IDFC-IDFC First Bank merger: Did the bank get the short end of the stick?

Equity swap ratio for Proposed merger of IDFC Limited with IDFC First Bank In favor of IDFC, whose shares command a higher value than that of the bank. IDFC shareholders will be allocated 155 shares for every 100 shares owned.

This is despite the fact that the bank is the holding company’s primary asset after selling the latter’s mutual fund business to Bandhan Bank. IDFC holds a 39.93 percent stake in the bank as of June 2023.

In an interview, Managing Director and CEO V Vaidyanathan said that the merger will lead to a 4.9 percent increase in the book value of IDFC First Bank. Thus, to be fair to both shareholders, the share exchange ratio takes into account the value of IDFC’s holdings in the bank and the holding company’s deduction.

However, less business under the parent company means less discounting, which begs the question: Did IDFC First Bank shareholders get the short end of the stick?

Steady improvement

Over the past four years, IDFC First Bank has faced weak financial pressures via legacy portfolio pressures, high cost-to-income ratio, low share of retail liabilities, and poor capital adequacy and profitability. However, with financial conditions improving steadily, the bank’s shares have been among the biggest gainers among private sector banks over the past year.

Deposits grew at a compound annual growth rate of 36 percent, with the proportion of checking and savings accounts increasing to 49.77 percent as of March 2023 from 8.6 percent, and the share of retail deposits increasing to 76 percent of total deposits from 27 percent last year. Assets were around INR 1.6 crore and the bank generated a net profit of Rs 2,437 crore in FY23. It is also building its digital capabilities and has been selected by the regulator for pilot projects of initiatives like CBDC and UPI for foreigners.

Last week, the bank raised Rs 1,500 crore via Tier 2 bonds, after which the capital adequacy ratio improved to 17.68 per cent.

share exchange rate

While the overall NPA rate also improved to 2.51 percent overall and 1.65 percent for retail loans, concerns about the share of subprime or unsecured loans linger even as inherited negative perceptions continue to work against the bank. Hence, it becomes logical for the bank to look at the share swap ratio that motivates IDFC shareholders to continue investing in the bank.

In contrast, the benefits for the bank are seen in streamlining the corporate structure, streamlining regulatory compliance, and diversification of equity, which will allow the bank to gain scale. The merger is also seen to help improve the bank’s margins and contain expenses, as well as cash reserves of around Rs 600 crore which will come with IDFC from the sale of its MF business.

Vaidyanathan said that the merger will solve the problem of accumulation of IDFC’s 40 percent stake in the bank. However, the burden of the largest shareholder – the government – remains, despite the relief from the merger. It remains to be seen whether direct government control through a candidate or representative can change the dynamics of the bank in terms of its offerings, operations and strategy.

With the merger expected to take around 12 months, it could affect the bank’s shares and widen the arbitrage range. The real test for IDFC First Bank may not be whether IDFC shareholders keep investing given the sheer advantage, but how long they stay in business based on their long-term assessment of the bank.