Swap ratio key for SHTF and SCUF shareholders

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1 Sector Update 10 July 2017 Financials Motilal Oswal values your support in the Asiamoney Brokers Poll 2017 for India Research, Sales and Trading team. We request your ballot. IDFCBK: Financial Snapshot (INR b) Y/E March 2018E 2019E 2020E NII OP NP NIM (%) EPS (INR) EPS Gr. (%) BV/Sh. INR ABV/Sh. INR RoE (%) RoA (%) P/E(X) P/BV (X) Shriram Transport Finance: Financial Snapshot (INR b) Y/E March 2018E 2019E 2020E Net Inc PPP PAT Con. PAT EPS (INR) Con.EPS (INR BV/Sh (INR) BV (INR) RoE (%) Payout (%) Valuations P/Cons.EPS.x P/Cons.BV. x Div. Yld (%) Shriram City Union Finance: Financial Snapshot (INR b) Y/E March 2018E 2019E 2020E NII PPP PAT EPS (INR) EPS Gr. (%) BV/Sh. INR RoA (%) RoE (%) Payout (%) Valuations P/E (x) P/BV (x) Div. Yld. % IDFC Shriram: Creating a large financial conglomerate Swap ratio key for SHTF and SCUF shareholders IDFC Bank and Shriram Group have announced their intent to explore a merger during the course of a 90-day exclusivity arrangement. During this period, the boards of both companies will apply for regulatory approvals. The merger will place IDFC Limited as a holding company with three subsidiaries: (1) SHTF as a standalone NBFC subsidiary, which gets delisted, (2) IDFC Bank (IDFCB; into which SCUF will merge), and (3) insurance businesses (life and general), in which IDFC Limited will hold 75% stake. The company has commented that after all approvals, it will take 12 months to complete the transaction. IDFCB is the key beneficiary, in our view. IDFC Limited would get a strong operating company post-merger. We believe the deal would require a very favorable swap ratio for Shriram group investors. Key risks: regulatory approvals, execution risk, extent of holdco discount and meeting RBI requirement of minimum shareholding by IDFC ltd in IDFCB of 40%. IDFCB win-win The merger will give IDFC Bank (IDFCB) access to 2,000 touch points and 10m+ customers of the two Shriram group NBFCs, which will help it to generate retail deposits and fee income. Further, the merger will help ensure that IDFCB, with access to SCUF s loan book, can meet PSL requirements with ease (50+% PSL compliant). IDFCB has INR494b of loans and SCUF has INR230b of loan book. IDFCB s savings on the negative carry of PSL (~INR3b) is expected to outweigh SCUF s negative carry on CRR/SLR (INR1.7b). IDFCB is already carrying excess SLR on its balance sheet; hence, CRR/SLR should not impact profitability. Post-merger, IDFCB will have ~0.9% market share in loans. Further, there are low hanging fruits on opex (high employee base) in SCUF with the help of IDFCB technology can be extracted. Execution challenges, technology integration and HR challenges would be the key risks. SCUF swap ratio is key The biggest benefit for SCUF will be access to low cost deposits. In the near to medium term, organic growth would have remained healthy for SCUF and the liability side would not have been a concern. However, over a long period, doing lending business under a banking platform is more beneficial. Since IDFCB will be a major beneficiary of this merger, we expect favorable swap ratio for SCUF shareholders. IDFC Limited will holdco discount narrow? IDFC Limited will remain a holdco for all businesses. Apart from existing AMC, PE, IDF, Securities business and stake in the bank, insurance business and SHTF will be the key additions post-merger. Addition of a strong operating cash flow generating entity as a 100% subsidiary will be a key benefit for IDFC Limited and might reduce the holdco discount. Post-merger structure will be more like HDFC Limited, with the key differences being: (a) housing finance business at HDFC is done at parent level, rather than 100% subsidiary, like CV financing for IDFC, and (b) IDFC will have Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com); / Piran Engineer (Piran.Engineer@MotilalOswal.com); Subham Banka (Subham.Banka@MotilalOswal.com); / Anirvan Sarkar (Anirvan.Sarkar@motilaloswal.com); Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal 8 August Oswal 2016 research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital. 1

