Event update: Bank of Baroda (Downgrade to Neutral) - Merger will dilute BoB’s franchise

The government has announced the merger of BoB, Vijaya and Dena Bank. We had always believed that at least one M&A in state banks would happen before the next general elections. BoB has been given one strong and one weak bank – best of the worst – other combinations would have been more negative for BoB. Vijaya Bank is amongst the stronger state owned banks with loans equal to 29% of BoB’s. Dena Bank is amongst the weakest state bank. It is not only under PCA but it is also the only bank where RBI has imposed complete lending restrictions. Its net NPAs adjusted for tax are higher than its book value. Size wise, Dena’s loans are 15% of BoB’s.

No material change in numbers: Proforma merged numbers indicate that the merger does not change financial parameters materially for BoB. Rather consolidated BoB gains marginally on CET1 (due to higher CAR) of Vijaya and on CASA (due to higher CASA of Dena). The net NPA ratio also moves up only marginally to 5.7% from standalone 5.4%.

However integration issues, productivity and post merger clean up are key negatives: We believe integrating three banks with three different cultures is not going to be an easy task. Also, BoB’s NPL recognition policies are stricter than other banks. As such we believe BoB will recognize more NPLs specially from Dena’s  books post-merger.  Dena has a large MSME portfolio at 15% of loans  with a high NPL ratio of 20% plus. Every merger of state owned banks in the past has led to a significantly higher recognition of NPLs post-merger. It happened for the recent merger of SBI with its associates too. The merger also exposes BoB to higher bond risks as Dena’s modified duration is 5 years and Vijaya’s is 2.6 years versus BoB’s 1.33.

BoB’s new business strategy will receive a setback: BoB had just started reaping the financial benefits of its new business strategy which the current CEO started implementing 2 years ago. As post-merger integration will be the key focus, this strategy will be derailed. Productivity of both Vijaya and Dena is lower than BoB’s in terms of loan and deposits per employee. 

Downgrade to Neutral: We believe BoB is in for a de-rating with today’s announcement. Integration issues and higher NPLs post merger are our key concerns. We downgrade our target multiple to 0.7x from 0.95x We revise down TP to Rs130 and downgrade rating to Neutral.