Puts In Bid For Wing Hang Bank
According to media reports, OCBC  is said to have placed a bid for Wing Hang Bank (Wing Hang), Hong Kong's second largest family-owned bank. Reportedly, OCBC's bid  values  Wing  Hang  at  less  than  2x  P/BV,  which  puts  Wing  Hang's  value  at SGD6.7bn  (USD5.3bn)  based  on  its  30  June  2013  numbers,  or  around HKD133/share (13% premium to last closing price). Background  of  Wing  Hang.  Wing  Hang  is  one  of  four  remaining  family-owned banks  in  Hong  Kong.  Its  major  shareholders  are  the  Fung  family  and  BNY International  Financing  Corporation,  who  collectively  hold  a  45%  equity  stake.  The bank's  business  spans  across  Hong  Kong,  China  and  Macau,  served  via  over  70 branches.

Wing Hang reported  a net profit of HKD1bn  (SGD165m)  for  1HFY13,  down   2% y-oy,  mainly due to lower net gains from trading and financial instruments designated at fair value through profit or loss. Its annualized gross loan growth stood at 15%, driven by  trade  financing  and  corporate  lending.  While  deposit  growth  was  just  2% (annualised),  liquidity  appears  healthy,  with  the  loan  to  deposit  ratio  at  71%.  The bank's  ROE  and  ROA  stood  at  10.1%  and  1%  respectively  while  asset  quality appears  sound,  with  a  gross  impaired  loan  ratio  of  0.36%,  while  its  loan  loss coverage was 63%. Finally, CET-1 ratio was 10.8% as at end-June 2013.

Greater  China  expansion  ties  in  with  regional  strategy...  The  bid  is  unlikely  to surprise  investors  as  OCBC  has  said  that  it  is  open  to  potential  M&A  activities, especially  if  these  involve  any  of  its  four  key  markets  of  Singapore,  Malaysia, Indonesia  and  Greater  China.  OCBC's  Greater  China  operation  via  Bank  of Singapore  currently centers around corporate banking and retail banking.  It is likely that  Wing  Hang  is  seen  as  a  gateway  to  China,  as  well  as  potentially  enhancing OCBC's position to participate in the offshore yuan market and wealth management.

Based  on  OCBC's  1H2013  numbers,  Greater  China  made  up  13%  of  group  loans and 5% of pre-tax profit. The acquisition of Wing Hang will help double the size of OCBC's  Greater  China  loan  book  to  about  SGD40bn  (22%  of  gross  loans  for  the enlarged entity) while  the  pre-tax profit contribution from Greater China could rise to around 15%. The acquisition will also help OCBC to close the gap  with  DBS (DBS SP,  BUY,  FV:  SGD19.40)  in  terms  of  exposure  to  the  Greater  China  region.  Th at said,  there  will  still  be  a  significant  gap  to  be  bridged  in  terms  of  loans,  as  DBS reported  gross loans of SGD79.4bn  in  Greater China (33% of group loans). Pre-tax contribution from Greater China, however, was lower at 9% for DBS.

... but it's a  matter of pricing.  While pricing details are lacking, we think a price of 2x P/BV for Wing Hang is not particularly attractive, especially  stacked against  the Singapore  banks'  1.1-1.3x  FY14  P/BV  but  better  projected  ROEs  of  11-12%. Meanwhile,  the  recent  Chong  Hing  Bank  (Chong  Hing)  deal  could  have  set  a benchmark for M&A transactions with respect to family-owned banks in Hong Kong. In  Oct 2013, Yue Xiu Group offered to pay 2.1x P/BV to acquire  a 75% equity stake in Chong Hing. Compared with the Chong Hing transaction, a 2x P/BV for Wing Hang would be  more palatable from the standpoint of:  i) size, as  Wing Hang is about 2.5x larger than Chong Hing in terms of total assets; and  ii) profitability, as Chong Hing's annualised 1H2013 ROE and ROA stood at 7.5% and 0.7% respectively.

Impact  on  financials.  Assuming:  i)  an  acquisition  P/BV  multiple  of  2x  and  OCBC acquires a  100%  equity  stake  in Wing  Hang,  resulting  in  a  total  purchase  price  of SGD6.7bn;  ii)  the  acquisition  cost is funded via  equity  (issued at  a  10% discount  to the stock's  last close price);  ii) Wing Hang  sustains an annual net profit of HKD2bn (ie annualised 1HFY13 net profit); and iv) excluding merger synergies and integration costs,  we estimate  a dilution of 8% and 120bps to OCBC's FY14F EPS and FY14F ROE respectively.

Risks
The  risks  include:  i)  slower-than-expected  loans  growth,  ii)  weaker-than-expected NIMs, iii) weaker-than-expected capital market activities, iv) a deterioration in asset quality, v) adverse impact from rising bond yields on its securities portfolio; and vi) overpriced acquisitions. OCBC (OCBC SP)

No change to our earnings forecasts for now.Valuation and Recommendation

Our FV  of  SGD10.90  is based on  a  target P/BV multiple of 1.45x.  This is at a slight discount to the 5-year average P/BV  of 1.5x to take into account, among others,  a lower projected ROEs of around 11% compared  with 11-12% ROEs in the past. We think concerns  over  the potential dilution from the Wing Hang acquisition could also keep valuations below averages in the near term.  In the longer  term, the acquisition may  put OCBC on stronger footing to tap into the Greater China region for growth, although execution would be key. Thus, we  are maintaining our  NEUTRAL  call on the stock for now.

Source: OSK