2 NOFHC as a 100% subsidiary, unlike HDFC Limited, where stakes are held at the parent level. Running two parallel businesses of Banking and Lending (via SHTF) under same NOFHC will entail regulatory challenges. Valuation for Insurance and AMC businesses of Shriram Capital will remain a key thing to watch out for. SHTF how are minority shareholders likely to be compensated? Post-merger, SHTF shareholders will be given shares of IDFC Limited. A key thing to watch for is whether shareholders looking to own a moat CV financing business would like to hold shares of a holding company with stakes in diverse NBFC, banking, asset management and insurance businesses. In our view, shareholders of SHTF should get a very favorable share swap ratio deal to get unlisted and move away from a pure play company to a holdco structure. Challenges include regulatory hurdles and execution of integration The merger is subject to regulatory and shareholder approvals, which will be sought over the 90-day period. One regulatory hurdle could be housing an NBFC (SHTF) and a bank (IDFC Bank) under the same NOFHC (IDFC Limited), since the RBI does not allow an NOFHC to have separate entities where the same business can be done across departments. Although, as per management, there is a provision from 2016 universal bank on tap guidelines to allow such structure. Other challenges include (a) integration-related issues (especially technology and workforce), (b) ensuring the best interest of minority shareholders of SHTF, which will be de-listed (c) IDFC Limited s stake in the company would come down to less than 40% (based on CMP). While this removes the overhang of big dilution/supply in IDFCB by October 2018, as per regulation IDFC ltd will have maintain 40% shareholding in the IDFCB. This based on CMP share swap comes down to ~30%. Big dilution for IDFC group; return ratio accretive for IDFCB Share swap for SHFT and other businesses (ex SCUF) of Shriram Capital will entail over 75% equity dilution for IDFC Limited. Share swap with SHTF at current market price will make IDFC Limited s existing shareholders 30% owners of the merged entity. IDFCB s merger with SCUF will make existing shareholder of IDFCB ~57% owners of the merged entity. At current market price, share swap ratio for IDFCB and SCUF will be largely EPS-neutral; however, the merged entity will have RoA of 1.3%+ v/s the current ~1%, and due to excess capitalization, RoE will be less than 10%. Valuation and view Cross-selling opportunities and access to retail touch points provide significant benefits for IDFC Bank. In the near to medium term, IDFC group is the major beneficiary. Hence, we expect favorable swap ratio for Shriram shareholders. Yet, over the longer term, it is more beneficial to conduct a growing lending business under the banking platform. At the CMP, share swap ratio is likely to be 1:38.5 (IDFCB:SCUF), and this will lead to 13%/11% dilution for IDFCB s (merged entity) FY18/FY19 BV. We await the merger ratio. We have Neutral rating on IDFCB/IDFC Limited, with target price of INR62/81, and a Buy on SCUF/SHTF with a target price of INR2,689/1, July

3 Conference call highlights All operating businesses with be co-branded STF will be a 100% owned standalone unlisted NBFC under the NOHFC of IDFC Ltd Life Insurance & General Insurance businesses will be subsidiaries of IDFC Ltd. Shriram Capital will merge with IDFC Ltd Life insurance and General Insurance businesses are JVs with Sanlam. General insurance JV is one of the most profitable generals insurers in the country The next step in the process would be to get the swap ratio decided by the boards. The full process will take ~12 months to complete Rationale and regulatory details 5 regulators are involved for the transaction - RBI, SEBI, IRDA, CCI and NCLT. If the RBI were to approve only part of the merger (for eg, RBI allows SCUF merger but not SHTF), then the overall transaction will not go through. This is a composite scheme. Deal Rationale for IDFC bank 1. Direct access to almost 10m Shriram customer base. 2. Accelerated retailization for IDFCB (1000+retail touch points added to an existing infra heavy book). 3. Access to PSL loans (More than 50% of SCUF s portfolio is PSL-compliant) 4. Higher RoE of Shriram businesses compared to IDFC 5. Direct entry into South India where credit discipline is highest in the country. Deal Rationale for Shriram group 1. Significant reduction in cost of funds given that wholesale borrowing rates for banks are much lower than NBFCs 2. SHTF customers will have access to multiple banking products significant cross-sell opportunity Capital adequacy ratio of the bank will go up post-merger due to lower risk weights on PSL under a banking entity and high net-worth of SCUF. IDFC Ltd will be able to pay higher dividends as it now has a 100% owned operating subsidiary. This could also result in lower hold co discount, according to the mgmt. In 2016, RBI came with new regulations one of them was that RBI has the discretion to allow certain kind of business to remain outside the bank provided that the same business is not conducted within the bank. (this pertains to SHTF being housed under the NOHFC) As per regulations, NOHFC must reduce its shareholding in the bank to 40% by Oct 2018 and continue to hold 40% for 5 years. If IDFCB were to merger with SCUF and SHTF both, then due to the massive dilution, NOHFC s shareholding would drop to sub-40%. The management is confident of maintaining the 40% shareholding in this deal, despite the contours of the transactions not being clear. They have consulted with the largest minority shareholders of both SHTF and SCUF regarding the deal. CRR/SLR requirements will not be a problem given that IDFCB has excess CRR/SLR on its books. 10 July

