of the management as evidenced by the fact NPAs on the loans
disbursed over the last two years have in fact been much lower than their
overall gross NPAs of ~1.0%. Management is supremely confident that NPAs
would be around 1.0% at the end of FY10 (1.44% at the end of 3QFY10
which management claims is due to “technical” reasons) and fall below 1%
by the end of FY11.
Table 7 Change in estimates (all figures in Rs m unless otherwise mentioned)

Old estimates New Estimates Change (%)

(Rs m) Comments
FY10E FY11E FY12E FY10E FY11E FY12E FY10E FY11E FY12E
Total Income 10,248 13,262 16,943 10,248 13,544 17,599 0% 2% 4% The slightly increased income estimates for FY11
and FY12 are entirely driven by increased loan
growth assumptions on the back of management
guidance and improved economic environment.
Operating 1,669 2,016 2,377 1,669 2,121 2,471 0% 5% 4% Expenses increase with increase in income
expenses
Gross NPAs 1.1% 1.1% 1.1% 1.25% 1.25% 1.25% Lower gross NPA estimates based on guidance
from management.
Operating Profit 8,452 10,613 13,807 8,755 10,755 14,433 4% 1% 5% Increased operating profit estimate for FY10 is
driven by lower NPA guidance by the
management.
Source: Company filings, Execution Noble
We are valuing the company on “excess return to equity” model. Our Excess return
metric is ‘Net Profits – (cost of equity*beginning book value)’ for all the future years
discounted back to present at a cost of equity of 15%.
Our Excess Return to Equity model has three distinct phases:
1) FY10-FY14: We model each year discretely resulting in net profits growing at a
CAGR of 26% to hit an ROE of 25% in FY14.
2) FY15-20: Net Profits grow at a CAGR of 14% and ROE gradually fades to 20% by
FY20.
3) From FY20: Net profits grow at a CAGR of 4% maintaining an ROE of 15%.

Assuming; (a) a cost of equity of 15%; and (b) terminal growth of 4%, our “Excess
Return to Equity” valuation model values LICHF at Rs 943 (implied FY111E BV of 2.2x,
FY11E earnings of 11.6x) implying an upside of 6%.

Based on the same assumptions as above, Free Cash flow to Equity valuation model
values the company at Rs 966 implying 9% upside.
Whilst LICHF’s forward P/B multiple of 2.1x is at a 67% premium to its 12 month cross
cycle forward P/B multiple of 1.2x (between Dec05-Jan10), given the fundamental
changes in the company over last four years which has led to ROE expansion (ROE
increasing from 13.6% in FY05 to 26.1% in FY09) and net profits growing at a CAGR of

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Stock Exchange, Xetra, Virt-x and EuroNext.
38%, the current P/BV multiple is more than justified.
Figure 1 LICHF’s current valuation is at a premium to
historical valuations Figure 2 ROE expansion and profit growth led to rerating

900 6,000 28%

LICHF Stock Price
2.0x
26%
750
5,000
24%
1.5x
600
4,000 22%

450 1.0x 20%

3,000
18%
300
2,000 16%
150
14%
1,000
0 12%
Aug-06

Dec-06

Aug-09

Dec-09
Apr-06

Apr-09
Aug-07

Dec-07
Dec-05

Apr-07

Dec-08
Aug-08

Apr-10
Apr-08

- 10%
FY05 FY06 FY07 FY08 FY09

Net profits (Rs. mn) ROE (%)

Source: Reuters, Execution Noble Source: Company filings, Execution Noble

IDFC Ltd. (IDFC, Buy, 13% upside)

Whilst in terms of ROE expansion IDFC gains most from a becoming a bank, IDFC has
categorically denied any interest in applying for a banking license. In our recent IDFC benefits the most from
meeting with management we were told: becoming a bank but does not
want to become one.
• Infra NBFC to solve funding issues: Management believes that the currently
mooted “infra-NBFC” status would be a better option for IDFC as it gives the
company greater flexibility in terms of managing liabilities on the one hand
and keeping its focus on financing infrastructure on the other. The special infra
NBFC status would increase the bank funding limit to 20% from 15% of net
worth allowing a 30% increase in lending. Moreover, the capital requirements IDFC wants to become an “infra
NBFC”.
that the banks are required to put aside in order to lend to an infra-NBFC,
would be less onerous and hence the cost of banks lending to IDFC should
also decline over time. Thirdly, the RBI has said that it will consider allowing
infra-NBFCs to borrow in the form of external commercial borrowings (ECBs)..

