Sunday 23 March 2014

CB accepts NDB, DFCC and Vardhana merger proposals

By Duruthu Edirimuni Chandrasekera

The NDB, DFCC and DFCC Vardhana banks have submitted their merger proposals which have been approved by the Central Bank (CB) and the process is going on, according to sources close to all three entities and CB officials.

This is in line with the proposed consolidation programme, which is a pre-emptive strategy to establish a strong and dynamic banking and Non Bank Financial Institutes (NBFIs) sector in the future, according to last year’s budget proposals.

At a recent programme on “Consolidation of the Financial Services Sector organised by the CA Sri Lanka”, CB Assistant Governor C J P Siriwardena said that expected outcomes in consolidation in the banking sector are that there will be a reduced number of banks – at least five Sri Lankan banks will have assets of Rs. 1 trillion or more, with such banks also having a strong regional presence, there will be a large development bank that will provide a substantial impetus to development banking activities in the country and domestic banks which had assets less than Rs. 100 billion will have assets of Rs. 100 billion or more, through organic growth and merger/absorption with other banks and NBFIs over a reasonable time horizon.

Greater participation by foreign banks

“Foreign banks in Sri Lanka will demonstrate a greater participation in economic activities and will be making significant contributions to the economy, banks will rely on new and effective IT applications and they will have substantially lower interest margins through increased efficiency and prudent management of assets and liabilities,” he said.

The state banks will be expected to contribute significantly towards building a strong and dynamic banking sector, he said, adding that the two large state commercial banks, Bank of Ceylon and People’s Bank will be encouraged to grow and expand towards a stronger regional presence, and to operate with higher levels of capital. “They will also be expected to strengthen their off-shore banking operations and be able to attract funds, as well as conduct private banking on a wider scale and the NSB would be encouraged to broad-base their banking activities to contribute to the economy on a larger scale,” Mr. Siriwardena added.

The Pradeshiya Sanwardhana Bank (Regional Development Bank) will be encouraged to serve the niche market of microfinance, targeting inclusive growth in the provinces and the other smaller state banks will be encouraged to merge with the bigger state banks or with one another and play a more cohesive role, since at present these banks account for just 1.1 per cent of the market share. Larger foreign banks will be expected to further strengthen operations, he said, adding that smaller foreign banks will be expected to develop new strategies to grow, and to increase participation in the domestic economic activities through expansion of the necessary skills, product development and display of greater enthusiasm in private banking, off-shore banking, infrastructure financing and support for 5 + 1 Hub activities.

There will be about 20 NBFIs, of which around three would be specialized in micro finance, according to Mr. Siriwardena who said that that each NBFI will have an asset base of over Rs. 20 billion over the period.

Immediate disclosure requirement by CSE

The seriousness of the envisaged consolidation process is confirmed by having tax benefits provided in the Budget 2014, he said, adding that the exact details and implementation of such benefits are now being finalised with the Ministry of Finance and Planning and the Department of Inland Revenue and will be notified soon.

This merger/absorption process must not adversely affect the staff of the respective institutions, he said, adding that no staff member is to be forcibly retrenched as a result of these merger/absorption processes. “No salary of any employee is to be reduced from that prevailing as at 31st December 2013. Those involved in the merger/absorption process will be encouraged to appoint competent Human Resource Consultants to perform independent reviews on senior management.”

In the case of any capital infusion by the acquiring bank a matching long term advance will be made through the Sri Lanka Deposit Insurance and Liquidity Support Scheme on concessionary terms.

The CB will issue public notifications from time to time, to appraise the overall progress of the process. The CB will also liaise with other authorities such as Securities and Exchange Commission, Colombo Stock Exchange (CSE) and Registrar of Companies,wherever such support is needed.

The CSE rules require immediate disclosure of merger activity, Naomal Goonewardena, Partner Nithya Partners said in his presentation. “The Company Take-Over and Mergers Code may get triggered if the shareholdings thresholds of 30 per cent are triggered in the amalgamated company.” He said that ownership limits in banks may be exceeded and that loan covenants may be breached if succeeding entity is weaker. “If the objects of the amalgamating entities are different there may be a narrowing down of activities.”

