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Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
Merger & Acquisition In Banks
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Merger & Acquisition In Banks

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  • 1. Corporate Restructuring via Amalgamation in Private Sector Banks A Case Study of HDFC Bank and Centurion Bank of Punjab ______________________________________________________ a) Prof. Deepak Tandon (b) Manish Vohra & Meenakshi Saluja Professor –Finance PGP IInd Year students (Finance) IILM, Plot 69, Sector 53, Gurgaon manish.vohra.pgp09@iilm.edu, Email - deepak.tandon@iilm.edu meenakshi.saluja.pgp09@iilm,.edu 9811688833 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.
  • 2. Key Words SER (Share Exchange Ratio) NSE (Net Share Exchange ratio) DCF (Discounted Cash Flow Technique) EPS (Earning Per Share) TV (Terminal Value) WACC ( Weighted Average Cost of Capital) 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.
  • 3. 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. 2. Majority (2/3 rd) voting of the shareholders is passed. 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. Value Creation through Merger and Acquisition 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.
  • 4. 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) Vpq = Vp + Vq + Synergy The economic advantage is equal to: 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. Net Economic Advantage =Economic advantage – cost of merger NEA= [Vpq-(Vp+Vq)] – (cash paid – Vq) 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.  
  • 5. 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. 2. Changes in the key managerial personnel, infusion of capital, operational efficiencies, new products, work culture, improved ratings and profitability’s are the necessary outcomes of the Indian banks consolidation and help to increase or sustain the interest income. This can be easily depicted in the mergers among the Indian banks. 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.
  • 6. C. METHODOLOGY Case study analysis: Merger between HDFC Bank Ltd and Centurion Bank of Punjab About HDFC BANK 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. About Centurion Bank of Punjab 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.
  • 7. 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.
  • 8. MERGER OF HDFC BANK WITH CENTURION BANK OF PUNJAB Merger with Centurion Bank of Punjab in the swap ratio of 1:29 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. 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
  • 9. Other Investors Private Corporate Bodies 28598234 8.08 NRI's/OCB's/Foreign Others 6019811 1.70 Govt 3841342 1.08 Others 78110019 22.06 Subtotal 116569406 32.92 General public 38920380 10.99 Grand total 354075320 100.0 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
  • 10. Other Investors Private Corporate Bodies 782415732 41.77 NRI's/OCB's/Foreign Others 13299320 0.71 Directors/Employees 11080829 0.59 Others 287341856 15.34 Subtotal 1093907310 58.40 General public 266724046 14.24 Grand total 1872738603 99.99 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 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.
  • 11. • 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. KEY BUSINESS PARAMETERS (Rs Million)
  • 12. HDFC BANK DEC-07 CBOP DEC-07 Branches (Nos) 754 394 ATM (Nos) 1906 452 Customer A/C (M) 10 2 Debit cards (m) 5.0 1.1 Credit cards (M) 3.5 0.2 LIABILITIES Deposits 993,869 207,100 CASA Deposits 505,630 50,740 CASA Ratio % 51 25 Share capital 3,541 1,873 NETWORTH 113,584 19,633 Other liabilities 206,942 27,306 Total liabilities 1,314,395 254,309 ASSETS Advances 713,868 150,835 Retail 364,073 90,228 Other assets 600,527 103,204 Goodwill TOTAL ASSETS 1,314,395 254,309
  • 13. NET NPAs 2,798.0 2544.0 CBoP Trades at a premium to HDFC Bank (as on December 2007) 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 HDFC Bank Dec 2007 CBoP Dec 2007 Price as per agreed swap ratio (Rs) 1,475 51 Fully Diluted MCAP (M) 524,658 112,158 Current P/BV (Dec-07) 4.6 5.7 FY08E BV Rs 333.9 11.8 EPS Rs 45.6 1.0 P/B (X) 4.4 4.3 P/E (X) 32.3 51.4
  • 14. ROE % 17.7 10.6 FY09E BV Rs 382.8 12.8 EPS Rs 63.0 1.3 P/B (X) 3.9 4.0 P/E (X) 23.4 38.7 ROE % 17.6 10.9 Franchise Based Valuation MCAP/Branch Rs (m) 695.8 284.7 MCAP/customer A/C (E) Rs 52,465.8 44,863.3 MCAP/total deposits (X) Rs 0.5 0.5 MCAP/CASA Deposits (X) 1.0 2.2 MCAP/ Total Assets (X) 0.4 0.4 AFTERMATH OF THE MERGER A. Branch expansion/Size – likely determinant of the merger The biggest benefit to HDFC Bank from this acquisition would be addition of 394 of CBoP’ branches [which are concentrated in the states of NCR (55), Punjab (78), Haryana’s(28),
  • 15. Maharashtra (39) and Kerala (91)]. About 60% of CBoP’ advances are to retail (v/ss~50% for HDFC Bank) with dominance in the areas of mortgages, personal loans, 2-wheelers and commercial vehicles (CVs). 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. C.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.
