Merger & Acquisition

Document in Banking
Industry
SJMSOM,IIT-Bombay

Team Finacs

Ankur Choraria Akhil Jolly Laveen

Ramrakhiyani

ankurchoraria@gmail.com jollyakhil@gmail.com laveen10@gmail.com

09820709306 09757052508 09820704573

 Merger & Acquisition Document in Banking Industry

Industry Statistics

• Total bank credit grew at a CAGR of 28% from FY04 to FY08. Due to the
global slowdown from FY09, the growth in credit moderated to 17.1% YoY
during FY10

• Credit growth was 12.5% in H2FY10 as against 3.5% in H1FY10

• Total deposits, advances and net profit grew at CAGR of 19.6%, 27.4% and
20.2% respectively from FY03 to FY08

Banking Industry

• Most banks have seen improvement in quality of accounts excluding some

export oriented units (like textile, gems and jewellery) and aviation

• Most of the public sector banks contained their NPA levels due to the
restructuring option provided by the Reserve Bank of India

• The Scheduled Commercial Banks business expanded by 21.2% in March

2009 as compared to 25% in the previous year. PSB maintained their
growth momentum while private sector and foreign banks registered a
deceleration in growth.

• In 2014, the total assets with Indian Banks are forecasted to have a value
of $2765 billion, an increase of 225.3% since 2007

• Banks have significantly de-risked their portfolios and now hold 12%-45%
in AFS with duration of 2-3 years

• The quality of earnings and profitability too has improved vs. historical
levels

Public V/s Private Banks

• Banks have significantly de-risked their portfolios and now hold 12%-45%
in AFS with duration of 2-3 years

• Previously PSU banks held a much higher investment in GSec, 38%-40% of

deposits, vs. the mandatory requirement of 25% now in the range of 28%-
31% hence better poised in this cycle

• While private banks are comfortably placed with Tier-1 ratios of 9%-15%,
PSU banks’ Tier-1 ratios are relatively lower at 8.7%-9.7%

• Interestingly, PSU banks have shown strong growth of 21% in assets since
2001, and 66% of this growth has been funded from retained earnings

• Private banks have expanded their assets by 28%, and 53% of this growth
has been met through retained earnings

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• Private sector banks are sitting on adequate liquidity to ramp up their

market share in the coming year

• Growth in industry credit was fuelled by PSBs to a larger extent in the past
couple of years

• The strong CASA of banks like HDFC Bank, Axis Bank, PNB, SBI and BoB
paid off in terms of higher and stable NIM

Private Banks have seen stronger growth in book given their ability to
raise capital at higher multiples – a virtuous cycle

Source: India: Financial Services Goldman Sachs March 2009

Attractiveness

• Indian Banks are continuously growing stronger in terms of capitalization,

lower NPAs and better spreads in the past one-and-a half decade.

• Indian banks recovered a higher amount from NPAs during 2008-09 as

compared to the previous year, pointing towards efforts to improve asset
quality of banks

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• Higher credit growth is expected in FY11 and FY12 with growth in

industrial production (IIP), improved GDP growth outlook, high business
confidence and increased demand

Major Drivers

• Acceleration in India’s credit growth in excess of 20% in both FY11 and

FY12 on the back of:

– Stronger economy (GDP growth of 8.2% and 8.7% for FY11E and
FY12E)

– Infrastructure investments (road construction to increase from 9

km/day in December 2009 [4 km average until recently] to an
estimated 20 km by next year)

– Capital Expenditure

– Improved working capital cycle (from stronger demand and higher

commodity prices)

– Potential for retail financing high

– Rising per-capita income currently at US$689 vs. China’s US$1,934,

– Demographic trends – more than 42% of population is aged

between 24-59 years and this is estimated by the UN to grow to
46%

– Urbanization is expected to increase to 33% by FY20E from the

current 29.5%

– Declining average household size

• Deposit growth has remained resilient throughout the global crisis

remaining in the double digits throughout 2009 - ensuring abundant
liquidity in the financial system

• Huge deposit base, RBI's proactive measures to steadily improve banks'

balance sheet strength, and a demand in the economy for physical asset
creation are key factors

• Projected investment in infrastructure may be close to Rs. 10,750 bn for

FY11 and FY12 as per the planned outlay under the 11th Five Year Plan
implying that Infrastructure as a percentage of total bank credit to grow at
more than 40% YoY for the next three years.

