United they stand

SPECIAL REPORT

IDBI can hope to grow faster with the vast branch network of United Western Bank, but its earnings may not improve in a hurry.

The mad scramble for taking over the beleaguered Satara-based United Western Bank (UWB) and the suspense as to who will get the trophy finally came to an end last week.

As it turned out, public sector bank - IDBI - pipped to post 17 contenders including the big names in the private sector like ICICI Bank and HDFC Bank. IDBI officials were not available for comments. However, analysts have a mixed reaction to the merger.

While some feel that UWB's branch network is a boon for IDBI, which was already looking to expand, others fear about the impact on IDBI's financial performance which is anyway not so great.

Puneet Gulati, banking analyst, Stratcap Securities is positive on the merger and feels that IDBI is a good turnaround story. However he cautions that investors should have a horizon of minimum two years.

Adds Sejal Doshi, CEO, Finquest Securities, "IDBI's growth will be much faster and now there is more room for the stock to be re-rated."

On the other hand, one of the leading foreign broking firms fears that the earnings growth of IDBI, which is unimpressive due to the IDBI-IDBI Bank merger in 2004, will slow down due to UWB's high cost to income ratio (about 60 per cent as on June 2006) and huge non-performing loans.

IDBI currently has 195 branches spread all across the country with high concentration in the western region.

Like several other banks, it was facing problems in expanding its branch network due to restrictions imposed by the central bank after the IPO scam investigations revealed that the bank had violated Know Your Customer norms.

Consequent to the merger, the bank's branch network will more than double to 425. But UWB will not form a major portion of IDBI's balance sheet size. 
 

STRENGTH IN NUMBERS
Q1FY07	IDBI	UWB	Merged entity	UWB as a %  of merged entity
No of branches	195.00	230.00	425.00	54.12
No of employees	4500.00	3000.00	7500.00	-
Net profit (Rs crore)	150.57	-6.08		-
Deposits (Rs crore)*	26000.00	6453.00	32453.00	19.88
Advances (Rs crore)*	52739.00	3976.00	56715.00	7.01
Total balance sheet size (Rs crore) *	88633.00	7055.00	95688.00	7.37
Gross NPAs (Rs crore)	1171.59	493.61	1665.20	29.64
Gross NPAs(%)	2.09	13.24	-	-
Net NPAs (Rs crore)	565.97	201.68	767.65	26.27
Net NPAs (%)	1.02	5.87	-	-
CAR (%)	14	0.67	-	-
Adjusted Net worth (Rs crore)*	6484.00	-19.50	-	-
Adjusted Book value (Rs per share)*	80.25	-41.22	-	-
NIM  (%)	0.70	2.20*	-	-
Cost to income ratio (%)	50.00	61.00	-	-
* Figures for FY06

IDBI will get UWB's 230 branches (more than 85 per cent in Maharashtra) and customer base (mainly high yielding agricultural and SME clients) having a business size of Rs 10,400 odd crore (as on March 2006) at one go.

IDBI would have taken time if it had gone ahead with its own branch expansion plans. Possession of UWB's branches will also help the bank increase the proportion of its low cost deposits, which was only 29.4 per cent as on March 2006.

Besides, there is scope for improving its very low net interest margins (NIMs) of less than one per cent. But this will take time. As on March 2006, IDBI had 53 per cent of its total liabilities as borrowings which came after the IDBI-IDBI Bank merger.

Cost of borrowings is about 3-4 per cent higher than the cost of its deposits. The bank is expected to witness a marked improvement in performance 2009 onwards, as by that time it would have paid off most of its high-cost borrowings.

Further, UWB's branch location is in the industrial and agricultural belt of Maharashtra with priority sector lending at over 40 per cent of the net advances, which is a positive.

However UWB had high gross and net NPAs of over 13 and 5 per cent respectively as on June 2006. Though this does not seem to be a major concern as IDBI's balance sheet size is ten times bigger than UWB's, the actual quantum of net NPAs could turn out to be a cause for concern, say analysts.

"One of the major challenges for IDBI will be integration and management of change between the two banks. This has happened too soon after the IDBI-IDBI Bank merger," says Ajit Dange, analyst, UTI Securities.

IDBI will have to pay to UWB shareholders Rs 28 per share - 19 per cent higher than the current market price of Rs 23.6, which amounts to a cash outlay of Rs 150 crore.

The cash pay-out does not seem to be a big burden for IDBI due to strong capital position. But challenges lie ahead in integration of bank operations and employees and recovery of sticky loans of UWB.

In Q1FY07, IDBI exhibited a weak performance with core business incurring a loss, though net profit grew 39 per cent y-o-y at Rs 150 crore, thanks to recoveries from written off accounts and capital gains. 
 

FINANCIALS
(Rs crore)	Q1FY07	% chg (y-o-y)
IDBI
Net interest income	97.17	7.19
Other income	284.61	5.87
Operating profit	191.87	21.13
Net profit	150.57	38.76
UWB
Net interest income	46.56	15.99
Other income	22.84	41.95
Operating profit	26.85	1.46
Net profit	-6.08	-58.47

Net interest income (NII) including recovery from written-off accounts (non-recurring) in interest income grew only 7 per cent y-o-y and non-interest income declined by 8 per cent.

While IDBI may be able to grow faster, thanks to the additional branches, earnings improvement will take time.

The stock gained 14 per cent immediately after the merger announcement, though it has cooled down now and is trading at a price to book value (P/BV) of 0.73x and 0.66x for FY07E and FY08E respectively.

For an investor, there are other banks with better earnings potential available at a cheaper price. On the other hand, Dange believes that there are better plays like Syndicate Bank (1.3 P/BV and 1.1 P/BV respectively for FY07E and FY08E) and Karnataka Bank (1.1 P/BV and 0.9 P/BV respectively for FY07E and FY08E) available in the banking space currently.