  • 16. Major benefits accruing from the merger: • Wider distribution reach: 32% of CBoP branches are in metros 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%. Table 1: Expanding metro reach by 44% CBoP HDFC Metro 127 287 Non Metro 267 467 Metro Proportion 32% 38% Non Metro Proportion 68% 62% Chart 1: HDFC Bank to be largest private sector bank in terms of branch network
  • 17. Table 2: More number of branches would lead to reduced cost of funds FY08E FY09E FY10E No of branches 1,148 1,398 1,598 CASA Ratio 48.4 48.4 48.9 CASA per Branch 477 540 663
  • 18. Business per Branch 915 870 1,117 Cost of Funds 5.0 4.9 4. • Scope to enhance productivity 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. Table 3: Scope for improved utilization of branches INR mn HDFC Bank CBoP Merged entity Business/branch 2,289 908 1,812 Business/employee 80 65 77 Assets/branch 1,762 645 1,376 Assets/employee 61 46 58
  • 19. PAT/branch 24 5 17 PAT/employee 0.8 0.3 0.7 • 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. Chart 2: Retail loan break up
  • 20. Higher productivity to help HDFC Bank bring down cost to income ratio 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
  • 21. 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. Table 4: Senior management team of HDFC Bank Name Position Mr. Aditya Puri Managing Director Mr. Vinod G. Yennemadi Head, Finance, Administration, Legal and Secretarial Mr. Harish Engineer Head, Wholesale Banking Mr. Sudhir Joshi Head, Treasury Mr. C. N. Ram Head, Information Technology Mr. Bharat Shah Head, Merchant Services Mr. G. Subramanian Head, Audit, Compliance and Vigilance Mr. Paresh Sukthankar Head, Credit and Market Risk and Human Resources Mr. A. Rajan Head, Operations Mr. Abhay Aima Head, Equities and Private Banking and Third PartyProducts Mr. Kaizad Bharucha Head, Credit and Market Risk Mr. Pralay Mondal Head, Retail Assets and Credit Cards Ms. Mandeep Maitra Head, Human Resources
  • 22. Mr. Ashish Parthasarthy Head, Trading Mr. Rahul N. Bhagat Head, Retail Liabilities and Marketing Mr. P.V. Ananthakrishnan Head, Capital Markets and Commodity Business Mr. Bhavesh Zaveri Head, Wholesale Banking Operations Mr. Aseem Dhru Head, Business Banking and Commercial Transportation Group Mr. Shyamal Saxena Head, Branch Banking Mr. Navin Puri Head, Branch Banking Mr. Jimmy Tata Head, Corporate Banking Mr. Sashi Jagdishan Head, Finance and Administration
  • 23. Near term performance likely to be muted; benefits to accrue over medium term 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 POST MERGER CONSOLIDATION
  • 24. At a swap ratio of 1:29, it would lead to dilution of 21% for HDFC Bank. HDFC Bank would issue 76m shares ( fully diluted) to CboP shareholders.The merger would worsen HDFC Bank’s RoEs, CASA ratio and asset in the near term and make valuations additionaly expensive.Presented belo is a snapshot of the merged entities POST MERGER SNAPSHOT (Rs M) HDFC Bank CBOP Merged (Dec 07) (Dec 07) (Dec 07) Branches Nos 754 394 1148 ATM Nos 1906 452 2358 Liabilities Deposits 993,869 207,100 1,200,969 CASA Deposits 505,630 50,740 556,730 CASA Ratio(%) 51 25 46 Share Capital 3541 1873 4301 Net Worth 113,584 19,633 225742 Net worth net of goodwill
  • 25. Other liabilities 206,942 27,306 234,248 Total liabilities 1,314,395 254,039 1,660,959 Total liabilities Ex Goodwill 1,314,395 254,039 1,660,959 Assets Advances 713,868 150,835 864,703 Retail 364,073 90,228 454,301 Other assets 600,527 103,204 703,731 Goodwill 92,525 Total Assets 1,314,395 254,039 1,660,959 Total Assets Ex Goodwill 1,314,395 254,039 1,660,959 Net NPA (%) 0.4 1.7 0.6 Net NPAs (Rs m) 2,798.0 2,544.0 5,342.0 FY07 PAT (Rs.m) 11,415 1,214 12,629 FY08E PAT (Rs.m) 16,211 1,966 18,176 FY07 RoE (%) 17.7 10.6 1
