HDFC Bank to acquire Centurion Bank in $2.4 billion share-swap deal

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As per the terms of the deal, Centurion Bank shareholders will receive one HDFC Bank share for every 29 Centurion Bank shares.

The Rs.9510 crore ($2.4 billion) share-swap deal, touted as the nation's biggest financial sector buyout, will create a bank with 1,148 branches, surpassing largest private sector bank, ICICI Bank's 955 branches.

Centurion had 394 branches and HDFC Bank 754 branches as on Dec. 31 2007, HDFC Bank said in a regulatory filing, Feb. 22.

However, the merged entity's total advances of about Rs.87,000 crore ($21.75 billion) are far lower than ICICI Bank's Rs.2,20,000 crore ($55 billion).

In terms of assets too, ICICI Bank is much larger than the proposed new entity. While ICICI Bank has assets of Rs.3,76,700 crore ($94.2 billion), the proposed combined entity would have over Rs.1,10,000 crore ($27.5 billion).

The combined entity could have a market capitalization of about Rs.63,000 crore ($15.75 billion), based on their current market values. On the other hand, ICICI Bank is valued at $30.7 billion.

"The two Boards have resolved to pursue the merger subject to satisfactory due diligence, a fair share-swap ratio and all the requisite statutory, regulatory and corporate approvals," a joint statement issued by the banks said.

The merger will allow HDFC Bank to extend its reach in the country before a central bank review next year that may allow foreign banks such as Citigroup and Standard Chartered to buy Indian lenders.

In the past, both HDFC Bank and Centurion Bank aggresively carried out acquisitions. While HDFC Bank bought Times Bank from media publisher Bennett Coleman & Co. in 2000, Centurion, which was rescued by buyout firm Sabre Capital in 2003 after major losses, bought Central Bank of Punjab in 2005 and Lord Krishna Bank in 2006.

Bank Muscat and Sabre Capital are the two major shareholders of Centurion Bank, owning 14.02 percent and 3.74 percent respectively, as on Dec. 31, stock exchange data showed. Bank Muscat said it had no plans of selling its smaller stake in HDFC Bank after its takeover of Centurion.

HDFC Bank has a promoter holding of 23.28 percent, held jointly by HDFC Ltd, HDFC Investments and HDFC Holdings. HDFC will invest Rs.3900 crore ($975 million) in HDFC Bank to maintain its shareholding in the Mumbai- based lender. However, HDFC has no plans to merge with HDFC Bank, chairman Deepak Parekh said.

KPMG and Ambit Corporate Finance are advising the banks in the deal. The swap ratio was based on the recommendations made by joint valuers Dalal & Shah, a chartered accounting firm, and Ernst & Young, a tax consultancy and audit firm.

According to market analysts, the merger will give HDFC Bank a major boost as it will be able to consolidate its presence in southern India, especially in Kerala, where Centurion Bank has a concentration of branches.

Besides adding 2.5 million Centurion Bank customers, HDFC will also have access to talent. Earlier, HDFC Bank managing director Aditya Puri said a limited supply of skilled workers has made it tougher to expand in India, where the lender trails State Bank of India (SBI) and ICICI Bank. "We are dying for people," he said. Puri is expected to head the merged bank.

"We will also acquire a strong SME (small and medium enterprises) portfolio from Centurion Bank. There is no overlapping of HDFC Bank and Centurion Bank customers," a HDFC Bank official said.

Centurion Bank chairman Rana Talwar said the merger will help the bank compete with Indian and foreign rivals and was a better option than a possible acquisition by a foreign bank.

"This was a far superior option to waiting till 2009 and waiting for some foreigner to write a big cheque," Talwar said.

"This is the precursor of many more acquisitions, mergers and consolidations. In India's financial sector, we don't have global scale yet. But over a period of time, there will be fewer, stronger, better capitalized banks," he added.

"Most Indian banks are not (of a) great size. To tackle foreign banks, there could be more mergers. Most Indian banks are regionally focused," said one analyst with Religare Securities.

The deal "is positive for HDFC Bank as it has become more difficult to set up branches and get talent," said Sandeep Sabharwal, who oversees $3.2 billion as chief investment officer at Mumbai-based J.M. Financial Mutual Fund. "However, shareholders of Centurion Bank could be disappointed as they expected a ratio of about 1:25."

Analysts say the merger will only help HDFC Bank increase earnings. Merrill Lynch analysts Rajeev Varma and Veekesh Gandhi, in a note said that the merger gives an opportunity for HDFC Bank to leverage Centurion Bank's deposit base and distribution more effectively.

"We reckon it could help potentially take return on equity to around 20 percent by FY10," the analysts said.

