IDBI: Deciphering the UWB deal - Views on News from Equitymaster

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IDBI: Deciphering the UWB deal

Sep 13, 2006

Public sector banking major, IDBI, has emerged as the RBI's choice for the take over of the ailing United Western Bank (UWB). The latter was placed under a moratorium on September 2, 2006, after its networth turned negative. Under a draft scheme of amalgamation, the RBI has asked the boards of both banks to ratify the proposal by September 27. We herein try to comprehend as to how will the deal pan out for IDBI.

About IDBI
Earlier functioning as an infrastructure financing entity, IDBI merged its banking arm with itself in October 2004, a deal that was largely anticipated to be a win-win situation for both the entities. The erstwhile IDBI Bank, given its clean assets and impressive fundamentals, has offered valuable growth prospects, access to low cost deposits and extended reach, which in future will enable the consolidated entity to seek a better spread on its infrastructure funding. Post the merger with IDBI Bank, the government holding in IDBI stands at 58%. The bank is currently functioning with two SBUs (development finance and banking businesses). Although the merged entity is in the league of the largest banks in the country in terms of asset size, its lackadaisical rate of growth and baggage of high cost borrowings leaves it way behind its peers in terms of performance.

About UWB
With majority of the branch infrastructure in Maharashtra, the bank has considerable penetration in the rural segments of the state and offers ready infrastructure to financial entities looking to expand their scale in this region. While the public shareholding in the bank stood at 54% at the end of 1QFY07, SICOM is the principal shareholder with more than 10% stake. UWB had, during the last 5 months, made a bonus and rights issue to shore up its capital adequacy, which is in the negative (– 0.3% in 1QFY07) due to consecutive losses in the past 8 quarters. The bank that has been under RBI supervision since 2001, posted losses in FY05 and FY06, largely due to higher NPA and investment provisioning.

FY06 (Rs m) IDBI UWB % of IDBI
Total assets 886,973 69,168 7.8%
Deposits 260,010 64,802 24.9%
Advances 525,170 40,063 7.6%
Cost / Income (%) 53% 37.0%  
Gross NPA / Advances (%) 2.1% 12.3%  
Net NPAs / Advances (%) 1.1% 5.7%  
Accumulated losses N.A 2,051  
NIMs (%) 0.5% 2.2%  
Branches (nos) 195 230 117.9%
ATMs (nos.) 334 74 22.2%
Buisness / branch 3,071 456 14.8%
Employees 4,530 3,150 69.5%

The deal…
As per the merger deal proposed by the RBI, the scheme of amalgamation will protect the interests of UWB depositors and pay the shareholders Rs 28 per share (30% premium to the current market price) for shares held on the record date (yet to be announced). Once the scheme is accepted, all UWB assets and liabilities will be transferred to IDBI and the employees will be retained in the merged entity on the same terms as earlier.

Benefits accruing to IDBI…
Franchise: IDBI, which currently has less than 12% of its advance portfolio comprising of retail assets, has been taking nimble steps to grow its franchise and expand its retail exposure. The merger with UWB offers the bank a considerable headstart in this respect. Further, UWB has a strong presence in the rural and semi-urban areas of Maharashtra, which will again be benign to IDBI’s credit portfolio. Having said this, we believe that the price that is being paid by IDBI is at a considerable premium to the cost of setting up the additional franchise. It nevertheless, would have required IDBI a couple of years to set up this franchise, which it gets immediately due to the merger. Also, the RBI has given IDBI to the autonomy to close UWB branches that are overlapping that of its own.

Costs Rs m Benefits Rs m
Compensation 1,505.5 Cost of branches* 690.0
Loss writeoff 2,051.0 Cost of ATMs* 111.0
*Assuming cost per branch to be Rs 30 lacs and cost per ATM Rs 15 lacs

Low cost deposits: The merger will also benefit IDBI in terms of higher proportion of low cost deposits and lower operating cost (costs in rural areas are lower than that in urban areas), thereby aiding its sagging NIMs (0.5%, the lowest in the industry) and cost to income ratio.

Tax benefits: As in the case of OBC, we believe that IDBI will also get the tax benefit for writing off UWB’s accumulated losses, which will cushion its net profit margins despite the additional writeoffs.

Our view…
In an earlier article we had highlighted how UWB when compared to GTB seems to be on a much more sound footing at the time of moratorium. Also, given that UWB’s advance book is just 8% of that of IDBI’s, the accretion to IDBI’s net NPA will be marginal (the combined entity’s net NPA to advances will be 1.5% against IDBI’s standalone 1.0%).

At the current price of Rs 67, the stock is very attractively valued at 0.7 times our estimated FY08 adjusted book value (without considering the merger). While we believe that the benefits of the merger will certainly fructify in the longer term, IDBI will have to bear the burden of write-off in the interim. However, we see the stock to be very attractive from a long-term perspective.

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