Due diligence is a mandatory pain, yet a fruitful one.
Due diligence, in short, DD, is a comprehensive process of collecting and assessing the prospective target for mergers or acquisitions, which includes all aspects of the targeted company, from finance, business prospects, and operations to legal. The meticulous nature of DD leads to the need to appoint third parties, in this case, professional counsels with capital market licenses, who then will submit a DD report for the investor. Overall, DD usually takes a minimum of three months and could extend to six or twelve months, depending on the depth of the analysis. Investors would consider DD report in its decision-making, whether to pursue investment with the targeted company or back out before losing more money.
In Indonesia, banks are a highly regulated industry and heavy in capital burden. The implementation of Basel III for banks to maintain minimum core capital has been carried out since 2016. The increase in the quantity of the banks’ capital was achieved through the establishment of obligation additional capital as a buffer in the form of capital conservation buffer, counter-cyclical buffers, and additional capital in the form of capital surcharge for banks that are considered to have systemic potentials. These layered capital buffers urge commercial banks to consolidate if they cannot fulfill the minimum core capital of IDR 3 trillion (equivalent to USD 200 million) by the end of 2022.
Currently, all commercial banks have already complied with the rule, and eyes now move on to the municipal banks (BPD), which need to comply with the minimum core capital by the end of 2024. In contrast to commercial banks, which are privately owned and have many options for increasing capital, BPD shareholders are local governments, so a policy approach is needed to increase capital. Private commercial banks, among others, can increase capital by injecting additional capital, issuing additional capital with preemptive rights (PMHTED), or rights issues, as well as merging two banks or mergers. For BPD, this means the local government need to inject capital, and in most cases is not easy to get the approval from the Regional House of Representatives (DPRD).
The financial services authority in Indonesia, OJK, encourages consolidation for banks to ensure stronger capital and more efficient banks in the future. Currently, there are 106 commercial banks in Indonesia, shrunk by 8 percent compared to 2018 with 115 banks. With these numbers, banks are highly competitive in increasing their customer base among the 278 million population, while half of it is still unbanked. Competition for customers' funds pushes the bank's cost of funds to remain high, which leads to a wide profit margin. According to Deposit Insurance Agency’s (LPS) data, Indonesian banks have the second highest interest margin among ASEAN countries, with average NIM of around 4.68 percent in December 2022, compared to the Philippines' 3.56 percent, Vietnam's 3.35 percent, Thailand's 2.48 percent, Malaysia 1.96 percent, and Singapore 1.21 percent. This leads to Indonesia as the more attractive market for overseas investors who seek larger interest margins. Other than the State-Owned Banks and municipal banks (BPD), the majority of Indonesian private banks are owned by multinational investors as majority or controlling shareholders.
" Utilize the result of DD for the company to enhance its strength, change its bad habits and constantly pursue improvement, which will lead to better numbers "
The most important thing to look for in a controlling shareholder is its ability to fully support the bank's stability in capital requirement, liquidity, and business expansion in the long term. Therefore, banks must include corporate action for capital rising in their business plan. Capital raising from the new strategic investor will require a DD process. It is a comprehensive process which sometimes painful (additional work for the internal team and of course, additional costs for the bank) but mandatory to gain a strong and dependent investor.
The common sequences of corporate action, including DD in banks, are as follows:
Initial meetings (bilateral meetings or accommodated by a financial advisor).
● Submission of letter of intent (LoI) from the potential investor.
● Initial reports to regulators (banking supervisory and capital market supervisory) to ensure the proposed corporate action will be supported by the relevant authorities.
● The targeted company (investee) assigns an internal task force team (often titled the Corporate Action Team), which usually consists of competent representatives from the relevant units: corporate secretary/corporate affairs, corporate legal, corporate/strategic planning, compliance, finance/accounting & tax, business developments, human resources/human capital, operations/distribution channels, digital & IT, etc. The team will report to the Steering Committee, which usually lead by the chief finance officer or finance director.
● Follow-up meetings and signing of a memorandum of understanding (MoU) and confidentiality agreement (Non-Disclosure Agreement/NDA) also included the compromised project timeline.
● Deposit of fresh funds from the investor into an escrow account (at the targeted company or third party) as the commitment of the M&A process.
● Kick-off meeting with all related parties: potential investor, the investee, and the appointed professionals (legal counsels, financial advisors, financial auditors, public notary).
● Commence the DD process in several streams: finance & tax, business & strategies, operation & IT, legal & compliance, human capital & industrial relations, treasury & trade financing, etc. The reports are submitted in hierarchy: daily status-weekly cadence meetings – monthly reports, and so on.
● Management meetings are usually proposed to discuss major progress and issues which need clarification from the management.
● The pre-settlement meeting to compromise on the terms of the agreement for capital injection, which both parties, along with every legal counsel, usually followed by a shareholders' agreement.
● Submission of capital injection documents to the relevant regulator commonly takes process within two to three months (with several additional documents and inquiries submitted) until the registration documents receive effective approval from the regulator.
● Settlement process for the capital injection and post-settlement reports (including information disclosure for the public) as regulated.
● Post M&A process: transition of the new management or team to several positions, which is normal circumstances post changes in ownership, engagement of both current incumbents and the newly added teams, changes in the company's culture, with the spirit to improve the company’s performance sustainably.
Sometimes, the DD process will be cut off in the middle. Most likely because the investor's side has resumed its decision based on the ongoing DD, and they want to avoid losing more money (since the counsels are not cheap) and waste more time when the result is obvious. Sometimes, the completed DD process also did not ensure the investor decided on a positive confirmation for settlement. If this is the case, what should we do as a bank who needs a new investor?
When the condition is critical, the regulator will push the current controlling shareholder to be responsible and add capital as it is beneficial to keep the status of the bank. Failing to do so might compromise the controlling shareholder status and could lead to sanctions from the regulator. For the bank, to lose a potential investor is a red flag for the management. It is critical to do overall transformation with speed, knowing that the future of the company is in jeopardy. Therefore, the management must act swiftly to turn around the unfortunate outcome into a fruitful one by implementing an immediate and wholesome transformation in the company. DD has shown the aspects that need improvement, and next, the management needs to turn the plan into action. Hiring a consultant will be expensive. Therefore doing an internal-driven transformation will be more effective for the bank, and it needs all levels and all units to participate. Utilize the result of DD for the company to enhance its strength, change its bad habits and constantly pursue improvement, which will lead to better numbers. And doing so will increase the company's value and attract more reputable investors in the future.