4 Exhibit 1: BV accretion/dilution Premium to CMP CMP 5% 10% 15% 20% SCUF price for merger 2, IDFCB price Swap ratio* Shares to be issued % equity dilution (merged entity) FY18 BV FY19 BV BV accretion/(dilution) (%) FY18 BV -13% -14% -15% -16% -18% FY19 BV -11% -13% -14% -15% -17% *Swap Ratio is being calculated on 7 July Friday closing price Exhibit 2: SHTF loan mix Exhibit 3: SHTF borrowings mix M&LCV, 20% Passenger Vehicles, 25% Tractors, 5% Equipment Finance, 1% Total inst 16% 5% 7% 1% 39% Redemable NCD Term loans CC incl WC loans Fixed dep Others, 3% Term loans HCV, 47% 34% Subordinated Debt Source: Company, MOSL Source: Company, MOSL Exhibit 4: SCUF Loan mix Auto loan, 6% Personal Loan, 7% Gold Loan, 15% Exhibit 5: SCUF liabilities mix Commercial Paper, 12 Inst. Sub Debt, 2 2 -Wheeler loans, 18% Term Loan, 48 Public issure NCD, 2 Subordinate Debt, 4 Retail Deposit, 19 Small Business loan, 55% Cash Credit, 9 NCD (inst), 5 Source: MOSL, Company Source: MOSL, Company 10 July

5 Exhibit 6: IDFC Bank loan mix Exhibit 7: SCUF loan mix Exhibit 8: Combined entity loan mix Whole sale, 66% Retail + SME loans, 34% Gold, 14% Others, 12% 2W, 16% Whole sale, 44% HFC subsidi ary, 7% Retail + SME loans, 56% SME, 51% Source: MOSL, Company Exhibit 9: IDFC Bank shareholding pre-merger Exhibit 10: IDFC Bank shareholding post-merger IDFC Ltd, 30 Others, 47 % Shriram Capital, 14 IDFC Ltd, 53% Others, 42 Piramal Enterprises, 4 APAX, 9 Source: MOSL, Company Source: MOSL, Company 10 July

6 Exhibit 11: Pro forma merged entity (INR m) IDFC Bank Shriram City Union Finance Merged Entity FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E NII 23,979 29,378 34,497 33,793 39,956 47,190 57,772 69,334 81,687 Growth (%) Other Income 12,071 14,083 16, ,321 14,383 16,521 Growth (%) Net Income 36,050 43,462 50,718 34,043 40,256 47,490 70,094 83,718 98,208 Growth (%) Opex 16,703 19,902 24,135 12,761 14,815 17,398 29,464 34,717 41,533 Growth (%) PPP 19,348 23,559 26,583 21,282 25,441 30,092 40,630 49,001 56,676 Growth (%) Provisions 2,293 3,334 4,441 7,845 8,113 9,605 10,138 11,447 14,046 Growth (%) PBT 17,055 20,225 22,142 13,437 17,329 20,488 30,492 37,554 42,630 Growth (%) Tax 5,116 6,068 6,643 4,684 6,041 7, Tax Rate PAT 11,938 14,158 15,499 8,753 11,288 13,346 20,691 25,446 28,845 Growth (%) Equity 33,990 33,990 33, ,085 45,085 45,085 Reserves and surplus 1,21,935 1,32,780 1,44,653 56,952 66,498 77,943 1,78,887 1,99,278 2,22,596 Networth 1,55,925 1,66,770 1,78,643 57,611 67,157 78,603 2,23,972 2,44,363 2,67,681 Growth (%) Loans 6,37,930 8,06,503 9,92,680 2,73,605 3,23,729 3,83,336 9,11,535 11,30,232 13,76,016 Growth (%) Total Assets 14,38,793 16,82,236 18,91,114 2,61,589 3,08,490 3,64,357 17,00,382 19,90,726 22,55,471 Growth (%) EPS BV RoA RoE Swap Ratio is being calculated on 7 July Friday closing price Source: MOSL, Company 10 July

