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Case Study: Merger of ICICI Limited with ICICI Bank

Brownfield expansion has become one of the popular strategies being pursued by companies from all over the world. Indian companies are no exception to this trend. The wave of merger and acquisitions have been knocking at the door of Indian Financial system. But this trend is not exactly new. There have been 36 mergers in the Indian banking Industry since 1969- the year in which the banking sector was nationalised by the government. The merger of ICICI Ltd with ICICI Bank is an example of reverse merger led to the creation of India’s first Universal Bank.

ICICI Ltd merged with ICICI Bank on 30^th March 2002, with the swap ratio of 2 ICICI shares for 1 share of ICICI Bank limited. With this merger, second largest bank in India was born. RBI had given approval for reverse merger of ICICI Ltd with its banking arm ICICI bank. ICICI bank with its 1 lakh crore rupees asset base bank is second only to State Bank of India, which is well over Rs. 3 lakh crore in size. RBI also cleared the merger of two ICICI subsidiaries ICICI Personal Financial Services and ICICI Capital Services with ICICI Bank. The merged entity will have a capital base of Rs 95 billion, 8,300 employees and a huge nationwide branch network.

While clearing the merger which was cleared by the Bombay High Court and the Gujarat High Court, RBI said, considering that the advances of ICICI are not subject to the requirement applicable to the banks in respect of the priority sector lending, the bank will post merger have to maintain an additional 10% over and above the requirement of 40% that is 50% on the net bank credit on the residual portion of its advances.

This additional 10% by way of priority sector will apply until such time as the aggregate priority sector advances reach a level of 40% total of the net bank credit of the bank. RBI said, adding its existing instructions on sub targets under priority sector lending and eligibility of certain types of investments for reckoning as priority sector advances will apply to the bank.

On reserve requirements, RBI said, ICICI bank should comply with CRR requirements under section 42 of the RBI Act of 1934 and the SLR requirement under section 24 of the Banking Regulation Act of 1949 as applicable to banks on the net demand and time liabilities of the bank, inclusive of the liabilities pertaining to ICICI from the date of merger. Consequently, ICICI has to comply with the CRR/SLR computed accordingly and with reference to the position of net demand and time liabilities as required under existing norms.

ICICI has already mopped a whopping rupees 23000 crores of SLR and CRR of rupees 5500 core to conform to this norm.

ICICI bank will continue to comply with all prudential requirements, guidelines and other norms as applicable to banks concerning capital adequacy, asset classification, income recognition and provisioning, issued by RBI from time to time on its entire portfolio of assets and liabilities post merger.

The bank should also ensure compliance with section 20 of the Banking Regulation Act concerning granting of loans to companies in which directors of such companies are also directors. In respect of loans granted by ICICI to companies having common directors, while it will not be legally necessary for ICICI bank to recall the loans already granted to such companies after the merger, it will not open to the bank to grant any fresh loans and advances to such companies post merger. The bar also includes renewal or enhancement of the existing loans. The restriction contained in section 20 of the Act does not make any distinction between professional directors and other directors and will apply to all directors.

While taking over the subsidiaries of ICICI after merger, the bank has also been asked to ensure that the activities of the subsidiaries comply with the requirement of permissible activities to be undertaken by the bank under sections 6 and 19(1) of the BR Act. The takeover of certain subsidiaries presently owned by ICICI by ICICI bank will be subject to approval, if necessary, by other regulatory agencies like IRDA, SEBI, National Housing Bank etc.

After complying with all the requirements, the approval of the RBI gave birth to the reverse merger of ICICI ltd and ICICI bank.

Background of the Companies

Industrial Credit and Investment Corporation of India Limited (ICICI) was set up in 1955 as a public limited company by the Government of India, the World Bank and some private Institutions with a paid up share capital of just rupees 5 crores. Its primary objective was to provide foreign currency loans to Indian companies. But gradually it expanded its activities into the areas of project finance, underwriting, venture capital, mutual funds and establishment of various subsidiaries including that of ICICI bank in 1994. The institution was able to quickly grasp the opportunities thrown up by the economic liberalization of early nineties and grow into formidable force in Indian financial scene. Finally, when RBI allowed Indian development bank in October 2001 to convert themselves into universal banks, ICICI was the sole applicant to RBI and presented its case with a detailed scheme of reverse merger of itself with ICICI bank.

