THE PSB MEGA MERGER: AN OVERVIEW

On the 30th of August, 2019, Finance Minister (FM), Nirmala Sitharam announced the merger of 10 major public sector banks (PSBs) to reduce the number of players in the banking scenario from a whopping 27 to 12. This news comes in wake of the disappointing news that India faced a 5% GDP growth in the preceding quarter. It is expected that the merger will increase the CASA (Current to Savings Account Ratio) and enhance lending capacity. These reforms were deemed necessary to foster the idea of India becoming a $5 trillion economy. Illustrated below shall be the expected scenario if the mergers are proven successful:

Merger between

Rank (based on size)

Number of Branches

Total Business Size

(Rs in lakh crore)

Punjab National Bank (A), Oriental Bank of Commerce and United Bank – Merger I

2nd

11,437

17.95 (1.5 times of current)

Canara Bank (A) and Syndicate Bank – Merger II

4th

10,342

15.2 (1.5 times of current)

Union Bank of India (A), Andhra Bank and Corporation Bank – Merger III

5th

9,609

14.59 (2 times of current)

Indian Bank (A) and Allahabad Bank – Merger IV

7th

6,104

8.08 (2 times of current)

(A) Anchor Bank

It was also announced that Rs 55,250 crore of capital infusion will take place to ease credit growth and regulatory compliance. Now we’ll look at the capital infusion expected to take place to aid the mega mergers:

Bank

Recapitalization (Rs in crore)

Punjab National Bank

16,000

Union Bank

11,700

Bank of Baroda

7,000

Canara Bank

6,500

Indian Bank

2,500

Indian Overseas Bank

3,800

Central Bank

3,300

UCO Bank

2,100

United Bank of India

1,600

Punjab and Sind Bank

750

FM also announced multifarious administrative reforms to increase accountability and remove political intermediation. Bank management is made accountable as the board will now be responsible for evaluating the performance of General Manager and Managing Director. It is mandatory to train directors for their roles thus improving leadership in the PSBs. The role of the Non-Official Director is made synonymous to that of an independent director. In order to attract talent, banks have to pay competitive remuneration to Chief Risk Officers.

The banks were merged on three criteria – the CRR should be greater than 10.875%, the CET ratio should be above 7% (which is above the Basel norms) and the NPAs should be less than 6%. However, Syndicate and Canara bank have not been able to meet the criteria.

Post consolidation facts and figures:

  • Total Business Share
  • Ratios (all amounts in %)

MERGER – I

PNB

OBC

United Bank of India

Post-Merger

CASA Ratio

42.16

29.4

51.45

40.52

PCR

61.72

56.53

51.17

59.59

CET-I

6.21

9.86

10.14

7.46

CRAR Ratio

9.73

12.73

13

10.77

Net NPA Ratio

6.55

5.93

8.67

6.61

MERGER – II

Canara Bank

Syndicate Bank

Post-Merger

CASA Ratio

29.18

32.58

30.21

PCR

41.48

48.83

44.32

CET-I

8.31

9.31

8.62

CRAR Ratio

11.90

14.23

12.63

Net NPA Ratio

5.37

6.16

5.62

MERGERIII

Union Bank

Andhra Bank

Corporation Bank

Post-Merger

CASA Ratio

36.10

31.39

31.59

33.82

PCR

58.27

68.62

66.60

63.07

CET-I

8.02

8.43

10.39

8.63

CRAR Ratio

11.78

13.69

12.30

12.39

Net NPA Ratio

6.85

5.73

5.71

6.30

MERGER – IV

Indian Bank

Allahabad Bank

Post-Merger

CASA Ratio

34.75

49.49

41.65

PCR

49.13

74.15

66.21

CET-I

10.96

9.65

10.63

CRAR Ratio

13.21

12.51

12.89

Net NPA Ratio

3.75

5.22

4.39

Advantages:

  • Economies of scale.
  • Efficiency in operation.
  • Better NPA management.
  • High lending capacity of the newly formed entities.
  • Strong national presence and global reach.
  • Risk can be spread over and thus will be minimized.
  • Lower operational cost leading to lower cost of borrowing.
  • Increased customer base, organic growth of market share and business quantum.
  • Banking practices reform announced to boost accountability and professionalism.
  • Appointment of CRO (Chief Risk Officer) to enhance management effectiveness.
  • Centralized functioning promoting a central database of customers.

