>IDFC (CITI)

Sell: 1Q10 Results – Rating Downgrade Eclipses a Good Quarter

■ Profits up 26%, led by fees and margin expansion — IDFC's 1Q10 profits were in-line with estimates (up 26% yoy) driven by: a) 40bps NIM expansion to about 350bps, a historically high level, aided by low wholesale borrowing costs; and b) pickup in fee income levels. Fundamentally, a strong returns quarter (but with no growth) and overshadowed by the rating downgrade by Crisil.

■ Credit downgrades IDFC to AA+ (stable) from AAA — This was an overhang (Crisil-key rating agency, had forewarned), appears harsh and IDFC does have two other AAA ratings, but will probably hurt. It could hurt funding costs (spreads have widened 10-15bps), in cases access to some investors and possibly market standing. While the rating downgrade overhang is now possibly over (and in the price), it could pressure IDFC’s wholesale funded business model, particularly in a rising rate/tight liquidity environment (which is a risk).

■ The quarter itself was a strong one — 1Q10 was fundamentally a strong quarter (one of IDFC’s best) with higher margins, strong fee growth and stable asset quality. Earnings mix has also improved – greater annuity fees, reduced dependence on risk business and sub 5x leverage. The only offset – no meaningful growth, which management suggests should be addressed next quarter on (suggests industry level growth – we believe could lag).

■ Leverage to liquidity, capital markets is showing — IDFC's wholesale funding, asset management and capital market linked revenue stream shows through in this quarter's strong performance – we expect it to remain a key stock driver over the near term (as also the key risk). Maintain Sell (3M).

To see full report: IDFC