As DBS Bank sprung its S$2.2 billion ($1.2 billion) share placement on the equity markets this Monday, the question that immediately sprung to most lips was "why now" when the bank's share price is at a 52 week low? Explaining what at first appears a very strange move, commentators have come up with two different theories.
One the one hand, there are those who believe that the bank acted in the belief that markets might get worse rather than better. This group applauds DBS President and COO Jackson Tai for raising the necessary equity to replenish capital ratios ahead of schedule and provide a platform for the bank's share price to rebound.
On the other, there are those who believe that the MAS encouraged the bank to act after a controversy erupted among equity analysts over the calculation of its capital ratios, leading some to suggest that DBS' 'true' tier 1 ratio had fallen below the regulator's 8% minimum. This latter group believes their argument is given added weight by the fact that until only about two weeks ago, DBS had been repeatedly saying it was in no urgent need of capital and had until January 2003 to deal with the depletion that would occur from a second tranche of goodwill for its $5.37 billion purchase of Dao Heng Bank.
Few would disagree, however, that the share placement was a great success and ECM bankers have been uncharacteristically unanimous in their praise for the Deutsche Bank led deal. The German bank won the mandate over three other banks invited to bid by DBS - JPMorgan, Morgan Stanley and Salomon Smith Barney.
All four had been in discussions with the bank for a couple of weeks, before being told on Monday just before launch that Deutsche had won. Although invited to take syndicate roles, only JPMorgan agreed, becoming a co-lead.
Given the prevailing market conditions, Deutsche's decision to underwrite a S$1.05 billion ($576.7 million) block of shares has been described as bold one, but ultimately one that appeared to more than handsomely pay off. As one head of Asian ECM comments, "This deal has turned out to be a great success, but it was a pretty aggressive move on Deutsche's part when you consider the state of the equity markets, the reputation of this particular issuer and the changes in MSCI weighting.
"This is a large deal for Singapore," he continues, "since there have only ever been two larger equity issues and for Asia as a whole too. Few investment banks would have been willing to step up and underwrite an amount which represented 40 to 50 days trading volume."
Deutsche underwrote the block at S$9.50 and was also paid a 2% commission. Alongside the placement to global investors, there was also an S$1.15 billion ($631 million) placement to two US institutional investors in a trade that DBS is said to have arranged itself. Total proceeds from the deal were, therefore, S$2.2 billion, with a total of 228.83 million shares sold, representing 19% of outstanding DBS ordinary shares.
The 121.8 million share placement to Brandes Investment Partners and Capital Group International represented 8.4% of the enlarged equity base and was structured as a restricted depositary receipt programme, since both accounts would have exceeded the MAS' 5% individual ownership limit if they had bought the underlying shares.
These shares were priced at S$9.50, representing a 6% discount to DBS' close of S$10.10 the previous Friday.
The institutional block was launched as an accelerated bookbuild under a price range of S$9.50 to S$9.70 and closed in the early hours of Tuesday morning (Asian time) 3.3 times oversubscribed. This level of demand allowed the lead to price in the middle of the range at S$9.60 and also exercise a S$100 million greenshoe.
Just over 200 accounts were said to have had their orders filled, of which about 70% already held of DBS stock. There were no 10% plus orders and bankers report a distribution split of 40% Asia, 40% US and 20% Europe.
Pricing represented a 5% discount to Friday's close, a price to book value of 1.02 times earnings (not including goodwill for the Dao Heng transaction) and P/E ratio of 9.6 times 2001 earnings. The government's stake dropped from 38% to 32%.
The placement appeared to have proceeded flawlessly from start to finish. "Credit where it's due," comments one banker. "Historically the discount offered by a block trade at the re-offer would be about 9% to 10%. Given the size of this deal and the underlying market conditions, it would have been fair to expect DBS to come at the higher end of that range, but it didn't."
Lead bankers attribute three main reasons behind the deal's success. "Above all else, equity investors think that DBS is trading at a very attractive valuation at the moment," says one. "This deal is positive for the stock because it removes any overhang and uncertainty about needing to raise capital.
"The announcement of the third quarter results shows that DBS is being very careful in taking precautionary measures with its provisions," he continues. "Investors also believe that the integration between DBS and Dao Heng is proceeding well and will result in the right level of cost savings and revenue generation."
As a result of the share placement, DBS says that its tier 1 capital ratio has increased from 9.1% at the end of September to 11.9% and its total capital adequacy ratio from 14.9% to 16.8%. At the end of 2002, when the remaining 28% of Dao Heng comes under its control on the exercise of the put and call options with minority investors, DBS also says that its tier 1 ratio will stand at 8.3%.
The unusual structure of the Dao Heng transaction lies at the heart of the controversy surrounding the bank's capital ratios. Principally there are two issues to the debate: one concerning how the goodwill arising from the acquisition should be treated and the other whether the minority interest should have been allowed to count as tier 1 capital.
