Initial reactions to the announcement of the IDFC Bank-Capital First merger suggest that the market is not happy with the deal or is concerned about medium-term prospects amid some key challenges.

While IDFC Bank’s share price closed down 4.74 per cent before falling as much as 5.3 per cent intra-day, Capital First’s stock price erased intra-day gains of 7.7 per cent and ended with a marginal gain of 0.69 per cent on the National Stock Exchange. The cautious reaction seems justified as, like any merger, there are lots of “ifs” and “then” in this deal. According to some, IDFC Bank seems to have been aggressive in getting Capital First with 40 per cent equity dilution of the former and the deal valued at 3.1 times the latter’s FY19 estimated book value per share (12 per cent premium to the latter’s current market price).

The biggest task for the merged entity will be scaling up the liability base to be able to enjoy the lower cost of funds as a universal bank. Capital First, being a non-banking finance company, currently does not have access to low-cost liability (read CASA).

IDFC Bank has also been struggling to garner a favourable liability base since its de-merger from the parent, IDFC. Deposits form only 39 per cent of IDFC Bank’s borrowings and the current and savings accounts ratio is 8.2 per cent.

Further, the retail and SME loan book of the merged entity will get restricted to 47 per cent (balance being wholesale), according to financial advisory services firm Jefferies.

IDFC Bank, which is more dependent on wholesale lending as of now, has been struggling to grow its retail loan book as well. The bank’s retail portion of funded credit book is only 27.5 per cent, while 93 per cent of Capital First’s AUM comprise retail loans like loan against property, SME loans, two-wheeler and consumer durable financing.

Meeting priority sector lending requirements (30-35 per cent of Capital First’s portfolio qualifies for PSL), employee/key management exits, cultural synergies, timely execution and desired benefits are other risks to the merger.

However, synergies in terms of loan book, branches, employees, cost and customer base will wash out all the concerns but only in the long term. The combined entity will have a customer base of five million with an enviable distribution network of 194 branches, 353 dedicated BC (business correspondent) outlets and over 9,100 micro-ATMs.

“Strategically, the merger is a step in the right direction to achieve stated intentions of both entities: IDFC Bank: ‘Retailising’ its business; and Capital First: Transformation to a ‘universal bank’,” said Edelweiss.

Analysts expect 20 basis points and 200 bps better return on assets and return on equity to 1.2-1.3 per cent and 11 per cent, respectively, of the merged entity due to better profitability of Capital First.

While Jefferies feels that the deal is more favourable for IDFC Bank than Capital First from a business point of view, Motilal Oswal and Edelweiss have upgraded the target price of Capital First by 4 per cent and 11.4 per cent, respectively, not only from a valuation perspective but also because of benefits like reduction in costs and access to capital for growth.

Edelweiss has also upgraded the target price of IDFC Bank by 10.5 per cent.

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