Headwinds From Deterioration In Asset Quality

• Expansion in South India. The amalgamation of Lakshmi Vilas Bank (LVB) with DBS Bank India (DBI) under special powers of the Reserve Bank of India (RBI) and Section 45 of the Banking Regulation Act was completed on 27 Nov 20. LVB has a history of 94 years and a retail and SME customer base. The amalgamation enables DBI to scale up in South India, which has longstanding and close business ties with Singapore. DBS has injected Rs2,500 crore (S$463m) into DBI.
• Absolute NPLs estimated at S$614m. DBI has taken over LVB’s deposits of Rs20,973 crore (S$3,813m) and net advances of Rs13,505 crore (S$2,455m). LVB is alleged to have serious governance issues and lacked internal control. LVB’s loan book is said to have expanded five times from 2007 to 2019. Bad lending practices and the aggressive expansion into corporate loans have led to a spike in NPL ratio to 25%. LVS suffered losses over the past three years. It has experienced continuous withdrawal of deposits.
• Existing shareholders have to be compensated? The Madras High Court has directed DBI to provide an undertaking of cash compensation to existing LVB shareholders and to create a reserve fund amounting to face value of LVB shares (estimated at Rs781 crore or S$142m). This is a negative surprise as existing LVB shareholders were supposed to be wiped out under the scheme of amalgamation. The amalgamation was alleged to be on a fast track and was completed within 10 days. Existing shareholders were not given sufficient notice. The on-going saga creates legal uncertainties for DBI.
• Downgrade to HOLD. Our target price of S$29.45 is based on 1.35x 2022F P/B, derived from the Gordon Growth model (ROE: 10.1%, COE: 7.75%, Growth: 1.0%). We no longer ascribe a premium to our valuation of DBS. We have conservatively reduced BVPS by S$614m  for  NPLs  carried  on  LVB’s  balance  sheet  and  S$142m  for  the  potential compensation to existing LVB shareholders.

Source: OCBC Research - 25 Jan 2021