The two companies have signed an exclusivity agreement to hammer out a deal before the end of this financial year.
The deal, if finalized, will allow IndusInd Bank to expand its retail loan book and fulfil Bharat Financial’s ambition to offer banking services.
“Bharat Financial has entered into an exclusivity agreement with IndusInd Bank for agreeing to have an exclusive discussion with IndusInd Bank about the proposed potential strategic combination by way of amalgamation through a scheme of arrangement, or any other suitable structure," Bharat Financial said in a notice to the stock exchanges.
The transaction will help IndusInd grow its micro lending business. “We have been in the micro lending space for the past five-six years and already have a (micro) loan book of Rs3,000 crore. Merger with Bharat Financial will help us to further expand in this space as it has a large network and proven track record," Romesh Sobti, managing director (MD) and chief executive officer (CEO) at IndusInd Bank said over the phone. As of 30 June 2017, Bharat Financial had a loan book of Rs10,971 crore.
If the deal goes through, IndusInd Bank will also cross the priority sector lending targets. “There is a good market for priority sector lending certificates right now. The deal will allow us to sell these certificates to banks that are falling short of their priority sector targets. Moreover, we will be able to further expand the market for our savings products," Sobti said.
Founded as SKS Microfinance Ltd by Vikram Akula in 1997, the company fell into tough times in 2010 after alleged malpractices in the microfinance industry forced the Andhra Pradesh government to crack down on these institutions. It became India’s first publicly-listed microfinance company in 2010. The demonetization in 2016 that disrupted all cash-based sectors was another jolt for the company.
Morgan Stanley Mauritius Co. Ltd holds a 6.74% stake in Bharat Financial, while East Bridge Capital Master Fund Ltd, Mathews India Fund, Amansa Holding Pvt. Ltd and BNP Paribas Arbitrage own close to 3% each.
In the last six months, shares of Bharat Financial have gained 16.78%, while those of IndusInd Bank have gained 34.05%.
The companies did not comment on the deal valuation as the transaction closure depends on approval from the central bank, shareholders and the boards of the two companies. Sobti, however, said it will be an all-stock deal and will factor in all the risks associated with a microfinance institution (MFI) loan portfolio.
On 8 September, Mint reported that Bharat Financial is close to announcing a merger with IndusInd Bank, and the swap ratio being considered is one share of IndusInd Bank for 1.75 shares of Bharat Financial.
The withdrawal of high-value notes on 8 November 2016 triggered a countrywide cash crunch, hurting loan recoveries at microfinance companies across the board. Bharat Financial’s gross non-performing assets (NPAs) in the first quarter of the current fiscal stood at 6%, against 0.1% during the corresponding period last year. IndusInd Bank had a gross NPA of 1.09% as on 30 June.
On being asked how the bank will deal with high credit risk associated with the microfinance sector, Sobti said, “Given the current scenario, exposure to the corporate sector is far more risky as compared to the MFI segment."
Calling demonetisation a “Black Swan event", Sobti said it had only a one-time impact and Bharat Financial has been recovering well. M.R. Rao, MD and CEO of Bharat Financial, said the new loans offered since January 2017 have a recovery rate of 99.9%.
“For every MFI, the ultimate destination is to become a bank. We applied for the small finance bank licence but did not get it. Since then, we had been exploring various alternatives. Merger with IndusInd will benefit all stakeholders," Rao said.
In September 2015, 10 MFIs received in-principle approval from RBI to operate as small finance banks. Bharat Financial, however, did not make the cut. “After merging with IndusInd, we will become a financial inclusion company. We can then bring our borrowers on board and offer them other financial products like savings account and low-cost home improvement loans, among others," said Rao.
Bharat Financial also said its cost of funds will come down by 200 basis points after being integrated with IndusInd Bank. Due to the large amount of loan write-offs and higher provisioning on account of the impact of demonetization, the cost of funds for the MFI sector has gone up. The note ban pushed up credit costs for the microfinance industry to 5-8% of loan book in the current financial year compared to 1% the previous year, said Supreeta Nijjar, vice-president at rating company Icra Ltd. One basis point is a hundredth of a percentage point.
According to analysts, there is a lot of interest in the MFI sector as banks are now looking to grow their retail books aggressively. “Despite the fact that MFI loan book is a high-risk asset to acquire, it is easy to evaluate the portfolio quality as the repayment cycles are short. This allows the acquirer bank to understand the customer behaviour of the target MFI," said Harish H.V., partner at consultancy firm Grant Thornton India Llp. He said the “core fundamentals" of the sector remain strong as the micro loan segment is still underserved.