A merger occurs when two or more companies combines and the resulting firm maintains the identity of one of the firms. One or more companies may merge with an existing company or they may merge to form a new company. A fundamental characteristic of merger is that the acquiring company takes over the ownership of other companies and combines their operations with its own operations. An acquisition may be defined as an act of acquiring effective control by one company over the assets or management of another company without any combination of companies.
The boards of both HDFC Bank and Centurion Bank of Punjab (CBOP) have approved the merger between the two banks in the ratio of 1:29(1 share of HDFC Bank for 29 shares of CBOP) HDFC bank would also consider selling shares to HDFC in order to maintain its holding over 20%. We rate this merger as neutral for HDFC Bank on as a long term perspective. However on a short term basis, it is negative for HDFC Bank's stand-alone financials and shareholders
At the current price, the CBOP's is richly valued compared with that of HDFC bank despite CBOP's lower banking franchise, inferior return ratios and higher NPAs. CBOP's asset book constitutes about 20% of that of HDFC Bank; while its profit is merely 11%.Following is a case study of the key business parameters across HDFC Bank and CBOP and its merger.
INTRODUCTION
In order to nurse corporate health and growth pattern of developing and developed countries the concept of mergers and acquisitions is very popular in current scenario. Moreover, it is significantly popular concept after 1990s in India on the birth of liberalization and globalization.
HDFC BANK
The Housing Development Finance Corporation Limited (HDFC) is amongst the first to receive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a bank in the private sector, as part of the RBI's liberalization of the Indian Banking Industry in 1994. HDFC Bank is India's second largest having an average Return on Asset of 1.4%. With a growing branch network and expanding retail market, the bank has attained extensive expertise in the retail market. At end Dec.'07, HDFC Bank's retail loans constituted 53% of its loan book. HDFC Bank's share of low cost deposits stands at 51% as of December 2007, which is the most enviable feature vis-à-vis peers. HDFC Bank's asset quality (net NPAs at 0.4% of total advances) is very healthy.
CENTURION BANK OF PUNJAB (CBoP)
CBoP is a fast growing new generation private sector bank. CBoP has a strong and experienced management team. The management has demonstrated a marked capability to integrate diverse organizations by successfully merging Bank of Punjab with itself. It had recently acquired Lord Krishna Bank, integration of which with CBoP operations is currently underway.
The bank follows a retail focused strategy with SME as a strong second engine. The fee income share, at 40% as of December 2007and emanating from third party distribution of financial products, wealth management and foreign exchange business, is one of the best in the industry. A latent significant operating leverage continues to be the key attraction of the bank.
Merger between Bank of Punjab and Centurion Bank
Bank of Punjab (BOP) and Centurion Banks (CB) have been merged to form Centurion Bank of Punjab (CBP) before Centurion Bank of Punjab merged with HDFC Bank. RBI approved merger of Centurion Bank and Bank of Punjab effective from October 1, 2005. The merger was at swap ratio 9:4 and the combined bank is called Centurion Bank of Punjab. The merger of the banks had a presence of 240 branches and extension counters, 386 ATMs, about 2.2 million customers. As on March 2005, the net worth of the combined entity was Rs 696 crore.
CASE STUDY
Merger between HDFC and Centurion Bank of Punjab
Bank mergers in India have often been viewed as forced marriages: A strong healthy bank takes over a smaller and weaker institution at the behest of the country's central banker, the Reserve Bank of India (RBI).
A merger makes economic sense to the acquiring firm if its shareholders wealth is maximized. Merger creates an Economic Advantage (EA) when the combined present value of the merged firms is greater than the sum of the individual present values as separate entities.
The boards of directors of HDFC Bank and Centurion Bank of Punjab (CBoP) separately gave their approvals for merger of their banks. HDFC Bank was expected to pay Rs10, 000- 12,000 crore in shares for acquiring CBoP.
The Merger talks began in January 2008 between the principal shareholders of CBoP, which were as follows:-
Muscat Bank with 14.02 % Stake.
Sabre Capital with 3.48 % stake.
Kephinance Investment (Mauritius) with 6.13 % stake, decided to exit.
As these three companies signed a shareholder's agreement in 2003, which provide that any decision to sell the stake would be taken together, so this started after the three get ready to exit.
HDFC Bank is hopeful to complete the integration process in about five to seven months. They decided to sell the home loan portfolio of CBop to Housing Development Finance Corporation (HDFC). Otherwise the merged entity will lead to conflict of interest with HDFC Bank's Parent.