Disadvantages:

  • The slowdown witnessed by the economy coupled with the dangerously low demand in the automobile sector will maintain the existing situation pessimism.
  • The already existing exposure of NBFCs in the individual constituent banks will be magnified as the merged entities shall have more than 10% loan exposure to NBFCs and thus, in effect, the liquidity pressure that comes along with it.
  • As history dictates, the merger of these eminent banks will cause near-term problems with respect to restructuring, recapitalization, operation, flexibility and costs.
  • Near-term growth shall be hindered and core profitability may suffer.
  • Compliance becomes a huge barrier.
  • Difficult to merge human resources and their respective work cultures post-merger – this will in turn lead to low morale and inefficient workforce

Outlook:

The mergers were announced with a very noble idea in mind; however, the timing is a bit unfortunate. During these times of economic slowdown, India needs its bankers devoting their time to boost the economy. With the merger happening, the banks will be more pre-occupied with the integration process rather than enhancing the economic growth. Merely combining banks will not help enhance credit capacity, it is also important to see whether synergies in reality will be created (or if it is merely on paper).

The share of assets of the top three or four banks account for only 30%-32%. Thus, the banks still remain fragmented for a major part – systemic risk or contagion effect shall not be a problem as of now. Although this is the case, out of the four mergers not one of them can be said to be financially strong. This is a phenomenon of blind leading the blind; it cannot be expected that two financially weak banks can merge into one financially strong entity. “A chain is only as strong as its weakest link.”

This announcement comes at a time when even the results of the previous mergers (e.g. Bank of Baroda) have not yielded any fruit and the PSBs have recently jumped back from a long stress scenario. It seems as if there is no common theme in the mergers (i.e. retail, corporate or SME), no particular skill-set that has been emphasized upon. Rather, it was just assumed that all the banks fall under the same template and a haphazard combination was made – in such a case, there is a slim chance of synergy creation. Also, with no major theme in hand the multifarious objectives will confuse the banks with respect to the pressing matters at hand.

According to technical experts, it might take around three to four years to integrate the existing IT systems of the banks. Although all of the use the CBS, heavy customization is required, mobile apps need to be in sync, backend functions have to be centralized effectively.

As for the case of resolution of NPAs, it might actually become easier and faster. Earlier, the bankers had to talk to their counterparts, the approach the senior management to come to a resolution. Now, with these institutions merging and with lesser levels to report to, a solution plan can be implemented at the earliest with considerably less effort. Apart from this, now that the banks will have a common database and a larger network, they can increase the services offered at a higher level at lower costs – this might show an increment in the fees earned and in turn, the profitability. It is expected that the Anchor banks will be benefitted more from the mergers as the swap ratio will be in their favour.

Author
Chandreyee Sengupta
Team Member- Equity Research & Valuation
(MSc Finance, NMIMS Mumbai. Batch 2019-21)

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Non-Performing Assets (NPA) of India: Journey so far and the road ahead!

“The failure of a loan usually represents miscalculations on both sides of the transaction or distortions in the lending process itself.”

— Radelet, Sachs, Cooper and Bosworth (1998)


In the recent times the newspapers have been filled with some or the other news, issues, policies, regulation or resolution of NPAs. The NPA ratio has come down to 9.3% in March, 2019 from 11.5% in March,2018 according to mention by RBI Governor Shaktikanda Das. 

Source: SCB’s GNPA Ratio,Financial Stability Report, RBI

According to RBI, the definition of NPA is: ‘An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.’

A non-­performing asset (NPA) is a loan or an advance where the payment of principal/interest is due (in default) for 90 days or above.First, when there is a default of payment, till 90 days, the accounts are subsequently classified as Special Mention Accounts (SMA): SMA 0/1/2. Then after 90 days, these accounts are classified as NPAs.Further NPAs are classified into sub­standard,doubtful and loss assets.Any income for standard assets is recognized on accrual basis, but income from NPAs is recognized only when it is actually received.

Reasons for accumulation of NPAs:

Increasing cases of wilful defaults and frauds are often considered as the primary reason behind the accumulation of bad loans in the Indian banking system.

When an economy experiences healthy GDP growth, a substantial part of it is financed by the credit supplied by the banking system. As long as the GDP keeps growing, the repayment schedule does not get substantially affected. However, when the GDP growth slows down, the bad loans tend to increase due to macroeconomic factors, primarily among them are interest rate, inflation, unemployment and change in the exchange rates.Hence, bad loans accumulate as borrowers are unable to repay due to stalling/closure of the big development projects

Bank-related micro indicators such as capital adequacy, size of the bank, the history of NPA and return on financial assets also contribute to the accumulation of bad loans. NPAs, specifically in the Public Sector Banks (PSBs), have adverse effects on credit disbursement. Increasing amounts of bad loans prompt the banks to be extra cautious. This in turn has caused drying up of the credit channel to the economy, particularly industries, making economic revival more difficult.

