Does IDBI Bank-LICHFL merger make sense?

The divestment of IDBI Bank has been making headlines since February. We had reported told you in March that finding new promoters for the bank isn’t going to be easy.

While it turns out that there is reasonable investor interest, rolling out the expression of interest for the government’s 45.48 per cent stake is getting stretched.

Understandably, reasons such as differences in valuations and regulatory hurdles remain roadblocks. Here’s something that the Department of Investment and Public Asset Management, or DIPAM, could consider – merge LIC Housing Finance (LICHFL) with IDBI Bank.

This will seat IDBI Bank in a comfortable fourth position among private lenders, up from its seventh rank, based on FY22 financials, a factor that could sway its investment appeal by leaps and bounds.

LICHFL is a subsidiary of Life Insurance Corporation of India (LIC). With 81 per cent exposure to pure retail loans, it is India’s second largest mortgager. At ₹2.51-lakh crore of loan book in FY22, LICHFL is twice larger than IDBI Bank. LIC holds 49.24 per cent stake in the bank.

The merger can help IDBI Bank in two ways. At present, the bank is building its retail stacks. Retail, agri and MSME loans collectively account for 63 per cent of total loan book, while the share of corporate loans stood at 37 per cent in FY22.

With the addition of LICHFL’s assets, IDBI Bank can metamorphose into a formidable retail franchise. The share of housing loans in the bank’s portfolio will increase from ₹48,074 crore to ₹2.52-lakh crore, or 63 per cent of total combined book.

What’s more, 70 per cent of its home loans would be constituted by salaried customers, a section wooed by all lenders as they are a relatively safe bet.

At present, IDBI Bank is being packaged to investors as a deposits machine, with the share of low-cost deposits or current account savings account (CASA) at over 56 per cent. However, investors sieve banks based on the strength of their loans or customer base, not just the liability franchise.

The merger may be just the right pill to position IDBI Bank attractively, especially when the dynamics of the business is set to alter owing to rising interest rates.

IDBI Bank’s CASA, far superior than its peers (40-45 per cent), will give it the much-needed edge. Reports suggest that the ongoing merger of HDFC Bank and HDFC Limited may drag the bank’s CASA ratio to about 30-33 per cent post-merger. In IDBI Bank’s case, the impact may be much less and its advantage as a low-cost lender would remain intact.

Asset quality is another front where it would get massive relief. With all due respects to IDBI Bank’s management for bringing down the gross NPA from nearly 28 per cent in FY18 to 20.16 per cent in FY22, from a divestment perspective, this isn’t enough.

If YES Bank has found success in roping in new investors, it is predominantly because its gross NPA is expected to shrink to 2-2.5 per cent from over 14 per cent in FY22, after the sale of bad loans to JC Flowers ARC.

The merger could help reduce IDBI Bank’s gross NPA ratio to 11.5 per cent. Additionally, the bank has identified assets to be hived off to state-owned NARCL, which could further reduce the number by 5-6 percentage.

At 5-6 per cent gross NPA and near-negligible net NPAs, IDBI Bank’s appeal among investors would soar.

For the government, there won’t be much relief on its shareholding in the combined entity. Yet, having done these experiments with PFC and REC, ONGC and HPCL, and even the public sector banks as a preparation to its mega-divestment aspirations, it should explore the possibility of a merger between IDBI Bank and LICHFL to beef up the offering and get a good exit in future. For LIC, having infused capital into the bank at an average price of ₹61 per share in 2018-19, and at ₹514.25 per share in LICHFL in June 2021, the merger could be a win-win.

IDBI Bank presently trades at around ₹42 a share and LICHFL at ₹405. While the bank has staged a good turnaround, there are concerns on the performance of LICHFL.

It’s been on a shaky wicket due to asset quality issues since FY19 and 5.35 per cent gross NPA in FY22 (4.96 per cent in Q1 FY23). Even as HDFC Limited folding into HDFC Bank presents an opportunity for LICHFL, the road to recovery isn’t going to be easy, given its recent growth challenges.

Undoubtedly, LICHFL is one of the oldest and critical subsidiaries of LIC. Incorporated as an in-house lender, LICHFL has weathered several crises and revamps. But when LIC invested in IDBI Bank, one of the regulatory clauses mandated was that only one entity could pursue the housing finance business.

This has indirectly set the stage for merger. If IDBI Bank divestment doesn’t go through in a year, LIC may be forced to consider the merger, given that the five-year timeframe ends in November 2023.

Unlike other PSBs, IDBI Bank was set up under the Companies Act and, hence, was chosen as the divestment test case as the process may be relatively less cumbersome.

But as a former CEO of IDBI Bank puts it, the bank needs to be back on the map and not on the block.

“The present management has done what it takes to repair and re-establish the bank. With capital adequacy comfortable at 18 per cent, the focus must be on growth, including inorganic options.

“If employees must be rewarded for the hard work put in since 2018, constantly preparing the bank for divestment isn’t going to keep their morale intact,” he said.

Once known as a powerful corporate bank, IDBI Bank needs to reclaim its scale and specialisation. If this is in place, everything else will fall in line, including a good exit for its promoters.

COMMENT NOW