DOLAT CAPITAL

Consolidation in Indian Banking

India Research

Bachelor’s Party!!!

Analysts: Darpin Shah / Mayur Vani

Tel : +91-22-4096 9742 / 4096 9721
E-mail: darpin@dolatcapital.com / mayurvani@dolatcapital.com
May 2007
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Consolidation - need of the hour!!!!

The increased compliance requirements with the onset of Basel II have started a global spiral of consolidation.
Indian banking sector too is expected to witness its own share of similar activites. A proactive regulator has
already played its part in terms of laying a formal roadmap and guidelines to enable this migration. Indian
Banks are preparing themselves for necessary re-alignmnets/ makeovers in the interim. The valuation matrices
are soon expected to be weighed by the probabilities of individual bank participating in this activity. The cues
from current deal premia in the regional consolidation experiences provide additional opportunities of value
unlocking on eventual action...

Executive Summary
Consolidation - A Global Phenomenon
Banking sector consolidation is not just an Indian phenomenon but a Global reality on the back of Basel II implementations.
As India integrates itself with the world – the increased adherence to global compliance standards will become a major tool
for sustenance.

Indian Banking Character- Unlike globaly, the Indian Banking system is characterized by large number of small banks
participating in a large market. The top 5 banks cover around 45% of Assets in India, while globally they cover 75-95%
assest. We feel that size will soon emerge as a strategic compulsion to remain competitive in the emerging opportunities
from the Indian economic renaissance. Barring sparse instances, consolidation in Indian Banking industry till date has
been undertaken primarily as an external compulsion than internal strategic initiative.

Asian Experience - The Asian region (Malaysia, Taiwan, Singapore, Indonesia, South Korea and Japan), particularly after
the 1997 South East Asian Crisis, has witnessed its own share of consolidation in the recent past. Further, recent M&A
activity in the region has witnessed deal executions at 40%+ premia of prevailing valuations.

The Indian Banking Industry is governed by a regulator with pedigree of taking proactive measures that facilitate integration
of Indian Banking sector with emerging global trend. To facilitate timely entry of relevant global players in the banking
space, RBI has set its roadmap for consolidation in two phases –
l Phase I (2005-2009) – focused on enabling Indian Banks to become more competitive
l Phase II (post-2009) – providing competitive entry opportunities (Open branches and take over private banks) to foreign banks.

As we move closer to the 2009 deadline – both domestic as well as cross-border M&A activity is expected to gather further
pace. We also expect some of the futuristic bank managements to take complementary overseas bets during this period.
We also expect the activity to heighten further (post-2009) – given the strategic opportunity for the Global banks to
participate in the Indian pie.

Valuations
Till the actual action… Valuation segmentation – a natural transition
Till 2009 - the strategic complements in business, contemporariness of the bank, and its relevance/ ability/willingness to
participate in the activity, would start reflecting in valuation – thereby sharpening the valuation differentials further.

At the Action – a decisive strategic premium…

Adjusted for better growth opportunity, better regulatory compliances, adequate penetration of target assets and contemporary
technology complements – we expect the stakes to change hands at premia of 40-50% of the then prevalent multiples.

How does one play this…

We expect SBI to be the natural beneficiary (among the PSB segment) – and a direct play given clarity on the end and
means of its M&A related initiatives and preparedness.

The new-age private banks with their wide/decent spread of network, diverse product offerings, and better technology and
customer base – offer the best participation in this space for foreign banks. In this scenario, our top picks are ICICI Bank,
Kotak Mahindra Bank, Centurion Bank of Punjab and YES Bank.

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Indian Banking system – Fragmented structure

The Indian Banking System is well diversified and also has extensive banking network, both in rural as well as urban areas.
The Indian Banking system is classified in three types i.e. Schedule Commercial Banks (SCB), Regional Rural Banks
(RRB) and Cooperative Banks and Special purpose rural Banks.

Commercial Banks are further divided into Schedule and non Schedule Commercial Banks. However, in India these Banks
are classified as Public sector Banks, Private Banks (Old Private sector Banks New Private sector Banks) and Foreign
Banks. (Refer Annexure I )

Further, Indian Banking system is fragmented with top 5 banks covering around 45% of Assets, where-as world wide top 5
banks cover around 75-95% of the Assets. The Indian Banking system is characterized by large number of small
banks rather than a few banks participating in a large market.

Public Sector Banks (PSB) are still dominant in the business profiles of Indian banks, with around 28 of them controlling
around 74% and 72% of the Total Deposits and Total Advances respectively. The Private Sector Banks (a dominant
phenomenon post economic reforms) represent around 21% market share each in Total Deposits and Advances. On the
other hand, Foreign Banks (so far restricted in terms of local aggression for the limited scope offered by law), have mere
5.6% and 7.1% share in the Total Deposits and Advances respectively.

Market share in Indian Banking

FY1999 FY2006
90 Deposits 80 73.8 72.1 Deposits
82.0 82.0
80 Advances Advances
70
70 60
60
50
50
(%)
(%)

40
40
30
30 20.6 20.8
17.0 20
20 14.0
5.6 7.1
10 4.0 10
1.0
0 0
Public Sector Private Sector Foreign Banks Public Sector Private Sector Foreign Banks
Banks Banks

Source: RBI, Dolat Research

Size - minnows on Global scale

The size and structure of Banking system depends on stage of economic evolution, risk appetite of the economy for growth
and its financial market structure. Being a late participant in the global growth – Indian banks are in their early stage of
growth and thus are minnows, as compared to the global peers – on the critical parameters of Business size and geographical
reach.