Need for Solution

Reviving industrial credit is crucial for the health of the overall economy, because industry (particularly manufacturing) tends to create more employment.

Mounting bad loans suggests vulnerability in the system, wherein short-term deposit-taking banks have to extend credit for long-term big development projects. And this model is visibly failing. Hence NPAs put several small depositors of the banks, particularly in the PSB, at risk.

Also an improvement in the recovery rate and reduction in timeline for resolution for insolvent companies will increase investor confidence in Indian Bond Market.

Recognition of the problem and the solution:

NPAs story is not new in India and there have been several steps taken by the GOI on legal, financial and policy level reforms. In the year 1991, Narsimham committee recommended many reforms to tackle NPAs.

SICA Act, The Debt Recovery Tribunals (DRTs) – 1993, CIBIL: Credit Information Bureau (India) Limited-2000, LokAdalats – 2001, One-time settlement or OTS- compromise settlement-2001, SARFAESI Act- 2002, Asset Reconstruction Company (ARC), Corporate Debt Restructuring – 2008, 5:25 rule – 2014, Joint Lenders Forum – 2014, Mission Indradhanush – 2015, Strategic debt restructuring (SDR) – 2015, Asset Quality Review- 2015, Sustainable structuring of stressed assets (S4A)- 2016 were some of the techniques applied to tackle the problem by government and RBI.

Every method was entangled, rules were not that clear, there were lot of cases pending in front of DRTs owing to limited infrastructure, not enough field experts and hence, it took years for creditors to recover their money. India needed a structured process; thereby Insolvency and Bankruptcy Code (IBC) -2016 came into existence.

It sets a time limit of 180 days which can be extended by another 90 days to complete the entire process. Some of the features of the code include the allocation of a new forum to carryout insolvency proceedings, setting up a dedicated regulator, creating a new class of insolvency professionals and another new class of information utility providers.

The forum where corporate insolvency proceedings can be initiated is the National Company Law Tribunal (NCLT) and appeals against its decisions can be made in the (National company Law Appellate Tribunal) NCLAT. The IBC vests the NCLT with all the powers of the DRT.

Insolvency professionals will have the task of monitoring and managing the business so that neither the creditors nor the debtor need worry about economic value being eroded by the other.On acceptance of the application by NCLT for proceeding for Corporate Insolvency Resolution Process (CIRP), Board of Directors of the company has to step down and Insolvency Professional takes the charge and the plan for revival or liquidation of the company, approved by majority of creditors is put in the action according to the IBC rules and timeframe.

It is predicted that the NCLT is focused on the legal process while the insolvency professional is focused on business matters.RBI listed out the 12 major accounts in India, which has the largest share of NPAs in the country.

Source : ICRA

Some great results have fared in: Ranking for ‘Resolving Insolvency’ But still there is a long way to go: Suggestions

As mentioned above, there is a mismatch of assets and liability for the banks. Banks’ assets are long term loans, whereas banks liabilities are short term deposits, which have landed banks in failures. Hence, it makes sense to say that commercial banks should be focusing on short term assets to match their short term liabilities. And for Long term projects, special purpose vehicles (SPV) should be created to fund a particular sector project and financial institution should be created to fund these SPVs and should be given incentives and proper regulation from the government.

Also, as recapitalization of PSBs is going on, a bank should first divide its assets into good and bad, meaning viable and unviable asset. Banks should be recapitalized according to viable assets to revive with its positive core rather than just giving out public money. By this, banks can also focus on their core business rather than managing NPAs and not contribute to slowing of the economic growth.

SICA Act in India was a ‘Debtor in Possession’ (DIP) Model just like U.S. Chapter 11. But there were flaws in the act compared to the U.S.model. There was also a problem in the assessment of viability of the company as only a few accounts were revived. ‘Another relevant fact is the definition of insolvency or ‘sickness’ under the SICA. The N.L. Mitra committee criticized the definition provided by SICA i.e. ‘at the end of any financial year, accumulated losses equal or exceed its entire net worth’ stating that this is the end rather than the initial point where the company’s problems begin.’

Time has changed, India made a comeback with ‘Creditor in Possession’ (CIP) Model of IBC inspired by U.K. owing to similarities in the judicial process and SMEs culture, but there is one problem. In SICA, debtors were made liable to take the proceeding to court if it is identified by them that company is in trouble. Under IBC there is no such amendment and hence there is a ‘problem of initiation’ which was clearly seen in the case of Jet Airways. Just because directors didn’t want to step down, they dragged the process, rejected lot of revival bids in early insolvency phase. And be it any reason, even the financial or operational creditor did not initiate the process.

