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MOSL: FINANCIALS- Mega consolidation announced, but near term challenges remain; Government infuses INR550b in 10 PSBs

FINANCIALS: Mega consolidation announced, but near term challenges remain; Government infuses INR550b in 10 PSBs

** The Finance Minister has announced mega merger of six public sector banks (PSBs) with four better performing anchor banks on 30th Aug’19. The merger will see the number of PSBs reduce to 12 from 18 currently.

** The objective of the merger is to (a) enhance the flow of credit to the economy and support the government’s ambition of making India a USD5t economy; (b) build strong institutions that will enhance productivity and improve efficiency, and, (c) create a robust banking system with strong national/global presence.

** In deciding the combinations of the mergers, the government has picked relatively larger banks to absorb weaker banks; also banks with similar CBS platforms was considered to enable smooth IT integration. To support such a huge consolidation, the government is allocating higher capital to the anchor banks to strengthen their capital ratios and smoothly complete the integration process without sacrificing growth.

** We believe the consolidation of PSBs to be a positive move from a long-term perspective as it will help improve their competitiveness; however, this will come with its own set of challenges in the near term related to credit growth, integration issues, etc. We expect the asset quality of anchor banks like Indian Bank to deteriorate due to its merger with Allahabad Bank. Also, the integration process with a bank that is nearly of a similar size will entail longer time for normalization of business operations and earnings revival.

** Thus, we downgrade INBK to ‘Neutral’ from ‘Buy’ and revise our target price to INR200 (0.6x FY21 ABV). While the timeline for the process is not yet announced, we expect the merger process to get completed over the next 6-9 months. We retain our PT and ratings on other PSBs and await clarity on swap ratios and potential asset quality cleansing that may happen prior to the merger taking effect.