The composite index hosting public sector bank shares on the National Stock Exchange (NSE) has lost 7% of its value. It is a transparent indication that investors don’t like the government’s first try at bank consolidation. On Monday, the government declared that it would merge Bank of Baroda (BOB), Vijaya Bank and Dena Bank to create the third largest lender in India.

It has been proved that BoB shareholders stand to lose the most, While Dena Bank investors will have everything to gain from the transaction. After all, Dena Bank has an eminent toxic loan a lot and a capital canvas full of holes. It does not lend anymore and has been under the extreme care of the  Reserve Bank of India (RBI) for more than four months. The merger is rightly seen as a bailout for Dena Bank.

On Monday, after the announcements, Investors in Bank of Baroda and Vijaya Bank have lost 14% and 12% in market value, while Dena Bank investors gained 14%.

There is one way to convert wrong into right way by the government is by entering at a fair share swap ratio. According to the analysts reports that the recent surge in Dena Bank’s share price has made it one of the most costly stocks among PSU banks relative to its net worth and other unpleasant metrics.

Earlier before the merger announcement, Dena Bank’s stock was pricing in a fair bit of the pain in its numbers. It traded at a 33% discount to its book value as on June 2018, while Bank of Baroda was trading at a 20% discount. Based on their book values as of June, every share of BoB was worth 8.5 shares of Dena Bank.

Since then, due to the divergent movement in the stocks, every share of Bank of Baroda is now worth only 6.4 shares of Dena Bank. Because shares of Bank of Baroda and Vijaya Bank have moved more or less in combing, nothing much has altered in their swap equation.

But if the government were to use current prices as a benchmark, or rather if the markets are reading the government’s mind correctly, it would mean that there would be a 20% haircut on account of Bank of Baroda’s bad loans, while no such depreciation would be imposed on Dena Bank’s value. Needless to say, considering that the latter has a far worse bad loan problem.

Earlier it was marked as the government should rectify the anomaly when the swap ratio—the pre-announcement ratio of 1:8.5 seems more appropriate, considering Dena Bank’s financial metrics.

Else, it would be like that Bank of Baroda’s investors being ready to accept the consequences of the bad assets on their books, while at the same time giving a pass for Dena Bank’s toxic pile.

If the swap ratio favours Dena Bank, the government will stand to gain the most, given its 80% stake in the bank. In BoB, it has a lower stake of about 64%. But this will clearly be a nearsighted view, since the overall loss in the government’s portfolio is big, as is evident from the fall in the CNX PSU Bank index.

Hopefully, Dena Bank’s largest shareholder can view things in a realistic light.

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