Description
Documentation about detailed proposal for Yes bank and south indian bank merger. Yes bank is the acquirer bank and south india bank is the target bank.
Consolidation in Indian Banking Industry - The M & A Way
Proposal for Yes Bank & South Indian Bank Merger
Contents
1. 2. Executive Summary......................................................................................................................................... 3 Indian Banking Industry – Current Scenario ................................................................................................... 4 2.1 Challenges ..................................................................................................................................................... 5 2.2 Future Outlook............................................................................................................................................... 5 3. The Need for Consolidation ............................................................................................................................ 6 3.1 Benefits of Consolidation .............................................................................................................................. 7 3.2 Risk Associated With Consolidation ............................................................................................................. 7 4. YES Bank – The Acquiring Bank ................................................................................................................... 8 4.1 Yes Bank- Current Status .............................................................................................................................. 8 4.2 Business Segments- Identifying key Growth drivers in the coming years .................................................... 9 4.3 Yes Bank?s Business Strategy for the coming years ................................................................................... 10 5. 6. 7. The Process of Selection for Target Company .............................................................................................. 11 Why South Indian Bank as Target? ............................................................................................................... 16 Valuation ....................................................................................................................................................... 20 7.1 Financing ..................................................................................................................................................... 22 8. 9. Financial Statements Forecasting .................................................................................................................. 23 Synergies of Valuation .................................................................................................................................. 26 9.1 Financial Statement analysis ....................................................................................................................... 28 10. Conclusion ................................................................................................................................................. 30
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1. Executive Summary Yes Bank is reaching its second growth phase. The first phase witnessed profit growth of nearly 50% YoY when the banking sector was growing at less than 20%. Now the question arises, is this growth sustainable? What strategy does the bank?s management need to adopt in the next few years that will make Yes bank grow more than the Industry and become a large-size bank from a mid-size bank? The answer to the above questions can be given by analyzing the internal situation as well as the external developments. Banks in India are facing increased competition from foreign banks in the recent years. Factors like technology, Expertise, innovation, product mix have become crucial factors which would determine the performance of any bank in the coming years. Effective synergies need to be created through Mergers so as to build bigger banks to take on the competition from global banks. Growth of small and Mid-size may stagnate because of intensified competition from larger banks. So, Yes bank needs to take into consideration these macro economic developments so as to remain a profitable and a growing bank. The bank needs to look at inorganic ways in which it can grow by creating effective synergies through mergers. Internally, Yes bank is behind its competing banks in two important aspects: Interest Spread and Deposit Mobilization. Yes bank?s business model of growing by means of growth in fee-based businesses is gradually shifting towards Interest income based growth. But the Interest spread of the bank is one of the lowest in the industry which effectively means that the growth in absolute terms in interest income will be offset by interest expended by the bank. The bank needs to take measure of improving its current Interest spread of 3.21 when compared to the industry average of 5.64. Acquiring a bank with high Current account and savings account deposit mix will enable the bank to decrease its Interest expended and thereby enhancing its Interest Spread. Next, the current branch network of the bank is concentrated on the northern and the western part of the country. While the bank has initiated the process of opening banks in eastern India, the southern part of the country remains a non-accessed market for the bank. The above mentioned parameters are used in indentifying the target bank. After doing a series of analysis explained in the report, two banks stand out for possible merger targets-South Indian Bank and Federal Bank. Afterwards, four different valuations techniques namely EV/EBITDA, P/BV, PE multiple and Market price method have been used to arrive at fair values of Yes bank, Federal bank and South Indian bank. Finally, South Indian bank prevails over Federal bank as a prospective target
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bank due to many factors notably being wider branch base in southern India and currently low price level. If the merger process happens as proposed, what would be the benefits to the bank both qualitatively and quantitatively? Qualitative Synergies like access to wider customer base, diversified deposit mix, retail branch network, technology sharing and human capital knowledge sharing and expertise have been identified. Quantitatively, the forecasted financial statements of Yes bank with and without the merger have been used and a thorough ratio analysis has been done to compare and contrast the synergy would bring to the company. Overall, this merger would increase the wealth of the existing shareholder?s of the bank and would make the profits & performance sustainable over a long period of time.
2. Indian Banking Industry – Current Scenario
The last decade has seen many positive developments in the Indian banking sector. The policy makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made several notable efforts to improve regulation in the sector. The sector now compares favorably with banking sectors in the region on metrics like growth, profitability and non-performing assets (NPAs). A few banks have established an outstanding track record of innovation, growth and value creation. This is reflected in their market valuation. However, improved regulations, innovation, growth and value creation in the sector remain limited to a small part of it.
The cost of banking intermediation in India is higher and bank penetration is far lower than in other markets. India?s banking industry must strengthen itself significantly if it has to support the modern and vibrant economy which India aspires to be. Expansion of retail banking has a lot of potential as retail assets are just 22% of the total banking assets and contribution of retail loans to GDP stands merely at 6% in India vis-à-vis 15% in China and 24% in Thailand.
In fact, India has an expanding middle class of 250 to 300 million people in need of varied banking services. While 60% of our population has access to banks, only 15% of them have loan accounts and an overwhelming 70% of farmers have no access to formal sources of credit, reflective of immense potential for the banking system. While the onus for this change lies mainly with bank managements, an enabling policy and regulatory framework will also be critical to their success.
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Indian banks have performed favorably on growth, asset quality and profitability with other regional banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period. Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks.
In spite of the advances made by Indian Banking Industry, there still exists a lot of scope of improvement. There are a set of challenges, (discussed below) which needs to be overcome. 2.1 Challenges Four major challenges must be addressed before success can be achieved: 1. The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in feebased income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations. 2. Banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates provided. This will expose the weaker banks. 3. With increased interest in India, competition from foreign banks will only intensify. 4. Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks. 2.2 Future Outlook
The interplay between policy and regulatory interventions and management strategies will determine the performance of Indian banking over the next few years. 1. Legislative actions will shape the regulatory stance through six key elements: a. Industry structure and sector consolidation b. Freedom to deploy capital c. Regulatory coverage d. Corporate governance e. Labor reforms and human capital development f. Support for creating industry utilities and service bureaus. 2. Management success will be determined on three fronts:
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a. Fundamentally upgrading organizational capability to stay in tune with the changing market b. Adopting value-creating M&A as an avenue for growth c. Continually innovating to develop new business models to access untapped opportunities.
3. The policy makers need to make coordinated efforts on six fronts: a) Help shape a superior industry structure in a phased manner through “managed consolidation” and by enabling capital availability. This would create 3-4 global sized banks controlling 35-45 per cent of the market in India; 6-8 national banks controlling 20-25 per cent of the market; 4-6 foreign banks with 15-20 percent share in the market, and the rest being specialist players (geographical or product/ segment focused). b) Focus strongly on “social development” by moving away from universal directed norms to an explicit incentive-driven framework by introducing credit guarantees and market subsidies to encourage leading public sector, private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets. c) Create a unified regulator, distinct from the central bank of the country, in a phased manner to overcome supervisory difficulties and reduce compliance costs. d) Improve corporate governance primarily by increasing board independence and accountability.
3. The Need for Consolidation
Consolidation in the banking industry is crucial from various aspects. The factors inducing consolidation include technological progress, excess retention capacity, emerging opportunities and deregulation of various functional and product restrictions. The past one decade has seen the transformation of the banking industry throughout the world from a highly protected and regulated industry to a competitive and deregulated one. Especially, globalization coupled with technological development has shrunk the boundaries by which financial services and products are being provided to the customers residing at any part of the globe. Further, due to innovations and improvements in service delivery channels, the trend of global banking has now been marked by twin phenomena of consolidation and convergence. The trend towards consolidation has been driven by the need to attain meaningful balance sheet size and market share in the face of intensified competition, whereas the trend towards convergence is driven across the industry to provide most of the financial services such as banking, insurance, investment, cash management, etc., to the customers under one roof. In this scenario, if banks are to be made more effective, efficient and comparable with their counterparts functioning abroad, they would need to be more
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capitalized, automated and technology oriented, even while strengthening their internal operations and systems. Similarly, in order to make them comparable with their competitors from abroad with regard to the size of their capital and asset base, it would be necessary. Bank Consolidation assumes significance from the point of view of making Indian banking strong and sound apart from its growth and development to become sustainable. 3.1 Benefits of Consolidation a. As competition heats up, many banks having bigger size, will command more in the market. A bigger bank would have more staff strength, greater geographical reach, more financial resources, more delegated power and less operational and transactional costs due to economies of scale. A bigger financial conglomeration can easily withstand external assaults more effectively. b. Mergers and acquisitions can help banks with complimentary expertise to boost up their combined talents as well as on presenting a vastly improved performance. For instance, a foreign bank with proven merit in treasury operations when merged with a bank with investible surpluses could generate substantial profits. c. The geographical and regional spread would get widened when banks with different strongholds merge. Based on the principles of synergy, the business volume and geographical reach of consolidated entity automatically increases by many folds. d. The consolidated entity can serve the end user i.e. the customer in a better way through providing single window service by offering a variety of services like conventional banking, merchant banking, mutual funds, insurance etc. under one umbrella leading to innovation and origin of new hybrid products and services like ban assurance. 3.2 Risk Associated With Consolidation There are several risks associated with consolidation and few of them are as follows: a. When two banks merge into one then there is an inevitable increase in the size of the organization. Big size may not always be better. The size may get too widely and go beyond the control of the management. The increased size may become a drug rather than an asset. b. Consolidation does not lead to instant results and there is an incubation period before the results arrive. Mergers and acquisitions are sometimes followed by losses and tough intervening periods before the eventual profits pour in. Patience, forbearance and resilience are required in ample measure to make any merger a success story.
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c. Consolidation mainly comes due to the decision taken at the top. It is a top-heavy decision and willingness of the rank and file of both entities may not be forthcoming. This leads to problems of industrial relations, deprivation, depression and de-motivation among the employees. Such a work force can never churn out good results. Therefore, personal management at the highest order with humane touch alone can pave the way. d. The structure, systems and the procedures followed in two banks may be vastly different, for example, a PSU bank or an old generation bank and that of a technologically superior foreign bank. The erstwhile structures, systems and procedures may not be conducive in the new milieu. A thorough overhauling and systems analysis has to be done to assimilate both the organizations. This is a time consuming process and requires lot of cautions approaches to reduce the frictions.
4. YES Bank – The Acquiring Bank YES BANK, India?s new age private sector Bank, is the outcome of the professional & entrepreneurial commitment of its Founder, Rana Kapoor and its top management team, to establish a high quality, customer centric, service driven, private Indian Bank catering to the Future Businesses of India. YES BANK has adopted international best practices, the highest standards of service quality and operational excellence, and offers comprehensive banking and financial solutions to all its valued customers.
YES BANK has a knowledge driven approach to banking, and a superior customer experience for its retail, SME, corporate and emerging corporate banking clients. YES BANK is steadily evolving as the Professionals? Bank of India with the long term vision of “Building the Best Quality Bank of the World in India” by 2015. YES BANK is the only Greenfield license awarded by the RBI in the last 15 years, associated with the finest pedigree investors.