7 IDFC Bank: Financials & Valuations Income Statement (INR Million) Y/E March 2H E 2019E 2020E 2021E Interest Income 36,488 85,327 97,600 1,17,575 1,35,943 1,52,915 Interest Expense 28,015 65,154 73,620 88,197 1,01,447 1,12,785 Net Interest Income 8,473 20,173 23,979 29,378 34,497 40,130 Change (%) Non Interest Income 4,032 10,131 12,071 14,083 16,221 18,769 Fee income 677 3,600 5,040 6,552 8,190 10,238 Change (%) Other Income 3,355 6,531 7,031 7,531 8,031 8,531 Net Income 12,505 30,304 36,050 43,462 50,718 58,899 Change (%) Operating Expenses 5,106 12,770 16,703 19,902 24,135 28,833 Change (%) Pre Provision Profits 7,399 17,535 19,348 23,559 26,583 30,065 Change (%) Provisions (excl tax) 242 2,825 2,293 3,334 4,441 5,687 Credit Cost (%) PBT 7,158 14,710 17,055 20,225 22,142 24,378 Tax 2,489 4,512 5,116 6,068 6,643 7,313 Tax Rate (%) PAT 4,669 10,197 11,938 14,158 15,499 17,065 Change (%) Equity Dividend (Incl tax) 1,092 2,386 2,794 3,313 3,627 3,993 Core PPP* 4,044 11,003 12,316 16,028 18,552 21,534 Change (%) *Core PPP is (NII+Fee income-opex) Balance Sheet (INR Million) Y/E March E 2019E 2020E 2021E Share Capital 33,926 33,990 33,990 33,990 33,990 33,990 Reserves & Surplus 1,02,399 1,12,790 1,21,935 1,32,780 1,44,653 1,57,724 Net Worth 1,36,326 1,46,780 1,55,925 1,66,770 1,78,643 1,91,714 Deposits 82,190 4,02,082 6,52,632 8,40,831 10,25,501 12,15,574 Change (%) n.a CA 3,610 18,094 29,968 42,435 55,696 70,018 SA 800 2,368 7,296 19,712 37,248 58,406 Borrowings 5,71,598 5,02,622 5,46,101 5,73,674 5,65,817 5,34,876 Change (%) Infra Bonds 99,450 1,04,340 1,52,820 2,25,432 3,00,895 3,79,495 Other borrowings 4,72,148 3,98,282 3,93,281 3,48,242 2,64,922 1,55,381 Other Liabilities & Prov. 42,044 70,112 84,134 1,00,961 1,21,154 1,45,384 Total Liabilities 8,32,159 11,21,597 14,38,793 16,82,236 18,91,114 20,87,548 Current Assets 29,039 51,020 64,412 77,294 86,067 83,986 Investments 2,97,286 5,04,717 6,50,240 6,94,986 6,88,223 6,95,631 Change (%) G Sec 1,10,570 1,92,640 2,60,064 3,06,876 3,37,563 3,54,441 RIDF and PTC 0 1,36,000 1,96,491 1,75,057 1,16,302 83,396 Other investments 1,86,716 1,76,077 1,93,685 2,13,053 2,34,358 2,57,794 Loans 4,56,994 4,94,017 6,37,930 8,06,503 9,92,680 11,58,958 Change (%) n.a Other Assets 48,839 71,843 86,211 1,03,454 1,24,144 1,48,973 Total Assets 8,32,159 11,21,597 14,38,793 16,82,236 18,91,114 20,87, July

