Banks with strong networks will find takers

In terms of asset quality, for instance, IOB and UCO Bank are the worst placed as they had the highest gross NPA

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The government, which recently stepped up focus on consolidating weaker public sector banks (PSBs), plans to reduce the number from 27 now to six or seven larger banks.

While market capitalisation is a reflection of how the Street (investors, analysts, etc) views the bank's core fundamentals, the current state as well as the future prospects, a detailed look at the nine months' data of these banks provides some insight on their financial and business condition.

Read more from our special coverage on "PUBLIC SECTOR BANKS"

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• Budget credit-negative for PSBs: Moodys
• At Rs 4 lakh cr, bad loans exceed market value of PSBs
• PSBs credit profile at risk without more capital: Fitch
• ICRA expects bank stress to continue for three years

In terms of asset quality, for instance, Indian Overseas Bank (IOB) and UCO Bank are the worst placed as they had the highest gross non-performing assets (NPA) at 12.6 per cent and 11 per cent, respectively, as on December 31, 2015.

Dena Bank was the third on this list with gross NPA ratio of 9.9 per cent. However, if one adds the restructured assets, it would reflect the real asset quality picture of a bank. While the latest figures of total stressed assets for many banks are not available, the situation is not alarming, say analysts.

Many PSBs also have low levels of capital to fund growth as well as any fresh losses that they may witness on account of bad loans. For example, while Dena Bank reported a net loss for the nine months ending December 31, 2015; its Tier-1 capital of 7.1 per cent is the lowest amongst its peers. United Bank's Tier-1 capital ratio, too, stood at 7.1 per cent in this period. Again, not all banks have declared their Tier-1 capital ratios as at the end of the December 2015 quarter.

Notably, while PSBs consolidation will be largely driven by regulations, larger banks would not want to buy banks having low capital adequacy as well as poor asset quality, unless they prove to be of strategic importance. A key factor that will aid consolidation will be a bank's branch network. Historically, banks having larger presence in one region have bought smaller banks having stronger presence in another region. This ensures there is minimal overlap and the businesses are complementary in nature. The key hurdle and integration challenge, though, will be the employee unions in some of the PSBs that might resist such mergers and acquisitions. Nevertheless, with the advent of digital banking, the attraction of a branch network might not be enough.

Analysts, however, believe most smaller and relatively weaker PSU banks could be potential takeover targets.

Vaibhav Agrawal of Angel Broking says, "United Bank, IOB, OBC, Dena Bank, Vijaya Bank, Bank of Maharashtra, Andhra Bank, Indian Bank, Corporation Bank, among others, could be key takeover targets. The prime criteria will be complementary network, capital adequacy, asset quality, unions and actual integration of this merger."