4.1 Yes Bank- Current Status Yes bank has been witnessing tremendous growth right from its incorporation which is reflected in the charts below. With growth in profitability of more than 50% consistently on a Y-o-Y basis, the question is whether we will be able to sustain this growth momentum.
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4.2 Business Segments- Identifying key Growth drivers in the coming years
Institutional Banking
•Corporate Banking Institutional Banking ,Corporate Finance •Govt. Relationship Management , Emerging Corporate Banking •For sunrise sectors •Food & Agribusiness ,Life Sciences ,Telecom, IT ,Media, Real Estate etc. •Providing a consistent superior banking experience to all its customers through its high quality, state-of-the-art branch infrastructure
•Client Sales and Market Making • Propriety Trading & Balance Sheet Management Activities •Infrastructure Banking Unit (IBU) & Financial Restructuring Unit (FRU) •Structured & Project Finance Unit: Securitization , Structured Liability •Wealth Management , Global Indian Banking • Savings Account ,Current Account, Fixed Deposit & Depository Services •Microfinance(Wholesale lending and Direct Lending) • Sustainable Investment Banking
Business Banking
Branch Banking
Financial Markets Corporate Finance Retail Banking
Responsibility Banking
Points marked in „Italics? in the above figure represent the segments which will drive profitability in the coming years. One good thing about this is that all the points/ Growth drivers are related i.e. branch
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banking, Retail Banking and Responsibility Banking. Growth in these segments is complementary to each other and could be enhanced through economies of Scope. Below figure explains how:
Retail to Corporate and Business banking work out of a single localized branch – “One Bank system” Comprehensive product suite catering to different customer verticals. Offering tailor-made products and solutions to Customers. Bundling of products and Cross Selling
Strong fee-income based model. Mainstay of the revenue base
Strong Focus on Integrated operations and fast response time by leveraging technology
4.3 Yes Bank’s Business Strategy for the coming years While it is important to get operationally more effective as an organization year after year, long term success could be achieved only by developing and implementing effective business Strategies. For determining what our strategy is going to be, first as an organization we need to set targets and then develop strategies to achieve these targets. The targets for Yes Bank are as mentioned below:
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To achieve the target and to sustain the high performance as shown above, it has become imperative for Yes Bank to foray into the core of banking, i.e. Retail Banking. This will give access to new customers and would provide a larger base of funds at lower cost of capital. Also, rather than developing the whole infrastructure, it would make sense for Yes Bank to merge an existing bank, which has a well distributed Retail Banking network. Yes Bank has a very sparse presentation in the Southern Part of India & hence merger with Retail based Bank having their focus in the southern region seems to be the best strategy to obtain the sustainable performance along with meeting their targets. Keeping these points in mind, the discussion below continues with the selection process of the Target bank and then the synergy between Yes Bank & the target bank is shown through the projection of their financial statements and Financial Ratio Analysis.
5. The Process of Selection for Target Company Yes bank?s profit grew by more than 50 % in the financial year 2009-10 when the banking Industry is growing at a much lesser rate of nearly 20 %. So, the immediate question is, will Yes bank be able to sustain the growth momentum? To answer this question, we have to basically analyze how Yes bank will maintain its differentiation among its competing peers. For a bank, the key metrics that decides the profitability is the Interest Spread. Higher the Interest Spread, greater the profits if all other things remain constant. Yes bank?s other income as a percentage of Total income is coming down significantly and has reached to 20% level which is now become comparable to its peers. This signals that the future profitability of the bank will depend upon how well it generates its Net interest Margin.
Interest Spread
10 8 6 4 2 0 5.66 3.21 6.98 4.24 Mar-31 8.11
Net Interest Margin-March 2010
Kotak Mahindra Bank Axis Bank HDFC bank ICICI Bank Yes Bank 4.08 4.37 0 2 4 6 8 4.98 6.86 Series1 6.83
Source:moneycon trol.com
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The above two graphs indicate that Yes bank?s NIM as well as its Interest spread are below other private sector banks the size of whom Yes bank aspires to reach in the next 5-7 years. So, strategically, the bank needs to address this issue with greater concern in order to sustain its growth momentum. The interest income component can be driven by two factors. Firstly, increase loans and advances (Increase its Creditdeposit ratio).
Credit Deposit RatioMarch 2010
100 80 60 40 20 0 80.52 90.04 66.64 68.89
94.61
In percentage
From the above graph, we can see that the current Credit-Deposit ratio of Yes bank is presently comparable and hovers more than the sector mean of 74.21%. This means that there is little scope to develop in this aspect. The next alternative is to increase the interest rate charged by the bank on its loans and advances. This may not be a wise move as Interest rate among banks is highly competitive and also RBI keeps an eye on the interest rates. So, the next logical option left with Yes bank is to decrease its cost of Funds. The above graph indicates that Yes Bank has the highest cost of funds among its competitors. Why? The answer may lie in the Deposit Mix of the bank when compared to other banks.
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The above graph of Deposit Mix answers the above question. Yes Bank?s deposits are mostly non-CASA based. CASA deposits are the cheapest form of deposits a bank can have in its deposit mix. Yes bank has a lot of ground to cover in this aspect. Understandably, CASA deposits are generated by branch banking model which Yes bank is focusing on for the coming years. Yes bank is planning to add 60 branches in this financial year of 2010-11. But, it needs to be kept in mind that other competing banks are also planning to increase its branch network. So on a net basis, Yes bank may not all by itself be able to mobilize enough CASA deposits in the next 3-4 years so as to reduce its cost of funds significantly. One another point to be looked into is that Yes bank, by its very current business model is not a strong at branch Banking. It does not have the necessary expertise as well as human capital to foray into branch banking in a big way. Below diagram shows the branch network that Yes bank would have at the end of the financial year 2010-11 for a total of 250 branches.
It can be inferred that the Eastern and the southern part of India have a lesser percentage of branches. While eastern India is said to be an under-banked region by itself, it is wise for Yes bank to open new branches in this region and provide banking services. In the southern part of the country, lots of old private sector banks have built a very good network over many years and it will be difficult for Yes bank to penetrate into this region all by itself. So a merger/acquisition is a viable option. South India has the presence of prominent regional banks like
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a. Karur Vyasya Bank b. Federal Bank c. Karnataka Bank d. South Indian Bank e. Lakshmi Vilas Bank f. IndusInd Bank g. Dhanalaxmi Bank Among these banks, some banks have skewed presence in just one particular state for Example Karur Vyasya Bank and Lakshmi Vilas bank in Tamil Nadu and Karnataka bank in the state of Karnataka. By further analysis of branch network, South Indian bank, IndusInd bank, Federal bank have a reasonably decent presence in all the four southern Indian states.
Number of Branches-State wise Karur Vasya Bank Federal Bank 113 9 13 51 2 32 220 48 410 50 25 0 31 564
State Tamil Nadu Kerala Karnataka AP Pondicherry Others Total
Indusind Bank 19 14 9 16 0 119 177
South Indian Bank 106 318 35 24 2 27 512
Yes Bank 4 1 4 4 0 137 150
The branch network of IndusInd in southern states is not as prominent when compared to banks like federal bank and south Indian bank. So, purely by branch network, Federal bank and South Indian Bank have a reasonably decent presence in all the four southern States. So, for further analysis, we will take only these two banks into consideration. Just having a good branch network does not qualify a bank as a prospective bank. The to-be acquired bank also must also develop good synergies with the Yes bank in aspect like financials, Human Capital, growth strategy etc.
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Comparative Ratio Analysis
% of CASA Deposits 10 24 24 % of Retail FDs 12 46 51 Cost of Funds % 7.5 6.2 5.6
Bank Yes Bank South Indian Bank Federal bank
Others Deposits 78 30 25
Key Ratios Credit-Deposit (%) Investment / Deposit (%) Cash / Deposit (%) Interest Expended / Interest Earned (%) Other Income / Total Income (%) Operating Expenses / Total Income (%) Interest Income / Total Funds (%) Interest Expended / Total Funds (%) Net Interest Income / Total Funds (%) Non Interest Income / Total Funds (%) Operating Expenses / Total Funds (%) Profit before Provisions / Total Funds (%) Net Profit / Total funds (%) RONW (%)
Federal bank Mar-09 71.06 38.11 7.86 60.32 13.46 14.92 9.26 5.59 3.68 1.44 1.6 3.52 1.4 12.15 Mar-08 71.17 35.92 7.55 65.49 13.56 16.1 8.71 5.7 3.01 1.37 1.62 2.75 1.27 13.59
South Indian Bank Mar-10 67.32 32.19 5.81 70.64 11.66 16.99 8.44 5.96 2.48 1.11 1.62 1.97 1.02 16.98 Mar-09 67.08 32.02 5.93 69 9.04 17.89 9.01 6.22 2.79 0.9 1.77 1.92 1.04 16.04
Yes Bank Mar-10 80.52 40.33 7.62 66.75 19.69 16.97 7.99 5.34 2.66 1.96 1.69 2.93 1.61 20.27 Mar-09 74.16 41.47 7.6 74.55 18.65 17.02 10.04 7.48 2.55 2.3 2.1 2.76 1.52 20.65
From the comparative ratio analysis of Yes bank with South Indian Bank as well as federal bank, we can see that Federal bank has better performance in ratio like percentage of Interest expended, operating expenses as a percentage of total income but South Indian Bank performs better on Return on Net worth. But, a key factor which decides whether a bank is favorable merger target is by its valuation.
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6. Why South Indian Bank as Target?
SIB is one of the oldest banks in South India, based out of Thrissur, Kerala. The Bank mainly extends traditional banking services to its largely middle-income, semi-urban and urban clientele. FII and domestic institutional holding in the Bank is at a high 37% and 12%, respectively. Notably, the Bank has no identifiable promoter. SIB is helmed by Dr V A Joseph, who was earlier part of Syndicate Bank's top management and under whose leadership SIB has seen creditable improvement in its financial performance over the past two years. South Indian Bank (SIB) is one of the better-performing old private sector banks. Largely concentrated in the semi-urban areas of the Southern states of India, SIB's profitable, cost-efficient and technologically up-to-date network constitutes a reasonably attractive standalone franchise. The Bank's Deposit franchise includes a niche NRI customer base that contributes a meaningful 17% of deposits and gives it a distinguishing cost advantage over several of its peers.
The following pointers highlight the good performance of SIB and make it an attractive organization for merger with Yes Bank: ? Cost efficient, Technologically up-to-date network underpins Profitable growth in line with Industry: The Bank's largely semi-urban branch network is concentrated in the Southern states of the country. While enjoying customer loyalty that comes from years of association, the Bank has ensured that it remains sufficiently in step with product, technology and service level developments in the industry. ? Branch wise Distribution:
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We can see that the 91 percent of the branches are present in the Southern India, where Yes Bank has a very low presence. This fact complemented by the very higher proportion of banks being present in the Urban & Semi Urban regions, (which is the major target area of Yes Bank) weights very heavily in the favor of SIB as target for merger. ? Market share has been maintained over the past ten years: SIB's largely semi-urban branch network is concentrated in the Southern states of India. While enjoying customer loyalty spanning many years, the Bank has ensured that it remains sufficiently in step with product, technology and service level developments in the industry. As a result, the Bank has maintained its market share in not just Advances and Deposits, but also CASA Deposits over the past ten years as seen below.