Only 22 of Indian Banks figure among the top 1,000 banks in the world. State Bank of India (SBI), the largest bank of India
is around one-tenth the size of Citigroup, the world largest Bank on the Tier I basis. Further, SBI has around 90-100mn
customers and an Asset Base of $155bn; where as Bank of America has customer base of around 30mn and the Asset
Base of more than trillion dollars. In Asia, India’s SBI is the only local bank that had made it to the top 25 list. In comparison
China’s 4th largest bank is 2.5 times that of SBI. Also, the 5th largest Bank in China is probably larger than the top five banks
in Indian on the Total Asset front on aggregate basis.

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Tabel 1: -Banks in Different Categories
$Bn (March 2006) Tier I Capital Assets Profits RoA (%)
World
Citigroup 79 1,494 29.0 1.97
HSBC Holdings 74 1,502 21.0 1.40
Bank of America 74 1,292 25.0 1.95
JP Morgan Chase 73 1,199 12.0 1.02
Mitsubishi UFJ Financial group 64 1,509 13.0 0.85
Asia
China Construction Bank Corp. 36 568 7.0 1.21
Industrial & Commercial Bank of China 32 800 7.0 0.92
Bank of China 31 587 7.0 1.14
National Australia Bank 17 299 5.0 1.67
Kookmin Bank 12 181 3.0 1.78
India
SBI 8 155 1.9 0.89
ICICI Bank 4 56 0.7 1.23
PNB 2 33 0.5 1.09
BoB 2 23 0.3 0.79
Canara Bank 2 30 0.3 1.16
Source: Industry

Further, the statistics for Bank Credit to GDP (x), clearly indicates that India is still an under-banked country.

Banks Credit / GDP (x)

Bank Credit / GDP (x)
249

167
156
133
113 113
94
76 77
47
25 35
Thailand

China

UK

Hong
Brazil

Singapore

USA
Kong
Korea

Taiwan
Malaysia
India
Russia

Source: Industry, Dolat Research

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Asian Experience
In Asian region, Malaysia had reduced the number of banks from 55 to 10; while, Taiwan aims to bring down the number of
state banks from 12 to 6 (FY2004). Singapore government has also guided the banking system to lower the number of
Banks to mere 3 players with DBS being supported to become a regional leader. Similar initiatives have been undertaken
in Indonesia, South Korea and Japan – particularly after the 1997 South East Asian Crisis.

Consolidation – A Global phenomenon

Banking sector consolidation is not just an Indian phenomenon it is a Global Reality. As India integrates with the world –
the increased adherence to global compliance standards makes Capital Adequacy (to participate in growth – both in India
as well as outside) a major tool for sustenance. Basel II is an attempt to bring semblance into the global banking environment
to respond to the emerging challenges in terms of risk management to address increased “money-ness” of all assets
globally and would remain key driver of global M&A activity (Table 2). With the regulator sounding an early alert on preparing
for this eventuality – Indian Banking sector can not remain aloof to the emerging trends on Consolidation and M&As.

Table 2: - Basel II impacts on M&A

M&A Factors Basel II impacts

Capital release Acquires capital through IRB compliance to help fund purchase
Unsophisticated banks facing increase in capital requirements under standardised approach
could be acquired
Portfolio mixes Business Lines profitability shifts prompt shake-outs. Retails Banks benefit from increased
balance sheet flexibility
Targets identification Enhanced disclosure on risk and capital positions aids screening of targets and due diligence
Regional focus for expansion Regulatory capital changes will differ by country/ region, yielding a concentration of possible
targets
National barriers Basel II and IAS reduce international regulatory and accounting differences
Source: Mercer Oliver Wyman (2003)

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Indian Banking Sector - Consolidation roadmap
The Banking sector reforms in India were initiated in 1992, with a core focus on ensuring the safety and soundness of
financial institutions and at the same time making the banking system strong, efficient, functionally diverse and competitive.
The reforms included measures for arresting the decline in productivity, efficiency and profitability of the Banking sector.
The idea was to prepare a robust financial structure that enables the economy to operate in an open world environment. All
the key parameters like Capital Adequacy, prudential regulations, and accounting and disclosure standards have been
subjected to compliance of international standards since. Today, the level of compliance of the sector with the Basel
Committee’s Core Principles for Effective Banking Supervision, has refined financial soundness and consistent supervisory
practices of the Indian Banking system and made it resilient to absorb/respond global shocks.

While these initiatives on banking reforms have created a robust banking structure – it has also created a peculiar environment
by creation of multiple similar entities – small in size competing to create their sizeable identity over the next few years.
While base business growth remains favorable for each constituent in the current economic environment – size of business
(balance sheet) would remain a strategic compulsion to remain competitive in emerging opportunities from the Indian
economic renaissance. This makes mergers & acquisitions (both local as well as cross border) to form critical
components of the evolution of the Indian financial sector.

The main objectives for consolidation are typically –

l Migration towards Universal Banking Model
l Gain Size – Balance Sheet/ Geographic Presence
l Increase Market Share – Assets/ Liabilities
l Acquire Skills/ Processes – New Opportunities
l Diversification – Business Diversification, Risk Management
l To tap opportunities beyond regulatory restrictions

The major gains perceived from bank consolidation are the ability to withstand the pressures of emerging global competition,
to strengthen the performance of the banks, to effectively absorb the new technologies and demand for sophisticated
products and services, to arrange funding for major development products in the realm of infrastructure and telecom, etc
which require huge financials outlays and to streamline human resources functions and skills in tune with the emerging
competitive environment.

Banking Industry vision 2010 – a vision document of Indian Banks Association (IBA) has also highlighted consolidation and
M&A activity as an immediate agenda – driven mainly by expectations of shareholders. It sets a vision to deliver 4-5 world
class Indian banks by the year 2010. It also envisions a roadmap where Indian Banking system would witness emergence
of a few national banks of global scale and a number of regional players.

