SBI branch integration a key challenge

Merger of 5 associate banks with itself will have to overcome various hurdles; synergies will flow only in longer term

The path to merge State Bank of India (SBI)’s five associate banks with itself will see many challenges, believe analysts. The most significant will be rationalisation of branches and employees, as well as aligning the pay structure of employees of the associate banks with that of SBI’s.

The five associates together have a little over 70,000 employees or 34 per cent of SBI’s employee base on a standalone basis. While SBI employees receive pension, provident fund and gratuity, those at associate banks do not receive PF. The SBI management believes the actual incremental employee cost will depend on their internal arrangement and negotiations are currently on here.

On Tuesday, SBI chairman Arundhati Bhattacharya had said to a television channel that employee costs would go up by Rs 23 crore a month. This works out to Rs 276 crore a year or 2.4 per cent of annualised net profit for the nine months ended December 2015.

Analysts, though, peg the impact on employee costs at a much higher level. “For SBI, the total impact comes out to Rs 6,700 crore, which is 25 per cent of profit before tax and two per cent of the FY17 estimated book value on a consolidated basis. Note that over the years, actuarial assumptions have become more conservative and we see upside risks to these numbers,” says Suresh Ganapathy, financials analyst at Macquarie Capital.

He has extrapolated these estimates from the total impact of Rs 840 crore that SBI took at the time of merging State Bank of Indore and State Bank of Saurashtra into itself. On a per employee basis, the impact was close to Rs 10 lakh.

Another Street concern is that burgeoning bad loans of associate banks could further increase SBI’s provisioning in this regard. The management, though, says both SBI and the associates follow a completely real-time, online recognition of non-performing assets (NPAs). The parent is aware of the asset quality stress and is going ahead with the merger with open eyes.

Though SBI’s consolidated numbers capture this risk, it will be something to be watched. Asked if the merger will divert management attention from recovery of bad loans to integration, the SBI management said it would assign some of the excess staff towards integration and the focus on recoveries would continue.

Analysts also believe that with the SBI chairperson’s retirement date nearing (this September), the bank could face challenges and delays in integration. Though the bank management is not worried, more clarity on this front will be a positive. Analysts at Motilal Oswal Securities are, however, sceptical of SBI merging all the associates in one go. “In our view, a one-by-one merger or amalgamating all associate banks together and then merging the entity with SBI could have significantly reduced integration risk,” writes the brokerage.

On the other hand, benefits from this merger will materialise over the longer term and include opportunities to cross-sell SBI products. SBI is far more aggressive in growing its retail products and its fee income. The associate banks are bankers to local and state governments and a post-merger SBI can directly handle this business as well. As against six treasuries, the merged entity will have one large one, benefiting from the parent’s higher yields on investments.

The management further stated that despite the merger, they would not need capital till March 2017, as the associate banks had a big chunk of real estate, giving a fillip to capital adequacy. Also, “Bhartiya Mahila Bank will bring additional capital of about Rs 1,000 crore, as it was recently formed, with a small and under-leveraged balance sheet,” writes leading foreign brokerage CLSA.

Among other gains, the SBI management believes that after the merger, its balance sheet would increase to Rs 37 lakh crore from Rs 28 lakh crore currently and SBI will get fixed assets worth Rs 4,000 crore from the books of its subsidiaries. The management expects its cost of funds to come down by 100 basis points within a year, as the subsidiaries currently have high deposit rates, less of current and savings accounts, and higher dependence on wholesale funding. However, SBI’s benchmark lending rates are also lower than the others.

The street is also keeping an eye on the valuation that SBI pays to acquire the remaining stake in the three listed associate banks – State Bank of Travancore, State Bank of Bikaner & Jaipur and State Bank of Mysore. These stocks have run up in anticipation that the merger might take place at premium valuations. However, if that happens, the Street will react negatively, due to the relatively inferior financials of the associate banks. For instance, as of FY15, all associate banks had a return on equity of 10.1 per cent, roughly 100 basis points lower than SBI.