The four new bank mergers bring both opportunities and threats to the institutions involved. Some are better equipped to handle the fallout than others. Here's a quick run-down of the challenges involved for each of them.
Punjab National Bank (PNB)
For PNB, the merger comes at a time when its balance sheet is under stress. The merged entity will restore its status as the country's second-largest PSB and with better execution, there could be cost synergies through Oriental Bank of Commerce (OBC) and better geographic spread through United Bank of India (UBI). Wide presence, technology platform synergies and geographic reach brought this grouping together.
PNB has a strong footprint in north India, and so does OBC, but UBI's presence in eastern markets will come in handy.
Liability franchise remains unaffected as OBC's weaker network gets offset by UBI's stronger franchise. That said, the merger isn't devoid of risks. The combined entity's gross and net NPAs at 13 and 6 per cent respectively as of FY19 are one of the highest among peers. Asset quality deteriorated for all three banks owing to rising corporate slippages, while retirement-related costs could further increase provisions. The situation can stop worsening provided recoveries rise from NCLT cases.
For the combined entity, deposit and loan growth remained flat in the past few years, particularly for OBC and UBI, which were under the PCA framework. Cost of funds will remain elevated due to high retail deposits rates. UBI's strong presence in eastern and northeastern markets meant a traditionally higher market share in deposits, but this could be affected by a change in brand.
However, retail loans grew 500 bps to 21 per cent as of June 2019 and could drive incremental loans growth along with SME loans. While retail asset quality is better -- marginally weaker for PNB -- stress is building up in the agriculture sector and needs attention.
Indian Bank
Indian Bank is smaller in size and has lower market capitalization than Allahabad Bank, but has a strong balance sheet, thus making the merger an uneasy task. Indian Bank's stronghold is in the south and will take over Allahabad Bank, which dominates eastern markets. The CBS platform is the only common element that bought them together.
Indian Bank's shareholders will be hit near-term as the merger puts both growth and profitability at risk. Nearly all operating ratios may deteriorate, while its earnings and balance sheet will likely suffer. In contrast, Allahabad Bank shareholders will be winners. Though it has a stronger deposit profile, because the bank was under PCA, its business was shrunk, which the merger will likely improve.
According to Kotak Research, chances are both banks could end up operating as distinct entities in the medium-term. That's because their growth in terms of loan books and deposits has been quite different. While Allahabad Bank's loan book was flat since FY14, Indian Bank's grew at a modest 8 per cent. As for deposits, while Indian Bank historically had been a weakling, Allahabad Bank has a stronghold, but now runs the risk of losing its share to competitors like Bandhan Bank in West Bengal, which accounts for nearly 25 per cent of Allahabad Bank's deposits. So in the medium-term, deposits for the merged entity will likely grow at a sombre 7 per cent.
The combined balance sheet would result in the share of corporate loans increasing for Indian Bank to 48 from 42 per cent now. It's because corporate loans account for 55 per cent of Allahabad Bank's loan book. The combined balance sheet will have a CASA ratio of 40 per cent -- plus for Indian Bank's 35 per cent, but minus for Allahabad Bank, which has 50 per cent.
When the merger becomes effective in FY21, asset quality will get better. It fell sharply for Allahabad Bank due to a rise in corporate slippages with gross NPAs peaking to 18 per cent, while Indian Bank reported one of the best impaired loan books across PSBs. Allahabad Bank also saw massive capital infusion to improve its provision coverage ratio as resolutions have not been easy given the nature of impaired loans.
Union Bank of India
Its proposed merger with Andhra Bank and Corporation Bank won't be easy, but positions them better geographically to evolve as the fifth largest PSB. Andhra Bank's strong position in Andhra Pradesh and Telangana adds to Corporation Bank's position in Karnataka. Together, they complement Union Bank's presence in Maharashtra.
Size will be a challenge as the other two banks are similar to the anchor bank, which also means Union Bank shareholders may see book value dilution as the deal unfolds.
What brought them together? Scale, cost synergies due to network overlaps, revenue gains through JVs and subsidiaries, plus common technology platform were key elements. But unlike others, caution needs to be exercised with regard to the integration of human resources.
Analysts don't expect a surge in credit or deposit growth in the medium-term. Return on equity will be driven by improvement in margins and drop in credit costs. Asset quality deteriorated in all three banks, again due to corporate slippages. Gross NPAs soared to 15 per cent for the merged entity. But with better recoveries, gross NPAs will likely settle at 3 per cent by FY22, while slippages will decline to 3 per cent, as per Kotak estimates.
Loan growth was muted as all three banks grappled with similar asset quality concerns. Corporation Bank was under PCA with a restriction on incremental lending. Besides, higher write-offs from corporate accounts or sale of assets to ARCs curbed loan growth in all three banks. Retail loans, however, delivered strong growth with their share increasing 300 bps since FY17 to 20 per cent as of June 2019. But in the next 3-5 years, it may remain at 8-9 per cent. Deposit growth too was flat, but could grow by 6-8 per cent given the wider geographic reach of the combined entity.
Canara Bank
The merger with Syndicate Bank, which too has a dominant presence in Karnataka -- the home state from which each bank generates 25 per cent of their business -- can improve the combined entity's Return on Equity (RoE) provided it can yield cost synergies, reduce credit costs and prevent operating expenses from blowing up.
Both banks have a comfortable capital position and similar asset quality ratios, leading to minimal deterioration in the combined balance sheet. Interestingly, the credit-deposit ratio of 75 per cent provides enough cushion for growth. Credit and deposit growth will likely pick up in the medium-term as asset quality improves and capital position remains comfortable.
High corporate slippages, which peaked to 7.2 per cent during FY18, dragged asset quality down for both banks, but saw an improvement as bad loans fell and recoveries increased. Kotak Research expects slippages to decline to 2 per cent and gross NPAs to 4.4 per cent by FY22 from 9.2 per cent now.
While the corporate loan book remained flat, retail loans grew 200 bps since FY17 to 18 per cent as of June 2019. Overall, the merged entity's loan growth will be about 11 per cent in the next few years, but will be driven by retail and SME loans.
Deposit growth too was flat, but is expected to touch 10 per cent in the medium term, while CASA ratio will likely decline to 28 per cent by FY22 from 30 per cent now.
A slowdown in business expansion and drop in incremental pension and gratuity liabilities could improve cost-to-income ratio in the next two years, but incremental provision for wage revision needs to be factored in. So also the potential increase in costs due to integration expenses.