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Banks
A Case Study of HDFC Bank and Centurion Bank of Punjab
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ABSTRACT
Amalgamation in the Indian Banking Industry are the most happening arena apropos the
ballooning effect of NPA (Non Performing assets).Deregulation, favorable economic, financial
conditions and the structural legal changes have strategically made the” survival of the fittest”
theorem as a reality in the Indian Banking Sector. Keeping in view the financial restructuring of
the Banks and the aftermaths of the amalgamation the authors have attempted the intricacies and
financial basis of the amalgamation in the Banking sector. The authors have empirically studied
the basis of the scheme of amalgamation of HDFC Bank and Centurion Bank of Punjab. The
main aim of this research is to evaluate share swap ratio of this merger apart from what they have
benefited individually.. Extensive use of the EPS (earning per share) Discounted Cash Flow,
Terminal Value techniques has been explained whilst calculating the Share Exchange Ratio
(SER) and NSE (Net Share Exchange Ratio). Other key parameters of the strategic fitness in
terms of cultural approach of business have also been discussed. Post the merger, HDFC Bank’s
gains and the economies of scale have also been elaborated.
Key Words
INTRODUCTION
In order to nurse corporate health and growth pattern of developing and developed countries
especially eradicating sickness in industries, 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. The basic crux of Mergers and Acquisitions are
consolidating the process of survival of existing undertakings, large groups absorbing small
entities, cooperation of international business units welcoming to participate in the development
of nation’s economic growth and prosperity, to eliminate industrial sickness, to take tax
advantages, or free from stringent formalities of official procedures and red tape and corporate
restructuring and reorganization to meet challenges in the stiff competitive open market economy
demand such a task of mergers and acquisition.
The prevalence and success of consolidation in the banking sector across the world and the
compulsions imposed by globalization will make this dictum more visible in the Indian financial
system in the near future. The financial sector reforms set in motion in 1991 have greatly
changed the face of Indian banking. While the banking system in India has done fairly well in
adjusting to the new market dynamics, it would not be clichéd to reiterate that greater challenges
lie ahead.
The financial sector would be open to international competition once the tone for the rules of the
game is set under the WTO. Banks will have to gear up to meet stringent prudential capital
adequacy norms under Basel-II as they compete with banks with greater financial strength.
In the past, mergers were initiated by regulators to protect the interest of depositors of weak
banks. But it is now expected that market led mergers may gain momentum in the coming years.
The smaller banks with firm financials as well as the large ones with weak income statements
would be the obvious targets for the larger and better run banks. The pressures on capital
structure in particular is expected to trigger a phase of consolidation in the banking industry and
the pace would be swifter than we can conceive of today.
Bank mergers in India have often been viewed as shotgun marriages: A strong bank takes over a
weaker institution -- usually one that is about to go belly-up -- at the behest of the country's
central banker, the Reserve Bank of India (RBI). Sometimes the deal doesn't make sense, but
regulators force it through.
.
• The merger of the banking companies in India attract Section 44 A of the Banking
Regulation Act 1949 unlike other companies which are bound by Section / s 390 – 396 of
Indian Companies Act 1956. The central government has powers to undergo the drill of
amalgamating two banks as follows:
1. Draft scheme is to be approved by the respective boards of the amalgamating banks and
pass the same in EGM (Extraordinary general Meeting) of the shareholders.
3. Scheme to be submitted to RBI for vetting giving compliances of Section 44 A (4) of the
Banking Regulation Act 1949
4. Scheme of merger need not be approved by the High Court as mandatory for banks under
the Companies Act 1956.
A merger will make economic sense to the acquiring firm if its shareholders wealth is
maximised. Merger will create 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.
For example, if firm P and firm Q merge, and they separately worth Vp and Vq, respectively and
worth Vpq in combination, then the economic advantage will occur if:
Vpq = Vp + Vq + Synergy
EA=Vpq – (Vp+Vq)
Acquisition or merger involves costs. Suppose that firm P acquires firm Q. After acquisition P
will gain the present value of Q, i.e Vq, but it also have to pay price to Q. Thus, the cost of
merging to P is: Cash paid – Vq. For P, the net economic advantage of merger (NEA) is positive
if the economic advantage exceeds the cost of merging.