• Capital market business is doing well: Management says that IDFC-SSKI has
increased its market share in the institutional broking space and has also been
very active in the capital issuance space.

• Brand building in the asset management business: On the distribution

challenges on the domestic mutual fund side, the company is trying to build a
brand by heavy advertising (already visible in billboards in Mumbai) so that it
does not need to entirely depend on a sales push from its distributors.

Due to the diverse nature of the company’s earning profile, we have valued IDFC on a
sum-of-the-part valuation (SOTP) basis.

We have valued the lending business on free cash flow to equity (FCFE) matrix. Our
FCFE metric is ‘cash profits - capex – increase in working capital. Assuming; a) a cost
of equity of 15%; and b) terminal growth of 4%, our FCFE model values the lending
business at Rs 131p/s.

We have valued the asset management business at Rs 9 per share (at 5.5% of FY10E
AUM) whilst the PE business is valued at Rs 18p/s (20% of FY10 AUM across the Modest upside from this high
private and project equity funds; see table on the right). We have valued the trading quality lender.
book at Rs 19 per share (allocating market values to the listed investments while
valuing IDFC’s 8% stake in the National Stock Exchange at Rs 13bn in line with recent
quoted valuations in multiple financial journals) and the broking/I-Banking business at
Rs 11 p/s. This sum of parts valuation gives a total valuation of Rs. 188 per share (13%
upside).

IDFC is trading at 2.8x FY11E BV (on consensus estimates) which is in line with its long
term average leading P/BV 2.8x (calculated based on the period since the company
was listed in Sep-05). However, IDFC is still trading at ~9% discount to its average

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forward PBV of 3.2x from listing in Sep-05 to the peak of the last bull run in Dec-07.
Given that IDFC has been a highly cyclical stock (Bloomberg beta of 1.3), this modest
upside captures the upside inherent in this high quality lender if the stock market
behaves itself.
Figure 3 IDFC’s current valuations remain at a discount to peak valuations

250
IDFC Stock Price

200 3.5x

150 2.5x

100
1.5x

50

0
Oct-07
Sep-05

Dec-06

Jan-09
Aug-08

Nov-09

Apr-10
Mar-08
Jul-06

Jun-09
May-07
Feb-06

Source: Noble, Thomson (this is the historical profile of IDFC's forward PE)

Shriram Transport Finance (SHTF.IN, valuation under review,

10% downside on our last published valuation of Rs 502)
Despite ~320bps knock on RoE following the grant of a banking license, we believe
that Shriram Transport could become one of the more profitable banking franchises
with a 20% RoE if it could:

• Continue operating in its lending niche which consistently generates NIMs of

~8%.

• Focus on its captive CV borrowers for deposits: This group is under-banked

and hence ripe for targeting given SHTF’s historic links.

• Build a branch network at lower cost: As the company already has presence
of 482 branches, the additional cost of setting up new branches would be less
for SHTF vs IDFC and LICHF.

Shriram Transport Finance has outperformed the BSE Sensex over the last six months
with stable credit quality, improved pricing power, and healthy loan growth prospects
in the buoyant commercial vehicle finance sector. However, with the initial euphoria
over the government’s budgetary announcement of new banking licenses has resulted
in a 18% rally since our 16th February’10 note, further re-rating triggers are harder to
spot.
Shriram Transport’s indisputable competitive advantage in commercial vehicle lending
implies that the stock may continue to trade at a premium to its NBFC peers (trades at
2.7x FY11E P/BV, a 15% premium to peer NBFCs) since this premium will be supported
by the CV sales momentum and superior return generation vs. most peer NBFCs
whose ROEs are in the mid-teens vs. Shriram Transport’s FY11E RoE at 25.3%. However,
at this juncture our room to upgrade estimates and valuation to somewhere
meaningfully north of the current share price of Rs 559 is limited.
Based on our FCFE model, our last published valuation of the stock is Rs. 502 (implied
FY11E BV of 2.5x, FY11E earnings of 10.7x). We will be revisiting our valuation on this
stock after its results in late April.

