Kotak Mahindra Bank acquired ING Vysya Bank in an all-stock deal last week, taking it to the league of the top four private sector banks.

The deal comes at a time when competition in the sector is likely to intensify with the onset of new banks. ING Vysya Bank is a good fit for Kotak Bank and will help it expand its national footprint and compete better with larger private players such as HDFC Bank and ICICI Bank.

For every 1,000 shares they currently hold, shareholders of ING Vysya Bank will get 725 shares in Kotak Mahindra Bank. In terms of valuations, the deal is a good one for Kotak Bank.

It has acquired ING Vysya Bank at close to two times the book value — this seems quite reasonable given that earlier mergers in the banking space were effected in the range of two-six times the target bank’s book value.

Both stocks have rallied until the run up to the merger and even after the announcement made on Thursday.

At the current price of ₹1,199 the Kotak Bank stock trades at 4.1 times its one-year forward standalone book value. Kotak Bank has always traded at a premium to its peers, thanks to its higher return on assets (ROA at 2 per cent). The other businesses such as insurance, asset management and securities business also offer promise and can be valued at about ₹300 a share.

The current valuation of the combined new entity comes to 3.6 times the one-year forward book value.

This is attractive, given that the merged bank will still have a high ROA of 1.8 per cent and will be well capitalised (16.5 per cent capital adequacy) to grow over the next two years.

Leveraging branch network While the merger will help Kotak Bank expand its branch presence significantly, the geographical spread of the two banks is complementary too. Kotak Bank, with 641 branches, will nearly double that number with the addition of 573 branches of ING Vysya Bank.

Kotak Bank, which has presence mostly in the metros, will benefit from ING Vysya Bank’s better mix of rural and urban branches. Also, ING Vysya will provide Kotak Bank with a strong presence in two key southern states — Karnataka and Andhra Pradesh — where the latter has small presence.

Kotak has a strong footprint in the western and northern parts (80 per cent of its branches), while ING Vysya has 64 per cent of its branches in the south.

After receiving a banking licence in 2003, Kotak Bank started to focus on core lending only from 2007-08. Since then, the bank has been able to diversify its loan portfolio across retail, rural and corporate segments. But small and medium enterprises (SME) make up a small portion of its loans (less than 10 per cent).

Strong SME portfolio On the other hand, ING Vysya has been building its high-yielding SME loan portfolio which has been its core strength. The bank’s SME loan portfolio is 35 per cent of its loans.

In the past couple of quarters, Kotak Bank has been increasing its focus on the mid-market segment within the corporate business to drive growth. The merger should help the bank enhance its presence in this space.

Kotak Bank will also benefit from ING Vysya’s expertise in the SME space that entails higher risk. ING Vysya has been able to maintain its asset quality despite its exposure to SMEs. As of September, ING Vysya’s gross non-performing assets (GNPA) totalled to just 1.59 per cent of all loans. The combined bank will have a GNPA of about 1.59 per cent of loans.

Strengthen deposit base The merger will strengthen Kotak’s CASA (current account, savings account) base. ING Vysya has a healthy CASA ratio of 33 per cent. More than half of this is from current account deposits, which carries zero interest.

Kotak’s strong CASA base, on the other hand, has been led by growth in savings deposits. Differentiated rates, which the bank has been offering since the de-regulation of savings deposit rates from October 2011, have helped build a strong savings deposit base.

The merger will thus enhance the CASA profile for the combined entity. The merged bank will have CASA deposits of about ₹36,000 crore, which is 1.5-2 times that held by banks such as YES Bank, IndusInd Bank and Federal Bank. The CASA ratio of the merged entity is a healthy 31.8 per cent (as on September 2014). Kotak Bank has to cut down its promoter’s stake in the bank from the current levels of about 40 per cent to 20 per cent by March 2018, according to the RBI’s directive. Following the merger, the promoter’s stake in the combined entity will be 34 per cent.

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