CLSA Asia-Pacific Markets says PUBLIC BANK BHD []’s premium is unjustified as its tangible equity ratios are relatively weak compared to its regional peers.

The research house also said the bank’s dividend is likely to disappoint on expectation of consensus earnings downgrades and cash conservation to lift core capital adequacy ratio (CAR).

“We have cut our target price from RM9.20 to RM6.20 (based on target price to book of 2.2 times) and downgrade the stock to sell from outperform,” it said a report yesterday.

Public Bank has no plans for an equity cash call but it is looking to issue Tier-1 hybrids to boost its core CAR. Assuming a RM1 billion Tier-1 hybrid issue, the bank’s core CAR will improve to 8.6% but earnings will fall by 2%-3% in FY2009-2010 due to higher interest expenses, said the research outfit.

The yield on the potential hybrid issue could be high at 7%-8% due to the surge in bond yields. But excluding hybrids, Public Bank’s core Tier-1 CAR is low at 6.5%, it added.

CLSA noted that compared to regional peers, Public Bank would be perceived as more vulnerable to economic shocks due to its relative low tangible equity. The bank’s good asset quality and ability to generate capital internally mitigates the risk.

The research house believed Public Bank’s low CAR has to be seen in the context of its good asset quality both in terms of its investments held and loan book. Furthermore, its investments comprised mainly sovereign bonds and money-market instruments with low credit risk and it has a low exposure to corporate bonds.

“Assuming a RM1 billion non-innovative Tier-1 capital securities issue, hybrids as a percentage of Tier-1 capital will increase from the current 16% to 24%. To conserve capital, we believe Public Bank will reduce its dividend payout,” it added..

CLSA cut its dividend forecasts for Public Bank by 31%-36% for FY09-10, assuming a lower payout of 40% compared to 60% previously. However, it said there was still potential for the bank to distribute its remaining 80.4 million treasury shares as share dividends, allowing it to lift net yield to 4.7% in 2009.

Competition for consumer loans is heating up with Maybank trying to regain domestic market share with low mortgage rates — 2.3% for some property launches.

CLSA said this would put pressure on Public Bank’s net interest margin as it reduced mortgage rate to compete going forward. “We expect earnings to disappoint the market as loan-loss provisions rise,” it said.

As investors increasingly look at price-to-tangible book to value banks, Public Bank’s ratio of 3.5 times is the highest among regional peers.

This valuation method excludes intangibles amid investor concerns over potential writedowns of goodwill and the amount of real equity needed to support the group in the current global downturn.

“Regional peers’ share prices have fallen sharply while Public Bank has outperformed in relative terms. The bank’s PB (price to book) of 2.8 times is at a 155% premium to the regional financial-sector average of 1.1 times.

“This premium has widened substantially above the 14-year mean of 58%,” said CLSA which believed that the premium will revert closer to the mean on concerns over the bank’s relatively low core CAR constraining the dividend payout.

Public Bank lost 20 sen to close at RM7.30 yesterday.

This article appeared in The Edge Financial Daily, March 12, 2009.