LVB merged into DBIL - No other option?

AMALGAMATION: WAS IT THE ONLY OPTION FOR LVB? 

On 20^th Nov 2020, I wrote on the amalgamation of LVB with DBIL (https://viswoice.blogspot.com/2020/11/amalgamation-of-lvb-with-dbs-bank-india.html)

Since then, the draft scheme of RBI has been notified by the Central Government, which came into effect  from 27th Nov 2020. Much against the hopes of the shareholders of LVB, the draft scheme is implemented without a change. The shareholders' investments in the equity, including the share premium paid by them in the last rights issue in Jan 2018 and the Tier II bonds that carried loss absorption clauses as per Basel III norms, were fully written off. Naturally anguished, the shareholders of LVB filed writ petitions before the High Courts of Bombay and Madras.  While Bombay High Court refused an interim stay and posted the case for further hearing, Madras High Court gave certain directions to the respondents for the legal protection of the existing shareholders of LVB, till the case is concluded.  

In the above background, I decided to write my views and also the concerns expressed by many, who felt that the decision and implementation were super-fast, resembling a power play of a T-20 match.  Of course, RBI has got enormous powers under Sec 45 of the Banking Regulation Act, which may not be challenged in any court of law. In all fairness to RBI,  all permutations and combinations might have been taken into account, before deciding on the final 'draft' scheme to be put up to the Central Government. But as a lay man, I present a different view and hold onto my belief that there were better options available.

1. Whether negative CET 1 was the reason for exercising the amalgamation option?

In the recent past, two ailing banks were rescued by the regulator in consultation with the government. One was IDBI bank (completed in Jan 2019) and the other was Yes bank (completed in March 2020). While the capital infusion of Rs.21624 cr. by LIC to contribute to 51% of the paid up capital of IDBI Bank was termed as 'strategic investment' by the insurance behemoth, the capital infusion of Rs.10,000 cr. by select PSBs and private banks in the paid up capital of Yes bank was a plain 'restructuring plan'. In both the banks, the capital infusion followed seamless board room/management changes, while protecting the interests of the existing shareholders.

The above two experiments, which served as precedents to rescue ailing banks, was not tried out in the case of LVB. One argument is that both IDBI bank and Yes bank had positive CET 1 (Core equity from the shareholders) on the respective dates for considering the reconstruction, while LVB had negative CET 1. I do not subscribe to this ‘rationale’. In respect of stressed banks which are into losses, CET1 is a function of the level of provision coverage maintained. CET 1 being positive or negative should be studied along with PCR (Provision Coverage Ratio).  On the dates when the restructuring plans were announced for IDBI Bank and Yes bank, their PCR were 55 and 73 per cent respectively.  On the day when the LVB moratorium was announced, its PCR was 77%.  If the PCR maintained by LVB were to be taken into account for arriving at the CET 1 of IDBI bank and Yes bank on the respective dates when their restructuring plans were announced, their CET 1 were also negative by Rs.5867 cr. and Rs.238 cr. respectively. (Please see Annexure I for detailed calculations)

Again infusion of capital once only might not be adequate to take a stressed bank out of the woods for ever. In fact, second dose of capital infusion had taken place in both IDBI and Yes banks, shortly after implementation of the reconstruction scheme, to ensure that CET 1 is adequate to meet future losses/meet the regulatory prescriptions. (Rs.9300 cr. infused by LIC and GoI in IDBI Bank in March 2020 and Yes bank raised Rs.15000 cr. by way of equity from the market within six months of its reconstruction).

2. Public-Private partnership investment would have been a better option:

Reasons stated for choosing DBIL, subsidiary of the reputed DBS Bank Singapore are its strong capital base, ability to bring in capital as and when required and the parent being one of the leaders in digital banking in the international space. While none of these factors can be disputed, DBS has its Indian banking arm since 1995, but its success in terms of business levels, penetration in terms of branches/ATMs is limited.   Its experience into retail banking in India is of a recent origin.

Instead of an amalgamation, public private partnership would have given an ideal solution. There are three major south based PSBs (many more earlier, but three only now, after merger of PSBs) in addition to SBI, which has its LHOs in all the five southern states; the top three private banks have a huge presence in south; and added to the list are the eight to ten old private banks having their headquarters in south.  As bancassurance constitute a significant portion of total insurance business today, LIC, GIC and other major private players in life and general insurance must be eagerly waiting for opportunities to grow organically in this space. LVB with 570 branch plus network and substantial number of BCs, on any day, is an ideal choice for investment to these banking and insurance players.  

A public private partnership on similar lines implemented for reconstructing Yes bank, even with DBIL in the lead, would have helped LVB much more professionally, as the board and top management will have representations from people who had rich exposure to the Indian Conditions. It would have also opened the door for a foreign bank-indian bank partnership.

 3.Acquisition cost appears to favour DBIL

Nothing is available in public domain on this aspect. I venture into guessing what could have been the acquisition cost. Normally, factors considered for acquisition cost of a bank are (i) fresh capital required to run the business, (ii) compensation to be paid to the existing owners (iii) money brought in for meeting immediate losses and (iv) fill in the shortfall that may arise if the interest liabilities on deposits, staff expenses and other operating expenses are in excess of the  total income.

1.  Fresh Capital Needed:                                                                        Rs.1405 cr.

(As per the financial results of Sept 2020, Risk Weighted Assets of LVB are Rs.12917 cr. Regulatory Capital Needed is (12917x10.875%) Rs.1405 cr.)

2. Compensation to be paid to the existing owners                                           0

3.      Expected losses (Rs. in cr.) ((i)+(ii) below)                                        Rs.1547 cr.

(i)                 GNPA Rs.4063: Provisions held: Rs.3316 NNPA: Rs.947 expected loss: 947

(ii)               Major Contingent Liability: Rs.600 cr. 