The Bank was one of the first amongst its peers to have its network on the Core Banking platform and presently offers its clients standard products and channel options, including net banking, etc. ? Operating efficiency has improved aided by early tech adoption: In line with industry trends, the Bank has substantially improved its operating efficiency aided by technology and natural operating leverage. As a result, SIB's operating expenses, as a % of assets, are low which has helped it maintain reasonable Return on Assets (RoA). ? Niche NRI Deposit base underpins Deposit cost advantage over several peers: The Bank's Deposit franchise includes a niche NRI customer base that contributes a meaningful 17% of its total deposits and gives it a distinguishing cost advantage over several of its peers. The Bank's market share in NRE Deposits stands at about 3.2% (market share with respect to overall NRI Deposits stands at about 1.9%). This is significantly higher than the Bank's overall market share of 0.4% of total deposits. The cost of NRE Deposits, which is about 3.5-4% at present, puts these deposits just a notch above CASA Deposits that have a blended cost of 2-2.5%. Still we can see that the “Interest Expense” as % of average assets is significantly lower than the Yes Bank and few others private sector banks as well.
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?
NRE deposit base a significant cost advantage: The NRE deposit base puts the quality of the Bank's deposit mix above that of several other mid-sized PSU and Private Banks. However, till recently the high component of bulk deposits (at about 18-20% of overall deposits) was putting pressure on the Bank's overall cost of funds. But now, wholesale deposit rates have declined sharply. As a result, we believe that the Bank will be in a position to largely maintain its NIMs in time to come. Moreover, the environment has become meaningfully more conducive for NRE deposits. The RBImandated maximum spread to LIBOR permitted for NRE deposits stands at a high of 175bp and is unlikely to be brought down for the time being considering that overall forex inflows into the country remains subdued.
?
SIB to benefit moderately: SIB?s NRI customer base indicates that its typical NRI customers belong to the Middle-Income Segment, working in the Middle-East and having a family back home, usually in the semi-urban areas of the Southern states where the Bank has most of its branches.
Having had long-lasting ties with the Bank, there is usually a substantial sense of customer loyalty from them. That is to say, a good majority of the Bank's customers may not necessarily be very sensitive to near-term increase in spreads or improvement in exchange rate outlook. Also, given the higher rates available on domestic deposits (NRO accounts for NRIs), the Bank has seen a good chunk of NRI deposit inflows moving into NRO accounts.
Added to its existing customer base in this Segment, the increasing tie-ups with Middle-Eastern exchange houses are also expected to help the Bank garner a reasonable share of incremental inflows. This gives the Bank front-end access to new NRI customers to whom its staff can cross-sell the Bank's deposit products. The Bank added a few thousand customers through this route in FY2009. The Bank has also entered into tie-ups with other financial services companies such as Geojit Securities to offer a wider bouquet of services to its NRI customer base.
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?
Attractive merger candidate: Given that SIB has the potential to deliver healthy Return Ratios close to the Sectoral averages and enjoys a strong niche franchise in the semi-urban areas of South India as well as a niche NRI customer base, we believe it is an attractive merger candidate.
Moreover, keeping in mind the Bank's cheap valuations in terms of both P/ABV and P/E, acquisition by larger banks, especially Private Banks, would be accretive for the acquirer, both in terms of EPS as well as Book Value.
Why South India Bank over Federal Bank? Federal Bank valuation throws up the result that the valuation is on higher side. The share price calculated through the Relative Valuation comes out to be comparable to the Yes Bank. Hence, this expensive valuation doesn?t act in the favour of federal Bank. The balance sheet size of the Federal Bank is almost comparable to the Yes bank & it has been seen in the past that the merger of two comparable firms (especially in Banking sector) may turn out a sour one, with many issues. The branch network of Federal Bank is heavily focused in Kerala state and the distribution in other southern states is lower whereas South Indian Bank?s branch network is well-established in most of the southern states, thus giving a wider penetration to the Yes Bank.
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7. Valuation
For consolidation of two or more companies in any sector, Valuation lies at the core. Merger or Acquisition without valuation is incomplete. There are multiple valuation techniques used to value a company depending upon the sector and the businesses. While most businesses are valued primarily based on revenues, earnings, and cash flow, these are not effective methods for valuing a bank. Traditional banks have little control over the interest spread, which leads to fluctuating levels of revenue and earnings. Moreover Indian Banking sector is a highly regulated one, with RBI always keeping an eye in every move taken by banks across India. This regulation makes revenue forecast (i.e. Interest and Other Income) very difficult. The primary way to value a bank is by using Relative Valuation. In relative valuation the concerned bank is compared with its peer in the industry and the valuation is thus obtained. In order to arrive at the proper Swap Ratio for the merger, the following relative valuation methods were used to value YES bank and South Indian bank: 1. Price to Book Value Method 2. Enterprise value to EBTDA Method 3. Price to Earnings Method 4. Market Price Method Selection of Peer banks: In order to value both the banks correctly, we selected set of banks similar in operations and business line for both the concerned banks. The criteria on which we have chosen the comparable banks are: a) Business Per Employee b) Interest income as a percentage of total income Yes Bank has a very different business model, which makes it highly incomparable to other private sector banks in India. After going through a lot of parameters we finally selected these two parameters as the deciding factor for the banks being comparable. Using the above mentioned factors, we arrived at the following set of comparable banks for Yes Bank & South Indian Bank: a) Set of peer banks for South Indian Bank ? South Indian Bank ? Laxmi Vilas Bank ? Karnataka Bank ? Karur Vysya Bank b) Set of peer banks for Yes Bank
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? ? ? ? ?
Yes Bank HDFC Bank Axis Bank ICICI Bank IndusInd Bank
Price to Book Value Method: P/BV for both the set of Banks is calculated using the current market price (as on 19th August 2010). This is done by finding out the individual P/BV of banks in comparison and taking their weighted average. The prospective or forward BV is used for the calculation. We obtain the P/BV for both the sets as shown in the table. The respective comparable firms P/BV is then multiplied with the forward BV of Yes Bank & South Indian Bank to obtain the correct value of both the shares. The values are shown in the table below.
Price to Earnings Method: P/E method is similar to the P/BV as mentioned above. The prospective PAT is obtained for all the banks which are then used to calculate individual P/E for every bank using current market price. The respective comparable firm P/E is then multiplied with the forward Earnings of Yes Bank & South Indian Bank to obtain the correct value of both the shares. The values are shown in the table below. Note: The forward PAT is obtained here by taking CAGR of all the banks over the period of last 5 years. This is done to capture the effect of a complete industry cycle. We also observed that the quarterly growth in the PAT has been very random and could not be generalized to obtain the forward looking PAT. Hence, on a conservative approach we used the CAGR of PAT for all the banks to forecast forward PAT. Enterprise value to EBITDA Method: The prospective EBITDA is obtained for all the banks which are then used to calculate individual EV/EBTDA for every bank using current enterprise value. The respective comparable firm EV/EBITDA is then multiplied with the forward EBITDA of Yes Bank & South Indian Bank to obtain the correct value of both the shares. The values are shown in the table below. The forward EBITDA is obtained here by multiplying the Quarter 1 EBITDA by four. Market Price Method: In this method, the last six months average monthly market price of both the banks was retrieved. Its weighted average price was calculated using volume traded as the weights. The final market price arrived at 165.45 for South Indian Bank and 273.35 for YES Bank. Using these methods, the intrinsic price per share for both the banks was calculated. Prospective weights for all the four methods were given, and the corresponding intrinsic price per share was arrived. The book
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank
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value and the enterprise value method were given the higher weight-age because they are based on asset valuation rather than earnings. Using these methods, prices the swap ratio was calculated. Swap Ratio Calculation:
Method Value per Share P/BV Method P/E Method EV-EBIDTA Method Market Price Method Total Fair Value per share Ratio 314.97 405.05 469.20 273.35 YES Bank Weight Product South Indian Bank Weight Product
Value per Share
2 3 3 2 10
629.95 1,215.16 1,407.61 546.71 3,799.42 379.94 1
175.92 242.35 438.34 165.45
2 3 3 2 10
351.84 727.04 1,315.02 330.90 2,724.80 272.48 0.717
For every 10 shares of south Indian bank, 7-8 shares (negotiable) of YES bank. The Excel regarding the calculation done is attached long with the document: Valuation.xls 7.1 Financing In this case, the merger will take place by issuing fresh new shares to all the existing shareholders of South Indian Bank according to Swap Ratio calculated. The acquisition was not done as YES bank did not have enough cash to do complete cash deal. Moreover, banks generally do not have spare cash with them. They have to park large chunk of cash with RBI and rest the bank would lend to earn income. Due to issuing of shares, there would be dilution of the YES bank existing shareholders value, due to increase in no of shares outstanding. YES Bank Ltd
Ownership Pattern as on 31-03-2010 Indian (Promoter & Group) Total of Promoter Non Promoter (Institution) Non Promoter (Non-Institution) Total Non Promoter Grand Total No of Shares 92242450 92242450 209552523 37872296 247424819 339667269 % Share Holding 27.1567 27.1567 61.6935 11.1498 72.8433 100
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South Indian Ltd
Ownership Pattern as on 31-03-2010 Total of Promoter Non Promoter (Institution) Non Promoter (Non-Institution) Total Non Promoter Grand Total No of Shares 0 59664224 53342266 113006490 113006490 % Share Holding 0 52.7972 47.2028 100 100
Merged Entity – Shareholding Pattern
Ownership Pattern as on 31-03-2010 Indian (Promoter & Group) Total of Promoter Non Promoter (Institution) Non Promoter (Non-Institution) Total Non Promoter Grand Total No of Shares 92242450 92242450 251317480 75211882 326529362 415004929 % Share Holding 22% 22% 61% 18% 79% 100%
The Excel regarding the merged entity financial statements is attached long with the document: Financial Statement Merged Entity_Schedules.xls
8. Financial Statements Forecasting
For banking industry, the task of forecasting the earnings and assets position is tough due to the following reasons: 1. Highly regulated banking sector environment by RBI. 2. Interest rate fluctuation, which constitutes the major part of bank income. 3. Impact of fee based businesses on the earnings as it is highly volatile and variable. 4. Prediction of CAR is difficult to forecast due to development of BASEL norms. 5. Changing CRR and SLR effect on bank?s cash and bank balances. These are a few reasons why the DCF technique for valuation of the banks was not considered. But since, to find out synergies created due to merger of YES Bank and South Indian Bank, it helps in forecasting Yes Bank„s, South Indian Bank?s as well as the merged entity forecasted financial statements.
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Given below are the forecasted financial statements for the next three years for all the three entities (YES bank, South Indian Bank & Merged Entity). Assumptions taken while forecasting financial statements: 1. A conservative approach has been followed wile forecasting financial statements for both YES Bank and South Indian Bank. 2. The Capital structure of both the banks would remain same. 3. Use of existing banking ratios for e.g. interest expended by interest income was kept constant 4. Tax rate is kept constant at 34 percent. 5. Provisions & Contingent liabilities are increased in proportion to interest income. 6. Balance Sheet items have been forecasted by taking inot consideration the relevant effect creaed by relevant profit & Loss items 7. Bank will not enter in to any new line of business during the period of forecast.