  • 26. analysis BASES FOR DETERMINING EXCHANGE RATIO Valuations based on 31, Dec 2007 1.Market Price Method SER=Market Price of CBoP Market Price of HDFC Bank SER= 51 1475 SER= .0003458 No. of shares to be exchanged=SER X Pre merger no. of shares of CboP NSE= .0003458 x 18,730lacs NSE= 6.476834lacs
  • 27. No of shares after merger= Equity shares of HDFC Bank + No. of shares to be exchanged No. of shares after merger = 3,541 lacs + 6.47683 lacs No. of shares after merger= 3547.4768 lacs Post merger combined EPS= PAT of HDFC Bank + PAT of CboP No. of shares after merger Combined EPS= 11,415(m) + 1,214(m) 3547.4768 lacs Combined EPS= 12,629(m) 354.74768(m) Combined EPS= 35.599 Note: The market price taken above, the price at which swap ratio is actually calculated.
  • 28. 2.Earning per share SER= Earning per share of CboP Earning per share of HDFC Bank Earning per share (EPS) = Profit after tax No. Of shares outstanding EPS of CboP = 1,22.920(crore) 187.3(crore) EPS of CboP = .67 EPS of HDFC Bank = 1119.07(crore) 35.408(crore) EPS of HDFC Bank = 31.6
  • 29. SER = .67 31.6 SER= .021 That means 21 shares of HDFC Bank will be exchanged for 1000 shares of CboP. 3.Net Asset Value Method ( Based on 31, march 2007) NAV per share = net worth of company No. Of outstanding shares Net worth of CboP = company’s share capital + reserves & surplus Net worth of CboP= 156.69 crore + 1239.41 crore Net worth of CboP= 1396.1 crore No . of outstanding share = 156.69 crore NAV per share = 1396.1crore 156.69 crore NAV per share = 8.909 Note : Par value per share is 1
  • 30. 4.EBITDA multiple= Enterprise value ( Based on 31, march 2007) EBITDA Where, Enterprise value = Market value of equitty + Market value of debt EBITDA = Earning before interest, tax, depreciation and amortization Market value of equity = market price * no. of outstanding shares Market value of equity of CboP= 59.10 *156.69 crore= 9260.38 crore Market value of Debt of CboP = 14,863.72 crore Enterprise value of CboP= 24,124.10 crore EBITDA = 1,646.53 crore EBITDA Multiple = 24124.10 = 14.65 1,646.53 Note: Closing price of CboP(NSE) on 31, dec 2007 was Rs. 59.10 Sales Multiple = Enterprise value
  • 31. Net sales of curent year Enterprise value of CboP= 24,124.10 crore Net sales on march, 2007 = 1268.53 crore Sales Multiple= 24,124.10 = 19.017 1,268.53 CONCLUSION Summarizing the above results Market price method EPS method EBITDA multiple of CBoP SER= .0003458 SER= .021 14.65 Net asset value method SALES multiple of CboP NAV per share (CboP) 19.017 8.909
  • 32. HDFC Bank gearing for competition (would become 2nd largest) ICICI Bank, the largest private sector bank in the country, is likely to open around 425 new branches by June 2008, taking its total tally to 1,380. HDFC Bank, which currently has 754 branches and approval for 200 other branches, is in for stiff competition from ICICI Bank its peers who are eager to increase their share in the low cost deposit base. Hence, the current merger will catapult HDFC Bank with the highest network among private banks. Additional branches counter balance high deal value At times when branch licences are difficult to come by and with the possibility of the sector opening up to foreign competition post March 2009, leading domestic private banks are unlikely to sit idle. There is high possibility that these banks scale up their reach through the organic and inorganic route. We feel CBoP’s major presence in the northern part of the country (in Punjab post its merger with Bank of Punjab) and in the south (post its acquisition of Lord Krishna Bank) gives HDFC Bank sufficient room to Leverage these branches going ahead.
