On the fast lane with LKB deal

PENNY WISE

Centurion Bank of Punjab's deal with Lord Krishna Bank may be a tad expensive but there are merits in the merger.

Whether consolidation gathers pace in the banking sector overall or not, Centurion Bank of Punjab (CBoP) seems to be pursuing its inorganic growth strategy with great rigour. It has gone ahead with two mergers in little over a year.

After completing the merger of the erstwhile Bank of Punjab (BOP) with itself in October 2005, the bank has gobbled up Kerala-based unlisted private sector bank - Lord Krishna Bank (LKB)-in a share swap deal.

The deal values LKB at Rs 330 odd crore. The merged entity will have 361 branches and 12 extension counters with a dominant presence in North (Punjab) and South (Kerala), up from CBoP's 249 branches and 402 ATMS across 123 locations predominantly in the Northern region. Centurion has received RBI approval to open 30 more branches by FY07.

Analysts have a mixed view on the merger with a small-sized bank at a price to book value (P/BV) of 2x for FY06. Centurion had merged BOP at a P/BV of 1.9x in last October.

While Vishal Goyal of Edelweiss Securities feels that the merger is fairly valued, a banking analyst at another leading broking firm thinks that the deal is a bit expensive given the weak fundamentals of LKB.

The bank's net interest margin (NIM) is 2 per cent lesser than the industry average while its branch productivity is also low. 
 

HIDDEN COST BENEFITS
Key parameters (FY06)	CBOP	LKB	Merged entity
COSTS				Decline(%)
Assets per branch (Rs crore)	47.00	23.20	39.50	-15.96
Business per branch (Rs crore)'	66.10	330.00	55.60	-15.89
CASA ratio (%)	38.70	15.90 (FY05)	34.30	-
Net interest margins (%)	4.80	2.30	-	-
Net NPAs (%)	1.10	3.11	-	-
BENEFITS				LKB as a % of merged entity
Total Branch network	229.00	110.00	339.00	32.45
North	133.00	19.00	152.00	12.50
South	48.00	81.00	129.00	62.79
East	11.00	0.00	11.00	0.00
West	37.00	10.00	47.00	21.28
Capital adequacy ratio (%)	12.50	11.47	-	-
Total business (Rs crore)	15933.00	3699.80	19632.80	18.84
Source: Company, Alchemy Insite

This could drag down Centurion's NIM from the current 4.8 per cent to around 4 per cent and ROE from 15 per cent to 13 per cent in the short term, analysts fear.

Also LKB has a higher net NPA (non-performing asset) of over 3 per cent, though the bank has set a target of bringing it down to around 1 per cent by FY07.

However the long term outlook is bullish as the merger will give Centurion immense opportunity in terms of strong regional presence and substantial retail, SME (small and medium enterprises) and NRI business.

Though LKB will form only 21 per cent of Centurion's balance sheet size, it has a branch network of 112 branches (100 per cent computerised ) and 44 ATMs, 61 per cent of which is in Kerala.

This will increase Centurion's presence in southern India. Currently, Centurion has only 14 branches in Kerala but it enjoys a credit-deposit ratio of 80 per cent in the state which is higher than the industry average of 66 per cent.

With more cross selling of products and higher contribution from fee-based activities through LKB's branches, Centurion can hope to enhance its profitability.

Says Anil Jaggia, Chief Operating Officer of CBoP, "We are looking at a sustainable growth in our core business and are open to such opportunities which give us a blend of rural, urban and under-banked areas."

In the past, Centurion has demonstrated its capabilities in managing integration successfully. After the merger of BoP, Centurion had more than doubled its balance-sheet size to Rs 11,330 crore in FY06. Net profit grew 250 per cent to Rs 87.8 crore.

The bank has reported over 10 per cent growth in business on a quarter-on-quarter basis since December 2005, even post-merger.

Centurion's financial performance in Q1FY07 improved substantially on a year-on-year basis thanks to the merger of BoP, which was effected only in the second half of FY06. Net interest income (NII) jumped over 100 per cent to Rs 123.2 crore though NIM declined marginally to 4.7 per cent.

In addition, an over 350 per cent jump in other income led to doubling of operating profits. Thus, net profits grew over 150 per cent to Rs 28.7 crore despite a three fold increase in provisions and contingencies.

The Centurion stock has shot up about 11 per cent in a month and trades at a post-merger P/BV of 2.6x for FY07E. Most analysts have a buy recommendation on the bank. Sejal Doshi, CEO, Finquest however has a different opinion.

He says, "Though the fundamentals of the bank continues to be strong and the recent merger is more or less in line with the bank's strategy of inorganic growth, the current valuation reflects the future growth prospects to an extent."

The bank is likely to be a good M&A (merger and acquisition) play when foreign banks will be allowed to acquire private banks in 2009. Its asset size, decent branch network and good technology makes it a potent candidate for acquisition.

The share swap ratio of 5:7 (7 shares of Centurion for every 5 shares of LKB) will dilute Centurion's equity by 9.4 per cent. For this, the bank is raising Rs 421.5 crore through preferential issue of 75 million shares (Rs 184 crore) to India Advantage Fund and 95 million shares to Bank of Muscat ( Rs 238 crore). This will also improve its capital adequacy ratio of 12.6 per cent as on June 2006 quarter.