MOSL: INDUSIND BANK (Under Review)-IIB+BAHFIN = Most profitable universal bank-BAFIN-Removes political and regulatory risk

​INDUSIND BANK: IIB+BAHFIN = Most profitable universal bank; BAFIN: Removes political and regulatory risk; scale benefits to accelerate

(IIB IN, Mkt Cap USD16.5b, CMP INR1769, Under Review)

After months of speculations, IndusInd Bank (IIB) and Bharat Financial Inclusion (BHAFIN) have announced the signing of an exclusivity agreement to explore the possibility of a merger/partnership. As highlighted in our previous report, the merger can prove to be a win-win for both entities, helping a) IIB to consolidate its position as the most profitable universal bank in India, with sustainable RoA of 2%+ and b) BHAFIN to remove the political/regulatory overhang, led by balance sheet diversification. Besides, the pros related to the merger outpace the cons, in our view. While we remain positive on the merger, the rich valuations and the pending clarity on the swap ratio/regulator view prompt us to put IIB’s rating/target price under review.

Transition toward a sustainable 2%+ RoA bank

The key benefits to IIB from the merger include creation of a diversified and granular retail loan book, improvement in RoAs (we estimate ~20bp accretion without merger synergies), a strong PSL book (generating opportunities for fee income via PSLC), cross-sell opportunities, strong knowledge of the local economy, and scale benefits from BHAFIN with a customer base of 5.2m (which can be used to scale up the deposit base further). PPoP to average assets is ~6% for BHAFIN and ~3.5% for IIB. Furthermore, capitalization of BHAFIN is very high, with a CAR of ~32% (leverage of just ~4.6x).

BHAFIN – RoEs higher under banking set-up; removes political risk

Under a banking set-up, BHAFIN can generate higher RoEs due to a) elimination of the need to carry excess liquidity (negative carry), which is required in day-to-day operations and first loss margins for off-balance sheet, b) lower cost of funds (difference of ~400bp between IIB and BHAFIN; cost of funds to decline for BHAFIN by ~100bp post-merger), c) no cap on spreads, d) higher leverage (10x v/s 5x currently) and e) removal of political and regulatory overhang, helped by a diversified balance sheet. In our view, these benefits should more than compensate for the negative carry of CRR and SLR on the expanded balance sheet for IIB.