SHTF is trading at 2.9x FY11E BV (on consensus estimates) which is at 16% premium to
its long term average leading P/BV 2.5x (calculated based on the period since Apr-
06). However, SHTF is still trading at ~35% discount to its peak valuation of average

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leading P/BV 4.5x in Dec-07.
Figure 4 Post dilution valuation is at a premium to its average P/BV valuation of 2.5x

3.0x
500 SHTF Stock
Price

400
2.0x

300
1.5x
200

100

0
Oct-06

Oct-09
Oct-08
Oct-07
Apr-06

Apr-09
Jul-06

Jul-09
Jan-09
Apr-08
Apr-07

Jul-08
Jul-07

Jan-10
Jan-08
Jan-07

Source: Noble, Thomson (this is the historical profile of SHTF’ forward PBV)

Table 8 Comparative valuations

Company Price Market Asset

TICKER ROE (%) ROA (%) P/BV(x) P/E (x)
(INR) CAP Size

($ mn) (US$ mn) FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E

NBFCs under over coverage

IDFC IDFC 167 4,704 6,658 16.0 16.3 3.3 3.2 3.1 2.8 20.7 17.9
Shriram Transport SHTF 555 2,694 5,404 28.2 25.5 2.7 2.6 3.6 2.9 16.2 13.7
LIC Housing LICHF 892 1,830 6,362 23.7 21.7 2.0 1.8 2.5 2.2 12.4 10.8
Average - - - - 22.6 21.2 2.6 2.5 3.1 2.6 16.4 14.1

Other NBFCs
HDFC HDFC 2,748 17,058 25,104 19.4 20.4 2.5 2.5 5.6 4.9 29.8 25.1
Dewan Housing DEWH 222 394 1,480 22.8 22.7 2.0 2.1 2.1 1.8 12.0 8.5
Indiabulls Financial
Services IBULL 136 912 2,350 8.4 NA NA NA NA NA 13.1 9.8
Srei Infra Finance SREI 79 198 1,229 11.2 10.3 1.8 1.5 0.8 0.7 8.5 7.8
Mahindra and Mahindra
Financial Services MMFS 376 787 1,615 18.9 19.1 3.6 3.6 2.1 1.8 11.7 10.0
Power Finance
Corporation POWF 261 6,472 14,759 18.2 17.9 3.1 2.9 2.3 2.0 13.3 11.7
Rural Electrification ltd. RECL 258 5,499 12,102 22.4 20.1 3.1 2.9 2.5 2.1 12.8 11.2
Average - - - - 17.3 18.4 2.7 2.6 2.6 2.2 14.5 12.0
Source: Bloomberg, Execution Noble, Note: Priced as on 14th April, 2010.

Plotting FY11E ROE on horizontal axis and FY11E P/BV on vertical axis (see figure 5) we
found that LICHF is undervalued compared to its peers, SHTF is fairly valued and IDFC
is overvalued. The premium valuation for IDFC is arguably driven by its superior
management capabilities.

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Figure 5 LICHF is at a discount to its peers whilst IDFC is at a premium

5.0
HDFC
4.5

4.0
F
Y 3.5
1 3.0
1 IDFC
SHTF
E 2.5
LICHF
2.0
P RECL
POWF
/ 1.5 MMFS DEWH
B
1.0

0.5
SREI
0.0
10.0% 15.0% 20.0% 25.0%

FY11E Return On Equity

Source: Bloomberg, Execution Noble

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Summary Financials of Shriram Transport Finance (these estimates were
published on 10 Feb 2010 and are now “under review”)

Income Statement 2007A 2008A 2009A 2010E 2011E 20012E

Interest income 13,986 24,639 36,775 43,929 57,098 77,775

Interest expended 7,239 12,966 19,777 22,087 28,011 40,048
Loan loss provisions increase in FY10
Net Interest Income 6,747 11,673 16,998 21,842 29,087 37,727
resulting in overall increase in
Other Income 171 303 537 874 1,163 1,509
provision cost.
Total Income 6,919 11,976 17,535 22,716 30,250 39,236
Operating expenses 2,359 3,599 5,272 6,620 8,058 10,551
Operating Profit 4,560 8,377 12,263 16,095 22,192 28,685
Provisions 1,665 2,318 3,057 4,084 4,564 5,737
PBT 2,895 6,059 9,206 12,011 17,628 22,948
Less: Tax 988 2,160 3,082 3,964 5,817 7,573
PAT 1,907 3,899 6,124 8,047 11,811 15,375
EPS (Rs) 10.4 19.2 30.1 36.1 47.0 68.9
Noble EPS (Rs) 10.4 19.2 30.1 36.1 47.0 68.9
Dividend per share (Rs) 3.0 4.0 5.0 6.1 8.0 13.8