RBI has also on its part defined a clear roadmap recently to enable, facilitate and also regulate developments that make
consolidation an executable reality. The roadmap is split in two phases–

l Phase I (2005-2009) – focused on enabling Indian Banks to become more competitive (Refer Annexure II)
l Phase II (post-2009) – providing competitive entry opportunities to foreign banks (Refer Annexure III)

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Phase I (Pre-2009)

We expect following scenarios to evolve under these regulation during this phase. The existing banks will get
categorized in following six groups –
l Revitalized Banking Entities – Banks like Indian Bank/ IDBI (which have been at the receipt of Govt funding/ largesse
in the form rupee recapitalization/ favorable regulatory exemptions in the past) – would be allocated / acquire other
banks to become strong with wider reach.

l Public Sector Banks - with large domestic presence (Tier I banks – like SBI, PNB, Canara, BoB, BoI, Central, etc.)
that want to acquire bank with an overseas presence to become global entities. The Tier II banks (like Dena, Vijaya,
BoM, Andhra, etc.) in this segment might re-align to any of the bigger umbrella from among the first layer.
l Large Private Sector Banks – with contemporary management practices and high growth ambitions (ICICI Bank,
Kotak Mahindra Bank, HDFC Bank, UTI Bank)
l Niche New-Age Private Sector Banks – headed by aggressive CEOs, who have been leading ex-bankers (CBoP, Yes
Bank, DCB, etc.) and are driven by ambition to create a sizeable banking entity (through organic as well as inorganic growth)
l Niche Old Private Sector Banks – boutique regional presence with decent growth focus (Federal, South India, Karur
Vysya, Karnataka) – to align for strategic partnership options with a larger national player (foreign or domestic)
l Small Banks – Banks, which find organic growth restrictions with size and capital and would need to align with larger
banks to remain viable (Dhanalakshmi, City Union, etc). These are definite potential targets.

SBI offers maximum clarity on the structure and method of its evolution through this face to emerge as a larger participant
in the system.

Phase II (post 2009)

RBI has highlighted following key regulatory changes for operative principals for Foreign banks operating in India post 2009
l According Full National Treatment of Wholly Owned Subsidiaries (WOS) of Foreign Banks
l Dilution of Stake in WOS
l Merger and Acquisition of any Private Sector Banks

Foreign Banks entry - Increased services and healthy competition

Foreign Banks full-fledged entry is expected to transform the business of Indian banking in many ways, which would be
reflected in terms of greater breadth of products, depth in delivery channels and efficiency in operations. With better
technology and expertise in offering specialised banking products such as derivatives, advisory services, trade finance,
etc, the entry of foreign banks can enhance healthy competition and has a positive spillover effect on the domestic banks.

The impact of the entry of Foreign Banks on domestic Banks is likely to depend on various factors such as the structure,
strength and competitiveness of domestic Banks, the share of foreign banks, and the regulatory/supervisory framework.

We foresee following scenarios to emerge –

Scenario–I - BUY SBI – for clarity on means and end

Scenario II – Consolidation of Private Sector Banks
Scenario III – Region Centric Private Banks – strategic partners

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Scenario–I - BUY SBI – for clarity on means and end
SBI Clearly stands as a best bet amongst the PSB’s (on consolidation theme) on the back of the emerging clarity towards
the consolidation/ merger with its seven banking subsidiaries (3 listed and 4 unlisted).

Benefits for SBI and Group: - Currently, the subsidiaries together form the 2nd largest banking entity on consolidated
bases. The merger of these Banks with SBI would propel SBI to a newer orbit in terms of business, Balance Sheet to play
the larger turf globally.

Other PSB’s – Play for Value

Consolidation amongst the Public Sector Banks (PSB) - Government’s mercy

As the name suggests – Public Sector Banks bear a legacy of being owned by government – and barring a few stray
occasions, deliver similar pattern of performance, delivery, operations and brand equity. The likes of BoB, PNB, etc have
displayed wherewithal and strategic vision to embrace changing competitive realities. Barring these, there is not much to
separate one from the other – particularly on account of culture, vision, customer orientation (!), and operational efficiency.
The gaps are narrower, as we move to the Tier II Public Sector Banks. Therefore in this segment is critical from several
aspects, which include motives of value maximizations as well non-value maximization. Policy measures such as
government’s incentives that could accrue to the top managers are also important factors, which may determine the pace
of consolidation.

The Government has kept the forum open for the Nationalized Banks towards Consolidation. However, due to the lack of
initiatives from respective banks and also due to issues related to cultural mis-match, technology implementation and also
various other factors like human resource optimiz ation, over-lapping of branches; consolidation remains an unclear vision
for the Indian PSBs.

The proposed merger of Canara Bank and Dena bank has already sounded the bugle for the consolidation exercise. We
expect the momentum to only build from hereon. The obvious participants would be banks which need a definite capital
infusion, having GoI holding at threshold limit (51%) and on stand-alone find themselves in a non-distinctive market position.
However, there remains a possible outside trigger of substantial re-rating in this space if and when GoI decides to reduce
its controlling stake to 33% from the current 51% levels. (Refer Annexure IV)

We feel the value unlocking from consolidation opportunity in this segment is limited on account of lack of clarity on the
roadmap and higher complexities (in terms of internal realignments within PSB units) – and hence should be explored from
Value perspective as against consolidation perspective. We like PNB, IOB, BoB and Andhra Bank in this space on pure
valuation basis. (Refer Annexure V)

Scenario II – Consolidation of Private Sector Banks

Smaller Private Banks:- Amongst the Indian Private Sector Banks, the weaker and small banks are definite candidates
for the consolidation on account of lower Networth and inability to face competition. (City Union Bank, Dhanalakshmi etc).
However, the desire being on the seller’s side to raise capital and also to support the regulatory norms, we expect limited
upside to happen in this segment of private banks.