HDFC holds 23.28 Percent of stake in HDFC Bank. Its Holding is expected to fall less than 20 percent post- merger. Banking Sources said HDFC would approach to RBI to allow them to maintain 20 percent stake on HDFC bank.
The chairman of Centurion will have no role to play in the merged entity. Shailendra Bhandari, the MD and CEO of the Centurion Bank will be hired as a member of the merged bank and will have no role play in the everyday operations of the bank.
Big question for HDFC Bank after this integration as where HDFC would have to consider for reorganization, as CBop has close 170 branches in the north India and around 140 branches in south India, while HDFC Bank has nearly 250 branches in the north India and nearly 150 branches in Southern India, CBoP has a concentrated presence in the southern state of Kerela.
The integration was a challenge for HDFC Bank.
The HDFC Bank-CBOP merger is a smooth exercise when it comes to the marriage of technology at both banks.
Role of Reserve Bank of India
The boards of both HDFC Bank and Centurion Bank of Punjab (CBOP) have approved the merger between the two banks in the ratio of 1:29(1 share of HDFC Bank for 29 shares of CBOP) HDFC bank would also consider selling shares to HDFC in order to maintain its holding over 20%. We rate this merger as neutral for HDFC Bank on as a long term perspective. However on a short term basis, it is negative for HDFC Bank's stand-alone financials and shareholders. At the current price, the CBOP's is richly valued compared with that of HDFC bank despite CBOP's lower banking franchise, inferior return ratios and higher NPAs. CBOP's asset book constitutes about 20% of that of HDFC Bank; while its profit is merely 11%.
The Reserve Bank of India has sanctioned the Scheme of Amalgamation of Centurion Bank of Punjab Ltd. with HDFC Bank Ltd. The Scheme has been sanctioned in exercise of the powers contained in Sub-section (4) of Section 44A of the Banking Regulation Act, 1949. The Scheme will come into force with effect from May 23, 2008. All the branches of Centurion Bank of Punjab Ltd. will function as branches of HDFC Bank Ltd. with effect from May 23, 2008.
The biggest plus of the merger is the number of branches it will add to HDFC Bank. The RBI has been very cunning about letting banks open new branches. Going by the pace at which HDFC Bank has been allowed to expand its network in the past, this merger overviews two-and-a-half year in one fell swoop.
HDFC Perspective
While the swap ratio of 1:29 for HDFC-CBOP merger turned out to be more favorable for HDFC Bank than expected by the market, the merger appears to be long-term positive on market cap to branch basis.
Hence, HDFC Bank has been able to buy the franchisee of CBOP at almost one-third of what the market is currently giving to its own franchisee. If HDFC Bank manages to improve the productivity of these branches to even half the levels of HDFC Bank branches, the merger will become positive in longer term. It is expected that HDFC Bank will take a one-time charge of Rs3.5bn in order to clean up CBoP's balance sheet at the time of the merger and to account for the merger related expenses. While the merger would be EPS dilutive for HDFC Bank in the interim, more clarity is required in terms of the initial write-off the entity would have to take.
CBoP Perspective
Given the fact that the profitability ratios of CBoP are quite low, this looks an expensive proposition for HDFC in the short run. Thus the deal is a profitable deal for CBoP who in all probabilities would have sold out to a foreign player past 2009.
Post Merger Scenario
Retail segment will continue to be the main focus for the combined entity and would be the crucial growth driver. Post merger of HDFC-CBOP, HDFC's stake in HDFC Bank is projected to fall to 18.7% (including ESOPs allotment). However, HDFC Bank was expected to issue 26.3 m shares to HDFC on preferential basis, which will enable HDFC to maintain its stake of 23.28% post merger. Hence, HDFC is expected to infuse around Rs.39bn to HDFC bank to maintain its current ownership.
Due to an influx of 394 branches from CBoP, there will be a significant increase in the number of branches for HDFC. There is significant scope for improvement in utilization of the branch network, as branch/ employee productivity is still way below that for the peer group. As the combined entity leverages the CBoP's branch network, the opex to average asset will continue to trend down. The opex to average asset is expected to decline from 3.4% in FY08 to 3.28% in FY10.
CBoP currently has a weaker asset profile with net NPAs of 1.6% as against 0.4% for HDFC Bank. Going forward, HDFC Bank (combined entity) would aim to maintain its NPA profile at these levels, which would require a charge of ~Rs2bn. In addition, it is expected that HDFC Bank would provide for another Rs1.5bn towards any potential NPAs.
