The cost of integration and a potential clean-up of associates’ books will determine whether SBI investors have jumped the gun by driving up the stock sharply.

Investors have driven up the stocks of the listed associates of State Bank of India (SBI) by as much as 63% in the past month, ever since their merger with the parent was announced. Not surprisingly, these banks trade at significant discounts to SBI.

SBI shares, themselves, have gained by one-fifth in this period. This is despite a section of the market thinking that the merger will be a distraction for the management, which is struggling to clean up the balance sheet and resolve the bad loans problem. Note also that current chairperson Arundhati Bhattacharya’s term is set to end in a couple of months.

On the face of it, a merger with the associates shouldn’t add to SBI’s bad loans problem. The consolidation, if anything, will improve the situation marginally as the increase in bad loans will be slower than advances. The provision coverage ratio will also remain close to 60%.

The SBI management has stated that there are three sources of benefit from the merger. The consolidated bank is expected to manage costs better—the cost-to-income ratio could reduce by as much as 100 basis points (bps). One basis point is one-hundredth of a percentage point.

Second, a combined treasury could perform better and, third, the lower cost of deposits will boost margins. According to Ambit Capital Ltd, the management pegs total savings at Rs.3,500 crore, which is a quarter of the last three year’s average combined annual profits of the parent and associate banks.

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On the flipside, SBI will have to bear one-time pension liability cost as its employees are covered by both pension and provident fund; however, not all employees of these associate banks are eligible for a pension. The bank’s management had forecast this amount to be close to Rs.3,000 crore when announcing March-quarter results on 27 May.

“The immediate negative impact will be from pension liability provisions due to different employee benefit structures and a harmonization of accounting policies for NPA recognition,” said Alpesh Mehta from Motilal Oswal Financial Services Ltd.

The books of the associates have not been subjected to the same scrutiny as SBI’s and analysts are worried that they may throw up some skeletons. SBI, itself, has declared a bad loan watch list of Rs.31,000 crore.

“Higher restructured assets of associate banks cloud the future outlook since there is not much visibility and clarity. One has not heard from their respective managements about how their books have been so far,” cautions IIFL analyst Rajiv Mehta.

“Even if we build in the (SBI) management’s expected synergies in our estimates, the impacts on the combined entity’s RoA (12 bps) and RoE (194 bps) do not appear significant at this stage,” wrote Ambit analysts in a 16 June note. RoA is a return on assets and RoE is a return on equity.

The cost of integration and a potential clean-up of the associates’ books will determine whether SBI investors have jumped the gun by driving up the stock sharply.