Shenzen Bank Analysis

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Also it maybe as a result of book keeping i.e. the figures recorded are based on bank’s discretion by management hence recording low NPL numbers this to boost investor confidence.

NPL coverage ratio for SDB increased from 30.9% to 33.2% between 2001 and 2002 although compared to average of 55.3% of its peers it is relatively low implying less conservativeness of SDB.

Also we look at the Loan Loss Reserve (LLR), SDB has US $391million which is low, and it might be heading for insolvency .At this point the capital adequacy requirements would be affected i.e. Must increase amount of capital to satisfy standard for adequate capitalization. The industry average based on its peers is at 3.8%relatively lower than 3.9% of SDB of gross loans (exhibit 10) implying that other banks invested in safe loans with exception of BoCom meaning SDB takes on more risky loans .This is as result of poor credit risk management .

SDB fee income is at a negligible amount of US $ 9 million approx. 2.1% of its total operating income, average for US and Hong Kong 40.9% and 26.0% respectively is lower .Fee income is better than interest income as it doesn’t require equity .

Fee income businesses can have higher return on capital than traditional lending operations.

A Closer Look into Shenzhen Development Bank’s Earnings Capability

we also need assess the earnings capability of SDB ,according to exhibit 9,SDB had decreasing Net Interest margin of 3.5% to 2.4% in the previous three years and the Return On Average Assets(ROAA) and Return On Average Equity(ROAE) has similar declining trend from 0.9% to 0.3% and 22.4% to 9.1% this can be seen in fig 1.This bad performance can be attributed to fall in net profits from US$56 to US$46 million between 2000 and 2001.Even with the 1.8% growth in net profits in 2002 ,it’s still a small figure to profit in 2000 .The ROAA and ROAE of 0.3% and 9.1% respectively for SDB is relatively low compared to that of its peers in the industry of 0.6% and 26.8% respectively. The operating expense to operating income ratio for SDB of 58.3% is higher to its peers in the industry with average of 55.3% which is not a good sign for SDB.

The differences between SDB’s financial performance in relation to its peers is driven by these factors above. It shows a poor overall financial performance by SDB to its peers. Although the net return on earning assets is quite similar to its peers in the industry, it still has a lower ROAE and a significantly lower ROAA compared to its peers in the industry seen in exhibit 10.

The low ROAE and ROAA can be as a result of poor credit risk management leading to an increase operating expenses thus decreased ROAE. While high asset intensity leads to fall in ROAA as well as bad investment decisions.

An Analysis on Shenzhen Development Bank’s Capital Adequacy

We also need to analyze the capital adequacy of SDB before investment by Newbridge.

Chinese banks were not strictly regulated by capital adequacy requirements .SDB had equity – asset ratio of 2.6% at the end of 2002, capitalization level lower to that of its international peers due to loan quality troubles and failure to generate sufficient retained earnings.

Capital adequacy ratio monitors bank’s capitalization .It has to be above a minimum level required by government to ensure sufficient solvency.

SDB ‘s CAR fell from 10.6% to 9.5% between 2002 and 2003 as seen in exhibit 9.This can be attributed to quality of assets SDB invests in ;as quality of assets lower comparatively as seen in exhibit 8;ther e has been increase in NPLs implying that SDB ‘s credit risk weighted assets has increased.

The average total CAR of SDB peers is 8.8% lower than that of SDB and the average of Tier 1 for the peers is 6.0% which is higher than that of SDB which stands at 5.2%. SDB is not well capitalized.

The CAR for SDB is low but still above minimum level of 8% set by Chinese government as per the Basel Accord .It’s still in danger of having capital adequacy issues if the calculations for capital adequacy were to change it might not be able to meet the minimum level therefore SDB has to raise its capital adequacy as result any stake Newbridge has in SDB might potentially be diluted by large capital infusions .This leads to Newbridge stake in SDB to fall meaning that the price Newbridge should pay for its stake should be decreased given lower value of the investment.

To support loan growth, bank has to take more deposits and increase equity capital in order to maintain appropriate financial leverage and meet capital adequacy.

Evaluation of Newbridge’s Investment

Based on our analyst, financial performance of SDB is poor so the Newbridge investment seems unsound. We are going to talk about valuation of 1.6 times book value for the stake .The value seemed inappropriate as a result of the 5.5 times multiplier from exhibit 13 but it’s not the case it’s the multiplier with problem .There is belief that the multiplier is high only because SDB is overvalued as a result of the supposed increase in investors interested in getting a stake in SDB at relatively high prices. According to this notion the 1.6 times book value price seems like an unsound valuation.

There have been some past successful transactions that are similar to Newbridge investment that can be used for comparison to assess the probable valuation for SDB; this can be referenced in table 1 in appendices. Using this information the average price to book ratio for the past deals is 1.34 times book value lower than the SDB 1.6 times book value price paid hence this is an inappropriate price for SDB.

Based on the multiples valuation ,compared to SDB , its peers ;CMB ,Minsheng and SPDB with regards to financial and investment performance are doing better as seen in exhibit 10;CMB, Minsheng and SPDB have lower NPL ratio 0f 6%,3.4% and 4.4% respectively compared to 11.6% of SDB and have higher ROAA of 0.6%,0.5% and 0.6% respectively compared to 0.3% of SDB .ROAE of 17%,14.2% and 15.9% compared to 9.1% of SDB .

Price –book (2002) exhibit 13; 2.3times, 2.2 times and 4.9 times compared to 5.5 times of SDB.

As regards to these ratios, it seems SDB‘s 1.6 times book value is overvalued given its poor performance compared to its peers in the industry.

As regard to the financial investors, these are more concerned with liquidity than strategic