Bank failures carry systemic risks. Recall in 2008, the failure of Lehman Brothers setting off a chain reaction that resulted in the Global Financial Crisis. The problem with banks is that if even a hint of trouble materialises, there could be a run on deposits. Governments can prevent a failure turning into a systemic risk, and the Government of India appears to have done just.
Under an archaic law, a scheme of amalgamation using the special powers of the Government of India and the Reserve Bank of India from Section 45 of the Banking Regulation Act 1949, amalgamated Lakshmi Vilas Bank (LVB) with DBS India (DBI), a subsidiary of DBS Group Holdings, on Nov 27, 2020.
With it, shareholders and bondholders are - for want of a better word- wiped out by law. The Act empowers RBI “to prepare a scheme for the amalgamation of the banking company with any other banking institution”. The Indian press has reported various challenges that are now being referred to the Delhi High Court. However, prime minister Narendra Modi has a super majority in parliament, and is able to enact and implement various laws, including passing three seemingly unpopular farm bills that have triggered protests from farmers.
Back to DBS. In March 2019, to expand the franchise and build greater scale, DBS converted its India operations to a wholly owned subsidiary, making it one of the first foreign banks to subsidiarise. LVB can only be amalgamated with a local bank - which is what DBI effectively is. Hence, DBI injected $643 million into LVB.
More details were revealed during a results announcement on Feb 10. The provisional goodwill from amalgamation of LVB was $153 million, being the difference between the fair value of its assets and liabilities of $3.89 billion and $4.04 billion respectively. As at Dec 31, 2020, total loans transferred amounted to $2.14 billion, including net non-performing assets (NPA) and total deposits transferred amounted to $3.34 billion.
DBS’s 4Q2020 results included amalgamation expenses of $33 million and general allowances of $87 million. Additional general allowances were set aside at group level to pre-emptively build up general allowance reserves to 9.5% of LVB’s performing loans.
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LVB adds 563 branches to DBI, taking its total to 600 branches, and raises DBI’s ATMs in India to 1,000. LVB also brings with it two million retail customers and 125,000 non-retail customers.
Excluding LVB, DBI’s total income in FY2020 rose 40% to record $376 million, and its pre-tax profit quadrupled to $89 million. DBS’s South and Southeast Asia segment was able to turn a net loss of $22 million in FY2019 to a net profit of $104 million in FY2020. This was partly attributed to the the revaluation of deferred tax assets due to a cut in India’s corporate tax rate.
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Impact of LVB on DBS
On the ratio front, DBS’s common equity tier 1 (CET1) ratio was unchanged q-o-q at 13.9%. Chng Sok Hui, DBS group CFO says that LVB caused a 0.3 percentage point impact on CET1, keeping the ratio unchanged q-o-q. However CET1 could rise as profits continue to accrete.
LVB had $881 million of NPAs for which special provisions of $669 million have been taken. The remaining $212 million (NPA less special provisions) has been added to DBS’s NPAs. Of the $1.93 billion performing loans, DBS has taken $183 million in gross provisioning (equivalent to 9.5%).
“We’ve dealt with the LVB issue. We bumped up NPA by [16%] and provided for incremental NPA. Of the residual good book of $1.93 billion, $800 million is on gold loans,” says Piyush Gupta, group CEO of DBS. Gold loans, peculiar to Indian banks, are secured loans, when customers pledge gold to the lender for an amount based on the valuation of the gold.
DBS’s non-performing loan ratio held steady q-o-q at 1.6%. Ratios such as the leverage ratio, all currency liquidity coverage ratio and net stable funding ratios as at Dec 31 do not include the impact of LVB.
Forbearance loans shrink
Forbearance loans for DBS group have fallen from 5.1% to 1.2% of total loans (q-o-q) due to expiry of moratorium as many borrowers did not seek extensions. In Singapore, loans under moratorium declined by 90% for residential mortgages and 75% for SME loans. In Hong Kong, loans under moratorium for large corporates and SMEs have fallen by 50%. DBS has about $1 billion of forbearance loans in mortgages which are secured. The SME loans in forbearance total $3.5 billion, of which $1 billion are in Singapore, and $2.5 billion in Hong Kong.
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“For the loans that come out of forbearance, delinquencies are very low. Of the balance in forbearance we will only find out in April and May,” Gupta says.
In the meantime, DBS has taken a huge amount of general provisioning - now known as expected credit loss (ECL) stages 1 and 2. In FY2020, allowances charged totalled $3.07 billion. Loan loss coverage was at 110% with $4.31 billion in general provisions.
Under International Financial Reporting Standard 9, if any loans go into special provisioning, now known as ECL stage 3, 60% to 70% of the special provisioning comes from general provisioning, so these amounts are reversed out of general provisioning.
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Management overlays provide potential for write-backs
ECL stages 1, 2 and 3 depend on macro-economic variable (MEV) models. Hence the ECL framework tends to be pro-cyclical. Conservative banks such as the three local banks can provide for management overlays, which are amounts set aside over and above what their MEV models indicate or dictate. Banks can write back these into their profit and loss statements when MEV models turn more positive.
“We’ve a lot of management overlay, of $1 billion. We might have to take a look at that [for write-backs],” Gupta says. “There is scope for reversal but it’s not baked into our plans.” Write-backs are unlikely in 1H2021, or even FY2021. However, credit costs are likely to abate. Gupta indicates that DBS has already taken $3.07 billion in gross provisioning, and it may take another $1 billion over the next 12-18 months.
In FY2020, DBS’s net profit fell 26% y-o-y to $4.72 billion, largely because allowances surged to $3.07 billion. However, profit before allowances rose 2% to $8.43 billion, a record. If allowances decline significantly to $1 billion or lower this year, and profit before allowances is maintained, DBS’s net profit in FY2021 would obviously be $2 billion higher than FY2020’s level.
In the meantime, Gupta is looking increasingly at initiatives that should provide an avenue for growth. For instance, DBS’s digital exchange has started off with around 300 transactions a month. Established crypto exchanges such as Binance have revenues in the billions of dollars.
With Covid under control in most of Asia, China’s economy is rebounding. More immediately, though, the sprawling sub-continent could provide excitement for DBS. “India’s growth rate is [likely to be] 11.5% in the next fiscal year,” Gupta points out, adding that is the highest rate for a big economy. “We expect LVB to be profitable in 12-18 months.”
