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The proposed merger of the ailing Lakshmi Vilas Bank (LVB) into the wholly owned Indian unit of DBS may weigh on the Singapore lender’s profitability in the short to medium term.
It also raises some questions about DBS’s dividend trajectory, considering the imminent migration of credit risk related to the pandemic, Jefferies Equity Research said in a note Wednesday morning.
Jefferies analyst Krishna Guha lowered DBS’s rating to “hold” from “buy” and cut estimates of its dividend per share by about 10 percent.
He lowered the stock price target to S $ 22, from S $ 26 previously. As of 11:24 a.m. Wednesday, DBS shares were trading at S $ 24.72, an increase of S $ 0.07 or 0.3%.
Under a preliminary scheme by the Reserve Bank of India (RBI), LVB could be incorporated into the Indian business of the largest bank in Southeast Asia, DBS said in a document late Tuesday.
To support the merger, DBS will inject Rs 25 billion (S $ 463 million) of fresh capital into DBS Bank India Ltd (DBIL), if the plan is approved. This will be fully funded from existing DBS resources.
The original capital stock of LVB will be canceled and its existing shareholders will not obtain any interest in the new entity. No haircuts will be applied to depositors or bondholders.
LVB has been subjected to a one-month moratorium from November 17 to December 16. RBI said in a statement that the Indian bank’s financial position “has seen a steady decline” as it incurred continuous losses over the past three years and eroded its net worth. .
JPMorgan’s research team, which has an “overweight” rating and a S $ 24.50 target on DBS, wrote in a note Wednesday that the proposed deal is likely to be positive for the Singapore-listed group.
“Indeed, DBS is buying the (LVB) business at approximately 10 percent of current deposits. The Common Equity Tier 1 (CET1) impact for DBS will be around 10 basis points,” said JPMorgan analysts Harsh Wardhan. Modi and Saurabh Kumar.
Furthermore, as soon as a credible controlling shareholder enters, the LVB franchise will likely begin to regain share of the deposit market. JPMorgan also expects DBS to use digital capabilities to enhance its physical footprint in India. Therefore, the proposed deal could lead to a 30-40 percent increase in DBS’s Indian assets, according to JPMorgan.
Jefferies noted that although the estimated impact on DBS’s CET1 capital will be negligible initially, an assessment of the book, risk management practices, and subsequent growth may require a continuous infusion of capital, given high NPAs and nonperforming assets (NPAs) and the negative capital of LVB.
If successful, the deal will strengthen DBS’s presence in South India, which has long-standing and close business ties with Singapore, Guha said.
In particular, Singapore real estate companies have recently stepped up their presence in South India. DBS also previously highlighted the need to expand the presence of its branch to target small and medium-sized business (SME) loans.
However, the expansion will affect DBS’s profitability and efficiency, as a one percentage point increase in the group’s cost-to-income ratio will reduce earnings per share by 2.5% in the short and medium term, Guha said.
According to the RBI, LVB has not been able to raise adequate capital to address issues related to its negative net worth and ongoing losses, and is experiencing ongoing deposit withdrawals as well as low levels of liquidity.
Reuters reported that the Indian government said it had also temporarily limited LVB withdrawals. The bank has been looking for a partner since last year amid a surge in bad loans that adds to “governance problems,” Reuters added.
JPMorgan said the advantage for DBS will depend on its ability to consolidate the franchise and attract deposits, and generate consistent returns while maintaining credit risk.
Provisions will also need to be cut “drastically” in the short term, which JPMorgan analysts see as likely because almost all NPLs will be written off.
“We believe that DBS has developed underwriting or risk management capabilities in India, and at group level in recent years. That has led to a relatively resilient NPL (NPL) result.
“These attributes, combined with the digital offerings, should allow the bank to deliver PPoP RoA (pre-provision operating profit, return on assets) at least in line with its historical result,” they added.
If this thesis is fulfilled, DBS will see an increase in the value of the proposed transaction, JPMorgan said.
According to Jefferies, the merged entity will have the largest number of bank branches (598) in the country and will be in fifth place for loans between foreign banks, with a CET1 of 9.6 percent. “We understand that DBS may have the flexibility to streamline the presence of branches and take advantage of other concessions,” Guha said.
DBS said on Tuesday that it will await the final decision from the RBI and the Indian government on the proposed scheme before announcing further details.
LVB and DBIL members, depositors and other creditors have until 5 pm this Friday to send RBI their suggestions or objections, if any, on the draft scheme.
Jefferies remains constructive about the banking sector. On Wednesday, it updated UOB to “buy” from “hold” previously, and raised its price target to S $ 25 from S $ 22.
READ MORE: Troubled Indian Bank May Join DBS India Unit As Per RBI Proposal
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