Into Merlion’s Mouth
* Two troubled bank deals represent risk to capital, and managerial distractions; *DBS is also contemplating a purchase of Citi’s regional consumer franchise; and *Fundamentals are already challenges.
DBS Group Holdings (DBS.SG) [“DBS”] is Singapore’s largest bank and a key player in Asia. Instead of being deliberate through COVID and carefully assessing the lay of the land in its aftermath — particularly on its on its own balance sheet — DBS is has gone headlong on a buying spree with some fairly spicy transactions. And they are not done.
In late 2020, the Reserve Bank of India (“RBI”) approved the amalgamation of DBS Bank India (“DBI”) and Lakshmi Vilas Bank (“LVB”). LVB had been placed under moratorium by an order of the central government due to three consecutive years which eroded the bank’s financial condition. DBS infused SGD 463 mn (USD 337 mn) into DBIL. Herein lie the problems with LVB which no doubt will be prohibitively more costly than DBS’s initial investment:
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1. By our calculation and based on LVB’s FY 2Q21 results, the company would appear to be insolvent to the tune of INR 39 bn – nearly 56% greater than the DBI’s capital infusion;
2. LVB loses money on an operating basis prior to loss provisions, as revenues of INR 15.4 bn were less than operating expenses of INR 16.0 bn – or by 3.7% at FY 2Q21;
3. On a pro forma basis, the new DBI witnessed a stated capital decline INR 14 bn (23.2%) with its Tier 1 capital ratio declining 512 bp to around 8.0%. This is lower than the statutory minimum of 8.875%, suggesting an additional capital infusion of nearly INR 16 bn will ultimately be required;
4. In an audit review of 135 branches, only 70.6% of total loans were reviewed, suggesting no centralized loan processing system and a significant challenge within the larger portfolio;
5. There is a Religare Finvest lawsuit filed in 2018 that needs to be properly assessed for liability;
6. Deferred tax assets (“DTA”) were not recognized and retained. Losses would be higher by INR 1.2 bn; and
7. Poor disclosures with respect to Regulation 33 of SEBI, regarding income recognition, asset classification, and provisioning.
DBS has also acquired a 13% stake in the privately-held Shenzhen Rural Commercial Bank (“SRCB”) for CNY 5.3 bn (USD 814.3 mn), in a move that was supposed to accelerate its Greater Bay Area expansion strategy – then the mainland China real estate crisis hit. SRCB has one of the largest bank branch networks in Shenzhen, where 210 of its 217 branches are located. It also has over five million retail customers and over 170 thousand corporate clients. DBS is SRCB’s largest shareholder, although its unclear how much control DBS will actually be able to wield. Like LVB, the SRCB deal is very short on details. DBS, however, did disclose that the purchase price equated to a stated P/BV of 1.01x – well ahead of the 0.6x P/BV average for listed mainland Chinese banks. According to DBS, this investment will shave 20 bp off of DBS’s CAR. Not only was deal disclosure poor, but SRCB has yet to publish its 2020 financial statements – in fact, the last credit quality data points published were in 2019, where NPLs of CNY 2.4 tn amounted to 1.12% of total loans with reserve cover at 285% of NPLs. To be fair, 2019 credit data looks good, but the pandemic and ongoing real estate crisis has taken a toll on nearly every second-tier bank. DBS apparently isn’t done with its shopping spree, being in the running for parts of Citigroup's (C.US) consumer business in Asia.
Frankly, DBS needs to focus on improving its own legacy issues before it starts taking on the risk of other financial institutions. Case in point, DBS fundamentals continue to weaken, given weaker fees, compressed margins, and modestly weaker credit. Loss reserves are also quite light in this more challenging operating environment — especially considering its Hong Kong and mainland China risk. Reversing provisions to the tune of SGD 70 mn to meet consensus forecasts and not cover net charge offs is hardly prudent banking. In fact, we would argue that reserves should have been shored up during 3Q21 to the tune of SGD 1.1 bn – suggesting its bottom-line was grossly overstated.