The seizure of Kwong On Bank by the Development Bank of Singapore (DBS) has been months in the planning, but by the time the deal was tied up on Wednesday the bank had taken a significant step towards its goal of becoming a leading regional bank. The $3.56 billion takeover gives the Singapore bank an entree into Hong Kong's well-developed and sophisticated retail banking sector at a highly competitive price. In one move, DBS has expanded its retail network in Hong Kong by 33 branches, paid at least 20 per cent discount to book and insured itself against a depreciation in the bank's value through skilfully constructed takeover terms. The offer allows Kwong On shareholders to choose amongst three forms of consideration that, according to deal broker Morgan Stanley Asia, meet the needs of all. Conservative investors have the option of a $9.50 cash consideration, 30 cents above yesterday's $9.20 close. Fuji Bank chose the second option, which offered $9 per share and a 'contingent unit' designed to protect DBS from asset-quality deterioration in Kwong On Bank. Under the contingent entitlement option, investors will receive an amount per unit, providing Kwong On's loss ratio - non-performing loans divided by the number of loans outstanding - does not exceed 6 per cent as at June 30, 2000. Should the loss ratio be between zero and 1 per cent - which appears very unlikely as conservative estimates put next year's loss ratio at 4 per cent - investors will receive $2.50 per unit. The final option allows the investor to retain a stake in Kwong On by offering five cash and contingency units plus a share in DBS Group Holdings, a DBS wholly owned subsidiary, for six Kwong On Bank shares. Kwong On is expected to have enormous profit potential in post-Asian crisis Hong Kong and unsurprisingly those connected with the deal see it as a win-win situation for all concerned. Harry van Dyke, managing director of mergers & acquisitions at Morgan Stanley Asia, said offering a contingent entitlement was rare, but Morgan Stanley had tried to address the needs of all shareholders. Mr van Dyke heralded the contingent unit as offering those with conservative views the opportunity to take the $9.50 cash offer. He said the fact that Fuji Bank had chosen to take $9 cash and a contingent unit for its controlling stake was evidence of its optimism about the future. However, he admitted that should things not go as well as anticipated then DBS will only have paid $9 per share. However, analysts in Hong Kong have raised concern that the deal is a green light to overseas investors wanting a foothold in Hong Kong's banking sector. The message is that second-tier banks in Hong Kong have lost their value and can be snapped up at a discount. 'The expectation was a premium to book for Kwong On because it was the best of the second-tier banks on offer,' Todd Martin, head of Asian banking research at Warburg Dillon Read, said. 'It looks like this is getting done at less than market price.' According to Mr Martin, the question the deal raised was does this mark the end of franchise value of small banks in Hong Kong? - franchise value defined as the profit-generating ability of a business and its positioning in the market. Mr Martin said it was clear that long-term profitability was being squeezed and the market was starting to price small banks at less than book value. 'If franchise value doesn't exist, then overseas banks can come in and not have to pay a premium,' he said. Lachlan Christie, a banking analyst at South China Brokerage, said the contingent unit did not mean that Kwong On had skeletons in the closet, it was just DBS hedging against any more Asian fallout. 'DBS is an Asian bank with Asian exposure, so it's just hedging its bets,' he said. However, Mr Christie said the offer was not good for Kwong On shareholders. Mr Christie estimated Kwong On's book value at about $12.30 per share and had been expecting an offer price of more than $11. 'Even if you look at non-performing loan [NPL] write-offs over the next year or so, you still come out with $10.50 and that is making an aggressive assumption about NPLs. So the discount to book is quite substantial,' he said. Much of the negative analysis is targeted at the short-term downsides and many agree that Kwong On will benefit enormously from synergies derived from having a leading regional bank as a majority shareholder. The bank will be managed by DBS, together with Kwong On's founding Leung family. It was this concession, as well as Ronald Leung Ding-bong continuing as chairman of the board, that was rumoured to have put DBS in with the best chance of becoming the major shareholder. DBS said it believed its partnership with the family, which has an intimate knowledge of the banking market in Hong Kong, will further enhance the franchise of Kwong On. DBS will appoint an as yet un-named managing director and joint chief executive officer who will be responsible for the management and integration of the bank with DBS. Analysts have welcomed DBS' active role in the management of the bank, saying it would be good for Kwong On to have a pro-active management team compared with Fuji Bank's hands-off approach. However, the real winner still appears to be DBS. Tony Raza, banking analyst at Daiwa Research Institute in Singapore, said the deal was pretty attractive for DBS. He said it fitted into DBS' strategy of building a regional presence and that it was important these days to have a presence in all the region's key financial hubs. Mr Raza said: 'And the price . . . is pretty cheap for a bank as banks are normally sold at a premium significantly above book value.'