Marriage Of Convenience

Says Kalpana Morparia, general manager at ICICI: "The decision to merge the two institutions was taken in line with the consolidation process that has been going on in the financial sector." Morparia is not talking about India, she is referring to the global financial sector where big is indeed beautiful. The merged monolith will now be just about able to match the financial clout of the Industrial Development Bank of India (IDBI) and the State Bank of India (SBI).

In line with Finance Minister P. Chidambaram's vision of creating a few global financial intermediaries, the merger also appears necessary in a scenario where banks have started to enter the term-lending market and competition for resources has been hotting up between financial institutions. Said Finance Secretary Mon-tek Singh Ahluwalia: "Since the original purpose for which SCICI was set up had been gradually diluted, the strength lies in one company merging with another."

Observers have already started identifying this merger with the beginning of a trend. Says a senior banker: "Consolidation is the name of the game and only large institutions will survive the onlaught of globalisation. Recent mergers in the financial world—for example, that of Chase Manhattan and Chemical Bank—only go to reinforce this trend." Adds SBI Chairman P.G. Kakodkar: "In the case of financial institutions, the bigger and stronger the balancesheet, the better."

Once the rupee becomes fully convertible, which is inevitable in a few years, India will come closer to the global financial world as the country's real interest rates will also level out with international norms. Real competition from transnational financial institutions will then be felt. The only way out is to consolidate the domestic institutions for stronger financial clout. Says a senior FI executive: "In time, more and more foreign players will try to carve out a turf for themselves. It won't be surprising if some sort of consolidation takes place among other government-owned institutions in the future."

That the new merged entity will have far better financial ratios is beyond doubt. The 2:5 share swap (two shares of ICICI for every five SCICI shares) will leave the merged entity with an equity capital of Rs 476 crore and a total asset base of Rs 33,430 crore. Says K.V. Kamath, ICICI CEO: "The merger will be beneficial to the shareholders of both ICICI and SCICI. It will provide the required critical mass to operate in a rapidly-changing marketplace." Adds D.J. Balaji Rao, vice-chairman and managing director of SCICI: "The merger should be seen in the larger framework of what is in store for the financial sector as a whole. The synergies involved will improve the competitive strength of the merged entity."

The advantages of the merger are obvious. SCICI has the lowest non-performing assets at 2.9 per cent, compared to 7.8 per cent for ICICI. It has the highest capital adequacy ratio at 20.5 per cent against ICICI's 10.9 per cent as on March 31, 1996. SCICI also boasts of the lowest cost-income ratio at 8.8 per cent. In a comparative study of DFIs in India conducted by the Union Bank of Switzerland Global Research, SCICI was rated as the fastest growing, having the best asset quality, highest spreads, highest ratio of fee income to fund-based income of 6.5 per cent, and the most profitable with a return on net worth over 25 per cent. But, as the latest results show, suddenly the picture was turning slightly downbeat.

SCICI received a setback in the first half of the current fiscal year, due to the growing cost of funds. Despite a higher growth—64 per cent–in income from operations, SCICI ended up with a 8.2 per cent drop in net profit. Interest and operating expenses doubled, while depreciation on leased assets rose by even more.

Naturally, margins came under severe pressure. The operating pro-fit margin dropped from 43 to 23 per cent and net profit margin from 32 to 18 per cent. The annual earnings per share dropped by 25 per cent to Rs 6.38. Loan sanctions fell by a whopping 61 per cent and disbursals were near stagnant.

SCICI's woes started last year when the credit crunch made money costlier and the company got into a trap of mismatching interest rates. Inadequate subscription to its rights issue made matters worse and its spread declined from 4.7 to 3.3 per cent. Thus, despite a 60 per cent rise in income from operations during 1995-96, net profit rose by only 2.8 per cent.

ICICI was not on a better wicket either. Although it could maintain the growth in its income from operations at 22 per cent to Rs 1,707.81 crore during the first six months of fiscal 1996-97, its net profit rose by a measly 0.6 per cent. The net margin works out to 15.6 per cent, compared to preious year's 16.9 per cent. Clearly, its net spreads are shrinking which during the first half of the current year works out to a meagre 2.91 per cent. However, ICICI suffered less on account of sheer size.

And this is where the merger works out to the advantage of both. While SCICI's incremental cost of funds is higher than ICICI's, the former is also restricted by its size in striking larger deals. With the merger, ICICI's non-performing assets of 7 per cent will come down, its capital adequacy ratio will rise with the inclusion of SCICI's capital. The incremental cost of funds of the merged entity will also be lower and it will be better placed to go for even larger deals. While the asset size of ICICI will increase by 25 per cent to over Rs 33,500 crore, SCICI will also bring in higher profits to the tune of 25 per cent to the merged institution.

However, ICICI will also have to absorb SCICI's Rs 4,002 crore liabilities—Rs 2,068 crore rupee-based and Rs 1,934 crore foreign currency loans. The rupee commitments may not be a big strain on the merged entity, but the servicing of SCICI's foreign currency loans could be a different story. Most of its foreign debt—Rs 1,510 crore out of Rs 1,934 crore—is in the form of floating rate bonds or notes. In addition, SCICI had entered into an agreement with Chemical Securities Asia Ltd (CSAL), giving the bank an option to call up the liability under Eurodollar Loan III of $100 million. In July 1994, CSAL exercised the option and asked SCICI to pay up in four annual instalments commencing from July 1995. As a result, SCICI incurred an additional liability of Rs 73.49 crore of which Rs 50.8 crore is yet to be provided in the balancesheet.

ICICI itself has to service rupee debt to the tune of Rs 13,501 crore and Rs 6,094 crore worth of foreign currency loans over the next 15 years. Its debt servicing capacity is likely to be strained in the years 2000 and 2001 when it has to service not only its own rupee loans worth Rs 2,046 crore, it will have to take on additional responsibility of SCICI's commitment to the tune of Rs 675 crore as well.

Yet all these hiccups are expected to be neutralised by the greater amount of business that the merged entity is expected to generate. Says SCICI's Balaji Rao: "Both ICICI and SCICI have been competing for the same chunk of business and resources. Even for the non-fund based activities we woo the same clients." Adds Kamath: "The competition which is growing day by day in the financial sector would have hit SCICI. ICICI is able to raise funds at 0.5 percentage points below SCICI and after the merger, the rates could get finer. With huge infrastructure projects coming to the market, SCICI with its small size could obviously not fund them, hence the merger was necessary."

With McKinsey having already suggested the merger of SBI with its associate banks, will such consolidation of financial institutions become the trend of the future? Only time and impending global competition will tell.