8 IDFC Bank: Financials & Valuations Asset quality E 2019E 2020E 2021E GNPA (INR m) 30,583 35,891 41,063 45,609 52,618 61,948 NNPA (INR m) 11,390 12,562 14,372 15,963 18,416 21,682 GNPA Ratio NNPA Ratio PCR (Excl Tech. write off) E: MOSL Estimates Ratios Y/E March 2H E 2019E 2020E 2021E Spreads Analysis (%) Avg. Yield-Earning Assets Avg. Yield on loans Avg. Yield on Investments Avg. Cost-Int. Bear. Liab Interest Spread Net Interest Margin Profitability Ratios (%) RoE RoA Int. Expense/Int.Income Fee Income/Net Income Non Int. Inc./Net Income Efficiency Ratios (%) Cost/Income Empl. Cost/Op. Exps Cost per Empl. (INR m) of which for ex-infra bus. INR M NP per Empl. (INR Mn) Valuation Book Value (INR) Change (%) Price-BV (x) Adjusted BV (INR) Change (%) Price-ABV (x) EPS (INR) Change (%) Price-Earnings (x) Dividend Per Share (INR) Dividend Yield (%) E: MOSL Estimates 10 July

9 Shriram City Union Finance: Financials and Valuation Income Statement (INR Million) Y/E March E 2019E 2020E Financing Income 27,012 29,312 33,104 37,065 43,344 50,327 59,621 70,467 Financing charges 14,105 13,507 13,432 13,834 15,344 16,847 20,037 23,717 Net Financing income 12,907 15,805 19,672 23,231 28,000 33,480 39,583 46,749 Change (%) Income from securitisation 3,460 2,207 1, Net Income (Incl Secur) 16,367 18,012 20,915 23,889 28,452 33,793 39,956 47,190 Change (%) Fee & Other Income Net Income 16,442 18,500 21,434 24,139 28,528 34,043 40,256 47,490 Change (%) Employee Cost 2,239 2,708 4,116 5,132 5,503 6,163 7,211 8,437 Other Operating Exp. 3,987 4,531 4,820 5,362 5,857 6,598 7,604 8,961 Operating Income 10,215 11,261 12,499 13,645 17,168 21,282 25,441 30,092 Change (%) Total Provisions 3,559 3,462 4,088 5,577 8,632 7,845 8,113 9,605 % to operating income PBT 6,657 7,799 8,411 8,068 8,536 13,437 17,329 20,488 Tax 2,160 2,587 2,830 2,771 2,976 4,684 6,041 7,142 Tax Rate (%) PAT 4,496 5,211 5,581 5,298 5,561 8,753 11,288 13,346 Change (%) Proposed Dividend , ,187 1,450 1,582 (INR Balance Sheet Million) Y/E March E 2019E 2020E Capital Reserves & Surplus 21,537 28,390 40,352 44,457 49,624 56,952 66,498 77,943 Net Worth 22,092 28,983 41,011 45,116 50,284 57,611 67,157 78,603 Net Worth 22,528 29,017 41,036 45,136 50,300 57,628 67,174 78,619 Borrowings 1,27,287 1,20,491 1,24,017 1,44,084 1,70,420 2,03,961 2,41,316 2,85,738 Change (%) Other Liabilities & Prov Total Liabilities 1,49,815 1,49,508 1,65,054 1,89,220 2,20,720 2,61,589 3,08,490 3,64,357 Investments 730 6,276 9,817 7,923 7,145 6,443 5,811 5,240 Change (%) Loans 1,37,795 1,29,835 1,60,275 1,91,406 2,29,614 2,73,605 3,23,729 3,83,336 Change (%) Net Fixed Assets 884 1, Net Current Assets 10,407 12,384-5,861-11,309-16,837-19,315-21,899-24,982 Total Assets 1,49,815 1,49,508 1,65,054 1,88,869 2,20,704 2,61,589 3,08,490 3,64, July