New Private Sector Banks: - Post reforms in 1992, the new age private banks (ICICI Bank, Kotak Mahindra Bank, HDFC
Bank, YES Bank, CBoP etc) has captured a substantial share in the Indian Banking system. Further, these banks have
also built strong / decent franchise, products and services to cater the entire needs of customer. These Banks are expected
to takeover / merger some of the weak and smaller banks along with some cross border acquisitions to enhance their core
competency. Private sector banks are expected to witness a spate of mergers, acquisitions, and open offers post 2009
from global banks seeking complementary India Strategy.

India had its own-share of M&A over the last decade (Refer Table 3, Annexure VI)

Scenario III – Region Centric Private Banks – strategic partners

When the name of the game to increase footprint – we feel there exists a niche space for the Old Regional Private Sector
banks to join the party. Given their existing strong presence in their respective region and a legacy of relationships with
subsequent brand equity – they are natural targets. The banks however have compulsive strategic reasons that restrict
them from a complete sell-out (issues like retaining identity, maintaining culture, and dispersed shareholding).
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We feel that there exists very limited possibility to ride these banks from a sell out perspective. However – they do possess
a strategic relevance as channel partners/ strategic allies – which allow them to ride on their current channel strength and
improve fee based incomes through partnerships (non-core business income for foreign banks). We expect this to be the
natural transgression given their pedigree on technology, product offerings and market aggression. This could see the
emergence of niche alliances in differential functional areas and business segments such as housing, credit cards, mutual
fund, insurance etc.

Table 3: -M&A activity in India

Banks Particulars
HDFC Bank and Times Bank Emerged as largest Private Bank in India
Customer Base :- 650,000
Branch Network:- 107
Balance Sheet size:- Rs 9000cr
Advantages from Infrastructure and also employee work culture
ICICI Bank and Increased reach to 360 branches with BOMd’s 263 branches especially in Southern region.
Bank of Madura (BOMd) Largest customer base of 2.7mn ( 1.2mn of BOMd), thus enabling ICICI Bank to offer its
banking and finanical services and also cross sell products and services of ICICI group
BOMd also had better technology.
BOMd had an attractive business per employee of Rs.202lakh.
Asset Base of over Rs 160bn.
Problem Cultural Integration tough task for ICICI Bank.
ICICI Bank and ICICI Ltd Merged Entity to become 2nd largest Bank in India with Total Assets of about Rs 950bn, 396 branches
and Extension counter of ICICI Bank / 140 reatil finance offices of ICICI To leverage on its large capital
base, comprehensive suite of products and services.
It had extensive corporate and retail customer relationships, strong technology-enabled distribution
architecture, strong brand franchise and vast talent pool
The strong corporate and retail relations to further help of fee based income and also other financial
products
OBC and GTB The merger has helped OBC to widen its branch network by 104 branches. GTB had a strong foothold
in the Southern region where OBC had only 59 branches.
With this merger OBC also got ready access to around 1mn customers of GTB, with a high
concentration of HNI customers having a propensity for saving.
GTB’s thrust on retail had given it wider access in the area of non-interest income
OBC was relatively slow in its technology implementation plans. But, GTB being a private
sector bank had a strong existing IT platform with a centralized banking infrastructure in
place. The merger facilitated OBC in stepping up its technology drive.
Centurion Bank and Centurion Bank had a strong Advances Portfolio where as Bank of Punjab had a strong
Bank of Punjab CASA Deposits.
Centurion Bank had strong foothold in West and South while Bank of Punjab had presence
in North (highest CASA Deposit in the region) given a better senergy.
Strong nation wide franchise of 240 branches and extension counters and 386 ATM’s.
IDBI and IDBI Ltd The merged Entity to have Assets worth Rs 800bn, thus having size and strength to be
comparable to big players.
Merged entity to be 7th largest bank based on assets.
Profitability to improve after the merger, as IDBI bank’s portfolio of assets and liabilities also earn better.
95 branches, 302 ATMs and nearly 1mn customers of IDBI bank will help IDBI to raise
finances for its development finance activities.
It would also enable IDBI to reduce its cost of borrowing and lend infrastructure projects at a lower rate
Problem IDBI Public sector undertaking and IDBI Bank new age private sector bank - integration
problems, legacy corporate culture
ICICI Bank & Sangli Bank ICICI Bank paid higher valuation for the merger of Sangli Bank.
ICICI Bank got direct access to existing 198 branch network of Sangli Bank (ICICI Bank did not receive new
branch license for two quarters).
Sangli Banks 50% of the branches are located in the rural and semi urban area (Rural Business - next
growth driver for ICICI Bank).
On the Business front, Sangli Bank added mere 2% to ICICI Banks Total Business.

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Banks Particulars
IDBI & UWB IDBI paid a decent value to acquire UWB.
IDBI branch network reached to 425 branches with the acquisition of UWB’s 195 branches
(70% of the branches in the urban areas).
The strong branch network is expected to benefit IDBI to garner higher Retail Credit and also Low Cost
Deposits (CASA) Portfolio.
CBoP& Lord Krishna Bank CBoP continued its inorganic growth strategy and paid fair value to acquire LKB.
(LKB) LKB’s 112 branches and 44 ATMs extends around 50% geographic reach to CBoP, especially in Kerla.
LKB also increases CBoP Balance Sheet size by around 20%, thus making it the 9th largest Private Sector
Bank in India.
Source : Dolat Research

Foreign Banks with global strategy to look for opportunity-

Although post 2009, the foreign banks will be allowed to set up new branches and also to acquire Indian Private
Banks, only few foreign Banks having global presence strategy are expected to aggressively take advantage of
the reforms.

Foreign Banks having global presence strategy are expected to react in a different way depending on the level of presence
in India. These Banks are expected to have two options to spread their reach, expand business, customer base viz.
l Open newer branches and expand rapidly into newer areas,
l Buy out any Private Bank and expand on the ready made branches, customers and business.