• Easing of Inflation will result in RBI reducing the hiked key policy rates

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High Credit growth and rising per-capita income brightens the future of Banking
in India

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Source: RBI website

84 SCBs with total asset base of `60, 69,570 crores and deposit base of `47,
92,995 crores

Private Sector Banks are gradually increasing their shares in deposits and asset
base

• Private Sector contributes to 23% of total deposits and 26.8% of total

assets

• Net NPAs at 1.03% and RoA at 1.28% is better than the industry average
which has net NPAs at 1.12% and RoA of 1.05%

Opportunities & Trends

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• Banking Industry is poised to grow 3X to serve the huge addition of

bankable population, much of which will come from private sector

• Improving efficiency by virtue of lower NPAs due to stringent lending

norms

• Fee-based income to register higher growth fuelled by large increase in

M&A activities

• Large number of MSMEs as potential customers

Challenges

• Net Interest Margin may shrink due to higher cost of funds and asset
quality may deteriorate as banks may lend ruthlessly to increase their
customer base

Banking Industry – Potential in South Indian Market

Strong GDP contribution by South India

Strong Saving Deposit growth rate

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South Indian Banks set to outperform Industry

NIM to improve due to higher CASA ratio

IndusInd Bank – Acquiring Firm

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IndusInd profile and recent developments

• Incorporated in 1994 as a vision of Srichand Hinduja , head of the Hinduja

group

• Offers a wide range of products and services like deposits, loans,

investments, insurance, forex services, demat services, online services
and wealth management services

• Raised $250 million through QIP route in Sep, 2010

• Network of 209 branches and 427 ATMs spread over 168 locations in 28
states with no significant concentration in any state

Strong financial profile

Measure Value

AUM(`Crores) 35,505.5

Deposits (`Crores) 273,824.3

CASA 24.3%

NIM 3.3%

RoE 23%

RoA 1.3%

Cost - Income 49.5%

Credit - Deposit 74.4%

EPS 11.54

Cost to Asset 2.6%

Source: Company Website, Annual Report-FY2010, Economic Times

Well diversified revenue sources

Source: Company Website, Annual Report-FY2010, Economic Times

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Diversified exposure across industries

Source: Company Website, Annual Report-FY2010, Economic Times

Aggressive expansion plans for the future

Source: Company Website, Annual Report-FY2010, Economic Times

Probable Target Firms

Federal Bank

Company Overview

• 708 branches – 77.30% in South India and 59.90% in Kerala only

• Substantially low-cost deposits base comprising CASA (26%) and NRI

deposits (20%) in FY10

• At 17.3% CAR and 15.3% tier-1 at end-1QFY11, Federal Bank’s capital is

sufficient to support growth over the next 2-3 years

• Diversified loan book with 40% of it exposed to corporate advances, 30%

to SME advances and 31% to retail advances

• Gross NPAs spiked up sharply by 27% QoQ, in 1QFY11

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Financial Health

Market Cap: `7107 crores (BSE)

FY09 FY10 FY11e FY12e FY13e

Deposits (`Crores) 32,198 36,058 44,431 55,917 69,424

%age Growth 12 23.2 25.8 24.2

NII (`Crores) 1,316 1,411 1,770 2,197 2,738

%age Growth 7.2 25.5 24.1 24.6

Net Income (`Crores) 507 465 586 749 933

%age Growth -8.3 26.2 27.8 24.5

NIM % 3.9 3.6 3.7 3.8 3.9

Cost-Income % 31.2 34.9 35.5 36 36

RoE % 12.1 10.3 11.8 13.5 15

Source: Research Report by Anand Rathi, AR 2009-10

Karnataka Bank

Company Overview

• 464 branches – 74.80% in South India and 60.60% in Karnataka only

• Credit growth has steadily inched up to 21% in 1QFY11 compared with

10.5% in 1QFY10

• NIM has also shown sharp improvement from 0.79% in 1QFY10 to 1.74% in
1QFY11

• Share of CASA improved to 24.3% in 1QFY11 from 19.3 % in 1QFY10

• Operating efficiency Improved as the core cost-to-income (excluding

trading income) declined to 63.3% in 1QFY11 from 100.9% in 1QFY10

• Fee Income grew 75% YoY in 1QFY11

• Low P-BV of 1.36 due to recent dip in performance

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 Merger & Acquisition Document in Banking Industry

Financial Health

Market Cap: `2493 crores (BSE)

