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BOI-UBI merger: Complex synergies

Jan 12, 2005

To counter competition from their private sector counterparts, PSU banks are set to embark on a consolidation drive and use their majestic asset sizes as a bulwark against the efficiency of the private entities. The Bank of India (BOI) - Union Bank (UBI) merger that is expected to set the trend for the same, is likely to lend substantial synergies to the consolidated entity, although a generous portion of the 'benefits' will go to the government (a major shareholder in both). Also, mergers between 'big' banks in terms of number of branches and customers, adds to the complexities and their scalability poses a challenge. The BOI-UBI union is unlikely to be an exception.

Deposits (Rs bn)710 506
Borrowings (Rs bn) 45 9
Advances (Rs bn)458 294
Investments (Rs bn)272 224
CAR (%)13.0 12.3
Deposits growth (%)10.8 12.9
Adavnces growth (%) 7.6 15.3
Fee income growth (%) 4.7 9.1
Credit deposit ratio (%)65.5 55.5
NPAs/advances (%) 4.5 2.8

The upside…

The new order...
(Rs bn) FY04Balance sheetLoan book
SBI4,080 1,600
BOI+UBI1,430 753
ICICI Bank1,260 620
PNB1,030 472
IDBI+IDBI Bank 830 584
Second only to SBI: The union of BOI with UBI is set to create the second largest banking entity in the country, after the mammoth sized SBI. The merged entity although restricted geographically, will have the second largest asset size. This augurs well for amplifying the combined entity's credit portfolio.

Better capital adequacy: We believe, the government, the largest shareholder in both the banks, is backing the merger to allow the joint entity an easy access to the capital markets. UBI's Tier I capital adequacy ratio (CAR) of 6.5% is inadequate to support growth for more than 12 months. However, given that the government's stake in UBI is 61% and the same cannot fall below 51%, the bank may not be able to raise the required capital from the domestic market to increase its Tier I CAR beyond 8%. A merger with BOI will help resolve that issue. Upon the merger, the government's holding in the merged entity will be 65%, which will leave enough room for a fresh equity offering.

Access to cheaper funds: For Union Bank in specific, the merger would give ready access to foreign markets where Bank of India has presence currently. This will enable them access to cheaper funds from overseas markets.

Better asset quality: For BOI, the benefit from the merger will be in the form of access to the cleaner loan book of UBI. BOI's asset quality is poor with net non-performing assets at 4.5% of advances against 2.8% for UBI. The combined entity's net NPA's will stand at 3.7% based on FY04 numbers.

Enhanced profitability: The combined manpower need would be lower than the current status and rationalizing this would help improve the entity's profitability. The rationalization of manpower and lower operating expenses is expected to result in savings to the tune of Rs 3 bn.

The flipside…

Lack of geographical synergy:  Both BOI and UBI are banks based in western India, so the synergies from the merger will be limited and the merged entity will have to cope with overlapping branches and excess employees.

Resistance from staff unions: Under the proposed plan, 200 branches of the new entity will be closed, while 500 new ones will be opened in other parts of the country. The merged entity will then have 4,882 branches. Given the stiff resistance that the “employee rationalization” process is facing, the process of execution of the merger may last longer than expected.

The all important…swap ratio
According to media reports, the swap ratio for the merger is pegged at 1.8:1 (BOI - UBI). However, a look at the current valuations of both the entities tends to suggest that ratio may be settled at 1:1.1.

As of Jan 2005Bank of IndiaUnion Bank
Book value (Rs m) 40,263 29,804
No. of shares (m)487 460
BVPS (Rs) 83 65
Net NPAs (Rs m) 20,526 7,031
Adj book value (Rs m) 19,737 22,773 value/share (Rs) 41 50
Price/share (Rs) (7/1/05) 91 106
Price / adj. book value (x)2.25 2.14

The above can be further justified based on the following reasons:

  • Higher government holding in BOI at 69% compared to 61% for UBI. A merger ratio in favour of BOI will yield a better deal for the government.

  • Higher reported book value for BOI at Rs 83 compared to Rs 65 for UBI. Although BOI has lower adjusted book value as compared to UBI, its asset size gives it a better bargaining power.

  • As per banking regulations, banks with NPAs higher than 3% are restricted from dividend payout. Given the fact that government has a higher stake in BOI, bringing down its NPA levels below the stipulated requirements will mean better dividend inflows for the government.

At Rs 89, while BOI is trading 1.08x its book value, UBI at Rs 104 is trading 1.8x its book value. The combined adjusted book value of the entities for FY04 stood at Rs 65 bn. Based on the current market cap of both the entities, the merged entity's price to adjusted book value ratio stands at 1.5x. This puts the entity at the lower end of the valuation spectrum and leaves room for a positive adjustment. However, it is left to the merger ratio to decide as to shareholders of which of the merging entities will stand to benefit.

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