The Hindu Business Line : Centurion Bank-Bank of Punjab

(From left) Mr Shailendra Bhandari, MD, Centurion Bank, Mr Tejbir Singh, ED, Bank of Punjab, Mr Rana Talwar, Chairman, Centurion Bank and Mr C. K. Sharma, CEO, Bank of Punjab... The merger handshake — Kamal Narang.

SHAREHOLDERS of Centurion Bank and Bank of Punjab can continue to hold the stocks. Fresh investments need not be considered now. Notwithstanding the substantial turnaround in the fortunes of Centurion Bank, the valuation of the combined entity is on the high side.

Given the present valuation, substantial scale up in volume of operations over the next two years would be needed to deliver reasonable returns.

It is also not clear if the merger of Bank of Punjab with Centurion Bank would prove to be an unmixed blessing. On the positive side, the turnaround of Centurion Bank appears to have been fast-tracked.

The experienced management of Centurion Bank, led by Mr Rana Talwar, is another positive. On balance, however, it appears prudent to hold the stock now and consider acquiring it when the valuation is more reasonable.

Bailed out by a bailee

It is not even a year since the combine of Mr Rana Talwar and Bank of Muscat bailed out Centurion Bank from the brink of disaster. Centurion Bank's net worth had almost turned negligible and only substantial cash infusion saved it.

Now, Centurion Bank, with enough cash at its disposal to absorb the business of Bank of Punjab, is confident enough to lend succour to the beleaguered bank.

Bank of Punjab needed this merger more than Centurion Bank. The former had to contend with a rapid increase in the proportion of its bad loans in FY-05. The proposed preferential allotment of shares to select investors had also come unstuck.

With the capital adequacy ratio of Bank of Punjab poised precariously near the regulatory minimum of 9 per cent, this merger may have come in handy for Centurion Bank to ward off regulatory intervention.

The merger, however, does bring some value to Centurion Bank shareholders. At about 4.24 per cent, Bank of Punjab boasts of one of the lowest cost of deposits in the banking industry. Bank of Punjab's network of 136 branches is also almost entirely complementary to that of Centurion Bank.

The acquisition cost is also attractive for Centurion Bank. The price-to-book multiple for the acquisition works out to 1.85. The Centurion Bank stock trades at a price-to-book of 2.9 times. The acquisition would, thus, be cost-effective for Centurion Bank shareholders.

Centurion's progress

The merger unveils a number of favourable possibilities, considering the rapid progress made by Centurion Bank. The scale up of operations has been rapid since end-March 2004. Advances rose from Rs 1,500 crore to Rs 2,500 crore in 15 months, fast outpacing the growth registered by the industry.

The growth in advances would have been higher but for the securitisation, that is sale of a portion of the advances by the bank. In the meantime, the proportion of bad loans also fell by nearly half to 2.4 per cent of advances.

The bank's profitability also improved substantially during this period. Net interest margin improved and the proportion of costs to income fell sharply. The contribution of fee income is also rising with the bank making a mark in the intensely competitive arena of wealth management.

If the management of Centurion Bank were able to replicate this exercise in the case of Bank of Punjab, there would be considerable value-addition, post-merger. Bank of Punjab does need the application of some management balm now. Apart from the rapid rise in the proportion of bad loans, its business growth has also not been attractive.

In FY-05, Bank of Punjab's advances growth was modest at about 15 per cent when much of the private sector banks reported growth in advances in excess of 25 per cent.

The less-than-impressive growth in advances was not able to offset the decline in income from the investment portfolio, leading to sharp fall in operating profit.

The travails seem to be continuing in FY-06 also with net interest income falling sharply by 17 per cent. Only a 60 per cent increase in `other income' restricted the decline in profits to about 11 per cent.

Much of the reason for the poor growth could also be due to the lack of adequate capital. If the management of Centurion Bank, which has sufficient capital, were able to arrest the decline in spreads and improve business growth, the profitability of the merged entity can only improve.

Stiffly priced

The stock may have fully factored in the turnaround in fortunes of Centurion Bank. The adjusted earnings of the combined entity for the past 12 months work out to about 50 paise per share. The PE multiple would, thus, work out to nearly 30. This need not be considered stiff for a bank that is on the verge of a turnaround.

In addition, if you apply a return on net worth of 15 per cent is applied to the combined net worth of Rs 725 crore and assume profits of nearly Rs 110 crore, the PE multiple works out to less than 17.

It is highly likely that the management of the combined entity would endeavour to enhance the return on net worth to 15 per cent within a year.

The risks, however, are rather high. First, the proportion of two-wheeler loans in the total advances portfolio is rather high at 40 per cent.

This may also be behind the substantially high net interest margin of about 5.3 per cent enjoyed by Centurion Bank. The risks of higher incidence of bad loans are real. In addition, the bad loans of Bank of Punjab rose nearly 100 per cent in FY-05.

It is not known if the proportion of bad loans would increase this year too. It would, thus, be better to hold on to the stock now and contemplate adding to the exposures when the valuations are more reasonable.

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