"The merger gives HDFC Bank on a platter a year plus of growth, and a 50 percent increase in its banking network. There are synergies the banks can benefit from - Centurion Bank has a strong presence in high-yielding retail loans, while HDFC Bank has been very good at raising low-cost deposits," said Shriram Iyer, head of research at the brokerage Edelweiss Capital.

"Integration will be a significant challenge, but we are confident of management's ability to deliver synergy benefits given track record and experience," said Credit Suisse in an analyst note. The merger will likely be dilutive to earnings in the 2009 fiscal year, but combining functions and economies of scale should drive returns on earnings and earnings per share accretion from the next year, it said.

The deal will help HDFC Bank stave off a challenge from Axis Bank (formerly UTI Bank), Citigroup analysts said in a report, which had grown significantly faster than HDFC Bank, "and done so profitably."

So far, the Indian banking sector has not seen many mergers unless mandated by the banking regulator.

Global Trust Bank, a private bank was merged with state-owned Oriental Bank of Commerce (OBC) in 2004, while United Western Bank was merged with the Industrial Development Bank of India (IDBI) in 2006.

The last merger in the Indian banking sector was between Bharat Overseas Bank and Indian Overseas Bank (IOB) in March 2007.

"Larger banks make stronger banks. Size and scale do matter in the banking space and this deal has not come as a surprise. Stricter capital adequacy norms with Basel II implementation could force more banks, especially several of them down south, to merge with bigger entities. Thus, consolidation in the banking sector should go on for a while," said Kamlesh Gandhi, country head (Investment Banking) at Religare.

With capital requirements for banks set to get more stringent next year onward as per the Reserve Bank of India's Basel II norms, consolidation in the banking industry may become more common.

Basel II implementation could see banks' operational costs shooting up and a consequent rise in charges levied from customers. Thus, bigger banks with a better scale of economies would be able to provide services at a lower cost and prevent customer attrition. Basel II mandates stricter capital requirements based on the banks' own measures of risk that require comprehensive data collection and analysis, which will be expensive to implement. Further, the norm will require significant changes in internal systems and processes, which are expensive as well.

However, some analysts have questioned the proposed merger.

"I think this is just a merger for the sake of a merger. I don't see any immediate value addition to HDFC Bank because of this," said Sejal Doshi, CEO, Finquest Securities.

"I couldn't really understand why they bought a bank like Centurion, spending a substantial amount of $2.4 billion. There is some concern on that front," said R.K. Gupta, managing director, Taurus Mutual Fund.

"Maybe they want to grow bigger before April 2009 (when Basel II norms take effect) so there's less possibility of becoming a takeover target when foreign banks come in," he said.

India's biggest bank, the state-run State Bank of India (SBI), has a market value of $33.5 billion - just a fraction of Industrial and Commercial Bank of China's $282 billion.

Morgan Stanley said the deal will not significantly alter market share in lending, retail loans and deposits.

"From a longer-term perspective, it can be a good move as it increases HDFC Bank's physical distribution significantly," Morgan Stanley analysts wrote in a note, adding the deal will lift HDFC's customer base by about 30 percent, to 13 million.

"However, in the near term, it's likely to act as an overhang on the stock," it said, noting Centurion Bank was one of India's less profitable banks.

"We believe this acquisition is driven by longer-term strategy intent, rather than near-term economics, or a particularly opportune asset or pricing environment," Citigroup analysts said in a report.

Crisil, the Indian division of Standard & Poor's Ratings Services, also said it believes that the proposed merger will have a positive impact on HDFC Bank's business profile over the medium-term.

The deal will give HDFC Bank access to a wider branch network and help it expand its business geographically, specifically in the states of Kerala and Punjab, where Centurion Bank has a good presence, the ratings agency said.

Crisil added that the benefits in terms of access to an expanded branch network and wider geographical coverage will more than offset the impact of a slightly weakened asset quality and resource profile in the short-term.

Crisil said HDFC Bank's strong risk management systems and focus on maintaining high current and savings levels will ensure that the merged entity will maintain its asset quality and resource profile at levels significantly better than the rest of the banking system over the medium-term.

HDFC Bank will retain its healthy capital levels following the merger, Crisil added.

Meanwhile, bank employees are wary that the takeover will result in loss of jobs. "If the Centurion Bank takeover results in job losses, we will call for an agitation," said C.H. Venkatachalam, convenor of the United Forum of Bank Unions and joint secretary of the All India Bank Employees Association.

However, HDFC Bank's Puri has assured that there will be no job cuts. "We have no integration and people issues...the overlap of branches of both banks is almost none," Puri said, clarifying that there will be no issue of downsizing.