Some strong words on Singapore and DBS

Highly regarded and highly independent bank analyst Sunil Garg of Fox-Pitt, Kelton gives his views.

A trend at the moment seems to be the decline of family banking in Asia. Is this a trend you see, a part of globalization?

I don't know whether it is part of globalization, but it is certainly a trend being forced first by consolidation, which in turn has been accelerated by the crisis. The cozy time that banks had before the crisis doesn't exist anymore. You now have revenue pressures, pressure to innovate -- otherwise you don't survive. That has led to the family-owned structures declining. One of the biggest areas for family-owned banks is still in Hong Kong. You still have a have a huge number of family-owned banks but some have sold out. The big change over the last 18 months is that banks are now increasingly willing to sell out -- all of them -- given the right price, particularly after the DBS-Dao Heng deal. Most of them realize that in an environment where growth is not going to be as heady as it used to be, competition is going to be much stronger. The reason why I say it is not necessarily globalization is because the competition is not coming necessarily from the global players; it is coming from the same set of players as always, except the stronger players are now taking more market share because they have more resources. Family banks have limitations on resources. Before the crisis, you also had loan growth rates of 20%; now you struggle to make single digits, and in some cases negative. In that sense, everyone is competing for the same dollar. Obviously that's an expensive business. You lose margins, have to do expensive marketing and keep up with technology and Internet platforms. That's what is causing owners to sell out or look to.

You've seen some of that in Singapore too, with OUB selling out. Korea wasn't so family-owned in the first place. Thailand's family issue has been sorted out in all but two banks, Bangkok Bank and Thai Farmers. Even there, the controlling families may sell down. My expectation is give it two or three years and those banks may see a change in ownership as well.

Indeed, the globalization aspect is actually strongest in Thailand. Thailand has sold four banks to foreigners like ABN AMRO, DBS, UOB and Standard Chartered. These banks are able to take market share from the local players. I think Banthoon Lamsam said I am the last Lamsam to be the president of the bank. That indicates these guys are willing to institutionalize. My view is that these banks will eventually have to consolidate. Thailand hasn't seen much consolidation. Give it two or three more years and you will have a more concentrated banking system.

In Malaysia, the family situation has been sorted out by the consolidation. In this case, it is not globalization, but the government deciding to create 10 banks one fine day. Some of the families have been forced to sell out.

Market economic forces have driven most of the changes, however. You have a weak growth environment, and there are players who have to get out, apart from Malaysia where it has been government-driven. However, Malaysia would have consolidated on its own thanks to the same economic forces in two or three years time. My view on Malaysia is we'll see another round of consolidation. The bottom three or four of the 10 new groups do not have an independent future and will sell out as well. They don't have the strength to take on the competition. MayBank, Public and Commerce will become much stronger, and it won't be easy for the smaller players to survive.

Do you think the Utama RHB deal will go ahead?

It looks like a done deal. In general, RHB has not been getting a good deal. RHB, the erstwhile DCB, used to be a good bank. And when you think of what it has been reduced toĆ  They've had a restructuring plan that has yet to be approved and now it turns Utama is buying this stake and effectively there will be a reverse takeover. And when they were looking to create the original six anchor banks, RHB wasn't even in there, and one of the smallest banks, Multi-Purpose was supposed to be acquiring it.

RHB's restructuring plan was actually quite sensible and got rid of the myriad cross-holdings. But while the stock looks undervalued, there are some political concerns.

From what I can make out, Utama is looking to buy 22% of the RHB Bank's parent company. That implies they will be in control when the merger takes place.

Malaysia's consolidation is more forced but it has meant a lot of family control has gone away.

As an equity analyst, do you think that bank stocks which are institutionalized perform better than family-owned ones?

Let's take an example, Dao Heng Bank versus Hang Seng Bank. Since 1999, Dao Heng has done very well versus Hang Seng. And the Wing Hangs of this world have done well versus Hang Seng, too. Your point is true, but it is not a given. Family controlled institutions may lack professional management, have a corporate governance issue and so forth and therefore do not always take decisions in the interests of all shareholders including the minorities. By and large, family-controlled institutions suffer from these problems anywhere in the world.

The other issue is expansion. If you need resources for this, either financial or management, family controlled institutions would have problems. Families do not want to be diluted and so will not necessarily expand and thus face gradual attrition.

When you look around Asia, India doesn't have a history of family-owned banks.

There used to be many family-owned banks until 1969, and then you had nationalization, and the whole thing became state-owned. A typical problem with family institutions is they go bust and so the state takes over. About 10 years ago, the government said the financial system was stable enough to handle new private sector banks. But they said to get a new license you would have to be well capitalized and that within three to five years, the major shareholder had to reduce its stake to 40% or less. But family banks are not a big component of India's financial scene.

When you look at these new private banks, HDFC Bank and ICICI Bank, they are actually very professionally managed, aren't they?

The reason they are, is first they have no legacy of bad lending. The other is that these banks started off as lean operations that could use technology to their advantage and they're run by people who are probably the best bankers around.

The state-owned sectors pay badly, while these new private banks realize that to attract the best people you have to pay top dollar. So their compensation systems mean they attract talent.

And management seems to be very focused on return on equity.