FY09 FY10 FY11e FY12e FY13e

28,7 34,7 42,0

Deposits (`Crores) 20,33323,731 14 44 40

%age Growth 19.5 16.7 21 21 21

NII (`Crores) 505 336 484 565 683

%age Growth 10.0 -33.5 44.0 16.7 20.9

Net Income (`Crores) 170 68 204 262 353

%age Growth 0 -60 200.0 28.4 34.7

NIM % 3.9 3.6 3.7 3.8 3.9

Cost-Income % 24.7 21 18.7 17.2 15.8

RoE % 12.3 4.4 11.1 11.9 13.3

Source: Company Website, Annual Report-FY2010, Economic Times

Karur Vysya Bank

Company Overview

• Network of 335 branches and 376 ATMs across India with major
concentration in Tamil Nadu and AP

• Healthy asset quality with provision coverage ratio of 89.7% and

restructured portfolio at 4% of advances

• Bank’s 14.5% CAR and tier-1 capital of 12.9% provide it cushion for future
growth and additional loan defaults

• Very low net NPA of the bank at mere 0.2% is one of the lowest in the
industry

• Adjudged as the Best Mid-sized Bank by Business Today – KPMG for 2009

Financial Health

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 Merger & Acquisition Document in Banking Industry

Market Cap: `4049 crores (BSE)

FY09 FY10 FY11e FY12e FY13e

Deposits (`Crores) 15,101 19,272 24,143 30,688 38,473

%age Growth 20.3 27.6 25.3 27.1 25.4

NII (`Crores) 410 565 740 934 1,216

%age Growth 20.3 37.6 31.1 26.1 30.3

Net Income (`Crores) 236 336 391 475 588

%age Growth 13.3 42.3 16.4 21.4 23.7

NIM % 18.6 22.6 22.1 22.6 23.6

Cost-Income % 38.1 42.9 41.5 41 41

RoE % 18.6 22.6 22.1 22.6 23.6

Source: Company Website, Annual Report-FY2010, Economic Times

South Indian Bank

Company Overview

Market Cap: `3017 crores (BSE)

FY09 FY10 FY11e FY12e FY13e

Deposits (`Crores) 18,092 23,012 28,933 35,910 44,170

%age Growth 19.4 27.2 25.7 24.1 23

NII (`Crores) 523 568 754 979 1,258

%age Growth 32.7 8.7 32.7 29.9 28.4

Net Income (`Crores) 195 234 278 345 439

%age Growth 28.4 20 18.8 24.1 27.4

NIM % 3 2.6 2.7 2.8 3

Cost-Income % 47.8 47.1 46.8 46.5 46.5

RoE % 15.8 16.8 17.4 18.8 20.5

Source: Company Website, Annual Report-FY2010, Economic Times

Analysis of Probable Target Firms

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Source: Capital line, AR 2009-10, BSE Website

Source: Capital line, AR 2009-10, BSE Website

Higher NPAs and lower RoA reveals the scope of improvement in

performance and hence market values

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Karnataka Bank and South Indian Bank have lower market

capitalization per branch making them attractive targets

Lower P/BV makes them cheap and hence attractive targets to acquire

Appropriate Target: Karnataka Bank

Karnataka Bank emerge as the most appropriate target

• Karnataka Bank has relatively higher potential for improvement in NPAs

due to expected recovery in retail & SME lending, concentrated in the
South

• Higher scope for improvements in operations under able management of

IndusInd as Karnataka Bank’s current operating expenses are relatively
much higher

• Available at much lower P/BV than the industry average, making

Karnataka bank a cheaper bet than other targets

• Large presence in rural and semi-urban areas (187 branches out of 464),
which is the emerging area in banking sector

• High growth potential on the back of stabilization in asset quality in next

two years

Relative Standings

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* Size of bubble indicates number of branches

Federal Karnatak Karur South

Bank a Vysya Indian
Bank Bank Bank
Potential 2 3 3 2
Growth
Price 3 4 1 2
Attractiveness
Scope of 2 4 1 3
Improvement
Size 1 3 4 2
Compatibility

In terms of attractiveness: 4 – Maximum 1 – Minimum

Karnataka Bank – Target Firm Analysis

Steady business growth

Higher productivity & fee income

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Improving Asset Quality

Well diversified revenue sources

Diversified exposure across industries

Source: Company Website, Annual Report-FY2010, Economic times

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The Football Field: Valuation

Source: Capital Line, AR 2009-10

Note1: Valuation based on terminal growth rate varied within 7%-8.5%

Note2: Valuation based on terminal growth rate varied within 7%-8.5%

Assumptions & Risks

Assumptions in Valuation of Karnataka Bank

Business Growth

• The deposits and advances will grow at 21%

• Terminal growth rate, which represents the long term credit growth, is
assumed to be 7%– 8.50%.

