On April 05, 2019, the board of private lender Lakshmi Vilas Bank
(LVB) approved its merger with mortgage lender Indiabulls Housing Finance Ltd
(IBHFL) in an all-stock-deal. The merged entity, to be called Indiabulls Lakshmi Vilas Bank, is the latest occurrence of a bank combining with a non-banking financial company.
The share swap ratio for the merger has been fixed at 1:0.14, which means that for every 100 shares of LVB held by shareholders, they will be entitled to receive 14 shares of IBHFL, according to the filing on the stock exchanges. This swap ratio indicates IBHFL will pay high fees to access LVB’s deposits of over Rs30,000cr. It would also secure access to more than 100,000 customers with a cross-selling opportunities to help boost fee income.
This deal will pave the way for IBHFL gaining a banking licence. The non-bank lender had attempted to enter the sector about six years ago when the RBI had sought applications for a banking licence. However, it failed to receive the license from the monetary authority in 2014.
This latest transaction adds to the growing list of mergers between banks and non-banking lenders which includes Bandhan Bank’s proposed acquisition of Gruh Finance, the merger of IDFC Bank and Capital First Ltd, among others.
The merger will need the approval of Reserve Bank of India (RBI). Typically, the regulator does not agree to a bank licence transfer as part of a merger. As such, the licence will continue to be held by LVB.
The management indicated that shareholder approval may be sought over next month and thereafter it would apply for a bank licence which could take 4-6 months. According to management, approvals from other regulators, etc, could take 6-9 months, so the merged entity is likely to be effective from the end of FY2020 or early FY21.
RBI’s clarification that it has not yet given a clearance
When the deal was announced, there were speculations that the RBI had already sanctioned the deal. This was mainly due to the presence of 2 nominee directors of RBI on the board of LVB, which many media outlets took as indirect approval for the deal by RBI.
However, the very next day the central bank clarified that the merger has not yet received its approval, and it will examine the proposal once it receives it from the merging entities. The RBI statement further noted that it would examine the proposals as per extant regulatory guidelines and directions and when it receives them from the entities concerned. On the very same day, LVB in a press statement clarified that the RBI nominee directors did not participate in the voting or express any views.
The question to ask is - whether the said deal measures up to RBI’s strict regulatory guidelines. There are a few concerning factors that could raise the difficulty in terms of gaining RBI approval. They are:
Promoter of IBHFL has interests in real estate, and RBI in the past, has not been very keen on mixing banking with real estate.
IBHFL has applied for a banking licence before as a single entity and was rejected. So, will they be given a licence now, just because it is now doing so through a merger?
LVB itself was under pressure from the RBI because of a weak capital base and high share of bad loans. Based on the latest numbers, the lender was at risk of coming under the RBI's prompt corrective action.
The “on tap” licensing policy of RBI says “In case the individual promoters/promoting entities/converting entities have other group entities, the bank shall be set up only through an NOFHC.” Indiabulls website shows several entities, including Indiabulls Ventures, as part of the group. In this case, RBI could decide that the merged bank and Indiabulls Ventures' financing business could not co-exist.
While the deal makes the compliance cut-off and is within the purview of the policy framework, a brief glance at similar transactions in the past indicate that the RBI is very stringent and particular while awarding banking licenses. Thus, uncertainties do exist for the IHFL-LVB merger. However, in the recent past, the banking authority has approved similar deals, which could be taken as an encouraging sign.
What if RBI approves the merger?
This is the fourth instance of a marriage between an NBFC and a bank. RBI has approved the previous 3 mergers. Would it be so difficult for this proposal to get the nod? Assuming everything goes as expected and the union gets RBI’s blessing, what could be the plausible benefits of such a merger??
The deal gives IBHFL a chance to transition into a banking entity and build sustainable and scalable model, which it has been aspiring for past 6 years. The deal also gives it access to low-cost funds.
For LVB, the merger could aid enhance its franchise value, and thus help it take better advantage of market opportunities.
