The Kotak-ING merger is on track, with second-quarter fiscal 2016 merged entity numbers broadly in line with our estimates. While earnings for second quarter were 27% higher than same quarter last year, they were just 1.4% higher than for the first half. Taking first-half results, much of the growth in total income (up 32%) was lost as one went down the profit statement—on accounting for higher interest spends, operating expenses and loan provisions.
Net interest margins at 4.3% for the September quarter, continue to be better than our long-term expectation of 4.2% for this narrow economic moat bank. This was achieved despite offering higher interest rates to erstwhile ING bank savings account customers, which is quite commendable. Savings account deposits for the bank have gone up 73% since March post merger, and 7% sequentially since June as the higher rate attracts more deposit customers.
The proportion of savings deposits to total deposits has moved to 19.8% from 18.7% in the same period. Interestingly, offering the higher rate has not cost Kotak much more, with overall weighted average cost of savings accounts moving to 5.48% in September versus 5.43% in March. This is because of their tiered structure on savings account deposits where they offer a maximum of 6% to any savings customer. On the asset quality front, the bank continues to recognize stress in ING's loan book as it transitions to the merged entity. Management maintains that credit costs for the year will be 80 basis points of loans. On the operating cost front, since the back-office and front-office (ATM, branch) integration of the two entities is still under way, it is hard to estimate overall costs.
We maintain our high uncertainty rating on the bank as credit costs and operating costs are key drivers for our discounted cash flow valuation on Kotak. We believe the stock is currently overvalued trading at 4 times price/book value, and ahead of our INR 585.50 per share intrinsic value.
Kotak continues to embrace the digital revolution in banking and is exploring new ways to use technology to shorten service time, and reduce costs at the back-end like all banks in India. We believe its payment bank partnership with leading telecom player Airtel (in which Kotak owns 20% equity share) could be a winning one, given that over 300 million mobile subscribers are already on the Airtel network.