For details of Foreign Banks Exposure in India (Refer Anexure VII)

If the foreign Banks opt to buy out private sector banks they would seek –

Radar Chart for The Prospective Acquirer

Retail - Credit

Brand Retail - CASA

Mgmt Style - Grow th/Safe Technology

Mgmt Style - Risk/Agrresive Pricing Policy

Corporate Relations Products Innovation

Source : Dolat Research

External View Internal View

Consumer Beheviour Degree of Integration of Channels
Potential Degree of Decentralisation
Brand Competence source & Impacts
Price Policy AND Management Policy
Service Process & Structures
Customer Contact Responsibilities
Core Products & Services Range of Products & Services
Sales Channel Openness

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Presence and Non Presence of Foreign Banks in India – what they look for...

Foreign Banks

Having Presence Not Having Presence

Small size Tier II Banks Larger size Banks

Decent Branch netw rok Strong Netw ork
Technology Superior Techonolgy
Estabilshed products Estabilished products
Strong Retail Presence

Banks Banks
CBoP ICICI Bank
YES Bank Kotak Bank
Indusind Bank HDFC Bank
DCB UTI

Regional Banks
Federal Bank
KTK
SIB
KVB

Source: Dolat Research

In this scenario the following Banks come into play

Banks Particulars
ICICI Bank ICICI Bank is the largest Private sector Bank and 2nd largest bank in the country
The Bank has largest retail assets base
Universal Bank i.e. offering gamut of financial products and services
Kotak Mahindra Bank Kotak’s commercial banking business, to grow at much higher pace then industry given its small base.
The Bank continues to focus on High Interest Margin business and expected to continue.
Kotak, with its market leadership in broking and capital markets, appears to be one of the best listed
plays on this theme.
Universal Bank i.e. offering gamut of financial products and services.
HDFC Bank HDFC Bank is 2nd largest private sector bank.
Consistent 30% earnings growth.
Higher efficiency and high return ratios.
Best NPA’s in the industry.
UTI Bank UTI Bank is one of fastest growing tech savvy bank
Strong retail presence
Superior return ratios
CBoP CBoP is the fast growing new generation bank.
Strategic mix helping the bank to have highest margin in industry.
Aggressive organic as well as inorganic growth strategy.
YES Bank New generation Bank with unique Banking strategy (knowledge banking).
Strong Management Team.
Growing at around 80% in Business.
Further expected to continue the growth momentum for next couple of years.
DCB The new generation bank with the strong turn-around Story (Both Balance Sheet as well as Earnings).
Strong Promoter group.
Source: Banks; Dolat Research

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Global Banks M&A Scenario- Developing Countries

l ABN Amro Bank acquired 93.4% in Prime Commercial Bank (PCB) of Pakistan at PKR 13.8bn or Eur 172mn (PKR 54/
share). The acquisition made ABN as 2nd largest Foreign Bank in Pakistan and one of the top 10 banks in the country
with Total Assets of PKR 124bn and around 80 branches. PCB had Total Assets of PKR 52bn or EUR 654mn, Deposits
to the tune of PKR 41bn or EUR 508mn. Further PCB had 69branches and was the 19th largest bank in the Country. PCB
was valued at 4x its Book Value and represented around 42% premium over PCB’s average share price over last
one year.
l Standard Charted Bank (Pakistan) acquired 80.9% stake in Union Bank Limited (Pakistan) for $ 413mn. Union Bank
was eight largest Bank in Pakistan by market share, had around 65 branches, 37ATMs and 4 lac retail customers.
Banks’ Total Assets were $ 2009mn, Advances $1201mn and Net Assets $91mn. Union Bank was valued at 17.1x
FY2005 earnings and 5.6x FY2006 Net Asset Value (Book Value)
l Citigroup to buy Taiwan’s Bank of Overseas Chinese (BOOC) for T$14.1bn ($ 426mn) or T$11.8/share. The acquisition
will boost Citigroup’s Taiwan-based assets to $22.8bn, making it the 13th largest bank on the island. In the first three
quarters of last year, BOOC posted a net loss of T$510 million

Strategic Relavance of India for Global Bank

Emerging economy in terms of spending, saving, investments and growth
India is the 2nd fastest growing emerging Economy and also the fastest growing economies in the terms of spending,
saving, investments and growth.

Important peg of the future growth pie

The strong corporate capex pipeline, growing retail business with increased spending power, along with Infrastructure
projects, makes Banking Credit growth to remain healthy above global averages. This makes India presence strategically
crucial for every global financial conglomerate.

Regulatory environment poised to complement the opportunity

The Apex Bank i.e. RBI has set norms for the Foreign Banks, where-in these Banks cannot expand their reach extensively
during the Phase I (March 2005-2009). Subsequently, the Foreign Banks are missing the crucial current growth momentum
in the Indian Banking system. Further – RBI to its credentials has enough history in terms of agility to respond to the
emerging global business standards in banking – ahead of global timelines.

Enough Available Options

The well-dispersed diversified Indian Banking System provides large complementary offerings (options/ alternatives) to the
Foreign Banks depending in terms of the presence, need and business strategy.

How Much??? - Beauty lies in the eyes of beholder; Valuation in those of buyers!!!
The valuations for the eventual transactions would be driven by the ultimate strategic premia that the buyers would be keen
to pay for gaining access/ control in the Indian banking space.