ICICI banking corporation limited was set up as a scheduled commercial bank in 1994 by ICICI Ltd as its wholly owned subsidiary. In 1999, ICICI bank became the first Indian bank or financial Institution from non Japan Asia to be listed on the New York Stock Exchange. Consequent to the merger, the ICICI group’s financing and banking operations, both wholesale and retail, have been integrated into a single entity. After the merger, the holding of ICICI Ltd in the bank was diluted to 55.6% from the pre merger level of 62.6%.

ICICI Bank has now became India’s second largest bank after The State Bank of India with a total assets of about Rs. 1,679.59 billion as on 31^st March, 2005. It has a network of 562 branches and extension counters and about 1,880 ATM’s. It is now offering a wide range of banking products and financial services to corporate and retail customers through its specialised subsidiaries and affiliates. The domestic affiliates of ICICI Bank are ICICI Venture Funds Management, ICICI Prudential Life Insurance Company, Lombard General Insurance Company, ICICI Securities Limited, ICICI House Finance Limited, ICICI Investment Management Company Ltd., Trusteeship Services Ltd., and ICICI Distribution Finance Private Ltd.

Reason behind merger:

The reasons that compelled ICICI Ltd. to become a universal bank has much to do with change in global banking environment rather than its internal dynamics. The reasons for the merger merely reflect the dilemma faced by the entire Indian banking community in general and development-banking sector in particular.

1. Commercial banks have access to low costs funds in the form of savings and current account deposits. But development banks can access public money only through bond of at least five years maturity and a fairly high rate of return. So the attraction of cheap source of funds lured ICICI Ltd to reverse merger itself with its commercial offspring.
2. It became quite clear after 1992 that concentrating only on project finance was a very risky strategy. ICICI needed to spread its risks. And the only way for it was to became a financial conglomerate- a financial superstore that provides banking, insurance, fund management, mutual funds and securities trading under the same umbrella.
3. Development banks provide long-term project finance. Therefore, they need cheap source of long-term funds. The lowering of the bank rate and the Cash Reserve Ratio by RBI has led to a fall in the prime lending rate leading to erosion in bank income. This falling interest rate regime has led to serious asset liability mismatch for the banks. This is another reason for development banks like ICICI Ltd to convert themselves into universal banks.
4. One of the prime reasons for the merger was to deprive operational synergies as both the entities were in the same line of business with slightly different specialization. While ICICI Ltd was expert in long-term management of finance and dealing with large institutional clients, ICICI focus on the domestic consumer and small to medium sized corporate. Moreover, the merger was also expected to lead to greater tax efficiencies and consolidation of holdings.
5. India has around 61,000 millionaires as of 2003-04 as per a survey conducted by Merill Lynch Capgemini. Thier combined wealth is approximately Rs. 12,00,000 crores. Moreover, this number is expected to grow by 40% within the next two years. This category of rich individuals require a different class of banking known as personal banking. Personal banking is a high marginal line of business with ample opportunities to push another financial projects like insurance, mutual funds etc. But this being a type of retail banking product, is out of the reach of development banks like ICICI Ltd. The combined entity was thus expected to be able to put even more resources into this line of business that was not possible for ICICI Bank to do alone.
6. Indians are now following the global trend of spending tomorrow’s money today, i.e. the practice of using credit to finance purchases of all kinds of goods. Banks from both the public and private domain are now providing consumer loans at cheap rate of interest. But again development banks cannot provide consumer loans until they get converted into commercial ones. A similar product targeted at consumers is that of credit cards. The number of credit cards owners during the last four years has grown at a compounded annual growth rate of 35%. Credit card companies charge users interest at up to 39% per annum. This is a very high rate of return for banks when they can earn only around 9% per annum on home loans. But development banks are not authorised to issue credit card to thier customers.
7. India has 95 scheduled commercial banks, 4 non-scheduled commercial banks and 196 regional rural banks. A total of more than 68,000 branches dot the landscape with an average of one branch per 15,000 people. This mammoth sized network with an over active trade union movement has led to uneconomic segmentation of the industry. This makes consolidation inevitable partly due to market forces and partly due to regulatory intervention. As an offshoot of this trend, development banks are going to merge with commercial banks.
8. India is slowly becoming a global economy. So inevitable every industry has to reach global scale to survive. But out of 95 scheduled banks, only State Bank of India ranks among top 200 banks in the world. So all types of banks are frantically trying to grow in size in any way possible. And the shortest way to achieve it is through the way of merger. During the last 35 years, about 36 banks and non-banking finance companies have merged. But the greatest wave is yet to come. ICICI Ltd has shown the way. IDBI bank has taken the same path.

