Public Bank - Momentum picking up

Public Bank (PBK) reported a net profit of RM611m, up 2.9% yoy and 3.6% qoq. The better-than-expected results were mainly driven by non-interest income and stronger loans growth of 7.2% ytd. Non-interest income was mainly lifted by an increase in unit trust management fees and stockbroking income. PBK declared a gross dividend of 30.0 sen/share, or a net dividend of 22.5 sen/share or a net yield of 2.2%.

Loan approval picked up in 2Q09. Loans grew RM8.7b, or 7.2%, in 1H09, on track to meet our expectation of 15.0% for 2009. There was a strong pickup in loan approval during 2Q09, mainly driven by SME and corporate loans, a third of which came from SME refinancing. Strong loan approval will sustain loans growth in 2H09 and may even spill over to 1Q10.

Margin to remain under pressure. Though rate cuts may come to an end, the pressure on net interest margin (NIM) will continue amid PBK’s aggressive involvement in price wars to gain market share. Currently the mortgage lending rate is at a historical low of BLR-2.4%, vs BLR-2.2% in early-09. But the recent upward adjustment of the hire purchase rate by 80-100bp will mitigate pressure from mortgages.

Overseas operations unlikely to turn around in 2009. For 1H09, pre-tax profit (PBT) from overseas operations fell 24% yoy due to a 53% drop in Public Bank Hong Kong’s net profit to HK$118m from 1H09. The decline was affected by higher impairment allowance and a decline in non-interest income. Management does not foresee a turnaround in the Hong Kong operations in 2H09 due to a high level of personal bankruptcy.

Asset quality best in class. Surprisingly, absolute non-performing loans (NPL) came off in 2Q09, falling RM24m qoq and bringing net NPL to 0.8%. Although management does not rule out potential weakness in asset quality, it seemed less pessimistic compared to a quarter ago. On restructured loans, management commented that since early-08, only RM1.8b in loans were restructured, with only 7-8% of restructured loans relapsing or turning into NPLs at a rate of 30-40bp.

Potentially more special dividends. Two potential sources of special dividends: a) Potential write-back of general provisions with the implementation of FRS 139 on 1 Jan 10. The write-back will go into shareholders’ funds and this will strengthen the bank’s overall capital and core capital base. b) Another potential share dividend from the remaining 80.4m units of treasury shares. Assuming one dividend share for every 43 shares held, this will imply a net yield of 2.3%.

As at Jun 09, PBK’s risk-weighted capital ratio and core capital ratio remained healthy at 13.9% and 8.7% respectively after the proposed dividend. We maintain HOLD on PBK for its high dividend yield of 5-6% and potential special dividend for another 2% yield. Our fair price of RM9.00 implies a target P/B ratio of 3.13x, and is derived from the Gordon Growth Model (ROE: 18%, payout ratio: 65%, required return: 10%). Entry price is RM8.10.