Projected Financial Statements
Yes Bank Income Statement
Particulars INCOME : Interest Earned Other Income Total Income EXPENDITURE : Interest expended Operating expenses Provisions and contingencies [includes provision for income tax and fringe benefit tax] Total Expenditure Profit : Net Profit Consolidated profit for the year attributable to the Group 429.11 429.11 743.61 743.61 865.67 865.67 987.06 987.06 1,611.40 389.86 520.49 2,521.75 1,905.25 500.00 386.00 2,791.25 2,252.17 600.00 523.98 3,376.15 2,661.66 720.00 721.47 4,103.13 2,369.71 581.15 2,950.86 2,843.65 691.20 3,534.85 3,412.38 829.44 4,241.82 4,094.86 995.33 5,090.19
(in Rupee Crores)
Mar 2010 Mar 2011E Mar 2012E Mar 2013E
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank
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Yes Bank Balance Sheet
Particulars Capital & Liabilities Capital Reserves & Surplus Deposits Borrowings Other liabilities & provisions Total Assets Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets Total Contingent Liabilities 1,995 678 10,210 22,193 115 1,191 36,383 1,05,788 2,926 1,017 12,252 29,295 139 1,334 46,962 1,40,886 2,953 1,525 14,702 38,083 166 1,494 58,924 1,76,772 4,555 2,288 17,643 47,604 200 1,673 73,963 2,21,888 340 2,750 26,799 4,749 1,745 36,383 340 3,342 34,838 6,174 2,269 46,962 340 4,061 43,548 8,026 2,950 58,924 340 4,920 54,435 10,434 3,834 73,963
(in rupee Crores)
Mar 2010 Mar 2011E Mar 2012E Mar 2013E
Yes Bank- South Indian Bank Merged Income Statement (in rupee Crores) Particulars
INCOME : Interest Earned Other Income Total Income EXPENDITURE : Interest expended Operating expenses Provisions and contingencies [includes provision for income tax and fringe benefit tax] Total Expenditure Profit : Net Profit
Mar 2010 4,305.43 836.76 5,142.19 2,949.19 671.11 810.39 4,430.69 711.50
Mar 2011E 5,812.33 962.27 6,774.60 3,952.38 1,151.68 891.43 5,995.50 779.11
Mar 2012E 7,846.65 1,202.84 9,049.49 5,257.25 1,538.41 998.40 7,794.07 1,255.42
Mar 2013E 10592.972 1503.553 12096.525 6885.432 2056.409 1118.209 10060.050 2036.476
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Yes Bank-South Indian Bank Merged Balance Sheet (in rupee Crores) Particulars
Capital & Liabilities Capital Reserves & Surplus Deposits Borrowings Other liabilities & provisions Total Assets Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets Total Contingent Liabilities 3,386.26 1,274.66 17,365.55 38,016.04 268.00 1,606.04 61,916.56 1,08,517.66 3,709.72 1,784.53 20,838.66 44,829.08 321.60 1,927.24 73,410.84 1,32,139.51 4,112.79 2,319.89 22,922.53 55,588.06 385.93 2,119.97 87,449.16 1,57,408.49 4,859.09 3,015.85 25,214.78 68,857.47 463.11 2,331.96 1,04,742.27 1,88,536.08 415.00 4,159.83 49,810.09 5,080.04 2,451.58 61,916.55 415.00 4,938.94 59,772.11 5,588.04 2,696.74 73,410.84 415.00 6,194.36 71,726.53 6,146.85 2,966.42 87,449.16 415.00 8,230.83 86,071.84 6,761.53 3,263.06 1,04,742.27 Mar 2010 Mar 2011E Mar 2012E Mar 2013E
The Excel regarding the detailed calculation of both the Banks forecast done is attached long with the document: Financial Statements _ Forecasted.xls
9. Synergies of Valuation 1) Merger of South Indian Bank with Yes Bank will expand yes bank?s network in the southern region, where it has had minimal presence. This larger penetration and wide customer base will further fuel Yes Bank?s fast & aggressive growth. 2) Through the high proportion of South India bank?s NRI account, Yes Bank will gain access to the NRI & NRE money, which can further be leveraged to expand its High Net worth Individuals (HNIs) customer base. 3) South India Bank?s operation is majorly focused on the Retail Investors, which definitely provides the synergy between the two bank as Yes bank has very low retail presence and going forward it plans to expand its retail business. The already existing infrastructure as well as the customer base in this segment would reduce Yes bank?s pain of creating new customers & setting up new branches. The Merged Entity will result in 662 total branches at the time of merger. As per the independent plans of both the banks prior to the merger, both the banks planned to add 50 branches a year in the
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank 26
coming years. This adds up to nearly 1000 branches by year 2013 which will make the bank counted among the mid-large size banks in India. 4) The Merged entity will have a large gamut of financial services varying from Corporate Banking, Wealth Management to Retail Banking & hence will be able to most of the customer needs. This end to end services availability under a single brand name would enhance the market reputation and will reap higher returns in future. 5) The highly efficient & aggressive approach of Yes Bank along with high technology usage would further boost up the performance of the South Indian Bank & hence, of the merged entity. 6) The high proportion of CASA deposits of South Indian Bank will bring down the Cost of funds for Yes Bank & hence will help in improve margins for the merged entity. South India bank?s already low „cost of funds? as compared to other comparable banks help the cause in a much better way (shown below is comparison of deposits distribution of major banks vis-a-vis merged entity).
Bank Yes Bank Axis Bank South Indian Bank Federal bank Karnataka Bank Yes bank-South Indian bank combined
% of CASA Deposits 10% 43% 24% 24% 18% 16%
% of Retail FDs 12% 14% 46% 51% 76% 28%
Others Deposits 78% 43% 30% 25% 6% 56%
Cost of Funds % 7.5 5.8 6.2 5.6 6.9 6.85
7) The CASA Deposits as a % of total Deposits is set to increase in the years as the number of new branches to be added by the merged entity will be nearly 300 in that period. This will result in an increase in CASA deposit percentage which will give the merged entity to low cost funds which is important in a competitive environment and sustain profitability.
The ratio analysis along with the specific comments, (shown below) of the South Indian Bank, Yes Bank and the Merged Entity as forecasted in 2013 shows the quantitative impact of the synergy from the proposed merger.
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9.1 Financial Statement analysis
Profitability Ratios
Yes Bank
2010 South Indian Bank
Merged Entity
Yes Bank
2013E South Indian Bank
Merged Entity
Net Interest Margin Investment/ Total assets Efficiency Ratio ROA Asset Utilisation Expense Ratio ROE Net operating income to assets Other Income/ total income Operating expenses/ Total Income Net profit margin Interest Income / Total Asset Interest Expense / Total Asset Interest Expense / Total Income Non Interest Expense / Total income Non Interest Income / Non Interest Expense
2.83% 28.06%
2.23% 28.02%
2.72% 28.05%
2.63% 23.85%
2.22% 28.02%
4.31% 24.07%
Comment Significant improvements in the Net interest margin by the merged entity when compared to Standalone Yes bank because of CASA deposit mobilization Comparable Efficiency ratio of the merged entity to improve substantially because of synergy creation Almost 50% better return on Assets Greater asset utilization by the merged entity High Expense Ratio. Need to check Expenses of merged entity Greater return on Equity to Shareholders of the Merged entity.
29.11% 1.18% 8.11% 6.93% 13.89%
47.15% 0.91% 8.40% 7.48% 15.71%
30.60% 1.15% 8.31% 7.16% 15.55%
29.65% 1.33% 6.88% 5.55% 18.77%
47.16% 0.91% 8.39% 7.48% 16.31%
39.46% 1.94% 11.55% 9.60% 23.55%
2.08%
2.23%
2.19%
1.94%
2.22%
3.54%
19.69%
9.70%
16.27%
19.55%
9.71%
12.43%
Almost 90% increase inoperating income of the merged entity. Other income is increasing at a decreasing rate than the interest income.
13.21% 14.54%
17.07% 10.88%
13.05% 13.84%
14.14% 19.39%
17.08% 10.87%
17.00% 16.84%
6.51%
7.58%
6.95%
5.54%
7.58%
10.11%
Comparable Slightly lower NPM because of expenses Higher interest income because of retail banking focus and increase in loans and advances given by the bank
4.43%
5.36%
4.76%
3.60%
5.35%
6.57%
Same as the above reason
54.61%
63.79%
57.35%
52.29%
63.79%
56.92%
Comparable
30.85%
25.33%
28.81%
28.32%
25.34%
26.24%
Comparable
63.84%
38.31%
56.48%
69.05%
38.31%
47.36%
Drop in growth of non-interest income
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Capital Adequacy Ratio: The CAR (As of 31st March 2010) of merged entity comes out to be 19.49%, which is much above the specified minimum CAR by RBI. Thus we can see that merged entity will be meeting the RBI norm in case of CAR as well. Calculation for the same is shown below in the table:
Capital Adequacy Ratios (as on March 2010) Equity capital to assets Tier 1 capital Tier 2 Capital Tier 1 Risk Based Capital Ratio Tier 2 Risk Based Capital Ratio CAR Risk Weighted Assets (RWA) Yes Bank 8.49% 3089.55 2185.25 12.90% 7.70% 20.60% 23950 South Indian Bank 5.81% 1484.715 239 12.42% 2.97% 15.39% 11954.23 Merged Entity 7.39% 4574.84 2424.25 12.74% 6.75% 19.49% 35904.23
NPA (Non Performing Assets) The table below shows the comparison between the individual bank NPAs and the merged entity NPA over the current year & forecasted year 2013E.
Yes Bank 60.202 47.2 0.24% 0.30% 0.18% South Indian Bank 2010A Gross NPA Net NPA Gross NPAs/Total Assets Net NPAs/ Net Advances Net NPAs/ Total Assets 201 61.57 0.79% 0.39% 0.24% 261.202 108.77 0.42% 0.29% 0.18% 132.264 103.698 0.32% 0.40% 0.25% Merged Entity South Indian Bank 2010E 330.249 101.161 0.79% 0.39% 0.24% 462.513 204.860 0.44% 0.30% 0.20% Merged Entity
Asset Quality Ratios
Yes Bank
Hence, the ratio analysis as done above clearly shows that the synergy does exist in the merged entity.
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10. Conclusion
Long term strategic decisions require trade off decisions. Yes bank needs to decide now whether it needs to grow organically or inorganically. Whatever the decision maybe, it should result in wealth creation to its shareholders.. Qualitative Synergies like access to wider customer base, diversified deposit mix, retail branch network, technology sharing and human capital knowledge sharing and expertise have been identified. Quantitatively, the forecasted financial statements of Yes bank with and without the merger have been used and a thorough ratio analysis has been done to compare and contrast the synergy would bring to the company. By the process of merger with South Indian Bank, both qualitative and quantitative synergies would be created resulting in achieving the above mentioned objective
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doc_545063618.docx
Documentation about detailed proposal for Yes bank and south indian bank merger. Yes bank is the acquirer bank and south india bank is the target bank.
