India Ratings & Research (Ind-Ra) has affirmed Kotak Mahindra Bank (KMB) long-term issuer rating at 'AAA'. The outlook is stable.
Ind-Ra expects ING Vysya Bank's (INGVY) merger with KMB to be credit positive for KMB over the medium term unless integration challenges prove insurmountable. The agency believes KMB will be able to maintain its consistently superior credit buffers post the merger. Ind-Ra expects KMB's strong buffers and above-average core capitalisation to help it absorb any credit weaknesses of the acquired bank, and the combined bank’s capitalisation, credit profile and profitability to remain akin to other 'AAA' rated private sector banks.
Ind-Ra's calculations show KMB's post-merger pre-provisioning operating profit on average assets will drop to 2.7% from 3.1% for KMB in FY14. Also, the Tier 1 ratio drops to 16.5% for the merged entity from 17.8% for KMB (non-consolidated) in FY14. These remain comparable to those of other ‘IND AAA’ rated banks while the merged pre-provisioning operating profit to credit cost buffer at 16x would be far superior to the peers (ranging from 11x-12x). Unless the risk-weighted asset growth accelerates significantly, these should help the bank to meet Basel III capital requirements without any additional capital raising over the medium term.
KMB lags behind its peers in branch network and the share of stable, low-cost deposits. This is likely to be meaningfully addressed through this merger which brings in geographical complementarity in branch network (particularly across metros) and a good chunk of current account holders. Over FY15-FY16, Ind-Ra expects the benefits from the potential repricing of INGVY's small and medium enterprise portfolio (7bp-8bp on total assets) to offset the impact of migrating INGVY's customers to a higher savings rate. In the medium term (FY17 and beyond), Ind-Ra expects the cost savings arising from curtailed expansion costs (15bp-20bp of assets per year) to largely offset the medium-term integration costs of aligning employee productivity, improving customer profitability and managing asset quality. Thus, while there may be short-term fluctuations in credit metrics (for FY16), Ind-Ra expects the benefits of this merger to start showing FY17 onwards.
The areas of immediate benefits are KMB's asset profile diversification and its potential to expand product suites. Another possible area of cooperation is mining of ING Bank NV's (INGVY's parent) customer base by offering fee-based products such as i-banking and advisory services. The key challenges of the merger would be aligning INGVY’s employee productivity to KMB’s benchmarks, managing INGVY's unionised workforce and aligning the underwriting practices of both the banks. A key profitability driver would be managing the profitability of INGVY’s liability customers (average ticket size per account of savings account holders for INGVY is half than that of KMB).
Ind-Ra expects the merger process to conclude by March 2015, subject to the receipt of all the necessary approvals including those from the shareholders of KMB and ING Vysya, the Reserve Bank of India, and the Competition Commission of India.
Shares of the bank declined Rs 31.85, or 2.66%, to trade at Rs 1,167.75. The total volume of shares traded was 118,152 at the BSE (1.47 p.m., Tuesday).