Financial Impact:

The most visible change that has come about as a result of the merger is in the income statement and the balance sheet. The total income and net profit figures have climbed up to Rs. 128.26 billion and Rs. 20.05 billion respectively. Operating profit has reached Rs. 29.56 billion while EPS has become Rs.27.33. ICICI bank is now in the process of strengthening its presence in various emerging financial sectors in India. It has collaborated with experienced foreign entities so that it can leverage upon its partners skills and support it with its own nationwide infrastructure. ICICI bank has designated these joint ventures as strategic Business Units and is striving to maintain or capture the top slot in each of these segments.

ICICI Lombard has become the largest private non life insurance company with a market share of 22% among a total of 12 players. ICICI Ventures is the largest private equity investors and plan to further consolidate its position in 2004-05. ICICI Prudential Life Insurance, with a market share of 5%, is among top five in its category. While ICICI Securities is among the largest arranger of funds in Debt and Equity Segments and also amongst the leading advisors in M&A.

Rationale for the Merger

For ICICI the merger meant:

1. Increasing the speed in financing long term projects.
2. Obtaining access to cheaper funds for lending.
3. Increasing its appeal to investors for raising capital base needed to write up bad loans.
4. Competing more effectively in retail finance market dominated by banks.

For ICICI Bank it meant:

1. Expanding geographically
2. Utilizing large capital base of ICICI.
3. Gaining brand equity from the strong brand name of ICICI.
4. Deriving benefits from ICICI’s well established corporate relationships.

The Merger deal and its Motivations:

The swap ratio was based on the valuations and recommendations of Deloitte, Haskins and Sells. ICICI was advised by investor bankers, JM Morgan Stanley and ICICI Bank by DSP Merill Lynch. The merger ratio was set at two ICICI shares for every ICICI Bank share that is one equity share of ICICI bank was swapped for two equity shares of ICICI. Under the scheme of amalgamation, American Depository share (ADS) holders of ICICI got five ADS of ICICI Bank in exchange of four ADS of ICICI.

Impact of the Merger on the Enlarged Entity

Through this merger, ICICI Bank became India’s first universal bank, that is, one stop-shop for financial services in India and acquired large market share of retail banking and offered a complete range of banking products. The enlarged entity (ICICI bank) derived the following benefits:

1. Optimum utilization of human capital.
2. Improved ability to further diversify asset portfolios and business revenue.
3. Reduced costs of funds.
4. Availability of more float money due to active participation in the payment system.
5. Diversified fund raising due to access to retail funds.
6. Leveraged the ICICI’s capital and client base in terms of increase in fee income.
7. Improved profitability by leveraging technology and low cost structure.
8. Access to ICICI group’s talent pool and thereby development of human resource at lower costs.

Performance Analysis

ICICI Ltd set before itself some specific goals prior to the merger process. The initial indications are that it is well on its way to fulfil almost all its objectives that propelled it to reverse merger with ICICI bank. Let us now analyze its financial results in the light of its merger objectives.

ICICI Ltd wanted to gain from the synergistic effect of the merger. This can be studied by comparing the projected figure of both ICICI Ltd and ICICI Bank with that of the merger entities for the years 2002-03 to 2004-05.

The trend growth rate for ICICI bank has been derived from the result of 1997-98 to 2000-01, the year before merger. The result of 1994-95, 1995-96 and 1996-97 have been left out because ICICI bank was still in its infancy and so the figures were too small to give any useful clue for future comparison. For ICICI Ltd the same period has been chosen for the sake of symmetry. The figure has been adjusted to inflation at 4.75% p.a., this has been done by multiplying the combined figure with average inflation rate so that it matches up to the nominal figures of the respective years with the effect of inflation already impounded.

