Operational synergies likely in the medium term

While the merger seems logical from the point of view of smaller associates as they would get the financial and technological muscle to survive the rising competition, the same is not too evident for the parent entity in the near term

State Bank of India’s merger with its associates may result in near term pressure on the bank’s operational performance even as there may be synergistic benefits in the medium term.

State Bank of India, India’s largest bank had last week announced that its board had approved the share swap ratio for the merger of its five associate banks and Bhartiya Mahila Bank with itself.

While the merger seems logical from the point of view of smaller associates as they would get the financial and technological muscle to survive the rising competition, the same is not too evident for the parent entity in the near term.

The biggest concern is on the asset quality front. Though the merger would add 27% to the bank’s gross advances propelling it to the world’s 45th largest bank, but at the same time its gross non-performing assets (or bad loans) would shoot up by 36% given the fact that combined gross

NPA ratio of five associate banks as at end of June 2016 stood at 9.14% as compared to SBI’s 6.94%. Add to this, higher slippages and higher credit costs for associates would lead to slight deterioration in asset quality metrics for the combined entity. The capital adequacy ratio, a measure of bank's strength too is likely to fall by over 50 basis points given that the capital

adequacy ratio for five associates stood at 11.06% to 12.43% as compared to SBI’s 13.12% as at end of fiscal 2016.

Analysts at Motilal Oswal Securities believe that the integration of 70,000 odd employees (34% of parent workforce) would pose a near term challenge apart from small negative impact on account of pension liability provisions.

However analysts believe that these near term challenges and costs would be more than offset by cost synergies in the medium term. The cost to income ratio for one, is likely to improve by over 100 basis points in the medium erm, as per the SBI management. The cost to income ratio for SBI as at end of June 2016 stood at 48.93% while that for its associates like SBBJ and SBH stood at 45.14% and 40.08% respectively even as other three associates had a higher cost to income ratio of 50-57%.

The rationalization of branches and ATMs including relocation and few closures, apart from focus on digital strategy would help the bank. Also the merged entity would benefit from combined treasury operations with SBI’s treasury earning more than that of its associates.

Among other positives, the combined entity would benefit from lower cost of funds given that deposit base would increase by 29% and SBI’s cost of deposits is lower.

“High networth post-merger makes SBI a default bank for corporate India. Further, strong branch network and SBI brand will increase retail and SME business. Liability franchise is likely to get further strength from the merger” wrote the analysts at Motilal Oswal Securities in an event update report released on August 18.

The market share of SBI is likely to increase to over 22% post the merger. The five Associate Banks of SBI had a Market share of around 5.30% in deposits and 5.33% in advances as on 31st March, 2016.

Most of the analysts remain positive on the bank with the stock of SBI gaining 4.15% to close at Rs 258.50 on Friday.