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DCB IPO: Our view - Views on News from Equitymaster

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DCB IPO: Our view
Oct 3, 2006

Development Credit Bank’s initial public offer (100% book building) for 71.5 m equity shares, at a face value of Rs 10 each, is open for bidding between the 29th September and 6th of October 2006. The minimum application size is 250 equity shares and going by the price band of Rs 22 to Rs 26, the bank is expected to mop up Rs 1.9 bn through the offer (at the higher band). The bank has appointed merchant bankers - JM Morgan Stanley and Enam Financial Consultants to manage the offer. Baggage of sticky assets and cumulative losses
Development Credit Bank was incorporated in 1981 got converted into a private sector bank in year 1995. At the end of FY06, the bank had a customer base of approximately 510,000 retail customers, 72 fully networked branches and 101 ATMs. The bank’s credit portfolio is skewed towards corporate segment (60%), while the retail segment comprised 33% of advances and 43% of the non-interest income of the bank. Until FY02, DCB earned profits and paid dividends. However, due to change in business strategy with increasing focus on big ticket advances, the bank got trapped in huge NPAs and made cumulative losses a loss of Rs.20.6 bn in the following 4 fiscals. The Bank’s main promoter - Aga Khan Fund for Economic Development (AKFED) operates in five broad sectors: industry and infrastructure, tourism development, financial services, media and aviation and has in the past, supported the bank by infusing capital as and when required.

Objects of the issue

  • To increase the Tier-I capital adequacy ratio (at present 6%) and overall CAR (at present 9.7%) for meeting the Basel norms going forward. Also, the bank needs to hike its capital base to meet the growth in the corporate and retail credit segment.

  • To put in place the bank’s re-vitalisation plan which includes:

    1. Emphasis on prudent risk management

    2. Address the historically high level of NPAs

    3. Implement a program to reduce the operating expenses

    4. Focus on raising capital for improving the CAR

    5. Growth of the advance book and treasury business

    6. Emphasis on growth of low cost consumer deposit products

    7. Focus on improving the composition of the bank’s three core businesses: consumer banking, commercial banking and treasury.

Capital structure
The issue is slated to bring down the stake of the promoter- Aga Khan Fund for Economic Development (AKFED) in the bank from 58.4% to 30.1%. In February 2006, HDFC and some other private equity investors had together picked up 15.3% stake in the bank at a price of Rs.45 per share. Post IPO, HDFC’s stake in the bank will reduce to 2.6%.

Pre IPO Private equity investments in the bank
Private equity investor No. of shares (m) Price (Rs) Investment (Rs m) Stake in the bank (%)
HDFC 3.6 45 160 2.4%
Khattar Holding Pte Ltd 3.6 45 160 2.4%
Suvijay Exports 0.2 45 10 0.1%
Rajeev Maliwal 0.7 45 30 0.5%
Amtel Finance Ltd 3.6 45 160 2.4%

Reasons to apply

New management at the helm: As part of the re-vitalisation plan, the bank has put in place a new management team and board of directors. This is primarily directed at rectifying the cause of the bank’s poor performance over the last 4 fiscals and redefine its business strategy. One of the main reasons that led to DCB accumulate poor assets was its diversion of focus from SME to big-ticket corporate customers to maintain profitability, which resulted in sacrifice on quality. Considering its size of operation, the new management has re-defined its business strategy and started aggressively focusing on SME and consumer banking, with adequate cautiousness on quality of assets.

Increasing focus on low cost deposits: The bank has also attempted to improve the proportion of low cost deposits in its deposit portfolio (CASA) to improve its net interest margins. CASA (current and savings accounts) as percentage of total deposit has improved from 22.7% in FY05 to 32.1% in FY06. This has resulted in to improvement in spreads from 2.1% in FY05 to 2.4% in FY06. Nevertheless, the same continues to remain one of the lowest in the sector.

Improving provision coverage: The Bank has had to make heavy provisions for NPAs in the past, resulting in losses in the corresponding fiscals. Although the net NPA levels are currently considerably higher than the industry average, the provisioning cover of the bank has visibly improved. It, however, remains to be seen whether the bank can restrict incremental slippages in its asset book.

Reasons not to apply

How is it different? The banking sector in India is highly fragmented and expanding branches or increasing retail contribution are not the solutions to differentiate in the long-term. As highlighted by HDFC Bank in the past, at the retail level, if one is a weaker player (i.e. not among the top three or five), it is unlikely to enjoy scale-related benefits. Unlike some other Indian banks that are regionally focussed (yet strong), we feel that DCB is yet another bank that is hoping to ride on the India story. From a long-term investors standpoint, we believe that this is the weakest link and therefore, do not believe that there is a compelling case for this bank to be a part of the portfolio.

Risks to treasury portfolio: At the end of FY06, 49% of total investments of the bank were held in the Held to maturity (HTM) basket. Thus, a major portion of the bank’s investment portfolio continues to be classified as Available for sale (AFS) and will require provisioning in a rising interest rate scenario.

Not yet a ‘turn-around story’: Despite bringing in a new management team and chalking out a revitalization plan, the bank is far from rolling out a turnaround in it performance in the immediate future. This is more so because the cost of writing off its accumulated losses and impaired assets will continue to drain its bottomline in the near future. Also, the bank needs to catch up with its peers in terms of net interest margins.

Financials
(Rs m) FY05 FY06 1QFY07
Interest earned 3,032 2,771 738
Interest expended 2,335 2,020 511
Net Interest Income 697 751 227
Other income 913 803 261
Total income 1,610 1,554 488
Other Expenses 1,651 1,752 403
Provisions 689 578 42
Tax - 31 -
Net profit (730) (807) 43
NPM (%) -24.1% -29.1% 5.8%
No. of shares (m) 65.5 76.1 76.1
EPS (Rs) (11.1) (10.6) 0.6

Valuations
FY06 C/D (%) NPM (%) CAR (%) Net NPA (%) P*/ABV (x)
Development Credit Bank 59.8% -29.1% 9.4% 4.1% 1.4
UWB 61.7% -21.9% 0.7% 5.9% N.A
Centurion BOP 71.8% 22.0% 12.6% 1.2% 3.7
* P/ABV has been calculated by considering prices as on 3rd October 2006

Our view
At the higher end of the price band of Rs 26, the bank is valued at 1.4 times its post issue adjusted book value. We feel that the offer is slightly overpriced for a bank like DCB that has registered losses for 4 cumulative fiscals. Despite the fact that the bank is making an attempt to revitalise its operations and adopt a more cautious approach to growth, the bank does not seem to be able to cash in on the buoyancy in the economy and holds prospects of better future performance only in the event of a merger with a more efficient bank. Meanwhile, with the firm trend in interest rates, the possibility of further deterioration in asset quality cannot be ruled out. As we do not see a substantial upside to the stock in the long term, we would advise investors looking for visible growth stories, to AVOID the issue.

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