Brokers' take: Jefferies downgrades DBS to 'hold' on proposed India deal

THE proposed amalgamation of ailing Lakshmi Vilas Bank (LVB) into DBS's wholly-owned India unit may weigh on the Singapore lender's profitability in the near to medium term.

It also raises a few questions about DBS's dividend trajectory, considering the impending pandemic-related credit risk migration, said Jefferies Equity Research in a note on Wednesday morning.

Jefferies analyst Krishna Guha thus downgraded DBS to "hold" from "buy", and lowered the estimates for its dividends per share by about 10 per cent.

He cut the target price on the stock to S$22, from S$26 previously. As at 11.24am on Wednesday, DBS shares were trading at S$24.72, up S$0.07 or 0.3 per cent.

Under a draft scheme by the Reserve Bank of India (RBI), LVB may be folded into the Indian business of South-east Asia's biggest bank, DBS said in a filing on Tuesday night.

To support the amalgamation, DBS will inject 25 billion rupees (S$463 million) of fresh capital into DBS Bank India Ltd (DBIL), if the scheme is approved. This will be fully funded from DBS's existing resources.

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The original share capital of LVB will be written off, and its existing shareholders will not get any stake in the new entity. No haircuts will be applied to depositors or bondholders.

LVB has been put under a one-month moratorium from Nov 17 to Dec 16. RBI said in a statement that the Indian bank's financial position "has undergone a steady decline" as it incurred continuous losses over the last three years and eroded its net worth.

JPMorgan's research team, which has an "overweight" rating and S$24.50 target on DBS, wrote in a note on Wednesday that the proposed deal will likely be positive for the Singapore-listed group.

"Effectively, DBS is buying the (LVB) business at about 10 per cent 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.

Moreover, as soon as a credible controlling shareholder comes in, the LVB franchise will likely start regaining deposit market share. JPMorgan also expects DBS to use digital capabilities to enhance its physical footprint in India. Hence, the proposed deal could lead to a 30-40 per cent increase in Indian assets of DBS, 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 call for continued capital infusion, given LVB's high non-performing assets (NPA) and negative equity.

If successful, the deal will strengthen DBS's footprint in southern India, which has longstanding and close business ties with Singapore, Mr Guha said.

In particular, Singapore real estate firms have recently deepened their presence in southern India. DBS also earlier highlighted the need to scale up its branch presence to target small and medium enterprise (SME) lending.

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.

According to RBI, LVB has not been able to raise adequate capital to address issues around its negative net worth and continuing losses, and is experiencing continuous withdrawals of deposits as well as low levels of liquidity.

Reuters reported that India's government said it had also temporarily capped withdrawals from LVB. The bank has been looking for a partner since last year amid surging bad loans that come on top of "governance issues", Reuters added.

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 (non-performing loan) 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.

If this thesis plays out, DBS will see value accretion from the proposed transaction, JPMorgan said.

According to Jefferies, the amalgamated entity will have the most bank branches (598) in the country and rank fifth by loans among foreign banks, with CET1 of 9.6 per cent. "We understand DBS may have the flexibility to rationalise branch footprint and avail other concessions," Mr Guha said.

DBS on Tuesday 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.

Jefferies remains constructive on the banking sector. On Wednesday, it upgraded UOB to "buy" from "hold" previously, and raised its target price to S$25, from S$22.

READ MORE: Troubled Indian bank may fold into DBS India unit under RBI proposal