SBI: Big leap forward

On April 1, India’s largest bank — SBI — got bigger and widened its lead over its peers. Given the bank’s size and reach, post-merger, it is perhaps the best play on the recovery in the economy.

SBI merged its five associate banks — State Bank of Bikaner and Jaipur (SBBJ), State Bank of Hyderabad (SBH), State Bank of Mysore (SBM), State Bank of Patiala (SBP) and State Bank of Travancore (SBT) — and Bharatiya Mahila Bank (BMB) — with itself.

With this, the bank has leaped into the league of top 50 banks globally in terms of assets. It now boasts of a balance sheet size of ₹41 lakh crore, 277,000 employees, 500 million customers and more than 22,500 branches and 58,000 ATMs. The merged entity will have about one-fourth of the deposit and loan market in the country.

A merger this size, will no doubt entail integration cost and risks. Add to it, there would be an immediate increase in employee cost, as over 70,000 employees of associate banks come on board.

But rationalisation of various departments, reduction in other administrative expenses and branch rationalisation, will lead to cost savings, going ahead. Reports suggest ₹2500-2700 crore of total savings, accruing in the next two years. The bank has introduced a voluntary retirement scheme to shed excess human resources. The rationalisation of headcount, however, may not be smooth sailing, and could face some hurdles from employee unions.

Nonetheless, overall long-term benefits will outweigh near-term challenges and costs. The merger will bring in synergies by cutting overlap and leveraging on a wider reach and diversified employee base.

At the current price, the SBI stock trades at 1.3 times its standalone one-year forward adjusted book value. This is in line with its historical five-year average. However, past valuations may not be comparable. Also, for a bank this size, undertaking a merger of this scale, there is a lot more at play besides valuations.

The key things to watch out will be the consolidated picture on asset quality, as bad loans remain high for both the parent (SBI) and its associate banks.

With the merger, SBI has taken a leap forward and its consolidated assets are now about one-fourth of GDP. SBI’s market share has also moved up several notches from 17 per cent to 22 per cent. The second largest bank, HDFC Bank, has an asset base of about ₹8.2 lakh crore, just one-fifth of SBI now. Size is an important factor in India’s fragmented banking industry. But organic growth takes time.

Consolidation will be the way forward, given the changing banking landscape in terms of regulatory pressures, tightening capital standards and influx of new players.

SBI’s size will give it the wherewithal to raise resources with more ease and, importantly, at a lower cost, thus giving a fillip to earnings. As such, SBI has always been able to offer one of the best lending rates in the market; the merger will help the bank widen the gap with other leading banks.

While the merger will lead to long drawn benefits, near-term concerns persist. Sluggish loan growth, weak margins and dodgy asset quality are factors that continue to weigh on the earnings of most state-owned banks. The story has been no different for SBI. The bank’s weak core performance on the back of muted credit growth has been a cause for worry.

Domestic loans grew by a muted 4.2 per cent year on year, as of December 2016. The management has guided for 11 per cent growth in 2017-18. Pick up of economic activity holds the key to faster revival in SBI’s earnings.

Given the slow pace of resolution of stressed assets and weak credit offtake, SBI continues to face marked pressure in its asset quality.

Gross non-performing assets for the bank stood at 7.2 per cent of its loans as of December 2016. The bank currently has a little over ₹1 lakh crore of bad loans and ₹1.4 lakh crore of stressed assets (inlcuding restrucutured assets)

After the merger, the provisioning requirement on account of bad loans could go up, given the worsening asset quality of the associate banks over the past year. SBI's five associate banks reported a 172 per cent increase in gross NPAs to ₹55,164 crore as on December 2016.

The combined gross NPAs of SBI and its five associate banks as on December 2016, stood at ₹1.6 lakh crore or 8.65 per cent of total loans.

While some of the near-term integration hitches can weigh on the bank’s earnings, over the long run, SBI seems better placed to benefit from a revival in the economy. Its entrenched presence in the large corporate segment and strong retail footprint are key positives.

Also, monetising its non-core assets such as its insurance ventures will help the bank raise the much-needed capital and unlock value in its subsidiaries.