  • 33. Profitability and return ratios to be affected HDFC Bank’s NIM at 4.5% is much higher than CBoP’s 3.6%, hence we expect NIM of the merged entity to decline in the medium term, but show improvement once HDFC Bank is able to leverage branches optimally. HDFC Bank’s productivity and profitability ratios are among the best in the industry, which is also expected decline in case of the merged entity. ANNEXURES Standalone Financials HDFC Bank Income statement (Rs. Million) Y/E March 2007 2008E 2009E 2010E
  • 34. Interest income 66,479 101,515 143,045 187,147 Interst Expended 31,795 49,832 69,432 90,704 Net Interest Income 34,685 51,682 73,614 96,444 Change (%) 50.8 49.0 42.4 31.0 Other Income 15,162 23,061 27,791 35,506 Net Income 49,847 74,743 101,405 131,950 Operating Expenses 24,208 36,984 50,553 65,824 Operating income 25,639 37,760 50,852 66,125 Change(%) 47.9 47.3 34.7 30.0 Other Provisions 9,252 13,921 17,912 22,057 PBT 16,388 23,839 32,941 44,068 Tax 4,973 7,629 10,541 14,10 Tax Rate % 30 32 32 32 PAT 11,415 16,211 22,400 29,966 Change (%) 30.8 42.0 38.2 33.8 Proposed Dividend 2,236 3,201 4,268 5,691 BALANCE SHEET (Rs. Million) Y/E MARCH 2007 2008E 2009E 2010E Capital 3,194 3,557 3,557 3,557
  • 35. Reserves and Surplus 61,138 115,204 132,610 155,918 Net Worth 64,332 118,761 136,167 159,475 Deposits 682,979 1,010,810 1,354,485 1,760,830 Borrowings 60,980 63,795 78,086 99,190 Other liabilities& Provision 104,065 135,285 175,870 228,631 Total Liabilities 912,356 1,328,649 1,744,607 2,248,125 Current Assets 91,539 108,614 126,972 151,880 Investments 305,648 434,020 564,226 733,494 Advances 469,448 727,644 982,320 1,277,015 Net Fixed Assets 9,667 11,500 12,500 12,500 Other Assets 36,055 46,871 58,589 73,236 Total Assets 912,356 1,328,649 1,744,607 2,248,12 Key Assumptions (%) Y/E MARCH 2007 2008E 2009E 2010E Deposit Growth 22.4 48.0 34.0 30.0 Advances Growth 33.9 55.0 35.0 30.0
  • 36. Investments Growth 7.7 42.0 30.0 30.0 Provision Charge 69.2 82.6 87.9 89.2 Dividend Per Share 7.0 9.0 12.0 16.0 E: MOST Estimates RATIOS Y/E MARCH 2007 2008E 2009E 2010E Spread Analysis (%) Avg.Yield-Earn Assets 8.5 9.5 9.7 9.8 Avg.Cost-Int. Bear.Liab 4.9 5.7 5.7 5.6 Interst Spread 3.6 3.9 4.0 4.1 Net Interest Margin 4.5 4.9 5.0 5.0 Profitabilities Ratios (%) RoE 19.5 17.7 17.6 20.3 RoA 1.4 1.4 1.5 1.5 Int. Exp./Int.Earned 47.8 49.1 48.5
  • 37. 48.5 Other Income/Net inc. 30.4 30.9 27.4 26.9 Efficiency Ratios (%) Operating Exp./Net Income 48.6 49.5 49.9 49.9 Employee Cost/Op. Exps. 32.1 35.8 36.9 37.0 Business Per Emp. (Rs.M) 51.3 51.4 55.7 61.3 Net Profit Per Empl. (Rs.M) 0.6 0.6 0.6 0.7 Asset Liability Profile (%) Advances/Deposit Ratio 68.7 72.0 72.5 72.5 Invest./Deposit Ratio 44.8 42.9 41.7 41.7 G-Sec/Investment Ratio 73.8 67.5 64.9 62.4 Gross NPAs to Advance 1.4 1.3 1.4 1.5 Net NPAs to Advance 0.4 0.2 0.2 0.2 CAR 13.1 13.4 11.5 10.0 Tier 1 8.6 10.4 9.2 8.2 VALUATION Book Value (Rs) 201.4 333.9 382.8
