Banking - Addressing the new Financial Service Bill

kiasutrader

Publish date: Thu, 17 Jan 2013, 10:02 AM

While Bank Negara Malaysia's ("BNM") new Financial Service Bill (FSB) may require additional equity at financial holding companies, we believe that other measures could help to address the shortfall issue, if any, at these companies such as by them disposing off noncore assets or executing a dividend reinvestment plan. These measures could eliminate the need to raise their capital and thus prevent a dilution in the earnings of these financial holding companies or a share overhang in their stocks in the market. Once these measures are carried out, market concerns on this issue should be assuaged and this should lead to a re-rating of the likely affected banking groups such as RHB Capital Bhd (RHBCAP, OP, TP: RM8.30) and CIMB Group (CIMB, OP, TP: RM8.20) going forward.

Financial holding companies are now preparing for Bank Negara Malaysia's stricter capital requirements, which will likely come into effect soon. Apparently, BNM are already engaged in discussions with the banks on the upcoming proposed FSB. The regulation and supervision of financial groups will change under the proposed FSB where a new regulatory framework for financial groups is now currently being considered. BNM will release details of the new framework including the various capital requirements soon in the next few months. Financial holding companies that are now operating on the "double leverage" approach, where the holding company borrows the money and in turn pumps it into the regulated entities, will be affected by the new framework. We believe that financial groups that are likely to be affected are RHBCAP, CIMB and Hong Leong Financial Group (HLFG, Non-Rated).

The potential new BNM capital requirement measures above are a laudable move to further strengthen the Malaysian banking system. BNM is unlikely to require the elimination of the "double leverage" approach but may require the disclosure of the relevant group's capital ratios. Methods to address a shortfall (if any) could include raising the equity at the parent company. However, in our view, other measures would be as equally effective as well to address the shortfall such as dividend reinvestment or the divestment of non-core subsidiaries. These measures could eliminate the need to raise capital and thus prevent a dilution in the earnings of these financial holding companies or a share overhang in their stocks in the market. Once these measures are carried out, market worries on this issue should be assuaged. In any case, we hope to see a pragmatic approach from BNM in allowing the affected financial holding companies a reasonable timeframe to address any capital shortfalls.

RHBCAP - Capital boosted by DRP and OSK deal. A major concern for investors on the group has been its high leverage. We understand from management that BNM plans to impose capital requirements for financial holding companies in the near term as highlighted above. Given that the group has so far not officially discussed its capital ratios at the holding company level in its published accounts, investors are likely to be concerned that the group may find it challenging to comply with the new regulatory capital requirements, resulting in the need for it to raise its equity capital.

However, with some capital boosts from its Dividend Reinvestment Plan ("DRP") and the OSK deal,

management indicated that the consolidated group Core Capital Ratio ("CCR") would be around 8.3%. Assuming the group continues its DRP and maintains a 30% payout ratio with a take-up rate of 60%, the group's equity capital is projected to grow at 13.0% p.a. In this case, the group should then have sufficient capital to meet the potential new regulatory requirement as well as meeting its own organic growth plan, negating the need for it to raise new capital in the medium term.

CIMB - Disposing non-core assets and a one-off DRP program. CIMB is one of the two groups in our stock coverage that does not report consolidated capital ratio. The group's double leverage ratio is at 117%, which shows that the equity capital of some of its subsidiaries is funded by debt issued by the parent company. CIMB's management has estimated the group's CCR at around 8.0% as at June 2012 and is now considering earnings retention via a one-off Dividend Reinvestment Plan (DRP). Management has further stated that its earnings retention plan together with asset divestments would be sufficient to boost its capital ratio if needed and there is no urgency to issue new equity.

In addition, its CCR ratio should decline by 30-40bps after its acquisition of RBS and BoC, which should be completed by 1Q13. However, management also guided that there would be 30-80bps rise in the CCR ratio from its possible divestment of CIMB Aviva depending on the final sale price. All these suggest a range of between 7.6% and 8.4% for its CCR ratio following the above corporate events of the group.

In conclusion, we remain optimistic on the prospects of RHBCAP and CIMB and investors should take any weaknesses in their share price ahead of the new FSB introduction as opportunities to buy as we think that market concerns on them having to raise additional capitals from the likely requirement of the new regulation are misplaced. We are maintaining our overall OVERWEIGHT call on the sector with OUTPERFORM calls on MAYBANK (TP: RM10.40), PBBANK (TP: RM16.80), RHBCAP (TP: RM8.30), CIMB (TP: RM8.20), AMMB (TP: RM7.40), AFFIN (TP: RM4.40) and BIMB (TP: RM3.60). AFG (TP: RM4.00) and HLBANK (TP: RM15.20) are rated as MARKET PERFORM calls.

Source: Kenanga