Consolidation in Indian Banking Industry - The M & A Way
Proposal for Yes Bank & South Indian Bank Merger
Contents
1. 2. Executive Summary......................................................................................................................................... 3 Indian Banking Industry – Current Scenario ................................................................................................... 4 2.1 Challenges ..................................................................................................................................................... 5 2.2 Future Outlook............................................................................................................................................... 5 3. The Need for Consolidation ............................................................................................................................ 6 3.1 Benefits of Consolidation .............................................................................................................................. 7 3.2 Risk Associated With Consolidation ............................................................................................................. 7 4. YES Bank – The Acquiring Bank ................................................................................................................... 8 4.1 Yes Bank- Current Status .............................................................................................................................. 8 4.2 Business Segments- Identifying key Growth drivers in the coming years .................................................... 9 4.3 Yes Bank?s Business Strategy for the coming years ................................................................................... 10 5. 6. 7. The Process of Selection for Target Company .............................................................................................. 11 Why South Indian Bank as Target? ............................................................................................................... 16 Valuation ....................................................................................................................................................... 20 7.1 Financing ..................................................................................................................................................... 22 8. 9. Financial Statements Forecasting .................................................................................................................. 23 Synergies of Valuation .................................................................................................................................. 26 9.1 Financial Statement analysis ....................................................................................................................... 28 10. Conclusion ................................................................................................................................................. 30
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1. Executive Summary Yes Bank is reaching its second growth phase. The first phase witnessed profit growth of nearly 50% YoY when the banking sector was growing at less than 20%. Now the question arises, is this growth sustainable? What strategy does the bank?s management need to adopt in the next few years that will make Yes bank grow more than the Industry and become a large-size bank from a mid-size bank? The answer to the above questions can be given by analyzing the internal situation as well as the external developments. Banks in India are facing increased competition from foreign banks in the recent years. Factors like technology, Expertise, innovation, product mix have become crucial factors which would determine the performance of any bank in the coming years. Effective synergies need to be created through Mergers so as to build bigger banks to take on the competition from global banks. Growth of small and Mid-size may stagnate because of intensified competition from larger banks. So, Yes bank needs to take into consideration these macro economic developments so as to remain a profitable and a growing bank. The bank needs to look at inorganic ways in which it can grow by creating effective synergies through mergers. Internally, Yes bank is behind its competing banks in two important aspects: Interest Spread and Deposit Mobilization. Yes bank?s business model of growing by means of growth in fee-based businesses is gradually shifting towards Interest income based growth. But the Interest spread of the bank is one of the lowest in the industry which effectively means that the growth in absolute terms in interest income will be offset by interest expended by the bank. The bank needs to take measure of improving its current Interest spread of 3.21 when compared to the industry average of 5.64. Acquiring a bank with high Current account and savings account deposit mix will enable the bank to decrease its Interest expended and thereby enhancing its Interest Spread. Next, the current branch network of the bank is concentrated on the northern and the western part of the country. While the bank has initiated the process of opening banks in eastern India, the southern part of the country remains a non-accessed market for the bank. The above mentioned parameters are used in indentifying the target bank. After doing a series of analysis explained in the report, two banks stand out for possible merger targets-South Indian Bank and Federal Bank. Afterwards, four different valuations techniques namely EV/EBITDA, P/BV, PE multiple and Market price method have been used to arrive at fair values of Yes bank, Federal bank and South Indian bank. Finally, South Indian bank prevails over Federal bank as a prospective target
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bank due to many factors notably being wider branch base in southern India and currently low price level. If the merger process happens as proposed, what would be the benefits to the bank both qualitatively and quantitatively? Qualitative Synergies like access to wider customer base, diversified deposit mix, retail branch network, technology sharing and human capital knowledge sharing and expertise have been identified. Quantitatively, the forecasted financial statements of Yes bank with and without the merger have been used and a thorough ratio analysis has been done to compare and contrast the synergy would bring to the company. Overall, this merger would increase the wealth of the existing shareholder?s of the bank and would make the profits & performance sustainable over a long period of time.
2. Indian Banking Industry – Current Scenario
The last decade has seen many positive developments in the Indian banking sector. The policy makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made several notable efforts to improve regulation in the sector. The sector now compares favorably with banking sectors in the region on metrics like growth, profitability and non-performing assets (NPAs). A few banks have established an outstanding track record of innovation, growth and value creation. This is reflected in their market valuation. However, improved regulations, innovation, growth and value creation in the sector remain limited to a small part of it.
The cost of banking intermediation in India is higher and bank penetration is far lower than in other markets. India?s banking industry must strengthen itself significantly if it has to support the modern and vibrant economy which India aspires to be. Expansion of retail banking has a lot of potential as retail assets are just 22% of the total banking assets and contribution of retail loans to GDP stands merely at 6% in India vis-à-vis 15% in China and 24% in Thailand.
In fact, India has an expanding middle class of 250 to 300 million people in need of varied banking services. While 60% of our population has access to banks, only 15% of them have loan accounts and an overwhelming 70% of farmers have no access to formal sources of credit, reflective of immense potential for the banking system. While the onus for this change lies mainly with bank managements, an enabling policy and regulatory framework will also be critical to their success.
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Indian banks have performed favorably on growth, asset quality and profitability with other regional banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period. Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks.
In spite of the advances made by Indian Banking Industry, there still exists a lot of scope of improvement. There are a set of challenges, (discussed below) which needs to be overcome. 2.1 Challenges Four major challenges must be addressed before success can be achieved: 1. The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in feebased income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations. 2. Banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates provided. This will expose the weaker banks. 3. With increased interest in India, competition from foreign banks will only intensify. 4. Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks. 2.2 Future Outlook
The interplay between policy and regulatory interventions and management strategies will determine the performance of Indian banking over the next few years. 1. Legislative actions will shape the regulatory stance through six key elements: a. Industry structure and sector consolidation b. Freedom to deploy capital c. Regulatory coverage d. Corporate governance e. Labor reforms and human capital development f. Support for creating industry utilities and service bureaus. 2. Management success will be determined on three fronts:
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank 5
a. Fundamentally upgrading organizational capability to stay in tune with the changing market b. Adopting value-creating M&A as an avenue for growth c. Continually innovating to develop new business models to access untapped opportunities.
3. The policy makers need to make coordinated efforts on six fronts: a) Help shape a superior industry structure in a phased manner through “managed consolidation” and by enabling capital availability. This would create 3-4 global sized banks controlling 35-45 per cent of the market in India; 6-8 national banks controlling 20-25 per cent of the market; 4-6 foreign banks with 15-20 percent share in the market, and the rest being specialist players (geographical or product/ segment focused). b) Focus strongly on “social development” by moving away from universal directed norms to an explicit incentive-driven framework by introducing credit guarantees and market subsidies to encourage leading public sector, private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets. c) Create a unified regulator, distinct from the central bank of the country, in a phased manner to overcome supervisory difficulties and reduce compliance costs. d) Improve corporate governance primarily by increasing board independence and accountability.
3. The Need for Consolidation
Consolidation in the banking industry is crucial from various aspects. The factors inducing consolidation include technological progress, excess retention capacity, emerging opportunities and deregulation of various functional and product restrictions. The past one decade has seen the transformation of the banking industry throughout the world from a highly protected and regulated industry to a competitive and deregulated one. Especially, globalization coupled with technological development has shrunk the boundaries by which financial services and products are being provided to the customers residing at any part of the globe. Further, due to innovations and improvements in service delivery channels, the trend of global banking has now been marked by twin phenomena of consolidation and convergence. The trend towards consolidation has been driven by the need to attain meaningful balance sheet size and market share in the face of intensified competition, whereas the trend towards convergence is driven across the industry to provide most of the financial services such as banking, insurance, investment, cash management, etc., to the customers under one roof. In this scenario, if banks are to be made more effective, efficient and comparable with their counterparts functioning abroad, they would need to be more
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank
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capitalized, automated and technology oriented, even while strengthening their internal operations and systems. Similarly, in order to make them comparable with their competitors from abroad with regard to the size of their capital and asset base, it would be necessary. Bank Consolidation assumes significance from the point of view of making Indian banking strong and sound apart from its growth and development to become sustainable. 3.1 Benefits of Consolidation a. As competition heats up, many banks having bigger size, will command more in the market. A bigger bank would have more staff strength, greater geographical reach, more financial resources, more delegated power and less operational and transactional costs due to economies of scale. A bigger financial conglomeration can easily withstand external assaults more effectively. b. Mergers and acquisitions can help banks with complimentary expertise to boost up their combined talents as well as on presenting a vastly improved performance. For instance, a foreign bank with proven merit in treasury operations when merged with a bank with investible surpluses could generate substantial profits. c. The geographical and regional spread would get widened when banks with different strongholds merge. Based on the principles of synergy, the business volume and geographical reach of consolidated entity automatically increases by many folds. d. The consolidated entity can serve the end user i.e. the customer in a better way through providing single window service by offering a variety of services like conventional banking, merchant banking, mutual funds, insurance etc. under one umbrella leading to innovation and origin of new hybrid products and services like ban assurance. 3.2 Risk Associated With Consolidation There are several risks associated with consolidation and few of them are as follows: a. When two banks merge into one then there is an inevitable increase in the size of the organization. Big size may not always be better. The size may get too widely and go beyond the control of the management. The increased size may become a drug rather than an asset. b. Consolidation does not lead to instant results and there is an incubation period before the results arrive. Mergers and acquisitions are sometimes followed by losses and tough intervening periods before the eventual profits pour in. Patience, forbearance and resilience are required in ample measure to make any merger a success story.
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank 7
c. Consolidation mainly comes due to the decision taken at the top. It is a top-heavy decision and willingness of the rank and file of both entities may not be forthcoming. This leads to problems of industrial relations, deprivation, depression and de-motivation among the employees. Such a work force can never churn out good results. Therefore, personal management at the highest order with humane touch alone can pave the way. d. The structure, systems and the procedures followed in two banks may be vastly different, for example, a PSU bank or an old generation bank and that of a technologically superior foreign bank. The erstwhile structures, systems and procedures may not be conducive in the new milieu. A thorough overhauling and systems analysis has to be done to assimilate both the organizations. This is a time consuming process and requires lot of cautions approaches to reduce the frictions.
4. YES Bank – The Acquiring Bank YES BANK, India?s new age private sector Bank, is the outcome of the professional & entrepreneurial commitment of its Founder, Rana Kapoor and its top management team, to establish a high quality, customer centric, service driven, private Indian Bank catering to the Future Businesses of India. YES BANK has adopted international best practices, the highest standards of service quality and operational excellence, and offers comprehensive banking and financial solutions to all its valued customers.
YES BANK has a knowledge driven approach to banking, and a superior customer experience for its retail, SME, corporate and emerging corporate banking clients. YES BANK is steadily evolving as the Professionals? Bank of India with the long term vision of “Building the Best Quality Bank of the World in India” by 2015. YES BANK is the only Greenfield license awarded by the RBI in the last 15 years, associated with the finest pedigree investors.
