Case study- “Merger of HDFC Bank and Times Bank”

In November 1999, when Deepak Parekh and S M Data, Chairman of new private sector banks shook hands, they created a history of sorts.  It is the first ever mega merger of Indian banks.  It signaled that Indian banking sector has finally joined the MBA bandwagon.  There is no denying the fact that there have been mergers in the Indian banking sector before, but they were essentially attempts by the government to bailout the weak public sector banks that made the stronger partners feeble.  Now, the paradigm shifts lies in the fact that while the earlier mergers took place at the behest of the government, the market forces drove the merger of HDFC BANK and Times Bank.

Any talk of M&A in the Indian banking sector would have been pointless a few years ago.  And any suggestion of merger of banks would be regarded as nothing short of blasphemy.  The Indian banking sector is inhabited by twenty odd public sector banks, many of which have become grossly inefficient under thirty years of government patronage.  Winds of change appeared with the onsets of financial sector reforms.  Entry barriers were introduced in line with the global practices. Interest rates were deregulated giving banks more freedom as well as more competition. The artificial divide between the Development Financial Institutions and Banks has been removed.  Technology came in to impact the banks in a big way.

The removal of entry barriers saw the emergence of nine new private sector banks, some of them being the banking arms of the Fl’s themselves.  While reforms of interest rates and capital adequacy brought pressure in performance, new entrants brought competitions into the market place.  Where there is competition and struggle for us primacy there would be M&A.  Public sector banks being entities owned by the governments cannot be participants in the M&A game.  Even if they were allowed to merge, mergers among the PSBs inter se would not produce any synergy, for the simple reasons that they are all alike.  They invariably have presence in the same segment and suffer equally from ills like overstaffing etc.  And any attempt to reap the benefits that might arise on account of rationalization of branches and staff could invite trouble from the mighty trade unions that fight tooth and nail. The rest of the pack comprises of old private sector banks and new private sector banks. While old private sector banks have been a shade different though not necessarily better than their public sector counterparts, the new entrants became very aggressive, innovation savvy and competitive.  It is, therefore, natural and this segment was the first to see M&A.

The new private sector banks emerged on the scene in 1995.  Over the years they made considerable efforts to get a foothold in the niche segments of the banking industry.  While the PSBs took a Lion’s share, these new entrants carved a niche for themselves in special segments of banking on the strength of technology, innovation and professionalization.  As has been the case elsewhere, size matters in the Indian banking, Sanjay Sakhuja, Partner (Corporate Finance) of Arthur Andersen says, “Size does matter.  Technology has become a sine qua non in the banking industry.  There is no way that individually banks can invest in best technological solutions.  That calls for a certain size.  The other issue is that of capital adequacy.  There are number of banks in India which do not have adequate capital.  Bankshae evolved in the past on the strength of regulatory environment.  With tighter regulation no more the order of the day making the system more, competitive, consolidation is inevitable.” It is size that provides the strength to expand and compete for a higher market share. The merger of the HDFC Bank needs to be viewed in the light.

The Times of HDFC

The merger deal was struck with a stock swap whereby the shareholders of Times Bank will get one share of HDFC Bank for every 5.75 shares held.  The Times Bank will merge with HDFC Bank and the emerging entity will continue to function as HDFC Bank.  With the RBI giving a green signal, the merger is likely to come into effect by the first quarter in 2000.  The Bennett Coleman group, which promoted the Times Bank, will have about 7.5 percent stake in HDFC Bank.  The equity capital of HDFC Bank will rise from Rs. 200 crore to Rs. 233 crore.

With one stroke the merger helped HDFC Bank become the largest of the private sector banks in the Indian banking industry.  The merger will increase the customer base of HDFC Bank by 2,00,000 taking the figure to 6,50,000.  It will also provide cross-selling opportunities to the increased customer population.  Various products of HDFC Bank as well as the housing finance products to its patent HDFC can be offered to the new customers.  Most importantly the branch network would increase from 68 to 107.  HDFC Bank’s total deposits would be around Rs. 6,900 crore and the size of the balance sheet would be over Rs.9, 000 crore.  Since Times banks has technology in place, HDFC Bank saves on the costs associated with technology up gradation.  According to the bank some amount of rationalization of the portfolios of corporate loans may be required.  The bank also gains from existing infrastructure.  The capital adequacy of HDFC Bank would be 10.3 percent post-merger and would go up to 11.1 percent after the proposed preferential offer to maintain the current level of holdings of different classes of investors.  The merger of those two banks has another distinct advantage.  The new private sector banks have nurtured employee culture in tune with competitive forces.  Thus there is unlikely to be any clash of cultures in the new entity.  This is likely to help the integration process.