UP THE LADDER
Rs crore
Total Assets
Mar-07
SBI
5,66,565.24
ICICI Bank
3,44,658.11
Canara Bank
1,65,961.04
PNB
1,62,422.50
Bank of Baroda
1,43,146.17
Bank of India
1,41,636.99
HDFC Bank +
Centurion BoP*
1,09,718.39
IDBI Bank
1,03,839.32
UBI
1,02,677.88
CBI
93,008.08
* HDFC Bank will jump to the 7th position from 10th after the merger
Shareholding pattern of HDFC Bank on 31Dec 2007
Face value 10.00
Promoter's holding
No. of shares % of holding
Indian Promoters 82443000 23.28
Subtotal 82443000 23.28
Non Promoter's holding
Institutional Investors
Banks Fin. Inst. And Insurance 10068939 2.84
FII's 94087619 26.57
Subtotal 116142534 32.80
Shareholding pattern of CBoP on 31Dec 2007
Face value 1.00
Promoter's holding
No. of shares % of holding
Subtotal N.A N.A
Non Promoter's holding
Institutional Investors
Banks Fin. Inst. and Insurance 1142025 0.06
FII's 501898631 26.80
Subtotal 512107247 27.34
Operational Statistics of HDFC and CBoP
Main Highlights of Merger
The merger was effected using the 'pooling of interest' method. The bank's main task was to harmonize the accounting policies and, as a result, HDFC Bank took a hit of Rs. 7 Billion to streamline the policies of CBoP. Of this Rs. 7 Billion, around 70% went toward the harmonization of accounting policies relating to loan- loss provisioning and depreciation of assets, and the balance 30% reserves write-offs were toward the merger-related restructuring costs like stamp duty, HR and IT integration expenses.
The loan book size of erstwhile CBoP was close to Rs. 150 Billion, largely constituted by retail loans with only around 15% of corporate loans. In terms of asset quality, the gross NPAs at the end of March2008 were around 3.8% and net NPAs at around 1.7%.
The CASA ratio at the end of June 2008 was 45%. This in line with expectations of analysts as CBoP had a much lower CASA ratio of around 25% compare to 56% of Pre-merged HDFC Bank. By the end of the year, the target CASA ratio is around 47-48%. This would primarily be driven by an increasing contribution of low-cost deposits from the erstwhile CBoP's branches.
Of the total non- interest income of CBoP, fee income constituted around 50% which was generated mainly through distribution of insurance products (Aviva) and from processing fees. In line with regulatory and operational issues, these streams of income have temporarily been discounted. This aspect act as a drag on the 'other income' of the merged entity and it would take 2-3 quarters for the issues to be addressed.
The cost/income ratio of the merged entity has increased to around 56% from 50% levels for standalone HDFC Bank. The increase was expected as CBoP's C/I ratio was around 60%. HDFC Bank has retained almost all the employees of CBoP and expects to achieve full synergies and efficiencies, in terms of the restructured HR and IT processes, in the next 2-3 quarters. This means that by Q4FY09, the entire workforce would be working at full efficiency levels as that of the existing bank and the technology and IT-platforms would be completely integrated to support efficient performance.
HDFC Bank has always maintained that fast branch expansion is a key ingredient that will sustain its high CASA deposits and margins. This merger with CBoP would result in the combined entity having 1148 branches at present, which is the largest branch distribution network for a private bank in India (ICICI Bank currently has 955 branches).
Positive aspects of the merger:
(1) increased footprint and metro presence;
(2) cost-income ratio has room for improvement;
(3) Enhanced management bandwidth to enable entry in to International business; and
(4) Both banks have senior managements of high caliber who have worked with Citigroup at some point in their career.
Negatives:
(1) Merger likely to be EPS dilutive for the next two years, due to valuations; and
(2) Integration of LKB branches may pose a challenge.
CONCLUSION
The case study is made before keeping each and every aspect in mind.
As per employee information analysis employee feels nice after merger, in term of organization culture, salary package, technological development and hierarchy level. And as per the consumer information analysis consumer are satisfied of banking services, advances increased. And shareholders are happy with the increase of share price and growth.
Mr. Deepak Parekh, Chairman, HDFC said, "We were amongst the first to get a banking license, the first to do a merger in the private sector with Times Bank in 1999, and now if this deal happens, it would be the largest merger in the private sector banking space in India. HDFC Bank was looking for an appropriate merger opportunity that would add scale, geography and experienced staff to its franchise. This opportunity arose and we thought it is an attractive route to supplement HDFC Bank's organic growth. We believe that Centurion Bank of Punjab would be the right fit in terms of culture, strategic intent and approach to business."
So, at last the conclusion is that there is tough competition ahead for the company from its major competitors in the banking sector.