4.1 Yes Bank- Current Status Yes bank has been witnessing tremendous growth right from its incorporation which is reflected in the charts below. With growth in profitability of more than 50% consistently on a Y-o-Y basis, the question is whether we will be able to sustain this growth momentum.
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4.2 Business Segments- Identifying key Growth drivers in the coming years
Institutional Banking
•Corporate Banking Institutional Banking ,Corporate Finance •Govt. Relationship Management , Emerging Corporate Banking •For sunrise sectors •Food & Agribusiness ,Life Sciences ,Telecom, IT ,Media, Real Estate etc. •Providing a consistent superior banking experience to all its customers through its high quality, state-of-the-art branch infrastructure
•Client Sales and Market Making • Propriety Trading & Balance Sheet Management Activities •Infrastructure Banking Unit (IBU) & Financial Restructuring Unit (FRU) •Structured & Project Finance Unit: Securitization , Structured Liability •Wealth Management , Global Indian Banking • Savings Account ,Current Account, Fixed Deposit & Depository Services •Microfinance(Wholesale lending and Direct Lending) • Sustainable Investment Banking
Business Banking
Branch Banking
Financial Markets Corporate Finance Retail Banking
Responsibility Banking
Points marked in „Italics? in the above figure represent the segments which will drive profitability in the coming years. One good thing about this is that all the points/ Growth drivers are related i.e. branch
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banking, Retail Banking and Responsibility Banking. Growth in these segments is complementary to each other and could be enhanced through economies of Scope. Below figure explains how:
Retail to Corporate and Business banking work out of a single localized branch – “One Bank system” Comprehensive product suite catering to different customer verticals. Offering tailor-made products and solutions to Customers. Bundling of products and Cross Selling
Strong fee-income based model. Mainstay of the revenue base
Strong Focus on Integrated operations and fast response time by leveraging technology
4.3 Yes Bank’s Business Strategy for the coming years While it is important to get operationally more effective as an organization year after year, long term success could be achieved only by developing and implementing effective business Strategies. For determining what our strategy is going to be, first as an organization we need to set targets and then develop strategies to achieve these targets. The targets for Yes Bank are as mentioned below:
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To achieve the target and to sustain the high performance as shown above, it has become imperative for Yes Bank to foray into the core of banking, i.e. Retail Banking. This will give access to new customers and would provide a larger base of funds at lower cost of capital. Also, rather than developing the whole infrastructure, it would make sense for Yes Bank to merge an existing bank, which has a well distributed Retail Banking network. Yes Bank has a very sparse presentation in the Southern Part of India & hence merger with Retail based Bank having their focus in the southern region seems to be the best strategy to obtain the sustainable performance along with meeting their targets. Keeping these points in mind, the discussion below continues with the selection process of the Target bank and then the synergy between Yes Bank & the target bank is shown through the projection of their financial statements and Financial Ratio Analysis.
5. The Process of Selection for Target Company Yes bank?s profit grew by more than 50 % in the financial year 2009-10 when the banking Industry is growing at a much lesser rate of nearly 20 %. So, the immediate question is, will Yes bank be able to sustain the growth momentum? To answer this question, we have to basically analyze how Yes bank will maintain its differentiation among its competing peers. For a bank, the key metrics that decides the profitability is the Interest Spread. Higher the Interest Spread, greater the profits if all other things remain constant. Yes bank?s other income as a percentage of Total income is coming down significantly and has reached to 20% level which is now become comparable to its peers. This signals that the future profitability of the bank will depend upon how well it generates its Net interest Margin.
Interest Spread
10 8 6 4 2 0 5.66 3.21 6.98 4.24 Mar-31 8.11
Net Interest Margin-March 2010
Kotak Mahindra Bank Axis Bank HDFC bank ICICI Bank Yes Bank 4.08 4.37 0 2 4 6 8 4.98 6.86 Series1 6.83
Source:moneycon trol.com
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The above two graphs indicate that Yes bank?s NIM as well as its Interest spread are below other private sector banks the size of whom Yes bank aspires to reach in the next 5-7 years. So, strategically, the bank needs to address this issue with greater concern in order to sustain its growth momentum. The interest income component can be driven by two factors. Firstly, increase loans and advances (Increase its Creditdeposit ratio).
Credit Deposit RatioMarch 2010
100 80 60 40 20 0 80.52 90.04 66.64 68.89
94.61
In percentage
From the above graph, we can see that the current Credit-Deposit ratio of Yes bank is presently comparable and hovers more than the sector mean of 74.21%. This means that there is little scope to develop in this aspect. The next alternative is to increase the interest rate charged by the bank on its loans and advances. This may not be a wise move as Interest rate among banks is highly competitive and also RBI keeps an eye on the interest rates. So, the next logical option left with Yes bank is to decrease its cost of Funds. The above graph indicates that Yes Bank has the highest cost of funds among its competitors. Why? The answer may lie in the Deposit Mix of the bank when compared to other banks.
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The above graph of Deposit Mix answers the above question. Yes Bank?s deposits are mostly non-CASA based. CASA deposits are the cheapest form of deposits a bank can have in its deposit mix. Yes bank has a lot of ground to cover in this aspect. Understandably, CASA deposits are generated by branch banking model which Yes bank is focusing on for the coming years. Yes bank is planning to add 60 branches in this financial year of 2010-11. But, it needs to be kept in mind that other competing banks are also planning to increase its branch network. So on a net basis, Yes bank may not all by itself be able to mobilize enough CASA deposits in the next 3-4 years so as to reduce its cost of funds significantly. One another point to be looked into is that Yes bank, by its very current business model is not a strong at branch Banking. It does not have the necessary expertise as well as human capital to foray into branch banking in a big way. Below diagram shows the branch network that Yes bank would have at the end of the financial year 2010-11 for a total of 250 branches.
It can be inferred that the Eastern and the southern part of India have a lesser percentage of branches. While eastern India is said to be an under-banked region by itself, it is wise for Yes bank to open new branches in this region and provide banking services. In the southern part of the country, lots of old private sector banks have built a very good network over many years and it will be difficult for Yes bank to penetrate into this region all by itself. So a merger/acquisition is a viable option. South India has the presence of prominent regional banks like
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a. Karur Vyasya Bank b. Federal Bank c. Karnataka Bank d. South Indian Bank e. Lakshmi Vilas Bank f. IndusInd Bank g. Dhanalaxmi Bank Among these banks, some banks have skewed presence in just one particular state for Example Karur Vyasya Bank and Lakshmi Vilas bank in Tamil Nadu and Karnataka bank in the state of Karnataka. By further analysis of branch network, South Indian bank, IndusInd bank, Federal bank have a reasonably decent presence in all the four southern Indian states.
Number of Branches-State wise Karur Vasya Bank Federal Bank 113 9 13 51 2 32 220 48 410 50 25 0 31 564
State Tamil Nadu Kerala Karnataka AP Pondicherry Others Total
Indusind Bank 19 14 9 16 0 119 177
South Indian Bank 106 318 35 24 2 27 512
Yes Bank 4 1 4 4 0 137 150
The branch network of IndusInd in southern states is not as prominent when compared to banks like federal bank and south Indian bank. So, purely by branch network, Federal bank and South Indian Bank have a reasonably decent presence in all the four southern States. So, for further analysis, we will take only these two banks into consideration. Just having a good branch network does not qualify a bank as a prospective bank. The to-be acquired bank also must also develop good synergies with the Yes bank in aspect like financials, Human Capital, growth strategy etc.
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Comparative Ratio Analysis
% of CASA Deposits 10 24 24 % of Retail FDs 12 46 51 Cost of Funds % 7.5 6.2 5.6
Bank Yes Bank South Indian Bank Federal bank
Others Deposits 78 30 25
Key Ratios Credit-Deposit (%) Investment / Deposit (%) Cash / Deposit (%) Interest Expended / Interest Earned (%) Other Income / Total Income (%) Operating Expenses / Total Income (%) Interest Income / Total Funds (%) Interest Expended / Total Funds (%) Net Interest Income / Total Funds (%) Non Interest Income / Total Funds (%) Operating Expenses / Total Funds (%) Profit before Provisions / Total Funds (%) Net Profit / Total funds (%) RONW (%)
Federal bank Mar-09 71.06 38.11 7.86 60.32 13.46 14.92 9.26 5.59 3.68 1.44 1.6 3.52 1.4 12.15 Mar-08 71.17 35.92 7.55 65.49 13.56 16.1 8.71 5.7 3.01 1.37 1.62 2.75 1.27 13.59
South Indian Bank Mar-10 67.32 32.19 5.81 70.64 11.66 16.99 8.44 5.96 2.48 1.11 1.62 1.97 1.02 16.98 Mar-09 67.08 32.02 5.93 69 9.04 17.89 9.01 6.22 2.79 0.9 1.77 1.92 1.04 16.04
Yes Bank Mar-10 80.52 40.33 7.62 66.75 19.69 16.97 7.99 5.34 2.66 1.96 1.69 2.93 1.61 20.27 Mar-09 74.16 41.47 7.6 74.55 18.65 17.02 10.04 7.48 2.55 2.3 2.1 2.76 1.52 20.65
From the comparative ratio analysis of Yes bank with South Indian Bank as well as federal bank, we can see that Federal bank has better performance in ratio like percentage of Interest expended, operating expenses as a percentage of total income but South Indian Bank performs better on Return on Net worth. But, a key factor which decides whether a bank is favorable merger target is by its valuation.
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6. Why South Indian Bank as Target?
SIB is one of the oldest banks in South India, based out of Thrissur, Kerala. The Bank mainly extends traditional banking services to its largely middle-income, semi-urban and urban clientele. FII and domestic institutional holding in the Bank is at a high 37% and 12%, respectively. Notably, the Bank has no identifiable promoter. SIB is helmed by Dr V A Joseph, who was earlier part of Syndicate Bank's top management and under whose leadership SIB has seen creditable improvement in its financial performance over the past two years. South Indian Bank (SIB) is one of the better-performing old private sector banks. Largely concentrated in the semi-urban areas of the Southern states of India, SIB's profitable, cost-efficient and technologically up-to-date network constitutes a reasonably attractive standalone franchise. The Bank's Deposit franchise includes a niche NRI customer base that contributes a meaningful 17% of deposits and gives it a distinguishing cost advantage over several of its peers.
The following pointers highlight the good performance of SIB and make it an attractive organization for merger with Yes Bank: ? Cost efficient, Technologically up-to-date network underpins Profitable growth in line with Industry: The Bank's largely semi-urban branch network is concentrated in the Southern states of the country. While enjoying customer loyalty that comes from years of association, the Bank has ensured that it remains sufficiently in step with product, technology and service level developments in the industry. ? Branch wise Distribution:
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We can see that the 91 percent of the branches are present in the Southern India, where Yes Bank has a very low presence. This fact complemented by the very higher proportion of banks being present in the Urban & Semi Urban regions, (which is the major target area of Yes Bank) weights very heavily in the favor of SIB as target for merger. ? Market share has been maintained over the past ten years: SIB's largely semi-urban branch network is concentrated in the Southern states of India. While enjoying customer loyalty spanning many years, the Bank has ensured that it remains sufficiently in step with product, technology and service level developments in the industry. As a result, the Bank has maintained its market share in not just Advances and Deposits, but also CASA Deposits over the past ten years as seen below.