Reportedly the branch network of both the banks do not overlap.  Despite the growth of Internet banking, branch network in the brick and mortar form is vital for reaching out to the customer especially in the Indian context.  HDFC Bank’s strategy for setting up of branches has been that of incurring lowest cost with about 6 8 persons per branch who look after both servicing and market functions of the bank.  The bank has also prompted the customers to use phone banking in a big way.  Since setting up of branches a new is a costlier affair, acquiring a readymade branch network could not have been better.  Product complementarily was more pronounced in the case of ATM card networks.  HDFC Bank had the Visa network and Times Bank had Master Card network.  On account of the merger, it would be part of both the networks.

Similarities in business segments and the prospects for synergies appear to be the major inducements for the HDFC-Times merger.  The table ‘Convergence Advantage’ shows that there is fair amount of convergence in the rate of business growth (in terms of deposits, advances and income) and diversification in non-interest income.  Says Bandi Ram Prasad, Chief Economist, Indian Banks Association;  “There is sizeable divergence in efficiency of operations (measured in terms of net profit as percent of working funds and Net NPAs as percent of working funds and Net NPAs as percent of Net Advances.  With its record of higher operational efficiency HDFC Bank could contribute value addition to the business growth of the Times Bank.  Since both are low on staff costs, better control of costs is also possible.  With HDFC having more metro branches (65 percent) and Times Bank more urban branches (43 percent) overlapping of branch network is also not very leading to enlarged potential market.  That is enough incentive for consideration of a merger.”

Sanjay Sakhuja opines that the merger was an excellent transaction.  He explains, “It is an excellent transaction both in terms of the speed with which it was conducted and the way in which it is put through.  HDFC Bank gains in terms of size and complementarily of network.  From the times point of view too, I think this merger makes sense. The merger made the shareholders of HDFC bank and erstwhile shareholders of Times Bank very happy.”

Competition of late had been heating up. Foreign banks have been radically altering their strategies. Some of the public sector banks also began attempting reshaping of their competitive strategies. New private sector banks also began attempting reshaping of their strategies. New private sector banks have been aggressive in the race to grab the market share, thus for HDFC Bank the timing of merger opportunity could not have been better. In the whole world of banking sector it was HDFC Bank and ICICI Bank, which maintained better valuations while price of rest of the banks in the industry, plummeted in the recent past.

E-merging Wave

Look at the way the market has cheered at the merger. Empirical research on mergers proved that the shareholders of the acquiring company tend to  lose out post-merger, while those of target company gain. But the merger of HDFC-Times begs to be different. Ever since merger announcement, the market caps of both the banks have swelled by about 150%. Market appears to be bullish on bank mergers.

Given that the merger of HDFC Bank and Times Bank has been the first of its kind in the Indian banking industry, does the merger signal further consolidation in the banking industry driven by M&A? While there is no gain saying the fact that competitive forces will ensure that the consolidation would follow, there are some bottlenecks to this process. The state ownership of public sector banks is one major hurdle. Since Indian banking industry is still dominated by these banks unless the government loosens its strings any kind of M&A is not possible in the public sector segment.

Among those who believe that the merger of Times Bank with HDFC Bank does not necessarily signal a wave of M&A about to take place I the Indian banking sector is VS Srinivasan, Managing Director of Centurion Bank says, “The major reason why there will not be a M&A wave is because a major consolidation has to take place in the public sector on which the government is still not clear in terms of the mechanisms for achieving such a consolidation. Despite the recommendations of the Narshimham Committee, this issue has not been addressed. The potential for M&A amongst old private sector banks does

That as it may, there is reasons to believe that the government would be under pressure to reduce its stake in the public sector banks. For one of the increasing capital adequacy requirements would require bleeding state owned banks to raise equity capital from the market. The government, which is already suffering from the fiscal deficit trouble, is unlikely to dole out heavy capital infusions as generously as it did in the past. Therefore, it is likely that the government stake in these banks would go blow 51%. Moreover fat wage bills are in no position to go in for technological up gradations.

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