IBHFL has advantage with respect to SLR and CRR compliances as it has cash of Rs27,512cr.
The merger will also increase the geographic presence of the merged entity as Indiabulls has a strong presence in northern and western Indian markets, while LVB has a strong presence in the South.
LVB would have come under RBI’s Prompt Corrective Action (PCA) framework which imposes a number of restrictions on a bank, including curtailing loan growth and branch expansion, if the prosed deal with IBHFL did not take place.
IBHFL comes under direct supervision of RBI and thus will have permanent access to liquidity via RBI window.
IBHFL were to become a bank, it would get access to retail liabilities, which may ensure that they can fund growth in a stable manner for multiple years.
The group entity’s arms have acquired life and general insurance licenses. Having a bank license will greatly benefit the growth of these businesses.
More of India’s smaller banks may become acquisition targets if the regulator gives a nod to the proposed merger of LVB. and IBHFL. If approved, the deal would be the first example of a non-bank financial company like IBHFL merging with a bank, following the 2016 relaxation of Reserve Bank of India rules. Many potential banking license enthusiasts would then favour mergers as a way to gain licenses and alter their business models. Many of India’s NBFCs have been facing liquidity issues caused by debt defaults of IL&FS and its group companies due to which it is becoming tough for such companies to access capital, atleast at lower costs. Hence, if this amalgamation were to be approved by the banking authority, it will be act as a cornerstone for other such mergers which will not only resolve the liquidity issues of NBFCs but also help in stabilising business models of smaller banks that are facing issues of capital infusion.
What is the risk?
A merger of a strong NBFC with a weak bank would typically be seen as a win for the NBFC. However, in the case of this merger, it is actually a win-win situation. The swap ratio indicates that IBHFL paid a premium for access to low-cost public deposits of LVB. Meanwhile, LVB will also receive the much-needed capital to boost its operations. But as much as there are benefits to the unification, there are also risks.
RBI approval: The biggest risk to the merger comes from the banking authority. Both the entities, at an individual level, have been on RBI’s radar for various reasons as explained earlier in this article. Though there are many reasons for the RBI to approve this merger, there are equal if not more reasons for the RBI to reject it. The management of both the entities have indicated that they do not have a plan B in place in case the RBI rejects the deal. Even if the RBI were to approve the merger, it could come with certain riders which could affect, if not alter, operations of the merged entity.
LVB’s legacy issues: The Chennai based lender, though a 9-decade old bank, has struggled to make mark in a growing banking industry, lost market share and has been constrained for capital. LVB had been scouting for possible partners for quite some time and had also raised Rs459.59cr in March through a QIP to bolster its capital adequacy and try and avoid the PCA framework of the RBI. In the mergers we have seen in the recent past, the banking entity had more assets and was the dominant partner in the amalgamation. Here, IBHFL is 4-5x the size of the bank and has significant exposure to corporates. Meeting priority sector targets will be difficult for the merged entity given the smaller loan size of LVB.
The case of declining RoE: If the merger were to go through, there is a high possibility that the RoE of the combined entity would decline and remain so over the medium term if not longer. The total cost of liabilities is expected to rise and stay elevated for a long period. Additionally, IBHFL would face significant competition in attracting retail deposits and may also face rising expenses as far as branch expansion is concerned. Additionally, there is also a possibility that IBHFL will have to scale down its developer finance business, arguably its most profitable segment, as the RBI tends to disapprove of banks having such a large exposure to this segment.
To conclude, the deal has its merits for both entities, though the transaction is slightly tipped in favour of IBHFL. The biggest catalyst for the merger will be the RBI. It needs to be seen how the banking authority views this merger. This amalgamation hinges on the green signal of the central bank. There are some other road-blocks to the deal in terms of protests from the employees of LVB, which could also pose a threat. However, if you look at the bigger picture, the deal will open doors for more such mergers between liquidity constrained NBFCs and small lenders struggling to stay afloat due to lack of fresh capital injection. But off course, all that depends on RBI’s discretion.