ICICI-ICICI Bank merger: A big discount for NPAs

Suresh Krishnamurthy

THE general impression in the stock market is that the beneficiary of the ICICI-ICICI Bank is the former.

However, the swap ratio for the merger indicates that the ICICI shareholders have also had to bear considerable losses.

Consider. The book value per share of ICICI and ICICI Bank at end-September 2001 is Rs 111.81 and Rs 65.53 respectively. However, ICICI's shareholders will get only one share of ICICI Bank for every two shares held in ICICI. In other words, for surrendering a book value of Rs 223.62, a shareholder in ICICI will get Rs 65.53. This works out to a discount of nearly 71 per cent to the book value of ICICI.

According to the management of both companies, relative market prices, discounted cash flows, and book values were considered before arriving at the swap ratio. However, the swap ratio for the reverse merger of ICICI with ICICI Bank appears to reflect predominantly the prevailing stock prices.

The need for a larger weight to the prevailing stock prices is understandable. However, significantly, the swap ratio ignores ICICI's book value. A 70 per cent discount may be understandable in the case of a manufacturing company or even in the case of a loss-making finance company. For a profit-making finance company whose assets are mainly moneys lent, the need for such a significant discount raises questions about the quality of the loans portfolio of ICICI.

The book value of the net assets of ICICI is worth Rs 8,777 crore at end-September 2001. The market value of the shares to be issued by ICICI Bank for taking over these assets is only around Rs 4,050 crore. It is also significant that the book value does not take into account the fair value of the investments by ICICI in profit-making companies such as ICICI Bank, ICICI Infotech, ICICI Venture, ICICI Home Finance and ICICI Investment Management Company.

ICICI's holdings in ICICI Bank alone are worth Rs 1,040 crore at prevailing market prices and these holdings will be held in trust for the benefit of the merged entity.

In the event, it can only be taken as a tacit admission _ one which reinforces earlier impressions, that all is not well with portfolio of ICICI's loans and advances. A sizeable portion of the difference in fair value of the net assets of ICICI and the consideration given by ICICI Bank for the merger may have to be taken as representing provisions for non-performing loans. Before the shareholders approve the merger, there is a case for finding out from the management the need for such a large write-down in the assets of ICICI.

Purchase method

For ICICI Bank though, such a sizeable write-down in the assets of ICICI may be necessary if the shareholders of the bank have to be placated. In this backdrop, the accounting for the merger in the books of ICICI Bank would provide clues to as to how much the loans of ICICI have been written-down.

While accounting is normally dismissed as less relevant, in the case of this particular reverse merger, accounting under Indian GAAP may be particularly relevant for ascertaining the capital adequacy of the `universal bank'. In addition, the merger accounting will determine the impact of the loans portfolio of ICICI on the future profits of the merged entity.

The ICICI Bank management has said that it would adopt the purchase method to account for the merger under both Indian GAAP and US GAAP. However, there is a significant difference in the accounting standards between Indian GAAP and US GAAP.

Under US GAAP, capital reserves (difference between purchase price and net assets taken over) are not recognised. The assets taken over have to be written down in value. In Indian GAAP, however, capital reserves are permitted.

If ICICI Bank recognises the capital reserve under Indian GAAP, it may have to make provisions later if some of the loan assets taken over turn non-performing. This will reduce profitability in years ahead.

It will also create a perception that ICICI Bank shareholders are paying for the non-performing assets of ICICI, though the swap ratio appears to have considered this aspect.

In contrast, if ICICI Bank does not recognise the capital reserve and adopts the same accounting under both Indian and US GAAP, it will have implications for the capital adequacy ratios of the universal bank, particularly the tier-I capital. This is unlikely to be desired by the management of the companies concerned. Either way, difficult decisions lie ahead.