10 Shriram City Union Finance: Financials and Valuation Ratios Y/E March E 2019E 2020E Spreads Analysis (%) Yield on loans Cost of funds Interest Spread NIMs (incl Securitisation inc) on AUM Profitability Ratios (%) RoE RoA Int. Expended/Int.Earned Other Inc. (incl. Sec. Inc.) / Net Income Efficiency Ratios (%) Op. Exps./Net Income Empl. Cost/Op. Exps Asset-Liability Profile (%) Loans/Borrowings Ratio Leverage Average leverage Valuations Book Value (INR) , ,192.5 BV Growth (%) Price-BV (x) Adjusted BV (INR) ,140.5 Price-ABV (x) EPS (INR) EPS Growth (%) Price-Earnings (x) DPS (INR) Dividend Yield (%) E: MOSL Estimates 10 July

11 Shriram Transport Finance: Financials and valuation Income Statement (INR Million) Y/E March E 2019E 2020E Financing Income 45,028 62,664 77,779 95,300 98,013 1,03,766 1,15,604 1,30,190 Finanancing charges 28,439 38,982 44,029 50,744 52,094 53,072 57,324 63,079 Net Financing income 16,588 23,683 33,750 44,556 45,919 50,694 58,280 67,111 Change (%) Income from securitisation 18,057 12,796 7,379 6,171 9,293 9,669 9,882 11,119 Net Income (Incl Secur) 34,645 36,479 41,129 50,727 55,212 60,363 68,162 78,230 Change (%) Other Income 1,885 1, ,009 Net Income 36,530 38,134 41,836 51,489 55,970 61,197 69,080 79,240 Change (%) Employee Cost 3,848 4,089 4,296 5,891 5,482 5,756 6,562 7,481 Brokerage & Commission 948 1, Other Operating Exp. 3,065 4,245 5,878 6,611 6,326 6,591 7,363 8,225 Operating Profit 28,670 28,573 31,054 38,400 43,682 48,332 54,575 62,885 Change (%) Total Provisions 8,508 10,293 12,630 20,586 24,443 21,506 21,794 24,316 % to operating income PBT 20,162 18,280 18,424 17,814 19,239 26,827 32,781 38,569 Tax 6,556 5,638 6,046 6,032 6,666 9,255 10,818 12,728 Tax Rate (%) PAT 13,606 12,642 12,378 11,782 12,573 17,571 21,963 25,841 Change (%) Proposed Dividend 1,590 1,588 1,815 2, ,811 3,294 3,876 Balance Sheet Y/E March E 2019E 2020E Capital 2,269 2,269 2,269 2,269 2,269 2,269 2,269 2,269 Reserves & Surplus 69,679 80,463 90,111 99,272 1,10,753 1,23,674 1,41,782 1,63,088 Net Worth 71,947 82,732 92,380 1,01,541 1,13,022 1,25,943 1,44,051 1,65,357 Borrowings 3,10,025 3,59,200 4,42,800 4,97,907 5,31,101 5,82,679 6,56,753 7,44,997 Change (%) Other Liabilities Total Liabilities 3,81,995 4,41,955 5,35,180 5,99,448 6,44,123 7,08,622 8,00,804 9,10,354 Investments 35,689 27,253 33,272 13,562 15,494 17,818 20,490 23,564 Change (%) Loans 3,11,227 3,64,878 4,92,271 6,37,701 6,78,402 7,57,996 8,64,009 9,88,314 Change (%) Net Fixed Assets 601 1,007 1,007 1, ,181 1,291 1,377 Net Current Assets 34,478 48,818 8,629-52,825-50,610-68,372-84,986-1,02,901 Total Assets 3,81,995 4,41,955 5,35,180 5,99,448 6,44,123 7,08,622 8,00,804 9,10,354 E: MOSL Estimates 10 July

12 Shriram Transport Finance: Financials and valuation Ratios Y/E March E 2019E 2020E Spreads Analysis (%) Avg. Yield - on Financing portfolio Avg Cost of funds Int Spread on Financing portfolio NIM (incl Securitisation) NIM (Excl Securitisation) Profitability Ratios (%) RoE RoA Int. Expended/Int.Earned Other Inc./Net Income Efficiency Ratios (%) Op. Exps./Net Income Empl. Cost/Op. Exps Asset-Liability Profile (%) Loans/Borrowings Ratio Net NPAs to Adv Leverage Average leverage Valuations Standalone BV (INR) BV Growth (%) Price-BV (x) Consolidated BV (INR) Price-BV (x) Standalone EPS (INR) Growth (%) Price-Earnings (x) Consolidated EPS (INR) EPS Growth (%) Price-Earnings (x) Dividend Dividend Yield (%) E: MOSL Estimates 10 July