Australia also followed CIP model, but faced the same problem and added the amendment to make directors liable for any default under their directorship, directors became scared to default and didn’t take any risky decision to grow the company making them stagnant. This also should not happen with India. But then Australia laid ‘Safe Harbor’ provision to ease out the rules. Hence still amendment in the IBC is required to make directors take help from outside professional for the revival of their company in the early insolvency stage itself.

On June 7,2019, RBI laid provision pertaining to rules for creditors to enter into a ‘review period’ in the first 30 days of default by the debtor account, and make a resolution plan for the concerned account and apply the plan in next 180 days to revive it. If the plan is not put into implementation, provision for this account is required to be increased more and more as days pass. This might lead the banks to initiate the CIRP of the account under IBC and may overcome the ‘Initiation Problem’ from the side of creditors. According to this new frame work for stressed assets, the above mentioned rule is now applicable to Small Finance Banks and NBFCs, as they have become an integral part of the economy and needs to be properly regulated to retain the trust of investors.

There can be a solution to mitigate the problem of NPA by forming a‘Bad bank’. But this is a very risky model as it requires extensive research and cross-country analysis as the taxpayers’ money is on table.

In India Secondary Market for Corporate Loans, particularly distressed loan is in the making, taking inspiration from U.S. and European market. But there is a problem of transfer pricing of these distressed assets. India will have to design a proper mechanism, a platform and regulation of valuation techniques using DCF method, so that there isn’t much of a gap between the bid and the ask price of the assets and so the market remains active and transparent.

India and the banking system requires a major turn around and all the financial professional will have to put in the work.

Author
Vishwa Parekh
Volunteer – Fixed Income & Risk Management
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

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In relation to SBI Merger, are fewer and bigger PSU banks better?

INTRODUCTION

Public Sector Banks (PSBs) are banks where a government holds a majority stake i.e. more than 50%. Currently, there are 27 public sector banks in India. Out of these, 21 banks are nationalized and 6 banks are of State Bank Group (SBI and its 5 Associates) and the shares of these are listed on the stock exchanges. In India, out of the total banking industry, the Public sector banks constitute 72.9% share while private players cover the rest. However, PSBs seem to be losing their market share on account of the huge Non-Performing Assets. Banking industry is undergoing unprecedented changes driven by consolidation by means of mergers and acquisitions all over the world. In recent years, banking industry of India has witnessed a transformation as it was working in highly regulated environment before.

L= Listed; UL= Unlisted

OBJECTIVE

The objectives of the study are:

  1. To analyze the impact on share prices of the company during pre and post-announcement period of the merger.
  2. To see the resulting change in the value of the company after the merger.
  3. To study the synergy effects of the merger
  4. To analyze whether the mergers add value to the Indian Banking System in general and Public Sector in particular.

ANALYSIS

VALUATION OF BANK

As on March 31, 2017, the firm was undervalued even after the merger and increase in share prices. The rise in the share price was not huge and keeping the stock of SBI as undervalued.

We have use FCFE method in calculation the value of Firm.

Assumptions-

  • The company is expected to grow at a high growth rate for 3 years. (SBI sees profit boost in 3 years after merger).
  • Growth rate of the firm is constant at 4.794%; it is calculated by growth in deposits of banking sector deposits.

Free Cash Flow To Equity= Profit After Tax – Capital Expenditure – Increase in working Capital + Debt Raised – Debt Repaid + Non Cash Expense

Before merger to calculate FCFE the sum of SBI with all the associates and BMB have been taken before merger so as to reduce the impact of errors.

Capital Asset Pricing Model (CAPM)

CAPM= Risk free Rate of Return +Beta (Market Return – Risk free Rate of Return)

Here, we have take 10 years monthly average of the Government of India Bond return for % years, which comes out to be 7.91%. (Annexure 1)Sensex average monthly return for 5 years comes out to be 11.889% (Annexure 1) and Beta of SBI is 1.3871 (Capitaline)

CAPM= 7.91%+ 1.3871 (11.889%-7.91%)

=13.429%

It is assumed that CAPM is the Present Value Factor and cost of equity of the firm.

DISCOUNTING OF FCFE

TERMINAL VALUE

Terminal value =

= 345049.4575

PV of Terminal Value = 345049.4575 X 0.60= 208442.968

Value of Firm = 284733.8107

MARKET VALUE

For market value of the firm we have taken the data as on March 31, 2017, the closing price of SBI and the number of total outstanding shares on that date.