Senior Partner of Ernst & Young, Duminda Hulangamuwa in his presentation on what the industry needs to be aware of in a consolidation process, said that amongst the taxes to be considered, Income Tax, Value Added Tax, Stamp Duty, Economic Service Charge (ESC) and Administration Tax are primary in the consolidation process.

Income Tax

“The disposal of assets is normally taxable on the excess of selling price over the tax written down value and one can claim capital allowances for the merging entity. There’s a deduction of cost incurred for the merger and current losses, if any, of the transferor company,” he said.

The proposal is to grant some concessions via guidelines to be issued by CB on a case by case basis, he said, adding that amongst them, no income tax on any profits arising on the transfer of assets, capital allowance is to be claimed by the merged entity on the original cost, expenses incurred for the merger will be a deductible expense, qualifying payment relief will be granted on the investment made in the merged entity and tax credits, refunds, etc of the transferor entity will be available for the merged entity.

On the transfer of shares, financial assets/liabilities, mortgages, land and building could attract stamp duties, he said, adding that a gazette will be issued exempting stamps duties other than for immovable properties.

“Unutilized ESC of both entities should be allowed to be carried forward in full, but so far no provisions have been proposed,” he said, adding that all pending assets of the transferor entity are to be taken over by the merge entity.

Due diligence is very important pertaining to this process Vajira Kulatilleke, CEO NDB said in a presentation on due diligence and other issues.

Valuation will establish upper and lower limits, he said, highlighting the need to negotiate after the merger and the importance of ‘avoiding negotiation ego’. “Post-integration management is extremely important,” he reiterated.

In an acquisition, the “buyer” aims to assume control of the target firm by acquiring a majority stake and establishes ownership of the acquired firm, Manilka Fernando, Management Consultant Financial Institutions in his presentation said. He said that a merger is usually the agreement between two firms to form a single entity where the outcome is by mutual agreement of the shareholders of the two firms. “This is often considered to be a “merger of equals.”

Not a merger of equals

He added that believing that a merger of equals can occur, the vast majority self-destruct because of this very premise. “By focusing so intently on strategic fit you fail to assess cultural fit, which is just as important to a merger’s success, if not more so. The conqueror syndrome by the acquiring company and entering into a “reverse hostage situation” should also be avoided.”

He pointed out that integrating too timidly and the employee resistances from the acquired company’s people as well as ‘paying too high a premium’ are issues.

“One needs to identify and communicate merger benefits early in the process while having a dedicated integration team to be in place before transaction closes,” he said, highlighting the importance of measuring and reviewing constantly what you plan to achieve. He said that the end is not concluding the transaction, but it is delivering value.

Painful statistics 

During 1988-90, 13 registered finance companies failed; two such companies were revived by new investments; 11 companies were liquidated.
In 2002, a bank failed. It was only in 2007 that the deposits of that bank were transferred to a new savings bank.

In 2009, eight NBFIs faced liquidity problems, mainly because of the collapse of a related company in a particular group; Those NBFIs were gradually revived under restructuring processes, as agreed with the Central Bank.

In 2013, an NBFI faced liquidity problems due to certain directors of that company siphoning out funds; the Central Bank started a process of restructure, although that has now been interrupted as a result of a stay order by Court.

“After the Asian Financial Crisis, most Asian countries realised the importance of consolidation and initiated merger programmes to consolidate the financial industry,” Central Bank Assistant Governor C.J.P. Siriwardena said.

In Malaysia, the financial sector was strengthened and the number of banks and financial institutions was rationalised during 1998-2000.

Singapore also consolidated its banks in early 2000 leading to bigger and stronger banks whose interests were aligned to the long term interests of the economy.

Other key Asian countries such as Indonesia, Korea and Thailand also followed this process.

Although the financial sector in Sri Lanka is stable and plays an important role, it is highly fragmented, Mr.Siriwardena said, adding that Sri Lanka’s present financial system now needs some structural changes to ensure that banks and NBFIs are well positioned in the envisaged US$100 billion economy.

Banks and NBFIs account for 64 per cent of the entire financial system assets: the banking sector comprises 22 local banks and 12 foreign banks and the NBFIs include 49 finance companies and nine leasing companies.

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Finance Cos. could lose licence if merger proposals are not ready by 31st March

By Duruthu Edirimuni Chandrasekera

Finance companies (Non-Bank Financial Institution – NBFI) could lose their licence if they fail to submit their proposals to merge under new rules, before the March 31st deadline.