Balance Sheet 2007A 2008A 2009A 2010E 2011E 20012E

Sources of Funds

Equity 1,842 2,032 2,035 2,232 2,232 2,232

Reserves and Surplus 9,022 16,132 21,131 34,995 43,407 55,184
Net-worth 10,864 18,163 23,166 37,227 45,638 57,416
Borrowings 87,093 147,730 201,194 226,187 295,635 417,230
Current liab. & Prov. 10,104 16,557 25,535 23,664 11,651 18,372
Total liabilities 108,061 182,451 249,896 287,078 352,925 493,018

Application of Funds
Truck loans 82,048 150,727 179,031 226,495 297,364 417,017
Investments 2,246 13,851 6,548 8,720 7,058 9,860
Cash and bank balance 15,478 13,742 57,849 45,299 41,631 58,382
Fixed Assets 1,277 1,426 1,343 1,701 2,009 2,895
Other current assets 7,011 2,706 5,125 4,863 4,863 4,863
Total assets 108,061 182,451 249,896 287,078 352,925 493,018

Assets under management 120,520 195,230 232,810 304,131 389,661 517,777

Growth metrics (%) 2007A 2008A 2009A 2010E 2011E 20012E

Total income 41% 73% 46% 30% 33% 30%

Operating expenses 22% 53% 46% 26% 22% 31%
Pre-provisioning profit 53% 84% 46% 31% 38% 29%
Provisions 104% 39% 32% 34% 12% 26% Net interest margins improve due to
Net profit 35% 104% 57% 31% 47% 30% stable lending yields, higher
Loan growth 63% 84% 19% 27% 31% 40% securitised volumes and modest
Spread analysis (%) 2007A 2008A 2009A 2010E 2011E 20012E increase in borrowing costs.
Yield on assets 17.1% 17.1% 17.0% 16.4% 17.8% 18.4%
Cost of funds 11.0% 11.0% 11.3% 10.3% 10.7% 11.2%
Net interest margin 8.4% 8.2% 7.9% 8.2% 9.2% 9.0%
Asset quality (%) 2007A 2008A 2009A 2010E 2011E 2012E
Gross NPAs (% of gross
advances) 2.1% 1.6% 2.1% 2.5% 2.7% 2.6%
Net NPAs (% of net advances) 0.8% 0.8% 0.9% 0.8% 0.7% 0.6%
Provisioning coverage 37% 43% 62% 69% 69% 68%
Gross NPAs expected to increase to
Efficiency ratios (%) 2007A 2008A 2009A 2010E 2011E 2012E
2.5% in FY10, marginal increase in FY11
Operating Cost/Income 34.1% 30.1% 30.1% 29.1% 26.6% 26.9% to 2.6% of advances, 2.6% in FY12.
Wage costs/operating expenses 30.5% 34.8% 38.0% 37.7% 37.5% 37.2%
Capital ratios (%) 2007A 2008A 2009A 2010E 2011E 2012E
Capital adequacy ratio 16.5% 15.1% 15.3% 19.1% 19.1% 17.8%
Tier-1 capital (%) 10.0% 9.7% 9.1% 12.9% 12.9% 11.6%
Valuation metrics (%) 2007A 2008A 2009A 2010E 2011E 2012E

P/E(x) 45.8 24.7 15.8 13.1 10.1 6.9

P/BV(x) 8.2 5.4 4.2 2.8 2.3 1.8
ROA 2.3% 2.7% 2.8% 3.0% 3.3% 3.6%
ROE 20.5% 27.5% 30.3% 26.9% 25.3% 29.8%
Dividend Yield 0.6% 0.8% 1.1% 1.3% 1.7% 2.9%
Source: Company filings. Noble, *Historical yields, cost of funds and net interest margins based on calculated values for
consistency.

