-  We are upgrading our rating on Public Bank Bhd (PBB) to BUY from HOLD, with a higher fair value of RM19.80/share. We have rolled forward our base year to FY14F. Our new fair value is based on FY14F ROE of 21.4% (from FY13F’s ROE of 21.6%) and a fair P/BV of 3.1x (from 3.0x previously).

-  PBB’s capital levels is now rising comfortably, with group common equity Tier 1 (CET1) at a solid 8.5%, way above the 7.5% level two years ago in FY11. This is the fifth consecutive quarter of group CET1 ratio remaining above 8%. Looking ahead, we now expect this to easily surpass 9% to 9.3% by end of next year.

-  Even at the bank entity level, CET1 (if we are to assume no phase-in arrangements allowed for investments in subsidiaries and associates) is also increasing well to 8.2% in 2QFY13, from 7.0% in FY11.

-  Recall that the minimum requirement is 7%, but this has not yet included the counter-cyclical buffer which could range between 1% to 1.5%. Assuming that the CET1 ratio is raised to 10%, PBB has earlier alluded to a possible rights issue. However, given that capital levels are now being built up comfortably, we expect rights issue to be very minimal, if at all required. At most, we expect a rights issue of only RM1.5bil or 2.5% of total market capitalisation, implying an easily digestible rights issue on a 1-right-for-29-shares basis.

-  In addition, PBB’s net earnings look highly resilient, with little downside risk from either the treasury operations, or larger-than-expected credit costs. We believe treasury risk remains minimal despite recent volatility.

-  As for credit costs, risk remains low given a high collateral value for its existing loan book. PBB disclosed that collateral values are estimated at RM307bil compared to overall group gross loan base of RM198bil for FY12. This implies a low loan-to-fair value ratio of only 64%. This is positive as it means that PBB is likely to be able to sustain its low credit costs given high collateral backing for most of its loans.

-  PBB is now trading at only 2.8x P/BV for FY14F, which is the lowest the P/BV has traded to during the financial crisis, but the main difference is there are no longer any major capital issue in terms of CET1 ratio unlike the case in 2008. After 2008, PBB rerated to a high of 3.4x. Looking ahead, we expect PBB to rerate on:- (a) confirmation of higher CET1 ratios; (b) affirmation of resilient investment and trading income; (c) decent loan growth; (d) ongoing excellent asset quality; (e) rising dividend and (f) likelihood of little capital raising required ahead.

Source: AmeSecurities