Clouded outlook suggests waiting on IDFC First Bank despite sharp correction

ET Intelligence Group: A sharp fall in IDFC First Bank‘s stock price on Monday, following the discovery of a fraud at one of its branches, has significantly dented its valuation multiple. While the correction may tempt value-seeking investors, caution must be observed not to fall in a valuation trap. Past examples such as RBL Bank and IndusInd Bank where a financial institution faced similar situations show that the affected lenders struggled to claw back the lost ground and regain higher valuation multiples. In addition, such instances may also affect reputation and depositors’ trust.

In the case of IDFC First Bank, the price-book (P/B) multiple inched up gradually to nearly two over the past three years from around one, aided by improving asset quality. In addition, the mid-tier bank also took efforts to revive its net interest margin to around 6% from under 2% seven years ago by shifting its focus on consumer lending and reducing corporate exposure. This makeover has attracted value investors over the past few years, supporting the stock price. The stock hit a 52-week high of 87 in the first week of January and continued to trade closer to this level in subsequent weeks.

This however changed on Monday when the stock crashed by 16% to ’70 from the previous session’s close. Monday’s closing price was nearly 20% lower than the 52-week high level. The bank’s P/B has shrunk to 1.3, the lowest in over three years. However, investors need to wait before making fresh purchases as the stock is likely to remain under pressure given the possible impact of the latest fraud.

IDFC Bank informed stock exchanges on Saturday about fraudulent activities in accounts linked to the state government at its Chandigarh branch, amounting to ‘590 crore. The Haryana government has de-empanelled IDFC First Bank and AU Small Finance Bank from parking of bank deposits. Outflow of government funds may put pressure on current account- savings account (CASA) of banks at a time when they are still facing slower growth in deposits. Sector experts say, a part of government deposits may move to public sector undertaking banks over the medium term. BSE PSU Bank index rose 1.4% outperforming Sensex’s 0.6% rise on Monday.
“This episode could prompt other states to reassess their comfort with smaller banks,” a banking analyst told ET. “For mid-sized and smaller lenders, the risk of losing state government business has clearly risen after this incident.”

IDFC First Bank has said that recoveries will help cushion the financial impact of the fraud. Analysts, however, caution that recoveries in such cases are typically slow. “If any third party chooses to pursue litigation, the recovery process could be significantly delayed,” the analyst said.
As per the Reserve Bank of India’s circular ‘Provisioning pertaining to Fraud Accounts’, banks are required to provide for the entire amount involved in the fraud. This provisioning can be done immediately upon classification or spread over a period of upto four quarters. For IDFC Bank, if the entire amount is provided in a single quarter, the bank may be forced to report a net loss given that it reported a profit of ‘503 crore in the December quarter.