Message for weak banks from Kotak-ING Vysya: Merge or lose out on market share

The Kotak-ING Vysya Bank merger is a done deal now with the shareholders of both lenders approving the plan in separate extraordinary general meetings held on Wednesday.  This was despite resentment from a section of the shareholders of ING Vysya regarding the merger swap ratio and the future prospects of employees of the target bank in the post-merged entity. The merger, executed through an all-stock deal with a swap rate of 725:1000 (725 Kotak shares for every 1000 shares held by ING Vysya shareholders), will make Kotak the fourth largest private bank with combined assets of Rs1,60,012 crore (replacing Yes Bank, which had total assets of Rs1,16,231 crore as of September) and total branches of 1,214. It is a win-win deal for both banks. The combined entity will have total deposits of Rs 1,12,755 crore and advances of Rs 1,00,506 crore. Whichever way one looks at it, the deal will be a win-win situation for both Kotak and ING Vysya. For Kotak, which has long been looking for a target to acquire, an acquisition will change its image as a small niche bank and become one of the private big ones, besides giving access to cheaper deposits of ING Vysya and its strong franchise in the southern states. For ING too the merger has come as an exit opportunity. The group had increased the stake in the Bangalore-based Vysya Bank in 2002 to 44 percent. As per the terms of the deal, ING group will have a lock-in period of one year. Pre-merger, the ING group has 42.73 percent in the bank. The stake was owned by ING Mauritius Holdings and ING Mauritius Investments. In the new entity, the ING group will be the second largest shareholder with a stake holding of 6.5 percent The deal works in Uday Kotak’s favour too as it will help bring down the promoter stake in the bank. The RBI has been piling up pressure on a host of private banks to bring down the promoter holding in phases to about 10 percent. These banks include DCB Bank Ltd (promoter Aga Khan Fund which holds 18.42 percent), Catholic Syrian Bank (single largest shareholder Sura Chansrichawla holds over 10 percent and IndusInd Bank (Hindujas together hold 15.13 percent). Given that Uday Kotak and family, promoters of Kotak Mahindra Bank, currently hold 40.07 percent, post merger, on the expanded share base, the promoters’ holding in the resultant entity will come down to 34 percent. This is something critical for Kotak given that there is an RBI deadline for Kotak’s promoters to bring down promoter stake to 30 percent by December 2016 and 20 percent by March 2018. Kotak has been trying to bring down his stake in the bank over years. In May this year, Kotak had sold 3.24 percent. On the other hand, ING too has been trying to exit the bank. It had increased the stake in the Bangalore-based Vysya Bank in 2002 to 44 percent. As per the terms of the deal, the ING group will have a lock-in period of one year. The Kotak-ING merger is different from some of the acquisitions among private banks happened in the past such as the ICICI-Bank of Rajasthan and HDFC Bank-Centurion bank merger, since in this case both banks are financially sound. ING has gross non-performing assets (NPAs) of less than 2 percent and has a capital adequacy ratio of over 14 percent. Kotak too have maintained its gross NPA levels consistently at less than 2 percent. The remaining smaller banks in the private sector could take a lesson or two from the Kotak-ING Vysya deal for the following reasons: One, it makes immense sense for those banks, which aren’t quite doing well, to consolidate and become strong entities especially in the face of expected tough competition when the new banks enter the industry and significant capital requirements arise. These lenders will have to raise considerable amount of capital to meet the Basel-III requirements (by March 2019) and if stress on their books worsen further. It may not be easy for weaker banks to attract investments to stay afloat. The ability to raise capital and seek fresh investments will be critical for their survival. To be sure, the stress asset scenario of these lenders isn’t alarming at this stage except in the case of Dhanlaxmi Bank. Dhanlaxmi bank has seen stressed assets rising significantly on its books in recent years. As of end September, its gross non-performing assets stood at 7.27 percent. See table below.  Two, when the differentiated banking regime kicks in, it would be difficult for smaller banks to rival their peers that focus on specific segments and deep-pockets. For instance, the proposed small finance banks, by definition, are permitted to operate only among low-income customers and small to medium-sized companies to push financial inclusion. This will put up stiff completion for existing banks in those segments. Same can be the case with banks, which are solely into infrastructure financing or funding of SMEs. Smaller banks will then be forced to find their niche areas and prove their strength to stay relevant, besides managing to attract sufficient investments with clean balance sheets. If not, they will have to eventually merge with stronger banks. Also, these banks can fetch good valuations when their balance sheets are still in good shape. The Kotak-ING Vysya merger, in that sense, is a perfect case they could study closely. (Data support from Kishor Kadam)