Public Bank’s proposed rights issue of up to MYR5bn should help lift CET-1 ratios to 10.3-10.9% at the bank and group level respectively, and propel the group to become one of the better capitalised banks domestically. The trade-off is mid-high teens ROEs (vs FY14F: ~20%) that investors will need to accept moving forward. Pending further details, Neutral call and GGM-derived FV of MYR19.90 maintained.

• Raising up to MYR5bn Common Equity Tier 1 (CET-1) capital via rights issue ...  Public Bank announced a capital raising exercise yesterday to raise gross proceeds of up to MYR5bn via a rights issue.  While the gross proceeds have been determined, the entitlement basis  and issue price for the rights shares will only be fixed at a later date.  Nevertheless, the Board has determined that the issue price of the rights shares shall be at a discount of at least 20% but not more than 35% from the theoretical ex-rights price (TERP). The rights issue is expected to be completed by 3Q14.
• … lifting fully-loaded CET-1 ratio to >10%. We estimate group and bank fully-loaded CET-1 ratios stood at 8.4% and 7.4% respectively, as at 31 March 2014. Assuming the size of the rights issue is for the full MYR5bn, we estimate the fully-loaded CET-1 ratios for group and bank would rise by about 250-290bps to 10.9% and 10.3% respectively. This is above the 9-10% CET-1 ratio range generally cited by banks to be a comfortable capital level. In our view, management appears to have opted for a more conservative stance in terms of its capital needs. The CET-1 ratios above should help see the group/bank comfortably meet the countercyclical buffer, as well as additional capital buffers (eg SiFi buffer) that BNM may require banks to hold ahead. Public Bank would also end up as one of the better capitalised banks domestically.
• Forecasts.We have not factored in the rights issue in our model. Assuming the full MYR5bn is raised and the rights proceeds earn 3.3% p.a. (3-month KLIBOR rate), we estimate the fund raising exercise would enhance our FY14F-15F net profit projections by 1.4-2.6%. However, we estimate 3-8% dilution to our FY14F-15F EPS forecasts and 200-300bps dilution to our FY14F-15F ROE projections.
• Investment case.We keep our Gordon Growth Model (GGM) derived FV of MYR19.90 unchanged for now. Valuations already look fair and therefore, we retain our NEUTRAL recommendation on the stock.

CET-1 capital to get a boost 

Raising up to MYR5bn CET-1 capital via rights issue. Public Bank announced a capital raising exercise yesterday to raise gross proceeds of up to MYR5bn via a rights issue. While the gross proceeds have been determined, the entitlement basis and issue price for the rights shares will only be fixed at a later date. Nevertheless, the Board has determined that the issue price of the rights shares shall be at a discount of at least 20% but not more than 35% from the theoretical ex-rights price (TERP). The rights issue is subject to the approvals obtained from, among others,

BNM, Bursa Malaysia and shareholders, and is expected to be completed by 3Q14. Capital raising exercise not a surprise, but timing earlier than expected … The capital raising exercise, per se, is not a surprise, as the need for a rights issue to meet capital requirements had been well communicated by management in the past. The timing, however, was earlier than expected. This is because management had previously said that the fund raising exercise would be done once further clarity on the various Basel III capital buffer requirements is known. Note that the concept paper on countercyclical buffer is only expected to be out later this year. We understand from management that the decision to proceed with the capital raising exercise was partly prompted by recent developments such as the introduction of the minimum 1.2% collective allowance and regulatory reserve, and market conditions. … while rights issue size larger than expected, lifting fully-loaded CET-1 ratio to >10%.We estimate group and bank fully-loaded CET-1 ratios stood at 8.4% and 7.4% respectively, as at 31 March 2014. These ratios include 1Q14 net profits of MYR1bn for the group and MYR830m for the bank, and approximately MYR1.1bn that would be required to be transferred from retained earnings to regulatory reserves to meet the requirement mentioned above. Assuming the size of the rights issue is for the full MYR5bn, we estimate the fully-loaded CET-1 ratios for group and bank would rise by about 250-290bps to 10.9% and 10.3% respectively. This is above the 9-1% CET-1 ratio range generally cited by banks to be a comfortable capital level and is also above the 9.5% CET-1 ratio that BNM may require banks to hold after taking into account the: i) minimum common equity capital ratio of 4.5%, ii) capital conservation buffer of 2.5%, and iii) countercyclical buffer of up to 2.5%. A MYR5bn rights issue would also be higher than our earlier estimated MYR3bn that Public Bank would need to raise (but within the <10% market capitalisation size guidance), although this was based on the assumption of a 9.5% CET-1 ratio.

In our view, management appears to have opted for a more conservative stance in terms of its capital needs. A CET-1 ratio of 10.3-10.9% should help see the group/bank comfortably meet the countercyclical buffer as well as additional capital buffers (e.g. SiFi buffer) that BNM may require banks to hold ahead. Public Bank would also end up as one of the better capitalised banks domestically. CIMB’s CET-1 ratio was 9.5% as at end-2013 (inclusive of MYR3.55bn private placement exercise) while Maybank’s fully-loaded CET-1 ratios for the group/bank were 10.1%/8.5% respectively, as at 31 Dec 2013.

Risks 
The risks include: i) slower-than-expected loans growth, ii) weaker-than-expected NIMs, and iii) a deterioration in asset quality.

Forecasts 
Given that certain details of the rights are still not available at this juncture (eg size of rights issue, pricing of rights shares), we have not factored in the rights issue in our model. Assuming the full MYR5bn is raised and the rights proceeds earn 3.3% p.a. (3-month KLIBOR rate), we estimate the fund raising exercise would enhance our FY14F-15F net profit projections by 1.4-2.6%. However, the enlarged share and shareholders’ equity base (+25% to group’s 31 March 2014 shareholders’ equity base) would result in an estimated 3-8% dilution to our FY14F-15F EPS forecasts and 200-300bps dilution to our FY14F-15F ROE projections (see Table 3 below).

Valuations and recommendation 

We keep our Gordon Growth Model (GGM) derived FV of MYR19.90 unchanged for now. Our FV assumes 8.9% cost of equity, 18% ROE and 4.5% long-term growth. Our FV implies 3.05x FY14F P/BV, a discount to the 3.2x 10-year average. We believe the discount is fair as the group moves to a period of lower ROEs on more stringent capital requirements. For illustrative purposes, assuming 8.6% cost of equity (COE) (lower COE as capital overhang removed), 16% ROE and 4.5% longterm growth, we derive an ex-rights FV of MYR18.10 vs. a TERP of MYR19.55, assuming the rights shares are issued at a 30% discount to the TERP. In our view, the group offers investors good earnings predictability, sound asset quality and cost efficiency. The rights issue would also help lift the capital issue 
overhang and place the group as one of the best capitalised banks domestically. That said, we think valuations are already fair and therefore, we are retaining our NEUTRAL recommendation on the stock.

Source: RHB