13 Click here for further details Annexure: New banking license guidelines Key takeaways from RBI final guidelines on banking license Eligibility criteria for promoters and Fit and Proper criteria Entities/groups in the private sector, owned and controlled by residents, sound credentials and integrity and having successful track record of at least 10 years will be eligible. RBI may, inter alia, seek feedback on applicant groups on fit and proper criteria or any other relevant aspects from other regulators and enforcement and investigative agencies like income tax, CBI, Enforcement Directorate etc as deemed appropriate. Entities/groups business model and business culture should not be uneven with the banking model and their business should not potentially put the bank and the banking system at risk on account of group activities such as those which are speculative in nature or subject to high asset price volatility. Entities in public/private sector shall be eligible to promote a bank through a wholly-owned Non-Operative Financial Holding Company (NOFHC) Corporate structure for setting up of NOFHC Capital structure of the wholly-owned NOFHC set up in private sector: 1) Any individual belonging to promoter group and entities in which promoter group hold not less than 50% of the voting equity cannot hold more than 10% of voting equity shares of the NOFHC and 2) Companies forming part of the Promoter Group whereof companies in which the public hold not less than 51% of the voting equity shares shall hold not less than 51% of the total voting equity shares of the NOFHC. NOFHC shall hold the bank as well as all the other financial services entities of the Group regulated by RBI or other financial sector regulators. The objective is that the Holding Company should ring fence the regulated financial services entities of the Group, including the bank from other activities of the Group and other regulated financial activities of the group. Financial services entities whose shares held by NOFHC cannot be a shareholder of NOFHC. No financial services entity held by the NOFHC would be allowed to engage in any activity that a bank is permitted to undertake departmentally. However certain specialized activities, such as, insurance, mutual funds, stock broking, infrastructure debt funds, etc. to be conducted through a separate Subsidiary / Joint Venture / Associate structure. NOFHC shall not be permitted to set up any new financial services entity for at least three years from the date of commencement of business of the NOFHC. However, this will not preclude bank from having a subsidiary or JV or associate. Shares of the NOFHC shall not be transferred to any entity outside the Promoter Group. Any change in shareholding (by promoter group), wherein shareholder acquires more than 5% in NOFHC will require prior approval of RBI. 10 July

14 Regulatory framework for NOFHC The NOFHC will be registered as a non-banking financial company (NBFC) with the RBI and will be governed by a separate set of directions issued by RBI. The financial entities held by the NOFHC will be governed by the applicable Statutes and regulations prescribed by the respective financial sector regulators. Prudential norms for NOFHC On a standalone basis, NOFHC may have leverage up to 1.25x of net worth. Actual leverage should be assumed based on ability of NOFHC to service borrowings from dividend income. On a consolidated basis, CAR should be maintained as per Basel II/Basel III guidelines as appropriate. Exposure norms: No credit or investment exposure to promoter group entity or outside group entities expect those held under it Exposure norms for the financial entities (ex-bank) held by the NOFHC The financial entities held by NOFHC shall not have: A) Any credit and investments exposure to the Promoter Group entities or individuals associated with the Promoter Group or the NOFHC. B) Shall not make investment in the equity / debt capital instruments amongst themselves. C) Cannot invest in equity instruments of other NOFHCs Corporate governance of the NOFHC NOFHC shall not have a Director on the board a person who is a Director in any other NOFHC or a bank other than a banking company under it. At least 50% of the Directors of NOFHC shall be totally independent of the Promoter or Promoter Group entities and their major customers and major suppliers (10% annual sales and purchase taken together). Ownership and management shall be separate and distinct in the NOFHC, the bank and entities regulated by RBI. Norms for the new banks Requirement of the new bank Applicants for new bank licenses will be required to furnish their business plan as to how the bank proposes to achieve financial inclusion. In case of deviation from the stated business plan after issue of license, RBI may consider restricting the bank s expansion, effecting change in management and imposing penal charges as may be necessary. The bank shall comply with the priority sector lending targets and sub-targets as applicable to the existing domestic banks. For this purpose, the bank should build its priority sector lending portfolio from the commencement of its operations. The bank shall open at least 25% of its branches in unbanked rural centers (population up to 9,999 as per the latest census) to avoid over concentration of their branches in metropolitan areas and cities which are already having adequate banking presence. The Board of the bank should have a majority of independent Directors 10 July

