DBS Thai Danu Bank (Danu) has sold 77% of its bad debts to two parties – a fund owned by Lehman Brothers and local finance company National Finance – at an average of 29 cents on the dollar. Danu raised Bt8.4 billion ($205 million) by selling loans in default with a combined face value of Bt31 billion, according to a company statement on Thursday.

Danu, a unit of Development Bank of Singapore (Singapore’s biggest bank), becomes the first Thai bank to get rid of its bad debt altogether. The sale also sets out the pricing terms for the industry. Lehman's unit Global Thai Property Fund and National Finance are both experienced handlers of distressed debt in Thailand.

"It's lifted a tremendous weight off everyone's shoulders at Danu. It's going to have extremely positive benefits all around. They have finally closed the door to the past and can look forward to the future," says Charles Newton, spokesman for DBS in Singapore.

Danu auctioned off a mix of retail and corporate loans through a competitive price auction, according to DBS. The sale reduces Danu's non-performing loans from 34% (or Bt32.7 billion in value) in June to just 10% – the lowest level among Thailand’s 13 commercial banks.

At 29 cents on the dollar, the price is in line with a number of auctions that the Financial Sector Restructuring Agency undertook in 1998 and 1999. The agency auctioned Bt800 billion of loans that were seized from 56 bankrupt finance companies in 1997. The loans sold at 27 cents on the dollar, analysts say, with the biggest buyers being units of Lehman, General Electric Capital Corp, Goldman Sachs and Thailand’s Kiatnakin Finance.

No writebacks, a clean balance sheet

Selling the loans off will not result in write-backs for Danu, as it made provisions for 81% of the loans as of the second quarter of 2000, according to Andrew Stotz, analyst at SG Securities in Thailand. Indeed, because of the sale, Danu says it expects to recognize a loss of Bt11.6 billion.

"It's good because they end up with a clean balance sheet," says Chaiyapat Paitoon, analyst at Salomon Smith Barney in Bangkok. "But it's bad because they have to take a hit immediately. We didn't expect them to sell the bad debts at such a low price."

Paitoon says Danu's outstanding loan loss reserve was Bt14 billion to Bt15 billion at the end of 2Q00, and the bank intended to make additional provision of Bt4 billion to Bt5 billion. Instead, the asset sale means Danu will incur an additional loss of Bt11.6 billion in the third quarter of this year . The price of Danu's bad assets is close to fire-sale prices, says Paitoon, which means that the collateral value has lower real value.

But Danu is unlikely to have trouble absorbing the loss. Even with the loss factored in, it maintains a tier-1 capital adequacy ratio (CAR) of 11%, and total CAR of 16%, one of the highest among Thai banks. Danu’s CAR is exceptionally high because it raised Bt13.5 billion less than a month ago to bolster its capital. DBS picked up most of the tab. Danu says it raised the funds so it could aggressively deal with its non-performing loans, including a sale to third parties, and focus on future growth.

Why an auction?

The auction route is unusual for Thai banks, which prefer to recover the loans themselves or sell them to an asset management company (AMC). In the latter case, a profit-sharing agreement allows the bank an avenue for a write-back – either when the AMC sells the loan to another party for a higher value, or when a debt restructuring, for example, leads to greater recovery on the loan. Most of Thailand’s banks say they will be pursuing the AMC path this year, analysts say.

Thai bank observers and watchers have welcomed Danu’s move, however. Its share price rose 6.3% to Bt6.70 per share on Thursday's announcement, a mark perhaps at investors' relief. Analysts point out that many investors have grown increasingly irate in the past year that Thai banks haven’t focused enough on the business of lending and say the banks have been too caught up in squeezing more from bad loans. They argue that where there is no loans growth, there can be little growth in return on equity. As one analyst suggests, troubled banks have two ways of growing: increasing their profitable assets or reducing the size of their total assets.

Danu acknowledged this bad loan dilemma in its statement on Thursday. The NPLs sold “represent those loans requiring longer recovery time and proportionately more significant staff resources than [Danu] was prepared to continue to expend,” the bank said. “We are now entirely focused on getting back to business, and building our banking franchise in Thailand,” added Pornsanong Tuchinda,  Danu’s president.

Analysts in Singapore expect Danu to focus efforts on lending to the consumer segment, and expect a slow rise in return on equity. Danu can afford to do so, since it has completely cleaned up its balance sheet, analysts say.

Auction sets a series of firsts

Many of the non-performing loans (NPLs) that went under the auction hammer are under litigation, fuelling analysts' concern prior to the sale that Danu would face difficulties in trying to sell them. The ideal solution, they surmised, would be for the ownership of NPLs to change hands without the litigation being dropped. As it turned out, the DBS unit bit the bullet in more ways than one.

Danu sold two kinds of bad debts. The first bunch is loosely tagged as corporate and non-legal retail loans. DBS told Financeasia.com that these will take one to two months months to sign over, since transferring titles of ownership takes time. The second batch of loans are legal retail loans, and DBS expects these to take three to four months to completely hand over. DBS will drop the litigation against these borrowers first before it hands them over to their new owners.