IndusInd Bank’s rural bet

This values BhaFin at Rs 1,118 (11.5% premium over CMP), implying FY19E BV of 3.6x, entailing dilution of 14.9% for IIB. (Image: PTI)

IndusInd Bank (IIB) and Bharat Financial (BhaFin) are finally set to merge (subject to RBI, CCI, SEBI and NCLT approvals). IIB board has agreed on swap ratio of 0.639:1 (639 shares of IIB for 1,000 BhaFin shares). This values BhaFin at Rs 1,118 (11.5% premium over CMP), implying FY19E BV of 3.6x, entailing dilution of 14.9% for IIB. The deal is an aggressive and determined bet in line with the bank’s Planning Cycle-IV objective of inclusive banking financing the livelihood. It also specifically chose BhaFin given its dominant leadership & domain expertise in the rural segment and BhaFin’s fully validated business model (BhaFin acted as its Business Correspondent for close to 5 years). Financially, this merger will be synergistic, capital accretive, boost return profile and provide cross-selling opportunities over the long term.

However, this segment, which will constitute 10% of combined portfolio, is volatile in nature (validated by historical anecdotes) and synergies will take some time to accrue. This may cap the near term upside. Having said that, IIB has proven track record of successful execution (organic & inorganic, reflected in vehicle financing & gems/jewellery portfolios). Maintain Buy.

Synergistic benefits aplenty…
We believe, IIB will reap significant synergistic benefits from the prospective merger wherein: (i) it will gain access to BhaFin’s granular rural portfolio with strong local knowhow; (ii) a fully PSL compliant book could provide fee income generating opportunities via PSLCs; and (iii) offer higher cross-selling opportunities (6.8 million customers). For BhaFin, the pact entails: (i) elimination of political risks and pave way for better leverage; (ii) no cap on lending rates; and (iii) funding cost benefits. Further, the merger’s timing is favourable as: (i) BhaFin has front-loaded provisions over the past couple of quarters; (ii) for the sector as well, NPLs have stabilised and repayments have normalised; and (iii) growth in the MFI segment is perking up.

… merged entity to be EPS and return accretive
As per the proposed structure, the business will be amalgamated with IIB, with asset and liability consumed at the bank level. Operating infrastructure (including people, branches, processes, systems) will continue in a wholly-owned subsidiary format as a business correspondent (IIB believes this has higher chance of regulatory approval given past experience). This will be followed by preferential issue to promoters (allowing them to maintain 15% stake), entailing 2.2% dilution.

In our view, synergistic benefits will boost IIB’s earnings (RoA to cross 2%, much better than most peers). We expect: (i) NIM to rise as funding cost benefit of >3% will flow for BhaFin’s borrowings and scale up of low cost deposits; (ii) better fee income (however, we have not baked that in our near-term estimates as we expect this to happen over time); and (iii) cost to income to come off significantly for BhaFins’ operations.

The merger will be immediately 2-3% EPS accretive in FY19 and adversely impact book value by 2-3%, though promoter infusion will provide a boost of 6% instead in FY19. We maintain ‘BUY/SP’ on IIB (TP of Rs 1,920) and BhaFin. We also expect this deal to have rub-off effect on valuations of other rural players (MFI/SFBs).