Buy rating on State Bank of India; Decks cleared for merger of SBI with its cubs

By: | Published: May 23, 2016 7:36 AM

While creating a behemoth, the move would entail higher employee costs, besides posing other challenges

Merger of five associate banks (ABs/cubs) with State Bank of India (SBIN) is now a certainty although the time horizon is not clear. In this context, we do a deep-dive of financial performance & asset quality of the cubs—basis of the eventual swap ratio for merger. While cubs could rally as they re-rate to parent’s multiple, the impact of higher employee cost (pension/gratuity difference between cubs & parents) should not be more than 2-3% of consol equity. SBIN reports 27 May.

Merger talk and implications: SBIN and its AB’s board has provided an in-principle approval to proceed for a merger creating a behemoth with a quarter of assets. SBI will also usurp the two-year old Bharatiya Mahila Bank (FY15: Profit R290m, Assets R185 bn). AB merger would entail higher employee costs given the difference in pension/gratuity calculation between ABs and SBIN— approx. R7 bn per bank or in aggregate about 2.2% of consol equity. The greater challenges are in employee redundancies, HR/Operations, Branch and ATM rationalisation, etc. Technology and accounting are similar.

We see a potential of risk-arbitrage between the listed-cubs—State Bank of Bikaner & Jaipur (SBBJ IN, Rs 507, NC), State Bank of Mysore (SBMS IN, Rs 424, NC) and State Bank of Travancore (SBTR IN, Rs 403, NC) —and SBIN.
We see this as the first of many reports on which ink will be spilt as we proceed closer to the eventual merger. To begin that journey, we do a deep-dive of the annual performance of the five associate banks.

Valuation/risks

SBIN trades at 1.3x consol trailing BV (Mar 16) and 5.1x EPS (12 m to Mar 17e). We value SBIN at R280, implying P/B & P/E multiples of 1.4x (Mar 17e) and 6.4x (12m to Mar 18e). This compares with 10-year averages of 1.5x and 9x, respectively. Key risks: Weak asset quality, weak loan growth.

Cubs—important for growth & asset quality: SBIN’s associate banks (five smaller banks or cubs) aggregate to ~26% of the standalone loan. In terms of total assets, it’s about 20% of consol assets. However, over time their contribution to the consol profits has come off to ~10% in FY16e versus >30% in FY11. However, the cubs’ contribution in slippages as compared to the standalone bank’s slippage has been significantly higher in the last two years. The net profit and ROE profile of the cubs has not diverged materially from the parent, except in the December 2015 quarter.

Growth consolidation to improve slippages over time: As we had highlighted in an earlier report, the growth consolidation at the cubs continued in FY16 as well, with aggregate loan growth coming in at 3.1% against an industry average of 10.7%+. We understand the cubs had an explicit direction from the parent bank to limit risk-weight asset (RWA) growth to 12% in FY16. While slippages have increased, we expect the trend to reverse over time.

Asset Quality—accelerated recognition: The key takeaways from the full year asset quality data of the cubs are as follows —
* Slippages are elevated this year, especially in Q4—a potential indicator that SBIN too could recognise larger NPAs
* Aggregate stressed asset has come off to 9.3% from 11%, implying accelerated recognition through classification of restructured accounts as NPA
* Most SDR accounts are either restructured or have already
become NPA
* The only possible underreporting could come from 5/25
refinancing on which we have no data points

It is possible that conversion of restructured DISCOM loans to bonds have also aided the fall in the total stressed assets, although we cannot ascertain the impact of this at present.

Restructured assets have declined: Restructured assets for cubs in aggregate declined to 5.8% in FY16 versus 8.4% in FY15, aided by lower fresh restructuring post removal of forbearance on asset quality from April 2016, and higher slippages of restructured assets to NPA (12.2% in FY16 vs. 11.3% in FY15). Conversion of DISCOM loans to bonds may have played a role in this too.

Graph 4

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