UNDERVALUED

Value of firm – Market value  = 284733.8107 – 233862.8853

= 50870.9254

SWAP RATIO CALCULATION

The company came out with Swap Ratio by analyzing three-weighted method in finding out the true value of its associates and making it a fair deal.

Three methods, which are, used are-

  • Market price method- It refer for determining the price of the similar items for determining the value of an asset. It is a business valuation method for determining the value of the business ownership. The weightage that was given to this method at the time of merger was 45%.
  • Completed Contract Method (CCM)- In this method, it enables the businesses to postpone their reporting of income and expenses until the contract is completed. This method can either under estimate the profit or over estimate it as there are contracts, which are not being accounted for till they are completed. The weightage given to this method is 45%.
  • NAV Method- This method focuses on the NAV of its total assets minus total liabilities divided by number of outstanding shares of the firm. This method was given a weightage of 10%.

The valuation of the company is done on the market value of firm as on 17 March 2017. The company came out with the Exchange rate of 2.8:1 for SBBJ, 2.2:1 in case of SBM and SBT. There was no Swap ratio for SBP and SBH as they were fully owned subsidiary of SBI and 4,42, 31,510 shares for every 100 crores shares of BMB.

(SES Governance)

CHANGES AFTER THE MERGER

Fixed Assets

The fixed assets of SBI went up to Rs. 51,884.15 crores post the merger from Rs.16,200.90 crores pre-merger as all the fixed assets of the associate banks merged with that of SBI converting it into a larger public-sector undertaking in terms of assets. The major increase in fixed assets was because of increase in Premises of SBI from Rs. 6,505.14 crores to Rs. 42,107.57 crores. After the merger, SBI joined the club of top 50 banks globally in terms of size of assets. The number of branches increased to around 24,017 and ATMs managed by SBI was nearly 59,263 across the country. This will increase the area managed and covered by the bank directly rather through its associates with a wide range of products at lower costs.

Net Profit and NPA’s

The net profit of SBI pre-merger was reported to be around Rs. 12,743.39 crores which was converted to a net loss of Rs. 390.67 crores post the merger due to integration of non-performing assets of SBI with all its associate banks. The NPA’s were reported to be at Rs. 57,155.07 crores compared to Rs. 38,024.06 before the merger. NPA’s of SBI increased by almost Rs. 19,131 crores which resulted in a great loss to SBI.

Out of all the associate banks, SBP had the largest amount of NPA’s of Rs. 2,924.03 crores and a net loss of Rs. 972.4 crores before the merger. While SBH reported the highest net profit of Rs. 1,064.92 crores with negligible NPA’s among all the associate banks. However, the loss incurred is of short-term nature and gradually with time, SBI will again start reporting profits as a result of economies of scale and reduction in costs of doing business.

VOLATILITY IN SHARES

On the date of the merger, markets were bullish on SBI and its associate as SBBJ shares price rose by 20% for two consecutive days hitting the circuit on both days. SBM’s share prices also rose by 20% after the announcement of merger following a growth of 15.74% on the next day. In fact, SBT’s share too rose by 20% after the announcement of merger and further by 15% on the following day. SBI owns a market share of 23.07% in deposits and 21.16% in advances as opposed to 18.05% and 17.02% in deposits and advances respectively.

The combined bank now caters to around 42 crore customers. There exists a large scale of inefficiency among smaller banks which when merged into a larger bank would make it more efficient in carrying its operations.

POST MERGER

Post-merger, the total customer base of the bank has reached 37 crores with a branch network of around 24,000 and nearly 59,000 ATMs across the country. The employees’ strength of SBI has increased to a total of 2,71,765. All the customers and employees of SBI associate banks have become the customers and employees of SBI. So, all the employees are now eligible for the same retirement benefits as the SBI employees. That means, the SBI employees get three retirement benefits i.e. provident fund, gratuity and pension and the associate bank staff members get two retirement benefits.

The merged SBI Bank now has a deposit base of more than Rs 26 lakh-crore and advances level of Rs 18.50 lakh crore. The board of SBI approved the merger plan under which SBBJ shareholders would get 28 shares of SBI for every 10 shares held. For both, SBM and SBT shareholders would get 22 shares of SBI for every 10 shares. However, separate schemes of acquisition for State Bank of Patiala and State Bank of Hyderabad were approved by SBI. Since they are wholly owned by the SBI, there will not be any share swap or cash outgo and for BMB, SBI’s 4,42, 31,510 shares for every 100 crores shares of BMB

Author
Apoorva Goenka
Team Leader- Equity Research & Valuation
(MSc Finance, NMIMS Mumbai. Batch 2018-20)

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