A woman signs a register to receive a loan during a meeting organized by SKS Microfinance Ltd. (Photographer: Adeel Halim/Bloomberg)

Bharat Financial Enters Into Exclusive Merger Talks With IndusInd Bank

Bharat Financial Inclusion Ltd., on Monday, informed the stock exchanges that it has entered into exclusive talks with IndusInd Bank Ltd. to explore a merger between the two. The formal intimation of the merger talks puts an end to months of speculation of a deal between the two entities. The deal will likely value the microfinance provider at about $2.2 billion, reported Bloomberg News.

The deal will help IndusInd Bank scale up its microfinance book, which will account for about 8 percent of the total book on closure of the deal, Romesh Sobti, chief executive officer (CEO) of IndusInd Bank told BloombergQuint on the phone. The deal will become accretive on day one because the margins will improve dramatically, said Sobti while explaining that along with the assets that IndusInd Bank gets immediately, the deal also allows the bank to strengthen the rural liabilities franchise and cross-sell other products.

We understand this business very well. We have been doing it for a long time. In fact, even in ABN Amro we used to do microfinance and we had almost a million customers. These are livelihood loans. It is part of our mission to do this and also it’s a viable business which has done well over a period of 20 years apart from a few hiccups here and there.
Romesh Sobti, CEO, IndusInd Bank

Bharat Financial's loan book currently stands at Rs 9,631 crore while that of IndusInd Bank stands at Rs 1,16,407 crore. Over the past few quarters, Bharat Financial has seen its bad loans rise due to disruption caused by the announcement of demonetisation in November 2016. MR Rao, managing director and chief executive office of the microfinance firm told BloombergQuint that asset quality indicators have stabilized and collection ratios are back above 99 percent.

Final contours of the deal should .be worked out in the next couple of weeks, said Rao while adding that the management of Bharat Financial would remain involved in on-ground microfinance operations of the merged entity.

While we will be a part of this merged entity, operations will continue to be run by the current management and employees. Essentially, I think we will be a part of the larger organisation without the scheme of things being changed at the operating level at all.
MR Rao, MD & CEO, Bharat Financial
Bharat Financial Enters Into Exclusive Merger Talks With IndusInd Bank

What It Means For IndusInd Bank

A merger with Bharat Financial will allow IndusInd Bank to tap the rural market for deposits while also allowing the bank to expand the customer base for its loan products. Bharat Financial’s strong sales force network would be an added benefit.

An additional advantage could come in the form of an increased proportion of priority sector loans (PSL). IndusInd could use the excess PSL portfolio to earn fee via the sale of PSL certificates, which is now permitted.

The business, however, will bring with it volatility inherent in the rural finance business. This is evident from the hit that the microfinance sector took in the aftermath of demonetisation.

Demonetisation has brought weak spots in the microfinance sector to the fore, said rating agency India Ratings & Research in a report dated June 15, which warned that companies in this business could face significant credit costs and equity erosion this year. Inherent weaknesses in the microfinance sector, such as excess leverage among borrowers, have been exposed due to demonetisation and political interference in the rural economy, said the rating agency.

However, Alok Prasad, former chief executive officer of Microfinance Institutions Network, said for a small to mid-sized bank there are few segments of growth left.

For the small to mid-sized banks, there is not much point in trying to compete for the business of large corporates...Even in the high end retail business there is intense competition. The segments which are relatively under- penetrated and offer a strong opportunity are in the lower end of the market.
Alok Prasad, Former Chief Executive Officer, Microfinance Institutions Network

A Chequered History

Bharat Financial, a name that was adopted by the firm in 2016, has had a chequered history. The firm founded by Vikram Akula in 1997 was the first to take the approach that microfinance needs to be a for-profit activity to really flourish in India.

In July 2010, SKS Microfinance was listed on the Bombay Stock Exchange. Soon after, in late 2010, a crisis broke out in the microfinance sector in Andhra Pradesh, where SKS’ operations were concentrated. The crisis followed an Ordinance by the state government which restricted micro lending in the state and clamped down on loan recovery practices. Microfinance firms in Andhra Pradesh, including SKS Microfinance, were crippled. The industry settled after regulation of microfinance was shifted to the hands of the RBI.

The crisis for SKS, however, did not end. In November 2011, founder Akula was forced out of the company following a high stakes battle on the future strategy of the company with the board. After Akula’s exit, the company and its new management tried to de-risk the company’s balance sheet. It also applied for a licence to convert itself into a small finance bank but was denied one.

The deal with IndusInd Bank, which has been in the works for some time now, will bring the independent history of the firm to a close.

As of now, for a microfinance institution in India I see only four options, reinvent yourself and your business model, get into a dedicated partnership framework with a bank, get acquired by a bank, or become irrelevant. The traditional  mono-line business of ‘Joint Lenders Group’ lending is yesterday’s model, not tomorrow’s.
Alok Prasad, Former Chief Executive Officer, Microfinance Institutions Network

The Analysts’ Take

Nidhesh Jain, research analyst at Investec told BloombergQuint that the deal will be positive for IndusInd Bank. The merger will be accretive for IndusInd Bank in terms of Return on Assets (RoA) and Return on Equity (RoE), said Jain whie adding that the bank will get a book with a RoA of close to 4 percent.

Jain added that Bharat Financial has cleaned up its books over the last few quarters, which suggests that there won’t be any asset quality surprises in store for IndusInd Bank.

While the swap ratio is yet to be announced, Jain said the ratio could be between 0.65-0.7 times.

Digant Haria, assistant vice president for equity research at Antique Stock Broking expects a swap ratio of 0.63 times. The merger will not be dilutive for shareholders of IndusInd Bank since both companies are trading at similar valuations, he said. It’s a win-win situation for both the companies, said Haria while adding that IndusInd Bank may be a bigger beneficiary.

Bharat Financial Enters Into Exclusive Merger Talks With IndusInd Bank

Shares of Bharat Financial Inclusion, earlier known as SKS Microfinance, swung between gains and losses. The stock rose as much as 2.17 percent to Rs 955.95 apiece after retreating 1.65 percent in opening early trade. Meanwhile, IndusInd Bank rose as much as 1.68 percent to Rs 1,724, a new lifetime high for the stock.