Industry sources said that the seriousness of this process has been communicated to the relevant NBFIs.

Separately, CB Assistant Governor C. J. P. Siriwardena told the Business Times that by this month end if the identified NBFIs (Category B NBFIs) haven’t submitted ‘concrete’ proposals pertaining to undergoing a suitable consolidation process, CB will ‘find’ a partner/s for them to merge with.

“All Category B NBFIs are to merge with local banks or Category A NBFIs (those who are stronger in their balance sheets like Central Finance), or merge among themselves, so that they fulfill conditions of the Category A NBFIs,” he said, adding that CB will ‘strictly’ adhere to this principle when finding partners. Initially, the local banks and Category A NBFIs will be given a time period of until 31st March, 2014 to identify partners of their choice from within the Category B NBFIs for such mergers/absorptions. There was positive response from the financial institutions and the CB met the Ceylon Bank Employees’ Union and clarified matters. “We are maintaining a close dialogue with the CB approved Panel of Auditors and other Consultants,” Mr. Siriwardena added.

“Discussions were held with the Securities and Exchange Commission and the Colombo Stock Exchange and with the Ministry of Finance and Planning on matters related to taxation.”

Due Diligence (DD) and Valuation of business is in progress, he said, adding that the CB has requested the Panel of Auditors (nine reputed companies) to conduct the due diligence and valuation of business of Category B NBFIs and all other Consultants to work with these Auditors. “These DDs and business valuations will be carried out using acceptable standards and will provide price guidance to buyers and sellers. By next Tuesday they will submit the DDs,” Mr. Siriwardena said.
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Chevron’s US$ 15 Million Plant Ready By October

The 15-million-dollar new blending plant being constructed at Sapugaskanda by Chevron Lubricants Lanka will be ready for commissioning by October 2014. According to Dr Kishu Gomes, Managing Director/CEO of the company, the new state-of-the-art plant will sport new technology and will also co-locate the warehouse on the same premises, a move that is expected to deliver cost savings for the Company. Elimination of the need to transport stocks from factory to warehouse, may reduce the carbon footprint further, says Dr Gomes in the company’s annual report.

“We have harnessed a blend of both Chevron global expertise in project management and local expertise in engineering both civil and mechanical, to complete the project in time and within planned expenditure and most importantly to avoid a single litre of unfulfilled orders during the transition. All the Base Oil storage and finished goods storage tanks have been completed. Prefabricated blending plant and warehouse structures have been erected,” he states.

Chevron Lubricants Lanka PLC has recorded a dynamic performance in a high pressure environment during the period under review. The Company has recorded a 12% increase in profits posting Rs. 2.53 billion, up from Rs 2.26 billion achieved in 2012. The ability to keep increasing the bottom-line progressively despite the challenging conditions, speaks for the maturity of its business strategies and its unwavering commitment to its sustainability agenda. The report states that 2013 marked 12 years of Sri Lanka operations without ‘loss time incidents’ – an enviable injury-free record – where no employee injured in the workplace had to forego a single day of work.

The report also states that less volatility in the exchange rate, somewhat stable base oil prices compared to 2012, prudent cost management and increased interest income from cash reserves had helped cushion the reduced volumes which stemmed from adverse weather conditions in the first quarter of the year, reduced demand from the thermal power sector and longer oil drain intervals.

The adverse weather conditions affected sales volumes from the agricultural and fisheries sectors. Volumes from export markets in Bangladesh and Maldives also had came under pressure due to adverse macro-economic and political factors in those markets. Total export revenue accounted for 6% of the total revenues.

Chevron Lanka had also continued to benefit from global synergies in various facets of its operations ranging from procurement of raw materials, product technology innovations, human resource best practices, brand & marketing and system & process support, all of which helped the Company to maintain its competitive position in the market.

The report notes that the year under review had tested the mettle of the Company and its ability to perform amidst complexity. The government’s decision to increase duties on the import of vehicles further had hampered growth in the automotive market. “We believe that the industry as a whole did not record any growth during 2013, which was already coming in from a low base of a 4% decline experienced in 2012,” Dr Gomes observed in the report.
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