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Table 5: -Global M&A activity - Premiums paid
Sr no Acquire Bank Target Bank Deal Premium
1 H&CB kookim Bank 0.2%
2 Overseas Union Bank United Overseas Bank Ltd 26.8%
3 DBS Bank Hong Kong DBS Group Holdings Ltd 61.4%
4 Taipei Bank Fubon Financial Holding Co 46.0%
5 Chohung Bank Shinhan Financial Group Ltd 7.0%
6 Chohung Bank Shinhan Financial Group Ltd 22.1%
7 Chohung Bank Shinhan Financial Group Ltd 5.2%
8 Ufj Holdings inc Mitsubishi UFJ Financial 35.8%
9 Bank Nisp Pt Overseas Chinese Banking Corp 5.1%
10 Prudential Bank Bank of Philippine Islands 95.6%
11 Equitable PCI Bank Banco De Oro Universal Bank 15.2%
12 Bank Buana Indonesia United Overseas Bank Ltd 0.9%
13 Farners Bank of China Taiwan Cooperative Bank 5.3%
14 Momji Holdings Inc Yamaguchi Bank Ltd -28.2%
15 Southern Bank Berhad Bumiputra Commerce Hldgs 6.8%
Average 20.3%
16 Centurion Bank Bank of Punjab 4.6%
17 ICICI Bank Bank of Madhura 100.0%
18 HDFC Bank Times Bank 8.1%
19 IDBI United Western Bank 21.0%
Average 33.4%
Combined Average 27%
Source : Bloomberg

Challenges in Consolidation
Some of the major concerns or issues for the Consolidation in the Indian Banking could be:
l Adaptation of Technology or technology platforms.
l Culture, working environment (Labor problems).
l Change in Government / Government Guidelines.

16 May, 2007 13
 DOLAT CAPITAL

What Does This Mean To Bank Valuations…???

Till the actual action… Valuation Segmentation – a natural transition

As we move closer to the 2009 deadline – both domestic as well as cross-border M&A activity is expected to gather further
pace. We also expect some of the futuristic bank managements to take complementary overseas bets during this period.

We expect the momentum to also build in terms of valuation differentials with a further sharpening during this period
towards the likely beneficiaries, vis-à-vis the ones where the chances for M&A/ consolidation are lower.

At the Action – a decisive strategic premium…

Adjusted for better growth opportunity, better regulatory compliances, adequate penetration of target assets and contemporary
technology complements – we expect the stakes to change hands at premia of 40-50% of the prevalent multiples.

How does one play this…

We expect the M&A activity to gain momentum sooner and heighten further as we approach the eventual 2009 deadline.
During this period, the strategic complements in business, contemporariness of the bank, and its relevance/ ability/
willingness to participate in the activity, would start reflecting in valuation – thereby sharpening the valuation differentials
further.

We expect SBI to be the natural beneficiary (among the PSB segment) – and a direct play given clarity on the end and
means of its M&A related initiatives and preparedness. In its peer-set - value would remain a dominant investment theme
along with a possible outside trigger of substantial re-rating in this space if and when GoI decides to reduce its controlling
stake to 33% from the current 51% levels.

The new-age private banks with their wide/decent spread of network, diverse product offerings, and better technology and
customer base – offer the best participation in this space.

In this scenario, our top picks are ICICI Bank, Kotak Mahindra Bank, Centurion Bank of Punjab and YES Bank.

Private Banks Valuation

Banks CMP NII NIM (%) Net Profit EPS (Rs)
Rs bn (Rs) FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E
CBoP 40 5.9 7.9 10.0 4.6 4.5 4.5 1.4 1.7 2.6 0.8 1.0 1.4
Federal Bank 267 6.9 8.2 9.8 3.2 3.2 3.3 2.6 3.1 3.8 30.5 36.7 43.9
HDFC Bank 1,034 36.8 46.6 58.4 4.6 4.4 4.3 11.5 15.0 19.5 36.6 47.8 62.4
ICICI Bank 919 66.1 88.0 113.5 2.4 2.4 2.5 33.0 40.7 51.2 35.0 45.8 57.5
Karnataka Bank 175 4.1 4.7 5.3 2.6 2.6 2.6 2.0 2.3 2.6 16.5 18.9 21.7
Kotak Mahinrda Bank 552 9.7 13.6 17.9 4.7 4.6 4.5 5.9 8.0 10.5 18.6 25.4 33.3
South Indian Bank 106 3.5 4.3 5.3 3.1 3.1 3.2 1.0 1.2 1.6 13.6 16.4 22.2
UTI Bank 541 15.7 21.6 26.8 2.9 3.0 3.0 6.6 8.1 10.4 23.4 28.7 36.8
YES Bank 164 1.7 3.7 6.1 2.5 3.0 3.1 0.9 1.7 2.7 3.5 5.5 7.9

Banks P/E (x) P/BV (x) P/ABV (x) RoANW (%)

Rs bn FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E
CBoP 52.3 40.8 27.8 4.4 4.0 3.5 4.7 4.2 3.6 10.7 10.3 13.4
Federal Bank 8.8 7.3 6.1 1.6 1.3 1.1 1.6 1.4 1.1 19.2 19.6 19.8
HDFC Bank 28.3 21.6 16.6 4.9 4.2 3.4 5.1 4.3 3.5 19.3 20.9 22.7
ICICI Bank 26.3 20.1 16.0 3.4 3.0 2.6 3.7 3.2 2.8 13.4 15.8 17.5
Karnataka Bank 10.6 9.2 8.0 1.7 1.5 1.3 1.8 1.6 1.4 16.9 17.2 17.4
Kotak Mahinrda Bank 29.7 21.7 16.6 5.8 4.2 3.5 6.0 4.3 3.6 22.1 22.8 23.1
South Indian Bank 7.8 6.5 4.8 1.0 0.9 0.8 1.2 1.0 0.8 14.1 15.1 17.9
UTI Bank 23.1 18.8 14.7 4.4 3.6 3.0 4.8 3.9 3.1 20.8 21.1 22.2
YES Bank 46.9 29.6 20.7 6.6 4.2 3.1 6.6 4.2 3.1 15.2 18.2 17.9
CMP as on 16/05/2007

16 May, 2007 14
 DOLAT CAPITAL
Annexure I
Structure of Indian Banking system

Scheduled banks in India

Scheduled commercial banks Scheduled co-operative banks

Public sector bank Private sector bank Foreign sector bank Regional rural bank

Scheduled urban Scheduled state

co-operative banks co-operative banks

Old Private sector bank New Private sector bank

State Bank & its

Nationalised bank
Associates

Source : Banknet India

Annexure II

RBI’s Roadmap for foreign banks in India

The banking sector in India is robust and its standards are broadly in conformity with international standards. In further
enhancing its efficiency and stability to the best global standards a two- track and gradualist approach will be adopted.