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Summary Financials of IDFC
Income Statement 2007A 2008A 2009A 2010E 2011E 2012E

Net income 7,158 12,245 15,009 18,280 22,752 28,205

-Net Interest Income 4,056 6,148 7,645 8,939 11,331 14,551
-Treasury income 1,706 2,956 3,400 2,701 3,179 3,371
Revenues to grow on the back of increased loan
-Fee based income 1,239 3,022 3,740 5,897 7,499 9,540
and fee income progression
-Others 157 120 223 743 743 743
Operating expenses 777 2,459 3,427 3,916 4,879 6,177
Operating profit 6,381 9,786 11,582 14,363 17,873 22,028
Provisions 175 700 1,532 652 1,246 1,598
PBT 6,206 9,086 10,050 13,712 16,626 20,430
Less: Tax 1,241 2,480 2,782 3,565 4,323 5,312
Operating profits to grow at slightly higher rate
PAT 4,965 6,605 7,268 10,147 12,304 15,118 than revenues due increasing contribution due to
Minority Interest, others 118 (102) (79) (59) (72) (88) lower loan losses and write back in later years.
Consolidated PAT 5,083 6,504 7,189 10,088 12,232 15,031

EPS (Rs)-Diluted 4.5 5.0 5.6 7.8 9.4 11.6

Dividend per share(Rs) 1.0 1.2 1.2 1.6 1.9 2.3

Balance Sheet 2007A 2008A 2009A 2010E 2011E 2012E

Sources of funds
Net-worth 29,476 55,933 61,759 69,829 79,615 91,639
Minority Interest - 241 281 340 412 500

Borrowings 149,028 223,035 236,046 282,624 365,631 461,997

Total assets 178,505 279,210 298,086 352,793 445,657 554,135
Application of funds
Fixed assets 489 3,850 4,543 4,543 4,543 4,543
Goodwill - 2,943 10,790 10,790 10,790 10,790
Investments 23,992 52,686 65,375 67,632 73,065 84,415
Infrastructure loans 139,184 199,051 205,962 250,488 332,112 422,077
Net working capital 13,102 20,136 10,369 19,340 25,147 32,309
Total liabilities 178,505 279,210 298,086 352,793 445,657 554,135

Growth metrics (%) 2007A 2008A 2009A 2010E 2011E 2012E

Total income NA 71% 23% 22% 24% 24%
Operating expenses NA 216% 39% 14% 25% 27%
Net profit NA 28% 11% 40% 21% 23%
Loan Book NA 43% 3% 22% 33% 27%
Borrowings NA 50% 6% 20% 29% 26%
Assets NA 57% 7% 18% 26% 24%
Spread analysis* 2007A 2008A 2009A 2010E 2011E 2012E
Yield on infra. loans 9.4% 10.2% 11.9% 11.2% 11.1% 11.1%
Cost of funds 7.0% 8.0% 9.1% 8.0% 8.0% 8.0%
Net interest margin 2.9% 3.0% 3.0% 3.1% 3.2% 3.1%
Efficiency ratios (%) 2007A 2008A 2009A 2010E 2011E 2012E
Operating Cost/Income 10.9% 20.1% 22.8% 21.4% 21.4% 21.9%
Capital ratios (%) 2007A 2008A 2009A 2010E 2011E 2012E
Leverage** 5.4 5.4 4.9 5.1 5.6 6.0
Capital adequacy ratio 20.2% 22.4% 22.9% 22.0% 19.6% 18.0%
Valuation metrics (%) 2007A 2008A 2009A 2010E 2011E 2012E
P/E(x) 35.4 31.9 28.5 20.7 17.1 13.9
P/BV(X) 6.1 3.7 3.3 3.0 2.6 2.3
ROA ROE and ROA to increase as the company
3.4% 2.8% 2.5% 3.1% 3.1% 3.0%
increased leverage on the balance sheet.
ROE 18.3% 15.1% 12.2% 15.3% 16.4% 17.6%
Dividend Yield 0.6% 0.8% 0.8% 1.0% 1.2% 1.4%
Source: Company filings. Noble, * Yield and cost on calculated basis for data consistency,
leverage defined here as the ratio of assets to equity

