Mergers

Merger , Amalgamation , consolidation , takeover , acquisition , combination are some of the terms used in Banking and Financial Sector Merger Defined : Combination of two or more companies into a single company where one survives and the other lose their corporate existence . Voluntary Action
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Merger Defined
The survivor acquires the assets as well as liabilities of the merged company or companies. Generally, the company, which survives, is the buyer, which retains the identity, and seller company is extinguished. Merger is the fusion of two or more existing companies. All assets, liabilities and stock of one company transferred to transferee company in consideration of payment in the form of equity shares of transferee company or debentures or cash or a mix of two or three modes.

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 Banking scenario since 1991 has been a process of transformation and consolidation Consolidation in the banking sector is crucial from various aspects. The factors inducing consolidation include technological progress, excess retention capacity, emerging opportunities and deregulation of geographic, functional and other restrictions
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Mergers and Acquisitions

Market forces are prime driving force Globalization and deregulation led to decline in Bank spreads and has adverse effect on Profitability Leading to M&A to reap the benefit of economies of scale and scope

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 The banking industry has been transformed throughout the world from highly protected and regulated industry to a competitive and deregulated one. Globalization coupled with technological development, has shrunk the boundaries by which financial services and products are being provided to customers residing at any part of the globe.
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 Amalgamation: Amalgamation is the blending of two or more

companies into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the company, which is to carry on the blended undertaking.

Acquisition: Acquisition is the process of purchase by one company of a controlling interest in the share capital of another existing company. An acquisition may be affected by a) agreement with the persons holding majority interest in the company management like members of the board or major shareholders commanding majority of voting power b) purchase of shares in open market; c) making takeover offer to the general body of shareholders; and d) purchase of new shares by private treaty.

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Acquisitions
Also known as Takeover buying of One Company (Target) by another . It may be friendly or hostile Usually refers to a purchase of smaller firm by a larger one Smaller firm acquiring control of a larger firm or a established company is called Reverse takeover

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Types
Buyer buys the majority Shares and takes Ownership Control of the Company Buyer buys the Assets of a target Company . Shareholders are paid back.

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 Indian market is over banked but under serviced. The existence of too many banks splitting customer accounts has resulted in low profitability per customer per bank and higher pricing for customers.

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Objectives of Merger
Diversify the areas of activities ; achieve optimum size of business Remove bottlenecks in development Improve profitability Serve customer better Achieve economies of scale and size Acquire assets at lower than the market size Bring separate enterprise under single control Grow without gestation period

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 Economy of scale: When larger volume of operations is performed for a given level of overhead of investment, average cost will be reduced. So by increasing the volume of business it is possible to reduce cost.

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 Economy of scope: The cost of offering various products and services by different units will be greater than that of the cost when one unit provides them. Thus by providing various services, it is possible to increase the revenue. Growth or Diversification: Merger or acquisition can be used to fulfill the desire of rapid growth in size or market share or diversification in range of products and services by merging or acquiring an existing firm that provides services other than what are provided by the acquirer firm. It can save lot of funds, time and various risks by acquiring suitable going concern. It is also possible to increase the products and services for the benefit of firm's existing customers.

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 Avoid or Reduce competition: Competition among the units providing the same products/services in same area of operation may be reduced through M&A. Use of best human resources available in both the firms can result in maximizing the profit. Rehabilitation of Sick units might allow claiming of tax concession u/s 72 of Income Tax Act 1961. Tax benefits may be allowed in the form of carry forward of loss and unabsorbed depreciation in case of sick unit with a healthy unit. Thus, M&A can help in granting certain amount of tax benefits also. Mergers and Acquisitions are also influenced by motives of reduction of costs, efficiency gains, economy of scales, increasing customer base and market coverage, to bring in new products and specialization thereof. It is observed that most of the banks increased their ranking immediately after merger.

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Creation of World Class banks through Mergers: Global corporations today expect their bankers to have the expertise, products and presence to serve them anywhere. Even retail customers are expecting wider reach from their banks as the new generation is more mobile and convenience conscious. Banks do need greater resource base and presence across a wide range of markets to satisfy their corporate customers and therefore, the necessary environment must be created to enable the development of institutions with the size and resources to complete globally.

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Benefits of Merger
Cost Savings Revenue enhancement Deregulation Safeguards interest of depositors Shareholder pressure

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Need
To satisfy Capital Requirements Pre-requisite for Globalization Historical Perspective

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 The consolidation in banking industry has further become important due to the reasons such as: Unhealthy competition among banks; expansion of branches, unviable branches; clusters of branches of various banks at particular centers, regional imbalance/unequal URS; improper deployment of staff; inter-zone transfer policy of officers up to specified scale in various banks; uneven promotions; and computerization/installation of ATMs/ Networking/ Core banking solution.

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Disadvantages
Customer Service : Dilutes competition Elimination of competition

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Problems
Technology upgradation : CBS Legal/regulation aspects : Various acts People issues

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Key M and A Deals

HDFC Bank Acquires Centurion Bank of Punjab (May '08) For HDFC Bank, this merger provided an opportunity to add scale, geography and management bandwidth. In addition, there was a potential of business synergy and cultural fit between the two organizations. For CBoP, HDFC bank would exploit its underutilized branch network with requisite expertise in retail liabilities, transaction banking and third party distribution. The combined entity would improve productivity levels of CBoP branches by leveraging HDFC Bank's brand name.

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Benefits
The deal created an entity with an asset size of Rs 1,09,718 crore (7th largest in India), providing massive scale economies and improved distribution with 1,148 branches and 2,358 ATMs (the largest in terms of branches in the private sector). CBoP's strong SME relationships complemented HDFC Bank's bias towards high-rated corporate entities. There were significant cross-selling opportunities in the short-term. CBoP management had relevant experience with larger banks (as evident in the Centurion Bank and BoP integration earlier) managing business of the size commensurate with HDFC Bank.

