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The integration of technology and human resources could be key challenges in the merger of AU Small Finance Bank and Fincare Small Finance Bank (SFB), slated to take effect from 1 April 2024, analysts have said.
Jaipur-headquartered AU SFB predominantly serves the North Indian region, and Bengaluru-based Fincare SFB commands a substantial footprint in Southern India, with more than 130 branches and 15,000 employees. The two financial entities currently operate on different technology platforms.
According to a research report by Motilal Oswal, the merger of two distinct organisational cultures, particularly the regional differences between employees of North and South, is an area of attention. “Challenges might arise in integrating HR and technology, as AU Bank operates on Oracle while Fincare uses FIS,” it said.
AU SFB hosted an analyst meeting on 18 March 2024 to update on its merger with Fincare SFB and the business roadmap.
The overall integration is expected to cost AU SFB around Rs 300 crore, including Rs 50 crore for technology integration. Out of the total, nearly Rs 200-250 crore is expected to be spent within six to nine months post-merger, with the remainder spread over the following two years.
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Analysts predict the upfront payment of nearly Rs 250 crore for the merger is likely to exert upward pressure on the cost-to-income ratio in the near to medium term, as per the Motilal Oswal report. The report forecasts cost ratios to remain elevated at 63 to 64 per cent in the financial year 25.
Rising asset quality risks
Analysts at Emkay Global Research believe that the cost pressures due to the merger could impact asset quality and delay AU SFB’s aspiration for a universal bank by at least 2-3 years.
“We believe that managing HR/ tech integration with Fincare and the Microfinance Institutions (MFI) portfolio amid rising asset quality risks (as evident in Fincare’s third-quarter results) will be a demanding task,” Emkay commented.
“While Fincare SFB’s acquisition will provide AU access to high-yielding Priority Sector Lending (PSL) and a relatively difficult Southern market for business, managing asset quality in the MFI portfolio will be challenging. Fincare SFB’s third-quarter (financial year 24) results indicated a rise in Gross Non-Performing Assets (GNPAs) to 1.9 per cent from 1.6 per cent in the second quarter (financial year 24), hinting at rising asset quality risks and possibly higher Loan Loss Provisions (LLP) in the near to medium term,” said the Emkay report.
AU SFB expects its cost of funds (CoF) to increase to 6.9 per cent by the end of FY24 from 6.7 per cent in the first nine months of the financial year 24, due to incremental CoF from the merger. However, calibrated investments, operating efficiency, and cross-selling opportunities are anticipated to lower operational expenses over time, thereby easing the pressure on margins for the bank.
A turnaround in the rate cycle and a gradual reduction in funding costs are expected to contribute to margin improvement, with a gradual reduction in cost ratios from the financial year 26 onwards, say analysts at Motilal Oswal.
Through the merger, AU SFB aims to nearly double its touchpoints to 2,352 from 1,049 as of December 2023. Additionally, the bank plans to continue adding more touchpoints by the end of FY24. The acquisition will expand its reach to nine states from the current four, with each state hosting over 100 touchpoints. However, the lender does not plan to add new branches in the financial year 25.
The merged AU SFB aims to keep the unsecured book at 15 to 20 per cent of Assets Under Management, including micro-loans at 10 per cent. Fincare’s loan book is 42 per cent secured.
