Mumbai: The boards of HDFC Bank Ltd, the third largest bank by market capitalization, and Centurion Bank of Punjab Ltd (CBoP), another Mumbai-based new private bank, will meet on Saturday to consider the biggest ever merger proposal in the Indian banking industry.
If approved, the merger will help HDFC Bank surpass India’s largest private sector lender ICICI Bank Ltd in terms of branch network, although the bank will still remain a distant second in terms of assets, with a third of ICICI Bank’s. With an asset base of Rs1.1 trillion on 31 March 2007, the combined entity will however overtake some public sector banks such as Industrial Development Bank of India Ltd (Rs1.03 trillion) and Union Bank of India ( Rs1.02 trillion)
Analysts say such a merger will help local banks take on foreign banks if the Reserve Bank of India (RBI) decides to open up the sector fully to foreign players in 2009.
Both banks informed the stock exchanges after market hours on Friday that their respective boards would meet on Saturday to consider a merger, ending speculation of the same that had been doing the rounds and which had been denied by the banks.
On Thursday, HDFC Bank had sent a notice to Bombay Stock Exchange, saying: “There is no such proposal for the consideration of the board of directors of the bank.” In a similar notice, CBoP had said: “It is not our practice to comment on speculative reports...”
HDFC Bank and CBoP are not new to mergers. HDFC Bank was the first new private bank to kick off consolidation in the segment by taking over Times Bank Ltd, promoted by Bennett, Coleman and Co. Ltd, in February 2000.
Centurion Bank Ltd, the earlier avatar of CBoP, which saw its capital adequacy ratio falling to 1.95% against RBI’s stipulated 9% in 2003, found a white knight in Rana Talwar, the former head of Standard Chartered Plc. The Talwar-promoted Sabre Capital first took over Centurion Bank, nursed it back to health, and then acquired Bank of Punjab in 2005 to create CBoP. This was followed by another acquisition, that of Lord Krishna Bank Ltd. While the Bank of Punjab acquisition gave the entity a footprint in north India, that of Lord Krishna Bank helped it spread its presence in the south.
The key shareholders in CBoP are Sabre Capital, Bank Muscat and Kephinance Investment (Mauritius). Housing Development Finance Corp. Ltd, India’s premier mortgage player, is the parent of HDFC Bank and holds a 23.28% stake in the bank. This will come down to 20% after the merger, analysts say.
Just before CBoP shares flared up on talk of a merger on Thursday, the bank was valued at Rs49.8 per share, or Rs9,327 crore in market capitalization. Shares of HDFC Bank were quoting at Rs1,537.2 each, nearly 31 times higher. Using these share prices as a simple benchmark, the share swap ratio could be 30-31 shares of Centurion Bank for every one share of HDFC Bank.
At this valuation of Rs9,327 crore, CBoP is valued at 4.75 times book value as on 31 December, which reflects the merger of Lord Krishna Bank. HDFC Bank’s market value of Rs54,428 crore gets a similar multiple of 4.79 times book value. That CBoP’s price to book ratio is as high as the No. 2 private sector bank is an indication that many people anticipated a merger.
CBoP Bank can’t fall back on earnings to expect a more favourable swap ratio. Based on its annualized earning per share or EPS for the December quarter (using trailing 12-month earnings do not make sense since Lord Krishna Bank was merged effective 27 August), CBoP trades at a price-earnings multiple of 47.9 times using the price of Rs49.8 per share. HDFC Bank gets a much lower valuation of 31.8 times annualized December quarter earnings.
After the CBoP stock’s outperformance in the past two trading sessions—it has gained 13% while HDFC Bank has lost 4%—the markets seem to be expecting a swap ratio of 1:26, based on Friday’s closing prices of Rs56.4 and Rs1,474, respectively. There is little reason based on fundamentals to support this expectation, unless HDFC Bank is extremely keen on the merger.
CBoP is less than a fifth the size of HDFC Bank and based on its financials for the quarter ending December 2007, it has a far higher cost-income ratio (63% versus 50% for HDFC Bank), enjoys a lower net interest margin (3.6% versus 4.3%) and has lower net profit margin (13.8% versus 20.3%).
Hatim Broachwala, an analyst with Khandwala Securities Ltd,?a?domestic?brokerage, says the merger might degrade the asset quality of HDFC Bank as CBoP is focused on two-wheeler and other retail loans. For the quarter ending December, HDFC Bank’s non performing assets were 0.4% of its advances and that of CBoP 1.69%.
However, another analyst with a large domestic brokerage, said the merger is a “win-win” as it gives HDFC Bank access to 394 branches and CBoP customers the products and service of one of the innovative private banks.
This is one of the rare mergers in the Indian banking space for consolidations and most of the mergers have been driven by the banking regulator to rescue weak players.