Table below shows that within first three years of merger, the effect of synergy has been reflected in certain areas. While total income is far short of projected combined figures for all the years, the net profit earned by the company in the post merger situation has been way ahead of projections. This shows that ICICI bank has an operational efficiency by a large margin. The rise in paid up share capital post merger (from Rs. 200 crores to Rs. 613 crores) has led to a far lower earnings per share and Book value figures in the later years in spite of the growth in net profit. All in all, ICICI bank has achieved operational efficiency to a large extent.

ICICI Bank has now become the second largest bank in India after State Bank of India in terms of asset size. Its total assets were rupees 1,67,659 crores in 2004-05 in comparison to rupees 4,59,800 billion of State Bank of India, India’s premier commercial bank. The immediate gain of the reverse merger was the near fivefold rise of total assets of the pre merger level. The growth in assets were continued even after the merger.

ICICI Bank’s overall average cost of deposit at 4.5% in 2004-05 is one of the best among Indian Banks. This is far better than figures of 2000-01 when it was high as 7.7% at the same time, its net interest margin or yield spread has started to improve  after a brief slide during post merger period as the effect of ICICI ltd wanes off.

Other income has grown from Rs. 574 crores in 2001-02 to Rs. 12,826 crores in 2004-05, a growth of 495%. Other income represents income earned by way of dividend, profit from sale of investments, profit from merchant foreign exchange transactions etc. This shows that ICICI bank is successfully reducing its dependence on interest income and increases soared from increasing exposure to fee based services. Its income from fee based services has soared from Rs 171 Crores in 2000-01 to Rs. 2,098 crores in 2004-05. Its retail loan portfolio has grown substantially. It now forms 61% of total loans disbursed compared to just 9.5% in 2000-01.

ICICI bank has now the leverage to force its investment banking clients to maintain thier salary and other employees account with the bank, there by boasting its captive client base and increasing its repertoire of cheap funds. ICICI Bank through its subsidiaries can also cross sell its mutual funds and non life insurance products to its institutional clients. Cross selling has become an important tool to increase the retail business.

One of the reasons behind the merger was to increase shareholder wealth. ICICI bank submitted its proposal for reverse merger on 1/10/2001 to RBI. Its share price has risen from Rs. 72.00 as on that date to Rs. 127.00 on 29/3/2002, just prior to the merger. This resulted in 76% gain for the shareholders just out of the news of merger. This shows that the stock market had welcomed the decision and has factored in the expected gains into the share price. The trend continued even after the merger.

ICICI Bank is actively getting into wealth management activities through its personal banking division. It has also launched its credit and debit cards. The number of such cards have risen from 6.5 million in 2002-03 to about 10.1 million in 2003-04, representing a growth of 55.5%. It has also become very active in the area on home loans and charges very competitive rates to its clients.

Model retail banking is all about technology banking. ICICI bank has deployed Finacle from Infosys to manage its Core Banking Applications. It has spread its wings in the area of tele banking, ATMs, call centres and e-banking. Its 1,759 seats call centres operate round the clock and handles 1.5 lakh calls from customer per day, while 1,880 ATMs provide banking services all round the country. Its e-banking facility has made anytime, anywhere banking a reality. Thus ICICI bank has been able to further solidify its position in the Indian banking scenario. The above instances clearly points out that ICICI bank is going all out to achieve the goals it has set for itself before the reverse merger.

Conclusion

Merger and acquisitions is nothing new in the Indian banking system. But there has been a change in the impetus. Earlier with the banks firmly under the control of RBI, mergers were forced upon to save weak banks from collapsing. The gradual privatization and globalization of the banking industry has now forced bank themselves to go in for merger. Increase in profitability synergies in operation, global scale and other such reasons has replaced the social and political motives of yesteryears, successful merger can lead to prosperity both for shareholders of the merged company and for the economy as a whole. The true catalysts of the successful merger is the top executive whose pragmatic and dynamic leadership and a clear foresight can help a merger click. The trick is to neutralize the expected pitfalls while bringing the best out of operational synergies. The making of ICICI bank into universal bank has shown the way. This reverse merger has thus opened up a challenge to the banks and financial institutions in India to merge and become ‘financial conglomerates’ by exploiting the preserve favourable business environment and to de-risk thier operating environment.