• The fee-based income is assumed to grow at 10% on account of higher

demand for other financial services and merchant banking sector.

• Total investments is taken as 45% of total deposits

• Equity will remain more or less as the same fraction of total assets on
account of maintaining the Capital Adequacy Ratio

Margin & Income

• The cost of funds will remain stable at 7.2%. The increase in term deposit
rates will be countered by increase in CASA ratio

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• The interest on advances will decrease slightly due to increased

competition from foreign and large-cap banks. The return is assumed to
remain the same at 9.8% in FY11 and will eventually decrease to 9.5% in
FY16

• The return on investments is assumed to be constant at 6.5% (same as

that in FY09 & FY10)

• The income on sale of investments is assumed to be stable at 1.2% of

total investments based on historical data

• Miscellaneous income is assumed to be constant at the last year levels

(miscellaneous income as the fraction of total income is negligible)

• Operating expenses will grow at 10% on account of more branches in

future and inflationary effects

Regulatory Concerns

• The deal would subject to RBI approval

• The prudential norms under BASEL-II will be met by the combined entity

• The promoter shareholding in IndusInd Bank has to be brought down from

19.73% to below 10% level

Where things can go wrong!

• Slowdown in Indian economy, as seen in recent financial crisis, particularly

in southern India will hurt the growth rate assumptions

• Increase in bad loans due to various reasons – farmer waiver or asset price
bubble in housing may impact earnings growth

• Large-cap banks may get into irrational competition and the interest
margins may get eroded

• The change in regulatory environment against the banking industry may

hinder the growth expectations

Synergy Benefits

Synergy Benefits arising out of improvement in operations

• Increase in branches from 209 to 673 is in line with IndusInd’s strategy to

expand its presence across India

• Karnataka Bank’s extensive network in rural and semi-urban areas (187

branches out of 464), gives IndusInd Bank access to high potential rural
markets

• The acquisition provides well trained local employees to IndusInd Bank

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• The acquisition provides 87.3% increase in CASA to IndusInd Bank

• The operations under more experienced management of IndusInd creates

an opportunity for the Karnataka Bank operation to:

• Improve operational efficiencies

• Reduce NPAs in line with IndusInd Bank’s conservative lending

strategy

• Technological benefits to Karnataka Bank operations from Indusind’s

developed technology platform

• Karnataka Bank’s operations gets access to lower cost funds

• After the acquisition the NPAs of Karnataka Bank may move down to
better management of IndusInd Bank

• Similarly, the operating expenses could be capped and grow at relatively

lower rate at 8%

• The scenario analysis based on improvement of operations and better

asset management is shown in the adjacent table:

• The value of Karnataka Bank’s business may even go as high as `4190

crores

NPA Provision of Karnataka Bank

(in ` Crores)
2.42% 2.00% 1.60% 1.20%

Operatin 10% 3,146 3,169 3,191 3,213

g
9.00% 3,643 3,667 3,688 3,710
Expenses
Growth 8.00% 4,123 4,146 4,168 4,190

Deal Structure & Timeline

Deal Structure

• IndusInd Bank would acquire the Karnataka Bank in an equity swap deal

• The current stock price of IndusInd Bank is `280.25 while the current stock
price of Karnataka Bank is `186.20

• The valuation of Karnataka Bank provides a range of `225 - `260 which

values the Karnataka Bank at a premium of about 21% and 40%
respectively

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• The price offered is `250 valuing the Karnataka Bank at P/E of 21.20 and
P/BV of 1.83 with the premium of 34.26% over prevailing market price

• For every 28 shares of Karnataka Bank, IndusInd Bank will give 25 shares
of its own

Outstanding Shares of Karnataka Bank

(crores) 13.402
Karnataka Bank Current Stock Price `186.2
IndusInd Bank Stock Price `280.25
Offered Stock Price for Karnataka Bank `250
Swap Ratio 0.8921
Premium Paid over current market price 34.26%
P/E at offered price 21.20
P/BV at offered price 1.83
No. of Shares of IndusInd Bank to be diluted 11.96

Time Line

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