One track is consolidation of the domestic banking system in both public and private sectors. The second track is gradual
enhancement of the presence of foreign banks in a synchronized manner.

Implementation of the policy decisions is as follows:

Phase1: (March 2005 to March 2009)

1. New Banks –First time presence

Foreign banks wishing to establish presence in India for the first time could either choose to operate through branch
presence or set up a 100% wholly owned subsidiary (WOS), following the one-mode presence criterion.

2. Existing banks- Branch expansion policy

For new and existing foreign banks, it is proposed to go beyond the existing WTO commitment of 12 branches in a year.
The number of branches permitted each year has already been higher than the WTO commitments. A more liberal
policy for under-banked areas will be followed.

3. Conversion of existing branches to wholly owned subsidiaries

In the first phase, foreign banks already operating in India will be allowed to convert their existing branches to WOS
while following the one-made presence criterion
The WOS will be treated on par with the existing branches of foreign banks for branch expansion in India.

16 May, 2007 15
 DOLAT CAPITAL
4. Acquisition of Shareholding in select Indian Private Sector Banks
In order to allow Indian banks sufficient time to prepare themselves for global competition, initially entry of foreign banks
will be permitted only if private sector banks that are identified by RBI for restructuring. In such banks, foreign banks
would be allowed to acquire a controlling stake in a phased manner.

In considering an application made by foreign bank, for acquisition of 5% or more in the private bank, RBI will take into
account the standing and the reputation of the foreign bank, globally as well as in India, and the desired level and the
nature of presence of the foreign bank in India. RBI may, if it is satisfied that such investment by the foreign bank
concerned will be in the long term interest of all the stakeholders in the invested bank, permit acquisition of such
percentage as it may deem fit. The RBI may also specify, if necessary, that investor bank shall make a minimum
acquisition of 15% or more and may also specify the time frame for such acquisition. The over all limit of 74% will be
applicable.

Where such acquisition is by a foreign bank already having a presence in India, a time bound plan covering a period not
exceeding six months to conform to the ‘one form of presence’ concept will have to be submitted by the foreign bank
along with the application for acquisition.

Annexure III

Phase II: April 2009

1. According Full National Treatment to WSO of foreign Banks

In the second phase removal of limitations on the operations of the WOS and treating them on par with domestic banks
to the extent appropriate will be designed and implemented after reviewing the experience with phase 1 and after due
consultations with all stakeholders in the banking sector.
2. Dilution of stake in WSO
In this phase, the WOS of foreign banks on completion of a minimum prescribed period of operation will be allowed to
list and dilute their stake so that at least 26% stake of the paid up capital of the subsidiary is held by resident Indians
at all times. The dilution may be either way of IPO or as an offer to sale.
3. M&A of any Private Sector Bank in India
In the second phase, after a review is made with regard to the extent of penetration of foreign investment in Indian banks
and functioning of foreign banks, foreign banks may be permitted, subject to regulatory approvals and such conditions
as may be prescribed, to enter into M&A transactions with any private sector bank in India subject to the overall
investment limit of 74%.

Annexure IV: - Government holding in the PSB and CAR(%)

Bank Government holding CAR (%)

Allahabad Bank 55.23 12.52
Andhra Bank 51.55 11.33
Bank of Baroda 53.81 11.80
Bank of India 69.47 11.85
Bank of Mah. 76.77 12.06
Canara Bank 73.17 13.50
Corporation Bank 57.17 12.76
Dena Bank 51.19 11.52
IDBI 52.71 13.73
Indian Bank 80.00 14.14
Indian Overseas 61.23 13.27
Oriental Bank 51.09 12.51
Punjab National Bank 57.80 12.90
State Bank of India* 59.73* 12.34
Syndicate Bank 66.47 11.74
UCO Bank 74.98 11.56
Union Bank of India 55.43 12.80
Vijaya Bank 53.87 11.21
*- RBI Holding

