Singapore
SOUTH-EAST Asia's largest lender DBS could make further inroads into the tough-to-crack India market if the proposed takeover of cash-strapped Lakshmi Vilas Bank (LVB) goes through, even though it will be saddled with the costs of turning around a distressed asset over the next few years, said analysts.
While the impact is unlikely to be material to the group's earnings now, it could still weigh on DBS's dividend trajectory and path to recovery, given that the bank is still setting aside hefty loan loss provisions on the back of the pandemic fallout, they added.
This is believed to be the first time that the India central bank has turned to a foreign lender to rescue a failing local bank, in a move that took the industry by surprise.
In an announcement late on Tuesday, DBS said that LVB could potentially be folded into its wholly-owned India unit, under a draft scheme by the Reserve Bank of India (RBI). DBS will inject 25 billion rupees (S$463 million) of fresh capital into DBS India if approved, to be funded internally.
Even prior to Covid-19, LVB has been suffering losses over the last three years, with the Indian bank on the hunt for a white knight since last year amid governance issues and mounting bad debt. It faces a need for urgent capital infusion, and has been put under a moratorium from Nov 17 to Dec 16. In this period, withdrawals per customer are capped at 25,000 rupees. The bank also cannot pay more than 25,000 rupees to any creditors without prior approval from RBI.
Reactions have been a mixed bag, with some analysts believing that India's central bank was the main force behind the decision.
Tay Wee Kuang, analyst at Phillip Securities Research, said: "Even though DBS was not forced to do so, I don't think DBS had intended to go out and acquire the bank."
Beyond the attractive valuation, there are likely more considerations that went into the deal, given that the India regulators were the ones to have orchestrated it, he added.
In response to scepticism from some quarters that DBS was pushed into the deal, the lender told The Business Times that this was not the case.
DBS reiterated that the proposed amalgamation will allow it to scale its customer base and network, particularly in South India, which has longstanding and close business ties with Singapore.
DBS has been in India since 1994, but it was only in March 2019 that it converted its India operations from a branch to a wholly-owned subsidiary.
India contributed less than 10 per cent of the group's income in 2019, but is considered one of DBS's six priority markets in Asia.
According to a report by Citi analyst Robert Kong, the impact to the group is "likely not material".
This comes as LVB has loans of about 165.9 billion rupees and deposits of 214.4 billion rupees, which is small relative to DBS Group's balance sheet and of similar size to DBS India's operations, he wrote.
The capital injection of S$463 million is also small relative to the group's common equity tier-one (CET-1) capital base of about S$44 billion, which represents about 15 basis points, added Mr Kong.
Among the analysts that view this move positively is Maybank Kim Eng analyst Thilan Wickramasinghe.
"This is driven by regulators to make sure that there is stability in the financial system, but there is also a commercial angle," he said. "There are a lot of banks in India, and the fact that DBS India is brought in likely means that there are synergies to be had."
Analysts noted that the merger with LVB will add 563 branches - mostly in southern India - to DBS India's current 34 branches in 24 cities, which could accelerate DBS's expansion plans in the region.
"DBS has been steadily growing its branch network in India, but with this move, it immediately gives them a much broader distribution network at an attractive pricing," said Mr Wickramasinghe.
JPMorgan analysts Harsh Wardhan Modi and Saurabh Kumar also view the development as positive, with expectations that the LVB franchise will likely start regaining deposit market share once a credible controlling shareholder comes in.
With DBS likely to use digital capabilities to enhance its physical footprint in India, the proposed deal could lead to a 30-40 per cent increase in Indian assets of DBS, they said.
This would tie in with DBS's plans to grow its physical presence in India.
In early 2019, DBS had said that the bank intends to establish over 100 customer touchpoints, through a combination of branches and e-kiosks, across 25 cities by 2020.
According to Jefferies, the amalgamated entity will have the most bank branches in the country and rank fifth by loans among foreign banks, with a CET-1 ratio of 9.6 per cent.
If successful, the deal will strengthen DBS's footprint in southern India, said its analyst Krishna Guha. In particular, Singapore real estate firms have recently deepened their presence there.
However, scaling up will weigh on DBS's profitability and efficiency, as an increase of one percentage point in group cost-to-income ratio will lower earnings per share by 2.5 per cent, in the near to medium term, Mr Guha said.
It also raises a few questions about DBS's dividend trajectory, considering the impending pandemic-related credit risk migration.
Although the estimated impact on DBS' CET-1 capital will be negligible initially, an assessment of the book, risk management practices and subsequent growth may call for continued capital infusion, given LVB's high non-performing assets (NPA) and negative equity, he said.
JPMorgan noted that the upside for DBS will depend on its ability to consolidate the franchise and attract deposits, and to generate consistent returns while maintaining credit risk.
Provisions will also need to be reduced "dramatically" in the near term, which the JPMorgan analysts see as likely because almost the entire amount of non-performing loans (NPLs) will be written off.
"We believe DBS has built underwriting or risk management capabilities in India, and at the group level in the last few years. Those have led to a relatively resilient NPL outcome.
"These attributes, combined with digital offerings, should allow the bank to deliver PPoP RoA (pre-provision operating profit, return on assets) at least in line with its historical outcome," they added.
DBS said it will wait for the final decision from RBI and the Indian government on the proposed scheme before announcing further details.
Members, depositors and other creditors of LVB and DBIL have until 5pm this Friday to submit to RBI their suggestions or objections, if any, on the draft scheme.
Shares of DBS closed at S$24.63 at the end of trading on Wednesday, down 2 Singapore cents or 0.08 per cent.
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