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 Drawbacks
The merged entity will not lend home loans given the conflict of interest with parent HDFC and may even sell down CBoP's home-loan book to it. The retail portfolio of the merged entity will have more by way of unsecured and two-wheeler loans, which have come under pressure recently.

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ICICI Acquires Bank of Madura

ICICI Bank Ltd wanted to spread its network, without acquiring RBI's permission for branch expansion. BoM was a plausible target since its cash management business was among the top five in terms of volumes. In addition, there was a possibility of reorienting its asset profile to enable better spreads and create a more robust microcredit system post merger. .

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 BoM wanted a (financially and technologically) strong private sector bank to add shareholder value, enhance career opportunities for its employees and provide first rate, technology-based, modern banking services to its customers

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Benefits
The branch network of the merged entity increased from 97 to 378, including 97 branches in the rural sector.9 The Net Interest Margin increased from 2.46% to 3.55 %. The Core fee income of ICICI almost doubled from Rs 87 crores to Rs 171 crores. It gained an additional 1.2 million customer accounts, besides making an entry into the small and medium segment. It possessed the largest customer base in the country, thus enabling the ICICI group to cross-sell different products and services.
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 Drawbacks
Since BoM had comparatively more NPAs than ICICI, the Capital Adequacy Ratio of the merged entity was lower (from 19% to about 17%). The two banks also had a cultural misfit with BoM having a trade-union system and IBL workers being young and upwardly mobile, unlike those for BoM. There were technological issues as well as ICICI used Banks 2000 software, which was very different from BoM's ISBS software. With the manual interpretations and procedures and the lack of awareness of the technology utilisation in BoM, there were hindrances in the merged entity.
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OBC with GTB

For Oriental Bank of Commerce there was an apparent synergy post merger as the weakness of Global Trust Bank had been bad assets and the strength of OBC lay in recovery.10 In addition, GTB being a south-based bank would give OBC the much-needed edge in the region apart from tax relief because of the merger. GTB had no choice as the merger was forced on it, by an RBI ruling, following its bankruptcy.

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Benefits and Drawbacks

OBC gained from the 104 branches and 276 ATMs of GTB, a workforce of 1400 employees and one million customers. Both banks also had a common IT platform. The merger also filled up OBC's lacunae computerisation and high-end technology. OBC's presence in southern states increased along with the modern infrastructure of GTB.
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 Drawbacks The merger resulted in a low CAR for OBC, which was detrimental to solvency. The bank also had a lower business growth (5% vis-a-vis 15% of peers). A capital adequacy ratio of less than 11 per cent could also constrain dividend declaration, given the applicable RBI regulations.

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Motives behind Consolidation

Growth - Organic growth takes time and dynamic firms prefer acquisitions to grow quickly in size and geographical reach. Synergy - The merged entity, in most cases, has better ability in terms of both revenue enhancement and cost reduction. Managerial efficiency - Acquirer can better manage the resources of the target whose value, in turn, rises after the acquisition. Strategic motives - Two banks with complementary business interests can strengthen their positions in the market through merger.
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Motives
Market entry - Cash rich firms use the acquisition route to buyout an established player in a new market and then build upon the existing platform. Tax shields and financial safeguards - Tax concessions act as a catalyst for a strong bank to acquire distressed banks that have accumulated losses and unclaimed depreciation benefits in their books. Regulatory intervention - To protect depositors, and prevent the de-stabilisation of the financial services sector, the RBI steps in to force the merger of a distressed bank.
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Future of M and A
In 2009, further opening up of the Indian banking sector is forecast to occur due to the changing regulatory environment (proposal for upto 74% ownership by Foreign banks in Indian banks). This will be an opportunity for foreign banks to enter the Indian market as with their huge capital reserves, cutting-edge technology, best international practices and skilled personnel they have a clear competitive advantage over Indian banks. Likely targets of takeover bids will be Yes Bank, Bank of Rajasthan, and IndusInd Bank. However, excessive valuations may act as a deterrent, especially in the post-sub-prime era.
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Narasimham Committee on Mergers

Persistent growth in Indian corporate sector and other segments provide further motives for M&As. Banks need to keep pace with the growing industrial and agricultural sectors to serve them effectively. A bigger player can afford to invest in required technology. Consolidation with global players can give the benefit of global opportunities in funds' mobilisation, credit disbursal, investments and rendering of financial services. Consolidation can also lower intermediation cost and increase reach to underserved segments.
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 The Narasimhan Committee (II) recommendations are also an important indicator of the future shape of the sector. There would be a movement towards a 3-tier structure in the Indian banking industry: 2-3 large international banks; 810 national banks; and a few large local area banks. In addition, M&As in the future are likely to be more market-driven, instead of government-driven.

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Conclusion
Firstly, banks can work towards a synergy-based merger plan that could take shape , with minimisation of technology-related expenditure as a goal. There is also a need to note that merger or large size is just a facilitator, but no guarantee for improved profitability on a sustained basis. Hence, the thrust should be on improving risk management capabilities, corporate governance and strategic business planning.

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Conclusion
In the short run, attempt options like outsourcing, strategic alliances, etc. can be considered. Banks need to take advantage of this fast changing environment, where product life cycles are short, time to market is critical and first mover advantage could be a decisive factor in deciding who wins in future. Post-M&A, the resulting larger size should not affect agility. The aim should be to create a nimble giant, rather than a clumsy dinosaur. At the same time, lack of size should not be taken to imply irrelevance as specialized players can still seek to provide niche and boutique services.
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