The economic advantage, i.e., [Vpq – (Vp + Vq)], represents the benefits resulting from
operating efficiencies and synergy when two firms merge. If the acquiring firm pays cash equal
to the value of the acquired firm, i.e. cash paid – Vq = 0, then the entire economic advantage of
merger will accrue to the shareholders of the acquired firm. In practice, the acquired and
acquiring firm may share the economic advantage between themselves.
The Indian Banking System and Economic Reforms
Keeping in view the structure of the Commercial banks in India and the growth of the Economic
reforms, Mergers and Acquisitions are most sought after means of reconstruction.
The economic reforms brought about a comprehensive change in the competitive landscape of
the Indian Banking System forcing many of the incumbent banks to adopt mergers and
acquisitions with the objective of restructuring themselves in order to enhance their efficiency,
profitability, and competitive strength. In addition, the Government introduced policy
initiatives aimed at deregulation and encouragement of mergers with a view to increasing the
size, profitability, and financial strength of Indian Banks thereby enhancing their capability to
compete globally. This climate of relaxed merger regulations fostered an increase in the
number of merger deals among Indian firms. In light of this, the dearth of empirical studies
examining efficiency benefits flowing from these mergers is surprising. The following section
provides a review of the few such studies that comprise this literature on Indian bank mergers.
B. OBJECTIVES OF THE STUDY
1. To study the SWOT analysis of the consolidation of the two banks. Since the banking
industry has already challenges in terms of managing capital. branch network, people,
technology; a need for low cost technology is felt. Various parameters of profitability
(operational efficiency and net interest margin, net interest income, non performing
assets) need to be studied.
3. To study the profiles of the two banks namely Centurion Bank and HDFC Bank, Swap
Ratio, Suitability analysis and the aftereffect of synergies of the merger.
4. To give a transparent, scalable, reliable table as a tool for the researcher giving explicitly
the situation of pre – merger and post – merger of the two banks in the study.
C. METHODOLOGY
Case study analysis: Merger between HDFC Bank Ltd and Centurion Bank of Punjab
Promoted in 1995 by housing development finance corporation (HDFC), India’s leading housing
finance company, HDFC Bank is one of India’s premier banks providing a wide range of
financial products and services to its over 11 million customers across over three hundred cities
using multiple distribution channels including a Pan-India network of branches, ATMs, phone
banking, net banking and mobile banking. Within a relatively short span of time, the bank has
emerged as a leading player in retail banking, wholesale banking, and treasury operations, its
three principal business segments.
The bank’s competitive strength clearly lies in the use of technology and the ability to deliver
world-class service with rapid response time. Over the last 13 years, the bank has successfully
gained market share in its target customer franchises while maintaining healthy profitability and
assets quality.
As on December 31, 2007, the bank had a network of 754 branches and 1,906 ATMs in 327
cities. For the quarter ended December 31, 2007, the bank reported a net profit of Rs. 4.3 billion,
up 45.2%, over the corresponding quarter of previous year. Total balance sheet size too grew by
46.7% to Rs.1, 314.4 billion.
Centurion Bank of Punjab is one of the leading new generation private sector banks in India. The
bank serves individual consumers, small and medium businesses and large corporations with a
full range of financial products and services for investing, lending and advice on financial
planning. The bank offers its customers an array of wealth management products such as mutual
funds, life and general insurance and has established a leadership ‘position’. The bank is also
strong player in foreign exchange services, personal loans, mortgages and agricultural loans.
Additionally the bank offers a full site of NRI banking products to overseas Indians.
On August 29, 2007, Lord Krishna Bank (LKB) merged with Centurion Bank of Punjab, Post
obtaining all statutory and regulatory approvals. This merger has further strengthened the
geographical reach of the bank in major town and cities across the country, especially in the
State of Kerala, in addition to its existing dominance in the northern part of the country.
Centurion Bank of Punjab now operates on a strong nationwide franchise of 394 branches and
452 ATMs in 180 locations across the country, supported by employee base of over 7,500
employees. In addition to being listed on the Indian stock exchanges, the bank’s shares are also
listed on the Luxembourg stock exchange.
