The transformation of the banking space with the entry of new players in varied formats — universal, small finance and payments — and the influx of digital disruptors will bring in new challenges for existing players.
Larger players, given their size, will find it more and more difficult to grow above the industry rate, while smaller private banks need more scale and leverage to make an impact, as they constitute a minuscule percentage of loans and deposits in the sector.
Given that public sector banks, despite their poor performance, still have a lion’s share in the banking system, consolidation among private players makes good business sense to tackle competition — offering a quick and efficient way to attain scale and expand geographical reach. Kotak Mahindra Bank’s acquisition of ING Vysya Bank towards the end of 2014, has taken it to the league of the top four private sector banks.
The merger has also brought in complementarities to the geographical spread and customer segments that both banks cater to. Kotak Mahindra Bank’s performance so far this fiscal points to a smooth transition and indicates that revenue and productivity synergies are on track.
At the current price, the stock of Kotak Mahindra Bank trades at 3.2 times its one-year forward consolidated book value, which is at par with its three-year historical average.
The bank has historically traded at a premium (15-20 per cent) to other private banks, such as IndusInd Bank and YES Bank.
This is thanks to its higher capitalistion, diversified loan book, and presence across financial services, such as insurance, asset management and securities business. The merger with ING Vysya Bank has put Kotak Mahindra Bank in a sweet spot to ride the recovery in financial services, with potential to expand geographically and across product lines.
The bank maintains healthy capitalisation — Tier I capital is at 15 per cent, which should help fund its growth. It is also well positioned to generate superior returns vis-à-vis peers over the next two to three years, as scale efficiencies, and cost and productivity synergies from the acquired business start kicking in.
After the merger, the bank’s standalone return on equity (annualised) works out to a relatively lower 11 per cent. This is lower than the 18-19 per cent that some of its peers deliver.
However, cost synergies from rationalisation of branch network and rental savings are likely to flow in from next year. This should boost returns.
Synergies in place
While Kotak has been able to diversify its loan portfolio over the years — across retail, rural and corporate segments — the small enterprises (SME) segment constitutes a small portion of its loan book.
Given that ING Vysya’s core strength lies in its high-yielding SME loan portfolio, it has been a good fit for Kotak Mahindra Bank. From less than 10 per cent of loans, SMEs now contribute about a fifth of Kotak’s loan portfolio.
The merger has also helped Kotak expand its national footprint and compete better with larger private players. The geographical presence of the two banks has complemented each other well. The acquisition of ING Vysya, which has strong presence in two southern states, has given Kotak a strong foothold in this market.
Steady loan growth across product lines and uptick in current and savings account (CASA) deposits as of December 2015, point to such synergies in place.
The combined entity has a CASA ratio of 35 per cent, up from 32 per cent for Kotak Mahindra Bank in the previous year.
CASA deposits have accelerated both at Kotak and erstwhile ING Vysya branches.
Higher interest rate on savings account, along with focus on customer acquisition, has helped increase average balances in accounts. Kotak Bank intends to maintain the higher 6 per cent it offers on deposits of more than Rs.1 lakh.
This should sustain the growth momentum in savings deposits.
Stressed assets
Despite stress in the overall banking system, Kotak has been able to maintain stable asset quality — gross non-performing assets (GNPAs) were flat at 2.3 per cent of loans (standalone) sequentially.
The bank’s restructured assets stood at Rs.346 crore (0.3 per cent of loans), marginally lower than in the previous quarter.
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