Malaysia Public Bank - Solid as a rock

Public is targeting mid-teens loan growth over FY09, aiming to outpace the broader sector for the eighth year in a row and build on its current loan market share of 15% (FY01: 6.4%). The focus is on mortgages, hire-purchase and SME lending, collectively making up more than 80% of its loanbook. Management has conservatively moderated the pace of expansion in Hong Kong and Cambodia, but with the core Malaysian market making up more than 90% of total assets, the resultant drag on earnings growth is marginal. Fee income growth is expected to be relatively flat over FY09F, as strong non-trade areas like remittances and insurance are overcome by weakness in trade-related revenues and in the unit trust division, where YTD gross sales are RM2.2bn, against RM7.6bn in 2008.

With the loan-deposits ratio just under 75% and interest rates trending lower, the group’s aggressive growth strategy is supportive of margins as excess liquidity is deployed out of the interbank market into loans. Coupled with positive re-pricing trends in the corporate and hire-purchase segments as well as a favourable funding structure (15.5% deposits market share), aggressive price competition in the mortgage and SME spaces are being substantially mitigated, hence cushioning the margin decline.

Public’s gross NPL ratio as at 1Q09 remained at a remarkable 1%, compared to 4% for the broader sector, with loan loss cover above 100%. Credit costs are largely unchanged from the previous year with 90-95% of customers being middle income with relatively higher credit risk ratings, while the SME portfolio is 80% comprised of non-export related businesses and has been helped by government credit support initiatives. Loan-to-value (LTV) ratios are conservative, at 50% for SMEs and 60% for mortgages, boosting recovery prospects in the event of delinquency.

While Public’s group end-1Q09 Tier 1 ratio appears low at 7.6% (sector: 12-13%), management is comfortable in maintaining a balance sheet leverage ratio in excess of 20x given the high quality of the assets being accumulated as well as the stability of the group’s retail funding base. Further, capital ratios are seen to benefit from the introduction of FRS 139 in 2010 (to add 1pp to the Tier 1 capital ratio), which will reduce general provisioning requirements as well as further Basel II-related capital improvements in 2011 (to add another 1.2ppts to the Tier 1 capital ratio) when the group makes the transition from the current standardised approach to the more rigorous internal ratings based (IRB) approach in 2010. Public raised RM1.2bn in noninnovative capital in June 2009, boosting the Tier 1 ratio to over 11% at the bank level, and more non-core equity capital is to be tapped, including innovative and noninnovative hybrid Tier-1 capital as well as subordinated debt, with the aim of optimising the group’s capital composition and hence ROE generation ahead of potentially restrictive new regulatory requirements on capital backing. Aiding the capital optimisation process will be a sustained high dividend payout policy of around 75% of earnings (the previous three year average is just over 5%), comfortably maintaining the dividend yield above 5%. Hence, medium-term group Tier 1 and CAR ratios are targeted at 8-9% and 13-14%, respectively.

Continuing to gain market share and with balance sheet ratios and ROE the bestgrounded in the industry, we believe low-beta earnings, a generous provisioning buffer and solid dividend yield conviction will continue to underpin premium valuations. The Gordon-growth derived target price (methodology unchanged; cost of equity at 11.5%, sustainable ROE of 24%, long-term growth of 5%) is RM9.00, or 2.6x FY10F book value and 11x FY10F earnings. In terms of risks to our view, as a consumer bank, Public Bank faces the possibility of higher-than-expected unemployment affecting customers’ ability to repay loans, and thus higher NPLs. This is true for both its Malaysian operations, and even more so in Hong Kong, where it runs a high-risk, highreturn consumer finance operation.