To some it seems as if DBS has been allowed to have its cake and eat it - being able to defer some of the goodwill write-off against its tier 1 capital and yet at the same time being able to count minority interest, which it did not have to write off, as tier 1 capital.
In a research report published on September 10, Morgan Stanley analyst Andrew Brown was said to have sparked the debate when he commented that were the minority interest to be excluded from the figures and a full 100% goodwill write-off accounted for, DBS would see its tier 1 ratio fall to 6.5%, well below the MAS' minimum threshold.
"DBS' staggered approach to accounting for goodwill allows the group to maintain its tier 1 ratio above the MAS minimum of 8% in 2001," he wrote. "In order to show the magnitude of the impact hypothetically, should good will be deducted upfront, DBS' tier 1 ratio would be pushed down to 6.5% in 2001."
In its interim results, DBS did not account for the full 100% of its acquisition of Dao Heng, but instead made a goodwill write-off against tier 1 equity of the 56.9% it had managed to acquire at that point. For the full financial year, it then intended to make a goodwill write-off of 72%.
This was done on the basis that the Guoco group had sold its 71.3% stake in Dao Heng Bank to DBS for cash and one share in DDH (DBS Diamond Holdings), an SPV owned by DBS. These shares have a put and call option, exercisable within seven days of the end of 2002. Minority shareholders also largely opted for the same package, leaving DDH with a split ownership, in which DBS holds 72%, Guoco 20% and minorities 8%.
As these shares will not be exercised until 2002, DBS was allowed to defer the goodwill write-off. However, as a number of analysts point out, this runs contrary to International Accounting Standards rules which state that, "When the acquisition agreement provides for an adjustment to the purchase consideration contingent on one or more future events, the amount of the adjustment should be included in the cost of the acquisition as at the date of acquisition if the adjustment is probable and the amount can be measured reliably."
The independent financial advisor for Dao Heng further stated in a letter that DBS intended to exercise its call option and acquire the full 100%. But as some bank capital experts explain, the MAS had the leeway to make its own interpretation when it came to regulatory capital.
One says, 'Accounting issues and regulatory issues are two separate matters. Normally it's the case that goodwill has to be written off in full for regulatory capital purposes. But in this instance, I can see why the MAS allowed the bank to only write-off 56.9% since DBS did not technically own the whole amount at the time."
Treatment of 28% minority interest
Where bank capital experts disagree with the MAS, on the other hand, is over the issue of treating the 28% stake wrapped up in the put/call options as tier 1 capital. Morgan Stanley's Brown says in his research piece that the S$1.19 billion in minority interests was included as tier 1 capital in DBS' interim results.
"I fail to see how a security with an 18 month maturity can be considered as tier 1 capital," one banker remarks. "To be considered tier 1 equity, a security has to have to a degree of permanence and be able to absorb losses on an ongoing basis. That is to say it is a security with a perpetual structure."
The MAS says that it does not comment on its individual dealings with specific banks and officials of the Basle Committee on Capital Standards also state that they are unable to do likewise. Some insiders say that a detailed analysis of the Dao Heng acquisition agreement shows that there are subtle complexities, which cloud the issue and that after consultation with Basel officials, who would not make a ruling on an individual case, the MAS decided to allow the issue through as tier 1 capital.
Yet most observers reply that after examining the agreement with a fine toothcomb, the put/call options still appear to be 18-month securities and should not be considered capital of any kind at all. "It's quite clear that if DDH holders do not put the issue, then DBS will call it," says one observer. "The structure amounts to nothing more than a deferred payment.
"It's a clever trick, through which the bank's advisor Goldman Sachs enabled DBS to overpay for an acquisition that it couldn't really afford," he argues. "One year ago, DBS was trading at S$28 per share. Through its acquisition of Dao Heng, the bank has destroyed shareholder value and now sold shares at the very bottom of the market to pay for it. The net result is that it now has the smallest market cap of any of the Singapore banks."
But others conclude that even though they do not think minority interest should be considered tier 1 capital, the MAS has allowed it and it should stand. "I don't see why equity analysts have been making such a fuss," one states. "As long as the regulator is happy with the standard employed, then an analyst should only begin to get worried once the ratio gets so low that the risks associated with the bank really start to increase. Since issuing equity of this magnitude is dilutive, analysts should have viewed the treatment as positive."
DBS is likely to hope that with the issue now resolved as a result of its equity issuance, its share price will start to find new support. Year-to-date, DBS has underperformed both the banking sector and overall Singapore market, falling 48.47% to Tuesday's close. By contrast, the Straits Times Index is down 30.7% over the same period, OCBC Bank down 23.64% and UOB Bank down 25.77%.
Likewise, Deutsche Bank is likely to be happy that having completed the placement, the stock closed up Tuesday at S$10.10.
Consensus opinion also suggests that DBS has made a sensible strategic move. "Whether or not it seemed that DBS was disguising the fact that it needed the capital is beside the point," one banker concludes. "It was very clear to everyone that they needed equity capital. They have now raised it and completed a very successful trade, which sets them up to get on with the more important job of integrating all their various acquisitions."