Shenzen Bank Analysis

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HBS Case Report: Shenzhen

Development Ban

Contents

Executive Summary ........................................................................................................................ 3

Shenzhen Development Bank’s Financial Performance ................................................................. 3

Shenzhen Development Bank’s Asset Quality ........................................................................... 3

A Closer Look into Shenzhen Development Bank’s Earnings Capability ................................. 4

An Analysis on Shenzhen Development Bank’s Capital Adequacy .......................................... 4

Evaluation of Newbridge’s Investment .......................................................................................... 5

Conclusion ...................................................................................................................................... 6

Appendices...................................................................................................................................... 7

Executive Summary

This report provides analysis and evaluation of Newbridge’s proposed investment into Shenzhen Development Bank(SDB).we are going to look at the bank’s financial performance ,asset quality earnings capability and capital adequacy.

 Also look at the appropriate price Newbridge should pay for the stake in SDB. Additional information is under the appendices of this report like tables, figures and exhibits.it is a recommended deal as we will see based on our analysis but it does of course has its upsides mainly as a result of small or limited bits of information or data.

Shenzhen Development Bank (SDB)

It was the first publicly listed bank in china ,founded 1987.in 2002,SDBhad total assets of RMB 165 billion, gross loans outstanding of RMB 84 billion and networking consisting 225 branches nationwide as in exhibit 6.it was relatively doing well in 2000,accounted for 5.1%of GDP,33% of total trade and 6.8% fixed assets investment.

As a result ,in 2000 its share price was RMB 10.32 and market capitalization of US $2,465 million, about 72.4% of shares outstanding were traded held by public and the remaining 27.6% were held by government .shares were held by three parties ;state ,legal person and public investors.

TPG Newbridge Capital (Newbridge)

It was an American firm founded 1994, was private equity firm big into Asian investment. Newbridge acquired 51%stake I Korea First Bank (KFB) ;it reshuffled management team, restructured balance sheet and improved quality of its loan portfolio and operating performance with this success it was looking for more opportunities and SDB provided this.

Newbridge got 18%stake and condition to appoint transitional committee of 8 to manage operation of SDB.

Overview of the economic situation at the time

At the time china banking sector had seen tremendous growth driven by strong economy and average GDP growth of 8.1%from 1996 to 2002.Asian banks had an average loan growth at compounded annual growth rate (CAGR) of 9.6% and 14.9% in china in same period. This was as a result of demand and time deposits being the primary investment vehicles for both corporate and retail customers.

The regulation before 2003 was done by China Central Bank and The People’s Bank Of China (PBOC).After 2003,then came the China Banking Regulatory Commission (CBRC) to regulate domestic banking institutions .China was dominated by 4 large state owned commercial banks; Agriculture Bank of China (ABC),Bank Of China (BOC),China Construction Bank (CCB) and Industrial and Commercial Bank of China (ICBC) these had numerous branches and perceived deposit safety aided them to receive low cost funding from retail and corporate customers.

Government encouraged more transparency and accuracy in bank filings, pushing Non –Performing Loan (NPL) disclosure and classification to be more in accordance with international practices. In 2002, PBOC mandated every bank to adopt the international 5-grade classification standard (normal, special mention, substandard, doubtful and loss) as opposed to the original 4-grade used.

To better monitor loan quality, SDB classified its loans based on this set up based on credit risk. Credit risk is regularly updated based o changes in various risk factors such as cash flows of borrower, value of collateral, length of overdue payment and credit worthiness of guarantor.

In 2003, 4 of 11 joint stock banks were listed on China domestic stock market; SDB ,China Merchants Bank (CMB),China Minsheng Banking Corp.(Minsheng) and Shanghai Pudong Development Bank (SPDB).As a result of WTO mandate to liberalize economy ,China lifted al restrictions on foreign banks’ investment in foreign –currency business in china .

The banking sector had been plagued by few challenges like poor corporate governance, risk management and credit monitoring systems, lack of independence for most banks i.e. poor credit limits, lack of head office control. This led to banks amassing an exorbitant amount of NPLs, massive low quality loans, undercapitalized balance sheet and poor profits as well as low return on assets. Overall average of listed banks in china had 0.47% ROA lower than average of 1.32% in US and 1.22% in Hong Kong.

SDB  Financial Performance;

Before the  investment ,Newbridge should look into the asset quality of SDB ,we use NPL ratio (NPL/Gross loan) and NPL coverage (LLR/NPL) ,lower NPL ratio means better quality of the loan portfolio. High NPL coverage ratio suggests more conservative provisioning for potential credit losses. In exhibit 10, NPL ratio of 11.6%is higher compared to that of its peers in the industry with exception to Bocom with 16.7% and its peers has an average of 7.3% meaning a proportion of SDB assets are of low quality and have high credit risk  of loans .this is as result of conflict of interest arising from management lacking independence as borrowers are same as management hence poor decision making and thus increased asset quality issues.