By and large, HDFC Bank does tend to be focused on ROE. On balance, professional managements are much more return-focused, but it is not always the case. You have professional managements with an open cheque book destroying value. This happens in all banking sectors globally. .

Do you think Singapore banks can become regional banks, or do they not have the necessary management skills?

I am willing to believe that DBS will become a successful regional bank. What Singapore lacks, it imports -- whether it is water or management talent. Having said that, you have to give credit to at least two institutions for trying. One is DBS, the other is OCBC. They have realized that if they don't have a resource, they need to acquire it. OCBC has hired a fairly savvy CFO in Chris Matten. DBS' costs show how much foreign management talent they have hired -- which I believe is a necessary investment for the future. Personally, I think the Dao Heng deal is a transforming deal for DBS and a strategic imperative and even the small overpayment -- 16-20% above fair value, we estimate -- is justifiable. However, the bid for OUB was more difficult to justify and now it seems that they are exercising acquisition discipline in not getting into a bidding war, since management has said that 'this is not a transforming deal, it's not central to our strategy, it's nice to have, if we don't get it, it's not a problem'. In such a situation, value preservation is paramount though the terms of the deal indicated dilution and value reduction.

DBS has done a few deals in the last few years and these have not necessarily played out as would have been originally envisaged. The Thai Danu deal was not engineered by the current management, so current management should get no debit for that. Also, this was a deal done too early in the down cycle. The Kwong-On Bank wasn't particularly bad or great so let's ignore that. DBS has bought a 20% stake in BPI [in the Philippines] which I do not see much sense in, even though BPI is a great bank. I do not believe that DBS will be able to get a controlling interest, and strategic alliances rarely work. At the same time, this strategic alliance is backed by an equity stake, which has halved in value -- in that sense, ROE has been compromised. The case for a successful transformation of these banks to regional powerhouses is yet to be proven, though as I said earlier, I am willing to believe that DBS will make the mark.

I also believe that the new managements need to be significantly 'incentivised' through stock options since that links compensation to performance

What does the management say about BPI? What's their logic?

Nothing fantastic, or specific. They say it is a good bank -- I do not disagree with that -- and potentially a good banking market. But the issue is the price you pay, and at a 20% stake you get three board directors, but you have to equity account profits and you don't get the benefit of an acquisition.

I thought their strategy was to control banks and become a distributor for other peoples products.But it is not necessarily a consistent strategy in that sense. DBS cannot be a distributor bank. It has to be a manufacturer of commercial banking products because it has a massive balance sheet.

The strategy does have a certain lack of consistency. Last year they took the insurance company Insurance Corporation of Singapore private. This year they've done the deal with CGNU.

Besides, if you think about it, if you are talking about being a distributor, then why have an exclusive distribution agreement with CGNU?

You mean offer best of breed instead?

Yes. Ultimately, a distributor model says 'I am going to focus on the customer'. It's about best of breed. You make distribution margins no matter whose products you sell. But you give the customer the product most suited to him. I think the model I most like in this respect is that of ANZ in Australia.

What's your view on Bank of East Asia?

It is a good bank. The First Pacific transaction was good; it is doing well on its bancassurance business, looking at last year's numbers; plus it is long-term China positive. The problem is that if Bank of East Asia was bought, the deal would have to be at the same multiple as Dao Heng. There, the question of perceptions comes in. I do not believe that management will sell Bank of East Asia for a multiple less than Dao Heng. Now the acquirer of Dao Heng has seen its stock price decimated. That issue may scare away another potential acquirer. The other thing is acquiring a Dah Sing at a toppy multiple will still require less capital in absolute terms because Bank of East Asia is a bigger bank. This also might be restrictive. In fact, the number of banks that could make a bid for Bank of East Asia is actually limited.

How much would it cost?

Its market cap is $3.2 billion and if you add a 50-60% premium, you are talking about $5 billion. That's not an easy deal for most people to do.

What about OCBC?

OCBC would have to raise capital to do that. It could do a Wing Hang deal at a stretch, without raising new fresh equity and a little hybrid capital. But Bank of East Asia would require fresh equity and might also have the same implication for the stock price that Dao Heng had for DBS. Would that scare them off? That is the question.

Wing Hang also has the more fragmented shareholding structure?

Yes, Wing Hang is the highest probability, although I believe it won't do anything for less than 2.5 times book. But Dah Sing may be the best option, with an excellent consumer franchise.

Bank of East Asia is trading at 1.8 times book or around there.

Yes, the stock is languishing. The bank announced its intention of buying a community bank in California, without any details. Things like that don't necessarily help the stock. That's why it is trading at fairly unexciting multiples. Otherwise what you have is a strong franchise; that is long-term China positive.

So how do you see things unfolding?

Well, you have the banks with franchises which are Dah Sing, Wing Hang and Bank of East Asia, then the rest are basically commodity banks and compete on price. A cross-border acquirer wants to buy a franchise and not a commodity bank. They'll pay up for that. A big local bank doesn't need a franchise, but it might buy out a small commodity bank competitor and take some market share. It is effectively like buying a loan portfolio, where you basically pay adjusted book value, which means close to book value.

So you can see Bank of China doing this?

Yes. But don't rule out Hang Seng either. This will allow them to improve their market share without damaging margins. That's what consolidation is supposed to do, right?

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