The Bank was one of the first amongst its peers to have its network on the Core Banking platform and presently offers its clients standard products and channel options, including net banking, etc. ? Operating efficiency has improved aided by early tech adoption: In line with industry trends, the Bank has substantially improved its operating efficiency aided by technology and natural operating leverage. As a result, SIB's operating expenses, as a % of assets, are low which has helped it maintain reasonable Return on Assets (RoA). ? Niche NRI Deposit base underpins Deposit cost advantage over several peers: The Bank's Deposit franchise includes a niche NRI customer base that contributes a meaningful 17% of its total deposits and gives it a distinguishing cost advantage over several of its peers. The Bank's market share in NRE Deposits stands at about 3.2% (market share with respect to overall NRI Deposits stands at about 1.9%). This is significantly higher than the Bank's overall market share of 0.4% of total deposits. The cost of NRE Deposits, which is about 3.5-4% at present, puts these deposits just a notch above CASA Deposits that have a blended cost of 2-2.5%. Still we can see that the “Interest Expense” as % of average assets is significantly lower than the Yes Bank and few others private sector banks as well.
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?
NRE deposit base a significant cost advantage: The NRE deposit base puts the quality of the Bank's deposit mix above that of several other mid-sized PSU and Private Banks. However, till recently the high component of bulk deposits (at about 18-20% of overall deposits) was putting pressure on the Bank's overall cost of funds. But now, wholesale deposit rates have declined sharply. As a result, we believe that the Bank will be in a position to largely maintain its NIMs in time to come. Moreover, the environment has become meaningfully more conducive for NRE deposits. The RBImandated maximum spread to LIBOR permitted for NRE deposits stands at a high of 175bp and is unlikely to be brought down for the time being considering that overall forex inflows into the country remains subdued.
?
SIB to benefit moderately: SIB?s NRI customer base indicates that its typical NRI customers belong to the Middle-Income Segment, working in the Middle-East and having a family back home, usually in the semi-urban areas of the Southern states where the Bank has most of its branches.
Having had long-lasting ties with the Bank, there is usually a substantial sense of customer loyalty from them. That is to say, a good majority of the Bank's customers may not necessarily be very sensitive to near-term increase in spreads or improvement in exchange rate outlook. Also, given the higher rates available on domestic deposits (NRO accounts for NRIs), the Bank has seen a good chunk of NRI deposit inflows moving into NRO accounts.
Added to its existing customer base in this Segment, the increasing tie-ups with Middle-Eastern exchange houses are also expected to help the Bank garner a reasonable share of incremental inflows. This gives the Bank front-end access to new NRI customers to whom its staff can cross-sell the Bank's deposit products. The Bank added a few thousand customers through this route in FY2009. The Bank has also entered into tie-ups with other financial services companies such as Geojit Securities to offer a wider bouquet of services to its NRI customer base.
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?
Attractive merger candidate: Given that SIB has the potential to deliver healthy Return Ratios close to the Sectoral averages and enjoys a strong niche franchise in the semi-urban areas of South India as well as a niche NRI customer base, we believe it is an attractive merger candidate.
Moreover, keeping in mind the Bank's cheap valuations in terms of both P/ABV and P/E, acquisition by larger banks, especially Private Banks, would be accretive for the acquirer, both in terms of EPS as well as Book Value.
Why South India Bank over Federal Bank? Federal Bank valuation throws up the result that the valuation is on higher side. The share price calculated through the Relative Valuation comes out to be comparable to the Yes Bank. Hence, this expensive valuation doesn?t act in the favour of federal Bank. The balance sheet size of the Federal Bank is almost comparable to the Yes bank & it has been seen in the past that the merger of two comparable firms (especially in Banking sector) may turn out a sour one, with many issues. The branch network of Federal Bank is heavily focused in Kerala state and the distribution in other southern states is lower whereas South Indian Bank?s branch network is well-established in most of the southern states, thus giving a wider penetration to the Yes Bank.
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7. Valuation
For consolidation of two or more companies in any sector, Valuation lies at the core. Merger or Acquisition without valuation is incomplete. There are multiple valuation techniques used to value a company depending upon the sector and the businesses. While most businesses are valued primarily based on revenues, earnings, and cash flow, these are not effective methods for valuing a bank. Traditional banks have little control over the interest spread, which leads to fluctuating levels of revenue and earnings. Moreover Indian Banking sector is a highly regulated one, with RBI always keeping an eye in every move taken by banks across India. This regulation makes revenue forecast (i.e. Interest and Other Income) very difficult. The primary way to value a bank is by using Relative Valuation. In relative valuation the concerned bank is compared with its peer in the industry and the valuation is thus obtained. In order to arrive at the proper Swap Ratio for the merger, the following relative valuation methods were used to value YES bank and South Indian bank: 1. Price to Book Value Method 2. Enterprise value to EBTDA Method 3. Price to Earnings Method 4. Market Price Method Selection of Peer banks: In order to value both the banks correctly, we selected set of banks similar in operations and business line for both the concerned banks. The criteria on which we have chosen the comparable banks are: a) Business Per Employee b) Interest income as a percentage of total income Yes Bank has a very different business model, which makes it highly incomparable to other private sector banks in India. After going through a lot of parameters we finally selected these two parameters as the deciding factor for the banks being comparable. Using the above mentioned factors, we arrived at the following set of comparable banks for Yes Bank & South Indian Bank: a) Set of peer banks for South Indian Bank ? South Indian Bank ? Laxmi Vilas Bank ? Karnataka Bank ? Karur Vysya Bank b) Set of peer banks for Yes Bank
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? ? ? ? ?
Yes Bank HDFC Bank Axis Bank ICICI Bank IndusInd Bank
Price to Book Value Method: P/BV for both the set of Banks is calculated using the current market price (as on 19th August 2010). This is done by finding out the individual P/BV of banks in comparison and taking their weighted average. The prospective or forward BV is used for the calculation. We obtain the P/BV for both the sets as shown in the table. The respective comparable firms P/BV is then multiplied with the forward BV of Yes Bank & South Indian Bank to obtain the correct value of both the shares. The values are shown in the table below.
Price to Earnings Method: P/E method is similar to the P/BV as mentioned above. The prospective PAT is obtained for all the banks which are then used to calculate individual P/E for every bank using current market price. The respective comparable firm P/E is then multiplied with the forward Earnings of Yes Bank & South Indian Bank to obtain the correct value of both the shares. The values are shown in the table below. Note: The forward PAT is obtained here by taking CAGR of all the banks over the period of last 5 years. This is done to capture the effect of a complete industry cycle. We also observed that the quarterly growth in the PAT has been very random and could not be generalized to obtain the forward looking PAT. Hence, on a conservative approach we used the CAGR of PAT for all the banks to forecast forward PAT. Enterprise value to EBITDA Method: The prospective EBITDA is obtained for all the banks which are then used to calculate individual EV/EBTDA for every bank using current enterprise value. The respective comparable firm EV/EBITDA is then multiplied with the forward EBITDA of Yes Bank & South Indian Bank to obtain the correct value of both the shares. The values are shown in the table below. The forward EBITDA is obtained here by multiplying the Quarter 1 EBITDA by four. Market Price Method: In this method, the last six months average monthly market price of both the banks was retrieved. Its weighted average price was calculated using volume traded as the weights. The final market price arrived at 165.45 for South Indian Bank and 273.35 for YES Bank. Using these methods, the intrinsic price per share for both the banks was calculated. Prospective weights for all the four methods were given, and the corresponding intrinsic price per share was arrived. The book
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value and the enterprise value method were given the higher weight-age because they are based on asset valuation rather than earnings. Using these methods, prices the swap ratio was calculated. Swap Ratio Calculation:
Method Value per Share P/BV Method P/E Method EV-EBIDTA Method Market Price Method Total Fair Value per share Ratio 314.97 405.05 469.20 273.35 YES Bank Weight Product South Indian Bank Weight Product
Value per Share
2 3 3 2 10
629.95 1,215.16 1,407.61 546.71 3,799.42 379.94 1
175.92 242.35 438.34 165.45
2 3 3 2 10
351.84 727.04 1,315.02 330.90 2,724.80 272.48 0.717
For every 10 shares of south Indian bank, 7-8 shares (negotiable) of YES bank. The Excel regarding the calculation done is attached long with the document: Valuation.xls 7.1 Financing In this case, the merger will take place by issuing fresh new shares to all the existing shareholders of South Indian Bank according to Swap Ratio calculated. The acquisition was not done as YES bank did not have enough cash to do complete cash deal. Moreover, banks generally do not have spare cash with them. They have to park large chunk of cash with RBI and rest the bank would lend to earn income. Due to issuing of shares, there would be dilution of the YES bank existing shareholders value, due to increase in no of shares outstanding. YES Bank Ltd
Ownership Pattern as on 31-03-2010 Indian (Promoter & Group) Total of Promoter Non Promoter (Institution) Non Promoter (Non-Institution) Total Non Promoter Grand Total No of Shares 92242450 92242450 209552523 37872296 247424819 339667269 % Share Holding 27.1567 27.1567 61.6935 11.1498 72.8433 100
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South Indian Ltd
Ownership Pattern as on 31-03-2010 Total of Promoter Non Promoter (Institution) Non Promoter (Non-Institution) Total Non Promoter Grand Total No of Shares 0 59664224 53342266 113006490 113006490 % Share Holding 0 52.7972 47.2028 100 100
Merged Entity – Shareholding Pattern
Ownership Pattern as on 31-03-2010 Indian (Promoter & Group) Total of Promoter Non Promoter (Institution) Non Promoter (Non-Institution) Total Non Promoter Grand Total No of Shares 92242450 92242450 251317480 75211882 326529362 415004929 % Share Holding 22% 22% 61% 18% 79% 100%
The Excel regarding the merged entity financial statements is attached long with the document: Financial Statement Merged Entity_Schedules.xls
8. Financial Statements Forecasting
For banking industry, the task of forecasting the earnings and assets position is tough due to the following reasons: 1. Highly regulated banking sector environment by RBI. 2. Interest rate fluctuation, which constitutes the major part of bank income. 3. Impact of fee based businesses on the earnings as it is highly volatile and variable. 4. Prediction of CAR is difficult to forecast due to development of BASEL norms. 5. Changing CRR and SLR effect on bank?s cash and bank balances. These are a few reasons why the DCF technique for valuation of the banks was not considered. But since, to find out synergies created due to merger of YES Bank and South Indian Bank, it helps in forecasting Yes Bank„s, South Indian Bank?s as well as the merged entity forecasted financial statements.
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Given below are the forecasted financial statements for the next three years for all the three entities (YES bank, South Indian Bank & Merged Entity). Assumptions taken while forecasting financial statements: 1. A conservative approach has been followed wile forecasting financial statements for both YES Bank and South Indian Bank. 2. The Capital structure of both the banks would remain same. 3. Use of existing banking ratios for e.g. interest expended by interest income was kept constant 4. Tax rate is kept constant at 34 percent. 5. Provisions & Contingent liabilities are increased in proportion to interest income. 6. Balance Sheet items have been forecasted by taking inot consideration the relevant effect creaed by relevant profit & Loss items 7. Bank will not enter in to any new line of business during the period of forecast.