Centurion Bank is India’s fourth largest private-sector bank, after the significantly larger ICICI
Bank, HDFC Bank and UTI Bank. Centurion's balance sheet is of modest scale, much smaller
than those of major private-sector banks. The bank is capitalized to support rapid growth, and its
high fixed operating costs suggest that profitability is leveraged to asset growth. Centurion's
acquisition of Bank of Punjab has substantially bolstered its distribution franchise, widened its
product and customer mix, and gives it the
Platform to aggressively expand its balance-sheet; which it has hitherto achieved quite well. It is
predominantly a Consumer bank – with almost 70% of its loans are in relatively high yield
segments. Its distribution concentration is largely in the Western and Northern parts of the
country, and it is seeking to acquire a mid-sized bank in the Southern parts of the country, to
broaden and expand its distribution franchise. Bank Muscat is the largest shareholder in the bank
post-merger with a 20.5% stake; Keppel Corp holds 9.0% and 18.6% is held through GDRs.
Sabre Capital and BOP promoters hold 4.4% and 5.0%stakes in the bank, respectively.
HDFC Bank and Centurion Bank of Punjab have decided to merge. It is the largest merger in the
space in recent times and perhaps the beginning of the consolidation wave in the BFSI sector.
The HDFC Bank-CBOP merger is a smooth exercise when it comes to the marriage of
technology at both banks. The merger comes as no surprise. With further liberalization, post-
2009, an account of WTO regulations, there would be greater accessibility for foreign banks to
Indian shores and vice-versa. With competition hotting up, Indian Banks will have to gear up to
compete with their global counterparts in terms of products, technology and people.
MERGER OF HDFC BANK WITH CENTURION BANK OF PUNJAB
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
summary of the key business parameters across HDFC Bank and CBOP.
Promoter’s holding
Institutional Investors
Promoter’s holding
Institutional Investors
• 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
bn to streamline the policies of erstwhile CBoP itself. Of this Rs. 7 bn, 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 bn, 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
harmonizing was done to bring in more stringent provisioning requirements for
identifying NPAs as the existing norms of the erstwhile CBoP were comparatively more
relaxed. The duration of CBoP’s lending portfolio is around 18-20 months so the risk of
incremental slippage would continue in near future; however the bank is confident of its
strong recovery management process and anticipates lesser pain.
• 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. Till these
issues are resolved positively, the ‘other income’ growth (primarily the fee income)
would remain muted for the merged entity.
• 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. The aim is to reduce C/I
ratio to around 52-53% by the end of FY09.
LIABILITIES
CASA Ratio % 51 25
ASSETS
Goodwill
CBoP’s current valuations are significantly higher versus HDFC Bank when compared on
traditional valuation parameters such as P/BV and P/E. However, on franchise-based valuation
parameters, the valuation appears comparable.
COMPARATIVE VALUATIONS
FY08E
BV Rs 333.9 11.8
FY09E
BV Rs 382.8 12.8
Both banks earn higher net interest margins — HDFC Bank is at 4%+ and CBoP is at ~3.6%.
Moreover, the banks have a similar business model and philosophy underlined by a thrust on
branch network expansion, retail assets, high margin business and strong fee income sources.
B. HDFC Bank would emerge as the biggest private bank in terms of branches
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). This apart, HDFC
Bank would gain dominance in states like Punjab, Haryana, Delhi, Maharashtra and Kerala.
(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
The merger will add close to 394 branches to HDFC Bank’s network of 750 branches, almost
50% increase in the existing network, while adding close to 19% to its asset base. HDFC Bank’s
branches are currently spread throughout the country, whereas CBoP has a strong presence in
Punjab, Maharashtra, and with the acquisition of LKB, now in Kerala as well. In view of RBI’s
stringent license policy, metro licenses have been hard to come by for most banks.
With the merger, HDFC Bank’s metro branches will increase by 44% in one shot, while its non
metro branches will increase by 57%.
CBoP HDFC
Metro 127 287
Chart 1: HDFC Bank to be largest private sector bank in terms of branch network
Table 2: More number of branches would lead to reduced cost of funds
CBoP’s, as a standalone bank, cost to income ratio is high at 63%; however, merging with a
larger organization like HDFC Bank gives significant scope for operating leverage with
economies of scale. There is also scope for improvement in utilization ratios with improvement
in branch and employee productivity to near HDFC Bank’s levels.