  • 38. 448.4 Price-BV(x) 7.3 4.4 3.9 3.3 Adusted BV (Rs.) 197.3 330.9 379.8 444.5 Price-ABV (x) 7.5 4.5 3.9 3.3 EPS (Rs) 35.7 45.6 63.0 84.2 EPS Growth (x) 28.2 27.5 38.2 33.8 Price Earnings (x) 41.3 32.4 23.4 17.5 OPS (Rs) 80.3 106.2 143.0 185.9 Price-OP (x) 18.4 13.9 10.3 7.9 E: MOST Estimates
  • 39. Mann- Whitney U Test: Parameters HDFC Rank CBoP Rank Net Profit Margin (%) 13.57 17 7.25 9 Return on Net Worth 17.74 19 8.69 11 Return on Long-Term 74.91 24 64.29 22 Funds Total Debt/ Equity 8.60 10 10.65 13 Reported EPS 35.74 21 0.82 2 Book Value (excluding Revenue Reserve per 201.42 26 8.75 12 Share) Capital Adequacy Ratio 13.08 16 11.05 14 Demand Deposits to
  • 40. Total Deposits 29.00 20 15.21 18 Operating Income per 12.14 15 4.30 5 Branch Financials Expenses per 4.65 8 1.66 4 Branch Advance/ Deposit Ratio 68.70 23 75.49 25 Net NPA (%) 0.40 1 1.26 3 Net Interest Margin (%) 4.50 6 4.61 7 Total Ranks 206 Total Ranks 145 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: n1= Number of items for HDFC Bank, = 13 n2= Number of items for CBoP, = 13
  • 41. R1= Sum of the Ranks of the items in HDFC Bank, = 206 R2= Sum of the Ranks of the items in CBoP, = 145 Calculating the U Statistic: 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. U = n1*n2 + [n1*(n1+ 1)/ 2] – R1 U = 13*13 + [13*(13+1)/ 2] – 206 = 54 (U Statistic) If the null hypothesis that the (n1 + n2) observation from identical populations is true, this U statistic has a sampling distribution with a Mean of: µU = (n1*n2)/ 2 µU = (13*13)/ 2 = 84.5 (Mean of the U Statistic)
  • 42. and Standard Error of: σU = √ [n1*n2*(n1+n2+1)/ 12] σU = √ [13*13(13+13+1)/12] = 19.5 (Standard Error of the U Statistic) Testing the Hypothesis: 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 H0: µ1 = µ2 (Null Hypothesis: There is no difference between the two populations, so they have the same mean) H1: µ1 ≠ µ2 (Alternative Hypothesis: There is a difference between the two populations, in particular, they have different means) α = 0.15 (Level of Significance for testing the Hypothesis)
  • 43. Since, we want to know that the mean score of either of the banks is better or worse than the other; this is a two- tailed hypothesis test. As the level of significance is 0.05, the level of significance on either side of the curve will be 0.025 (on both sides). Thus, the remaining value of acceptance on either side will be, 0.5- 0.025= 0.475. Now, we can determine critical z value from Appendix Table I. The critical z value for an area of 0.475 is 1.96(z = +1.96, z = -1.96) Now, using the equation to standardize the sample U statistic, z = (U – µU)/ σU = (54- 84.5)/ 19.5 = -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.

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