16 May, 2007 16
 Annexure V: - Public Banks Valuation

16 May, 2007
Banks CMP EPS(Rs) P/E (x) B.V. (Rs) P/BV (x) P/ABV (x) RoANW (x)
(Rs) FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E FY07E FY08E FY09E
Allahbad Bank 83 16.8 23.0 27.3 4.9 3.6 3.0 100.2 118.2 140.2 0.8 0.7 0.6 0.9 0.7 0.6 18.5 21.1 21.1
Andhra Bank 92 11.1 12.7 15.0 8.3 7.2 6.1 66.5 74.6 84.6 1.4 1.2 1.1 1.4 1.3 1.1 17.6 18.0 18.8
Bank of Baroda 276 28.1 35.5 44.0 9.8 7.8 6.3 235.2 262.8 298.4 1.2 1.0 0.9 1.2 1.1 1.0 12.5 14.3 15.7
Bank of India 207 23.0 28.0 32.8 9.0 7.4 6.3 121.7 145.7 174.6 1.7 1.4 1.2 1.9 1.5 1.3 17.4 16.8 18.6
Canara Bank 243 35.5 39.8 45.6 6.9 6.1 5.3 201.6 232.6 268.2 1.2 1.0 0.9 1.4 1.1 1.0 18.9 18.3 18.2
Corporation Bank 321 37.1 43.5 49.9 8.7 7.4 6.4 264.0 298.4 339.3 1.2 1.1 0.9 1.3 1.1 1.0 14.9 15.5 15.6
IDBI 100 9.1 11.3 13.6 11.0 8.8 7.4 94.8 103.5 113.9 1.1 1.0 0.9 1.2 1.0 0.9 9.9 11.4 12.5
IOB 118 18.5 22.8 27.6 6.4 5.2 4.3 76.1 98.1 125.1 1.6 1.2 0.9 1.7 1.2 1.0 27.6 26.2 24.8
PNB 557 50.7 61.1 84.5 11.0 9.1 6.6 340.2 392.9 468.9 1.6 1.4 1.2 1.7 1.4 1.2 15.9 16.7 19.6
SBI* 1,284 86.3 99.2 115.1 14.9 13.0 11.2 596.1 678.8 776.8 2.2 1.9 1.7 2.6 2.2 1.9 15.4 15.6 15.8
Syndicate Bank 82 13.7 16.0 18.4 6.0 5.1 4.5 64.9 77.5 92.2 1.3 1.1 0.9 1.4 1.1 0.9 23.0 22.4 21.7
Union Bank 122 16.7 19.8 22.9 7.3 6.2 5.4 102.6 117.4 135.3 1.2 1.0 0.9 1.4 1.2 1.0 17.4 18.0 18.1
CMP as on 16/05/2007
* Standalone
DOLAT CAPITAL

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Annexure VI: - Valuation table for the recent mergers and acquisitions

Particulars Sangli Bank LKB UWB

Price Paid (Rs mn) 3,000.0 3,400.0 1,500.0
Branches 198 112 230
Price / Branch (Rs mn) 15.2 30.4 6.5
Networth 250.0 1,631.0 791.5
Net NPAs 200.0 676.6 2,273.0
Effective Price 2,950.0 2,445.6 2,981.5
Total Business 28,920.0 36,997.4 104,860.0
Total Business / Branch (Rs mn) 146.1 330.3 455.9
Effective Price / Branch (Rs mn) 14.9 21.8 13.0
Total Business / Effective Price 9.80 15.13 35.17
Equity (Rs mn) 31.9 944.5 537.7
BV (Rs) 78.4 17.3 14.7
Price / Share 940.4 36.0 27.9
P/BV (x) 12.0 2.1 1.9
Adj BV (Rs) 15.7 10.1 (27.6)
P/ABV (x) 60.0 3.6 (1.0)
Total Business as on 31st March 2006
Effective Price = Price Paid -Networth + NPA
Source:- Banks, Dolat Capital

Annexure VII : Foreign Banks in India

FY2006 (Rs mn) Citi Bank Bank of America HSBC ABN Amro Deutsche Stan Chart
Capital 5,013.6 6,571.0 13,677.5 1,690.2 7,126.8 5,282.0
Deposits 279,117.4 21,062.1 249,551.1 118,637.7 43,799.0 284,598.1
Advances 244,552.8 33,690.7 168,122.9 150,732.2 25,817.8 240,767.3
Total Assets 454,592.5 59,927.2 374,730.6 235,437.9 120,502.8 481,824.0
Networth 41,955.5 15,742.3 39,254.1 15,885.9 13,113.2 45616.12
PAT 7,055.5 1,437.0 5,149.2 2,416.8 1,259.3 9,048.5
RoA (%) 1.55 2.40 1.37 1.03 1.05 1.88
RoAA (%) 1.78 2.50 1.58 1.24 1.10 2.12
RoNW (%) 16.82 9.13 13.12 15.21 9.60 19.84
RoANW (%) 19.2 9.6 14.1 16.5 9.9 23.2
Source: RBI, C-line, Dolat Research

16 May, 2007 18
 DOLAT CAPITAL
Annexure VIII: - Valuing an Acquisition

Component Valuation Guidelines Should You pay?

Value the combined firm with synergy built in. This may include Which firm is indispensable for the
A higher growth rate in revenues: Growth synergy synergy?
Higher Margins, because of economies of scale If It is the target, you should be
Synergy Lower Taxes, because of tax benefits: Tax synergy willing to pay up to the synergy.
Lower cost of debt: Financing synergy If it is the bidder, you should not.
Higher debt ratio because of lower risk: Debt capacity
Subtract the value of the target firm (with control premium) +
Value of the bidding firm (pre- acquisition). This is the value of
the synergy.

Value the company as if optimally managed. This will usually If motive is control or in a stand alone
mean that investment, financing and dividend policy will be valuation, this is the maximum you
altered: should pay
Investment Policy: Higher returns on projects and divesting
Control Premium unproductive projects.
Financing Policy: Move to be a better financing structure
Dividend Policy : Return unsused cash
Practically,
1. Look at industry averages for optimal ( if lazy)
2. Do a full fledged corporate financial analysis

Status quo Valuation Value the company as is, with existing inputs for investments, If motive is undervaluation,
financing and dividend policy. this is the maximum you should pay

Source: Damodaran on valuation

16 May, 2007 19
 DOLAT CAPITAL

The ratings are based on the absolute upside of our target price from the current price.
Upside Ratings
> 25 % Buy
15% - 25% Accumulate
0% - 15% Reduce
<0% Sell

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Mehul Mehta FMCG, Power, Engineering vikram@dolatcapital.com 91-22- 4096 9734
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darpin@dolatcapital.com 91-22- 4096 9743 Institutional Dealing Desk 91-22- 4096 9797
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This report contains a compilation of publicly available information, internally developed data and other sources believed to be reliable. While all reasonable care has been taken
to ensure that the facts stated are accurate and the opinion given are fair and reasonable, we do not take any responsibility for inaccuracy or omission of any information and
will not be liable for any loss or damage of any kind suffered by use of or reliance placed upon this information. For Pvt. Circulation & Research Purpose only.

16 May, 2007 20