(In the case relating to adjustment of third party deposits towards loan outstanding of Rs.794 cr., bank is holding a provision of Rs.200 cr.)

4.      Shortfall in total income to meet interest and operating expenses               0

The financial results of LVB for the last three quarters show that its total income is adequate to meet its interest obligations and operating expenses. (Interestingly, Sep 2020 presentation by the bank indicate the net interest income for the quarter at Rs.80 cr.; other income at Rs.75 cr. Hence total income is Rs. 155 cr. Against this, its operating expenses incl. staff expenses is Rs.159 cr.)

In respect of expected losses stated in (3) above, one should remember that this is a notional loss only and the actual loss will be determined only when the event crystallises viz. non-realisation of full dues in an NPA account and when the contingent liability falls on the bank. As it is notional and the PCR in respect of GNPAs is at 77%, there may not be any need for DBIL to bring this money upfront. There may not be any need to bring this money in future also if one considers the fact that the average recovery in GNPAs of any bank is in excess of 50% (Haircut is more in a corporate account but substantially less is small and medium accounts due to availability of security). In a worst case scenario, even if the bank is able to recover only 40% of its GNPAs, the expected loss of Rs.1547 cr. will be recouped fully. 

In a nutshell, of the four factors considered above, fresh capital of Rs.1405 cr. will be the immediate need. (Pumping in more money will not be termed as cost of acquisition, as it is for its expansion plans)  If this not advantage DBIL, what else is? There is no need to invest in 570 plus existing branches, 900 plus ATMs - up and running and the cost is met from the existing income. Plus experienced staff, who are familiar to the area of operations and retail banking. Plus the loyal customers, many of whom might have relationship banking as well. There is also the goodwill of confidence of trust, created by nine decades of mutually beneficial existence with the society it served.   Without factoring these ‘inherent strength’ benefits, the whole exercise appears to have been done based on simple arithmetic of financial assets versus liabilities. Unless the valuation or acquisition cost is made public, one cannot be faulted, if he strongly feels that the amalgamation favoured DBIL

(I have not made an attempt to arrive at valuation based on perceived shortfall in assets realisation over liabilities, which is attempted in the case of companies.  When the bank continues as a going concern, there is no run on the bank. Maturing deposits and liabilities are taken care from the monthly cash flow statement prepared to calculate LCR (Liquidity Coverage Ratio). As per the bank’s Basel III disclosures, its LCR as on June 2020 was 294%, more than adequate to meet maturing/premature closure liabilities. Other than deposits, the major liabilities are the Tier-II bonds for Rs.368 cr,, of which Rs.318 cr. is written off prior to amalgamation)

4. Holders of AT1 and Tier II bonds deserve better treatment

Loss absorption clause was invoked citing PONV (point of non-viability) by the regulator in respect of Rs.318 cr. of Tier-II bonds. This the second time this clause has been invoked, the first one being the AT-1 bonds for Rs.8400 cr. in the case of Yes bank. Debt instrument holders, who virtually had no role to play in the affairs of the bank, were the victims.  

From now on, raising of AT1 and Tier-II bonds, as per Basel III norms, is going to be difficult for all the banks including PSBs. Achieving total CAR with CET1 alone will be quite challenging. The position of holders of these instruments cannot be compared with any other debt instrument holders, since capital bonds are a totally different concept. Instead of applying the write down rule in the end by saying that PONV is triggered, RBI should give these investors an option to convert their holdings into equity on the happening of any one of the following:

a.       CET 1 falling below regulatory prescription: 7.375%

b.      Tier I falling below regulatory prescription: 8.875%

c.       CAR falling below regulatory prescription: 10.875%

This will enable them to participate in the equity and thereby in the affairs of the bank through Board or AGMs. If the situation warrants, they may also chip in with fresh infusion of capital.  At least, they will not blame that they were kept in the dark and lost all their money because of the perception of the regulator that PONV is triggered.

V.Viswanathan

29th November 2020

Annexure I

CET 1 and Provision Coverage Ratios of the three banks restructured/amalgamated in the last two years                                                                                                              (Rs. in cr.)

Position in major heads (prior to rescue plan)	IDBI Bank (Sep 18) Bank's presentation	Yes Bank (Dec 19) Bank's presentation	LVB (Sep 20) Bank's Presentation
GNPA	60875	40709	4063
GNPA (%)	32	19	24.45
NNPA	27295	11115	947
NNPA (%)	17.3	6	7
PCR(%)	55	73	77
CET 1	7426	1513*	-626
CET 1 (%)	3.87	0.6	-ve

1.     IDBI had a PCR of 55%, when the rescue plan was considered. Had IDBI maintained PCR ratio in line with what LVB had at the time of amalgamation, its CET 1 would have been negative by Rs.5867 cr.

(CET 1 on that date was Rs.7426 cr. Provision available was Rs.33580 cr., Requirement at 77% works out to Rs.46873 cr. Difference: Rs.13293 cr, Effective CET 1= 13293-7426= Rs.5867 cr.)

2.      In the case of Yes Bank, the CET 1 would be negative by Rs.238 cr. as per details given below:  

As per bank's presentation for the quarter ended Dec 2019,  CET 1 was 0.6%. It works out to Rs.1513 cr. if the amount is worked out in relation to total risk weighted assets (RWA) shown at Rs.252243 cr. Provision available was Rs.29594 cr., Requirement at 77% works out to Rs.31345 cr. Difference: Rs.1751 cr, Effective CET 1= 1751-1513= Rs.238 cr.) (Incidentally, in addition to the NPAs, Yes bank also had NPIs totalling Rs.9107 cr. as per its presentation to analysts for the quarter ended March 2020)