Bharat Financial-IndusInd Bank Merger Could Be A Win-Win For Both, Say Analysts

The speculated merger between IndusInd Bank Ltd. and Bharat Financial Inclusion Ltd. would, if concluded, be positive for both companies, said analysts tracking the companies in a series of research reports released since the news was first reported. On February 2, ET Now said that IndusInd Bank was considering an all-stock acquisition of the microfinance lender, formerly known as SKS Microfinance. Both companies have declined to comment on the speculation.

In the event of a merger, IndusInd Bank will benefit from the access to Bharat Financial Inclusion’s rural client base, which will give the bank an opportunity to cross-sell its products. Bharat Financial, in turn, will benefit from a lower cost of funds and no cap on lending rates. Bharat Financial Inclusion had applied for a small finance bank licence but was denied one by the Reserve Bank of India when the in-principle approvals were granted in 2015.

Does The Merger Make Sense For IndusInd Bank?

A merger with Bharat Financial will allow IndusInd Bank to tap the rural market for deposits while also allowing them to expand the customer base for their 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.

Besides microfinance is a high-RoA (return on assets) segment with strong growth opportunities, wrote Seshadri Sen, an analyst at JP Morgan in a report dated 2 February 2017.

A potential merger would be RoA-accretive as even under a banking setup, Bharat Financial Inclusion’s RoA would be significantly higher than IndusInd Bank, said Sumeet Kariwala, an analyst at Morgan Stanley. “We think a deal, if confirmed, would be a net positive for IndusInd Bank’s fundamentals. An increasing share of MFI loans would be materially accretive for return ratios, ” he wrote in his note dated 3 February 2017.

According to Adarsh Parasrampuria, an analyst at Nomura, IndusInd Bank has been positive on the microfinance business and has said that it plans to ramp it up from current Rs 3,000 crore to Rs 10,000 crore in 3-4 years. According to Parasrampuria’s calculations, the share of microfinance loans would triple to 9 percent of the merged entity’s loan book if a merger took place.

What’s In It For Bharat Financial?

A possible merger with a bank will lead to a regulatory shift for Bharat Financial Inclusion. On the upside, the firm would be able to access low-cost deposits, and there would be no cap on lending rates. On the downside, it would need to maintain cash reserve ratio (CRR) and Statutory Liquidity Ratio (SLR) to meet regulatory requirements. However, Bharat Financials maintains 20-25 percent of its balance sheet in liquid assets, which would help it meet these requirements.

The return on equity (RoE) for Bharat Financial Inclusion will be higher under a banking setup, said Alpesh Mehta, an analyst at Motilal Oswal in a report dated February 7. He added that the merger would remove political risk for the microfinance lender.

Bharat Financial Inclusion (erstwhile SKS Microfinance) has been keen to make the switch from a nonbanking financial company (NBFC) to a bank. However, it failed to get a small finance bank licence from the RBI in 2015. Ujjivan Financial Services Pvt. Ltd. and Equitas Holdings Ltd. were among the 10 entities who were granted the licence.

For microfinance firms that give tiny loans to low-income earners, the key incentive for converting into a small finance bank is the access they gain to deposits. They will also be able to offer a wider range of loan products to customers.

IndusInd Bank did not respond to an email from BloombergQuint.

In response to an email from BloombergQuint, a spokesperson for Bharat Financial Inclusion said the company will not comment on speculation of a possible merger with IndusInd Bank. When asked whether the company would apply for a banking licence on its own, the spokesperson said that it is yet to take a call.

The Existing Relationship

This is not the first time that speculation of a merger between IndusInd Bank and Bharat Financial has cropped up. The two companies already have a tie-up in place which has prompted talk of a wider partnership.

Bharat Financial acts as a business correspondent for IndusInd Bank for its 100 branches in Bidar, Karnataka. Through this partnership, IndusInd meets Rs 700 crore of its priority sector lending targets. Bharat Financial also offers its borrowers micro recurring deposits through the partnership with IndusInd bank.

When asked whether this partnership would be extended, the spokesperson for Bharat Financial said such conversations are taking place in the normal course of business.

At the current market price, IndusInd Bank (Rs 1,338 as of the close on Friday) trades at the financial year 2017-18 price to book value (P/BV) ratio of 3.46 based on Bloomberg consensus estimates. Bharat Financial Inclusion (Rs 868 as of the close on Friday) trades at 3.47 times FY18 P/BV ratio.

IndusInd Bank’s RoE stood at 16.14 percent in FY16 while that of Bharat Financial Inclusion was higher at 24.94 percent, according to Bloomberg.

Morgan Stanley’s Sumeet Kariwala, in his note to clients on 3 February 2017, wrote that he estimates around 15-18 percent dilution assuming share swap at 0-20 percent premium. Earnings per share impact is seen at negative 0.9 percent to 1.7 percent.