Projected Financial Statements
Yes Bank Income Statement
Particulars INCOME : Interest Earned Other Income Total Income EXPENDITURE : Interest expended Operating expenses Provisions and contingencies [includes provision for income tax and fringe benefit tax] Total Expenditure Profit : Net Profit Consolidated profit for the year attributable to the Group 429.11 429.11 743.61 743.61 865.67 865.67 987.06 987.06 1,611.40 389.86 520.49 2,521.75 1,905.25 500.00 386.00 2,791.25 2,252.17 600.00 523.98 3,376.15 2,661.66 720.00 721.47 4,103.13 2,369.71 581.15 2,950.86 2,843.65 691.20 3,534.85 3,412.38 829.44 4,241.82 4,094.86 995.33 5,090.19
(in Rupee Crores)
Mar 2010 Mar 2011E Mar 2012E Mar 2013E
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Yes Bank Balance Sheet
Particulars Capital & Liabilities Capital Reserves & Surplus Deposits Borrowings Other liabilities & provisions Total Assets Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets Total Contingent Liabilities 1,995 678 10,210 22,193 115 1,191 36,383 1,05,788 2,926 1,017 12,252 29,295 139 1,334 46,962 1,40,886 2,953 1,525 14,702 38,083 166 1,494 58,924 1,76,772 4,555 2,288 17,643 47,604 200 1,673 73,963 2,21,888 340 2,750 26,799 4,749 1,745 36,383 340 3,342 34,838 6,174 2,269 46,962 340 4,061 43,548 8,026 2,950 58,924 340 4,920 54,435 10,434 3,834 73,963
(in rupee Crores)
Mar 2010 Mar 2011E Mar 2012E Mar 2013E
Yes Bank- South Indian Bank Merged Income Statement (in rupee Crores) Particulars
INCOME : Interest Earned Other Income Total Income EXPENDITURE : Interest expended Operating expenses Provisions and contingencies [includes provision for income tax and fringe benefit tax] Total Expenditure Profit : Net Profit
Mar 2010 4,305.43 836.76 5,142.19 2,949.19 671.11 810.39 4,430.69 711.50
Mar 2011E 5,812.33 962.27 6,774.60 3,952.38 1,151.68 891.43 5,995.50 779.11
Mar 2012E 7,846.65 1,202.84 9,049.49 5,257.25 1,538.41 998.40 7,794.07 1,255.42
Mar 2013E 10592.972 1503.553 12096.525 6885.432 2056.409 1118.209 10060.050 2036.476
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Yes Bank-South Indian Bank Merged Balance Sheet (in rupee Crores) Particulars
Capital & Liabilities Capital Reserves & Surplus Deposits Borrowings Other liabilities & provisions Total Assets Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets Total Contingent Liabilities 3,386.26 1,274.66 17,365.55 38,016.04 268.00 1,606.04 61,916.56 1,08,517.66 3,709.72 1,784.53 20,838.66 44,829.08 321.60 1,927.24 73,410.84 1,32,139.51 4,112.79 2,319.89 22,922.53 55,588.06 385.93 2,119.97 87,449.16 1,57,408.49 4,859.09 3,015.85 25,214.78 68,857.47 463.11 2,331.96 1,04,742.27 1,88,536.08 415.00 4,159.83 49,810.09 5,080.04 2,451.58 61,916.55 415.00 4,938.94 59,772.11 5,588.04 2,696.74 73,410.84 415.00 6,194.36 71,726.53 6,146.85 2,966.42 87,449.16 415.00 8,230.83 86,071.84 6,761.53 3,263.06 1,04,742.27 Mar 2010 Mar 2011E Mar 2012E Mar 2013E
The Excel regarding the detailed calculation of both the Banks forecast done is attached long with the document: Financial Statements _ Forecasted.xls
9. Synergies of Valuation 1) Merger of South Indian Bank with Yes Bank will expand yes bank?s network in the southern region, where it has had minimal presence. This larger penetration and wide customer base will further fuel Yes Bank?s fast & aggressive growth. 2) Through the high proportion of South India bank?s NRI account, Yes Bank will gain access to the NRI & NRE money, which can further be leveraged to expand its High Net worth Individuals (HNIs) customer base. 3) South India Bank?s operation is majorly focused on the Retail Investors, which definitely provides the synergy between the two bank as Yes bank has very low retail presence and going forward it plans to expand its retail business. The already existing infrastructure as well as the customer base in this segment would reduce Yes bank?s pain of creating new customers & setting up new branches. The Merged Entity will result in 662 total branches at the time of merger. As per the independent plans of both the banks prior to the merger, both the banks planned to add 50 branches a year in the
Consolidation of Indian Banking Industry -- YES bank & South Indian Bank 26
coming years. This adds up to nearly 1000 branches by year 2013 which will make the bank counted among the mid-large size banks in India. 4) The Merged entity will have a large gamut of financial services varying from Corporate Banking, Wealth Management to Retail Banking & hence will be able to most of the customer needs. This end to end services availability under a single brand name would enhance the market reputation and will reap higher returns in future. 5) The highly efficient & aggressive approach of Yes Bank along with high technology usage would further boost up the performance of the South Indian Bank & hence, of the merged entity. 6) The high proportion of CASA deposits of South Indian Bank will bring down the Cost of funds for Yes Bank & hence will help in improve margins for the merged entity. South India bank?s already low „cost of funds? as compared to other comparable banks help the cause in a much better way (shown below is comparison of deposits distribution of major banks vis-a-vis merged entity).
Bank Yes Bank Axis Bank South Indian Bank Federal bank Karnataka Bank Yes bank-South Indian bank combined
% of CASA Deposits 10% 43% 24% 24% 18% 16%
% of Retail FDs 12% 14% 46% 51% 76% 28%
Others Deposits 78% 43% 30% 25% 6% 56%
Cost of Funds % 7.5 5.8 6.2 5.6 6.9 6.85
7) The CASA Deposits as a % of total Deposits is set to increase in the years as the number of new branches to be added by the merged entity will be nearly 300 in that period. This will result in an increase in CASA deposit percentage which will give the merged entity to low cost funds which is important in a competitive environment and sustain profitability.
The ratio analysis along with the specific comments, (shown below) of the South Indian Bank, Yes Bank and the Merged Entity as forecasted in 2013 shows the quantitative impact of the synergy from the proposed merger.
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9.1 Financial Statement analysis
Profitability Ratios
Yes Bank
2010 South Indian Bank
Merged Entity
Yes Bank
2013E South Indian Bank
Merged Entity
Net Interest Margin Investment/ Total assets Efficiency Ratio ROA Asset Utilisation Expense Ratio ROE Net operating income to assets Other Income/ total income Operating expenses/ Total Income Net profit margin Interest Income / Total Asset Interest Expense / Total Asset Interest Expense / Total Income Non Interest Expense / Total income Non Interest Income / Non Interest Expense
2.83% 28.06%
2.23% 28.02%
2.72% 28.05%
2.63% 23.85%
2.22% 28.02%
4.31% 24.07%
Comment Significant improvements in the Net interest margin by the merged entity when compared to Standalone Yes bank because of CASA deposit mobilization Comparable Efficiency ratio of the merged entity to improve substantially because of synergy creation Almost 50% better return on Assets Greater asset utilization by the merged entity High Expense Ratio. Need to check Expenses of merged entity Greater return on Equity to Shareholders of the Merged entity.
29.11% 1.18% 8.11% 6.93% 13.89%
47.15% 0.91% 8.40% 7.48% 15.71%
30.60% 1.15% 8.31% 7.16% 15.55%
29.65% 1.33% 6.88% 5.55% 18.77%
47.16% 0.91% 8.39% 7.48% 16.31%
39.46% 1.94% 11.55% 9.60% 23.55%
2.08%
2.23%
2.19%
1.94%
2.22%
3.54%
19.69%
9.70%
16.27%
19.55%
9.71%
12.43%
Almost 90% increase inoperating income of the merged entity. Other income is increasing at a decreasing rate than the interest income.
13.21% 14.54%
17.07% 10.88%
13.05% 13.84%
14.14% 19.39%
17.08% 10.87%
17.00% 16.84%
6.51%
7.58%
6.95%
5.54%
7.58%
10.11%
Comparable Slightly lower NPM because of expenses Higher interest income because of retail banking focus and increase in loans and advances given by the bank
4.43%
5.36%
4.76%
3.60%
5.35%
6.57%
Same as the above reason
54.61%
63.79%
57.35%
52.29%
63.79%
56.92%
Comparable
30.85%
25.33%
28.81%
28.32%
25.34%
26.24%
Comparable
63.84%
38.31%
56.48%
69.05%
38.31%
47.36%
Drop in growth of non-interest income
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Capital Adequacy Ratio: The CAR (As of 31st March 2010) of merged entity comes out to be 19.49%, which is much above the specified minimum CAR by RBI. Thus we can see that merged entity will be meeting the RBI norm in case of CAR as well. Calculation for the same is shown below in the table:
Capital Adequacy Ratios (as on March 2010) Equity capital to assets Tier 1 capital Tier 2 Capital Tier 1 Risk Based Capital Ratio Tier 2 Risk Based Capital Ratio CAR Risk Weighted Assets (RWA) Yes Bank 8.49% 3089.55 2185.25 12.90% 7.70% 20.60% 23950 South Indian Bank 5.81% 1484.715 239 12.42% 2.97% 15.39% 11954.23 Merged Entity 7.39% 4574.84 2424.25 12.74% 6.75% 19.49% 35904.23
NPA (Non Performing Assets) The table below shows the comparison between the individual bank NPAs and the merged entity NPA over the current year & forecasted year 2013E.
Yes Bank 60.202 47.2 0.24% 0.30% 0.18% South Indian Bank 2010A Gross NPA Net NPA Gross NPAs/Total Assets Net NPAs/ Net Advances Net NPAs/ Total Assets 201 61.57 0.79% 0.39% 0.24% 261.202 108.77 0.42% 0.29% 0.18% 132.264 103.698 0.32% 0.40% 0.25% Merged Entity South Indian Bank 2010E 330.249 101.161 0.79% 0.39% 0.24% 462.513 204.860 0.44% 0.30% 0.20% Merged Entity
Asset Quality Ratios
Yes Bank
Hence, the ratio analysis as done above clearly shows that the synergy does exist in the merged entity.
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10. Conclusion
Long term strategic decisions require trade off decisions. Yes bank needs to decide now whether it needs to grow organically or inorganically. Whatever the decision maybe, it should result in wealth creation to its shareholders.. Qualitative Synergies like access to wider customer base, diversified deposit mix, retail branch network, technology sharing and human capital knowledge sharing and expertise have been identified. Quantitatively, the forecasted financial statements of Yes bank with and without the merger have been used and a thorough ratio analysis has been done to compare and contrast the synergy would bring to the company. By the process of merger with South Indian Bank, both qualitative and quantitative synergies would be created resulting in achieving the above mentioned objective
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