15 Capital requirement and equity holding for bank Minimum capital requirement: Initial minimum paid-up voting equity capital for a bank shall be INR5b. The NOFHC shall hold a minimum of 40% of the equity capital of the bank which shall be locked in for a period of five years from the date of commencement of business of the bank. NOFHC holding excess of 40% in the bank shall be brought down to 40% within three years from the date of commencement of business of the bank. The shareholding by NOFHC shall be brought down to 20% within a period of 10 years, and to 15% within 12 years from the date of commencement of business of the bank. No single entity or group of related entities, other than the NOFHC, shall have shareholding or control, directly or indirectly, in excess of 10% of the paid-up voting equity capital of the bank. The Promoter Group entities / individuals associated with Promoter Group shall hold equity investment, in the bank and other financial entities held by it, only through the NOFHC. Bank as well as NOFHC will be required to maintain a minimum capital adequacy ratio of 13% of its risk weighted assets (RWA) for a minimum period of 3 years on a standalone and a consolidated basis. The bank shall get its shares listed within three years of the commencement of business. Banks promoted by Groups having 40% or more assets / income from nonfinancial business will require RBI s prior approval for raising paid-up voting equity capital beyond INR10b for every block of INR5b. Foreign shareholding in the bank Foreign shareholding (Including FDI, NRI and FII) in new private sector banks shall not exceed 49% for the first 5 years from the date of licensing of the bank. No nonresident shareholder, directly or indirectly, individually or in groups, or through subsidiary, associate or JV will be permitted to hold more than 5% paid up equity capital of the bank for the period of 5 years from the commencement of business of the bank. After 5 years aggregate foreign shareholding would be as per the extant FDI policy. Exposure norms for the bank The bank cannot take any credit and investments (including investments in the equity/debt capital instrument) exposure on the Promoters / Promoter Group entities or individuals associated with the Promoter Group or the NOFHC. The bank cannot invest in the equity of other NOFHCs Investment in equity by the bank in the entities engaged in financial and nonfinancial activities, outside the Promoter Group will be restricted to 10% and the aggregate of all such investments should not exceed 20% of the bank s paidup share capital and reserves 10 July

16 Additional conditions for NBFCs promoting / converting into a bank The NBFCs eligible to for a license will have three options Activities undertaken by the NBFC are not permitted to be undertaken by banks, In such cases, the activities undertaken by the NBFC which banks are allowed to undertake, will have to be transferred to the new bank If all the activities undertaken by it are allowed to be undertaken by a bank then convert the NBFC into a bank. However In such a case, the NBFC shall have a minimum networth of INR 5b Convert the NBFC into a bank and divest the activities which banks are not allowed to undertake departmentally. In such a case, the bank shall have a minimum networth of INR5b. Under the above options promoters will have to set up NOFHC. RBI will consider allowing the bank to take over and convert existing NBFC branches into bank branches only in Tier 2 to 6 centers Existing branches in Tier 1 centers can only be converted with prior permission of RBI and subjected to condition of opening 25% of these branches in unbanked centers. Click here for further details The on tap banking license guidelines which came out in 2016, allowed mono-line business to be run separately. However, RBI usually goes by the guideline under which the entity got the banking license. So the ball lies in the RBI s court Some of the key aspects of the 2016 Guidelines include resident individuals and professionals having 10 years of experience in banking and finance at a senior level are also eligible to promote universal banks large industrial houses are excluded as eligible entities but are permitted to invest in the banks up to 10 per cent Non-Operative Financial Holding Company (NOFHC) has been made nonmandatory in case of promoters being individuals or standalone promoting/converting entities who/which do not have other group entities Not less than 51 per cent of the total paid-up equity capital of the NOFHC shall be owned by the promoter/promoter group, instead being wholly owned by the promoter group Existing specialised activities have been permitted to be continued from a separate entity proposed to be held under the NOFHC subject to prior approval from the Reserve Bank and subject to it being ensured that similar activities are not conducted through the bank as well. 10 July

17 N O T E S 10 July

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