Business/employee 80 65 77
Assets/employee 61 46 58
PAT/branch 24 5 17
• complementary Overlay
CBoP has traditionally been strong in high yielding SME and retail segments, while HDFC Bank
has an enviable retail deposit franchise. With the merger, CBoP’s ability to grow its loan book
will complement HDFC Bank’s deposit franchise. On the product portfolio side, both the banks
have a strong foothold in vehicle financing, which is a natural synergy.
Improvement in productivity levels will help HDFC Bank lower CBoP’s cost to income ratio
over the medium term. High cost to income ratio, mainly due to lower productivity of some
merged branches and employees, has played a big role in restraining CBoP’s return ratios.
• Strong and experienced management team: HDFC Bank may add international
business
CBoP has a strong and experienced management team. The management has demonstrated its
capability to integrate diverse organizations by successfully reaping synergies of the merger with
Bank of Punjab. We expect the CBoP team to strengthen HDFC Bank’s management bandwidth
and consequently the latter may add international banking to its services kitty.
Name Position
Mr. Paresh Sukthankar Head, Credit and Market Risk and Human
Resources
Mr. Abhay Aima Head, Equities and Private Banking and Third
PartyProducts
The merger is positive from a strategic perspective; however, from minority shareholders’
perspective it is EPS dilutive, at least till FY09E. Consequently, we believe that near term stock
performance is likely to be capped due to this EPS dilution. With better utilization of branches
and rationalization of employees with organic expansion of business, the merger is likely to be
EPS neutral in FY10E. Upside risks exist in the form of sooner-than-expected merger synergies.
We expect 34% growth in balance sheet and 37% growth in EPS CAGR over FY08-10E. The
proposed issuance to HDFC is likely to provide adequate capitalization and enable strong
organic expansion over the next two years. The stock is trading at 3.0x FY10E adjusted
book(post merger) and 19.0x FY10E earnings
Liabilities
CASA Ratio(%) 51 25 46
Assets
Goodwill 92,525
SER= 51
1475
SER= .0003458
NSE= 6.476834lacs
No of shares after merger= Equity shares of HDFC Bank + No. of shares to be exchanged
3547.4768 lacs
354.74768(m)
Note: The market price taken above, the price at which swap ratio is actually calculated.
2.Earning per share
187.3(crore)
35.408(crore)
31.6
SER= .021
That means 21 shares of HDFC Bank will be exchanged for 1000 shares of CboP.
156.69 crore
EBITDA
Where,
1,646.53
Note: Closing price of CboP(NSE) on 31, dec 2007 was Rs. 59.10
1,268.53
CONCLUSION
SER= .0003458
SER= .021 14.65
ANNEXURES
Standalone Financials
HDFC Bank
Tax Rate % 30 32 32 32
E: MOST Estimates
RATIOS
VALUATION
E: MOST Estimates
Mann- Whitney U Test:
Demand Deposits to
Total Deposits 29.00 20 15.21 18
To apply the Mann- Whitney U Test to this problem, we began by ranking all the parameters
(considering both the banks together), from lowest (Rank 1) to the highest (Rank 26).
The symbols used in the Mann- Whitney test in context of this problem are:
We can determine the U Statistic, a measure of the difference between the ranked observations of
the two samples, by using the above values of n1, n2, R1, and R2.
= 54 (U Statistic)
If the null hypothesis that the (n1 + n2) observation from identical populations is true, this
µU = (n1*n2)/ 2
µU = (13*13)/ 2
σU = √ [n1*n2*(n1+n2+1)/ 12]
σU = √ [13*13(13+13+1)/12]
The sampling distribution of the U statistic can be approximated by the normal distribution when
both n1 and n2 are larger than 10. Because our problem meets the condition, we can use the
standard normal probability distribution table to make our test.
Assuming, the level of significance (α) to be 0.05 (95% confidence intervals), and testing the
hypothesis that these two samples were drawn from identical population
z = (U – µU)/ σU
= -1.564
Since, the acceptance region is from -1.96 to +1.96, and the calculated value of z lies within the
region (within the critical values of the test),
we conclude that the distributions and the means of two samples are same.