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Summary Financials of LIC Housing Finance
Income Statement 2007A 2008A 2009A 2010E 2011E 20012E
Net Interest Income 3,976 5,626 7,381 8,417 11,513 15,174
Fee Income 481 526 682 1,281 1,481 1,875
Other Income 281 747 802 550 550 550 Net interest income to grow at a CAGR
Total Income 4,738 6,899 8,864 10,248 13,544 17,599 of 23% between FY09-12 driven by loan
growth CAGR of 24% during the period
Operating expenses 1,009 1,305 1,508 1,669 2,121 2,471
Operating Costs 739 956 1,056 1,181 1,498 1,697
Employee Costs 269 349 452 488 623 774
Pre Provisioning Profit 3,730 5,594 7,356 8,579 11,423 15,128
Provisions 157 243 53 -176 668 695
Operating Profit 3,572 5,352 7,304 8,755 10,755 14,433 Net profits to grow at a CAGR of 23%
Depreciation 39 38 51 64 70 77 between FY09-12.
PBT 3,533 5,314 7,253 8,691 10,685 14,356
Less:Tax 746 1,451 1,948 2,380 2,926 3,931
PAT 2,787 3,862 5,304 6,311 7,758 10,424
Share of Profit of Associate 31 53 78 0 0 0
Net Profit 2,817 3,916 5,382 6,311 7,758 10,424
EPS (Rs)-Diluted 33.2 46.1 63.3 70.1 81.7 109.7
Diluted EPS (Rs) 33.2 46.1 63.3 70.1 81.7 109.7
Dividend per share(Rs) 8.0 10.0 13.0 14.0 16.3 21.9

Balance Sheet 2007A 2008A 2009A 2010E 2011E 20012E

Sources of Funds Loan book to grow at 24% CAGR
Equity 850 850 850 950 950 950 between FY10-12.
Reserves and Surplus 14,772 17,694 21,776 33,091 39,034 47,019
Networth 15,622 18,544 22,626 34,041 39,984 47,969
Borrowings 163,326 203,444 254,217 337,970 439,361 544,807
Total Sources of funds 178,948 221,988 276,843 372,011 479,345 592,776
Application of Funds
Loan Book 175,634 219,364 276,793 367,984 478,379 593,190
Investments 2,209 7,936 11,485 15,268 19,849 24,612
Fixed Assets 299 297 438 438 438 438
Other Assets 858 1,021 992 992 992 992
Net workking Capital -54 -6,632 -12,867 -12,674 -20,316 -26,459
Total Application of funds 178,948 221,988 276,843 372,011 479,345 592,776

Operating Metrics 2007A 2008A 2009A 2010E 2011E 20012E

Spread analysis
Yield on Loans 9.2% 10.3% 11.1% 10.1% 10.4% 10.7%
Cost of funds 7.4% 8.1% 8.8% 8.1% 8.3% 8.5%
NIM to expand by ~20 bps between
Spread 1.9% 2.2% 2.3% 1.9% 2.0% 2.1%
FY10-12.
NIM 2.5% 2.8% 3.0% 2.6% 2.7% 2.8%
Efficiency ratios (%)
Operating Cost/Income 21% 19% 17% 16% 16% 14%
Credit Quality (%)
Gross NPAs 2.60% 1.70% 1.10% 1.10% 1.10% 1.10%
Net NPAs 1.3% 0.6% 0.2% 0.5% 0.5% 0.5%
Provisioning Coverage 51.2% 62.2% 80.9% 55.0% 55.0% 55.0% Slight increase in gross NPAs between
Capital ratios FY09-12.
Debt to Equity 10.5 11.0 11.2 9.9 11.0 11.4
Capital Adequacy Ratio 13.0% 13.3% 13.5% 14.6% 13.5% 13.2%
Return ratios
ROA 1.7% 1.9% 2.1% 1.9% 1.8% 1.9%
ROE 19.3% 22.9% 26.1% 22.3% 21.0% 23.7%
Valuation ratios
P/E 27.4 19.7 14.3 12.9 11.1 8.3
P/BV 4.9 4.2 3.4 2.5 2.2 1.8
Dividend Yield 0.9% 1.1% 1.4% 1.5% 1.8% 2.4%

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