OCBC will soon complete the funding exercise for its takeover of WHB. Although the proposed rights issue  would dilute FY15F EPS by a mild 3%, the acquisition would lower ROE to 11.6% and CET-1 to 10.2%. With the  acquisition expected to be  EPS  and ROE  accretive only in 2017, we believe OCBC would continue to trade below mean multiples in the near term.  Maintain NEUTRAL on OCBC, as we prefer DBS for exposure to Greater China. 

Proposes  SGD3.32bn  rights  issue.  OCBC  has  proposed  a  1-for-8 rights  issue  (RI)  of  440.05m  new  shares  at  SGD7.65  per  share.  With SGD2,976m  raised  earlier  from  the  issuance  of  Tier-2  subordinated notes  and  its  Scrip  Dividend  Scheme,  the  RI  net  proceeds  of SGD3,320m  (ex-estimated  expenses  of  SGD50.2m)  would  bring  total funding  to  SGD6,296m.  This  would  sufficiently  cover  total  cash consideration of SGD6,228m (USD5.0bn) paid for its takeover of Wing Hang Bank  (WHB)  (302 HK, NR). OCBC would trade ex-RI on 25 Aug and management expects to complete the cash call by end-Sep 2014.  

Financial  impact.  Management  reiterated  its  earlier  guidance  that  the acquisition would only be EPS and ROE  accretive in Year 3 (ie  2017).With  the  RI  expanding  issued  capital  by  12.8%,  we  expect  a  mild  3% dilution in FY15F EPS. However, ROE would be cut by 110bps to 11.6%and  the  fully-loaded  common  equity  Tier-1  (CET-1)  ratio  would  fall  to 10.2%  (June  2014:  11.3%).  With  capital  management  plans   in  place, management  believes  OCBC  would  have  sufficient  capital  to  support growth without  the  need for another  RI.  We will include  the adjustments in our forecasts and TP after the stock goes ex-RI.

Key  risks  from  this  acquisition  include:  i)  execution  of  strategies  to capture  offshore  CNY  flows  and  growth  of  its  wealth  management business, ii) management of OCBC's capital position,  and iii) integration of operations and retention of WHB customers.

Maintain  NEUTRAL.  At  theoretical  ex-RI  price  of  SGD9.92,  OCBC  is valued at 10.6x FY15F P/E and 1.2x FY15F P/BV (historical mean: 12.7x P/E and 1.5x P/BV).  Although we believe the market has priced in the WHB  deal,  valuation multiples  would likely remain  below trend given the dilution impact over the next 1-2 years.  We prefer DBS (DBS SP, BUY, TP: SGD21.00) for exposure to Greater China prospects.

Proposes SGD3.32bn rights issue.  OCBC has proposed a 1-for-8 rights issue of 440.05m  new shares at  an issue price of SGD7.65 per rights share. The rights price is  at a 25% discount to the pre-announcement closing price of SGD10.20 on 15 Aug2014,  and  a  23%  discount  to  the  theoretical  ex-rights  price  of  SGD9.92. Management expects to complete the right issue by end-Sep 2014.

Completes funding  for  WHB  acquisition.  In its announcement, management said the rights issue will strengthen OCBC's balance sheet following the   completion of its takeover offer of WHB in end-July  2014. Proceeds from the capital-raising exercise will be utilised for general corporate funding purposes.
To recap, in April 2014, OCBC made a voluntary general offer (VGO) to acquire WHB shares  at  HKD125  per  share.  At  the  close  of  the  VGO  on  29  July  2014,  OCBC acquired  and  received  acceptances  totalling  300.73m  WHB  shares,  representing 97.52%  of  WHB's  issued  capital.  Total  consideration  for  WHB  of  HKD38,723m (USD4,997m or SGD6,228m) will be fully settled in cash.

With  the  proposed  right  issue,  OCBC  will  raise  the  required  capital  to  finance  the takeover of WHB.  Other capital management exercises undertaken  include issuance of  USD2.0bn  subordinated  notes  that  qualify  as  Tier-2  capital  under  the  Monetary Authority of Singapore's Basel III framework  in April and June 2014,  and SGD486m from reinvestment of FY13 final dividend under the Scrip Dividend Scheme.

 

Financial impact from WHB acquisition with rights issue
Acquired  WHB  at  1.77x  P/BV.  OCBC's  offer  price  of  HKD125  per  WHB  share values  the  Hong  Kong  lender  at  1.77x  book  value  as  at  end-2013.  With  ROE  of 10.6%  and  ROA  of  1.06%  for  FY13,  the  acquisition  multiple  appears  unattractive compared with  Singapore banks' current valuation of 1.3x FY14F P/BV, with ROE of 11.4% and ROA of 0.95%.  The  1.77x  valuation multiple, we believe, incorporates a scarcity  premium  given  that  WHB  is  one  of  four  remaining  family -owned  banks  in Hong Kong.

Fully-loaded  CET-1  would  be  cut  by 110bps.  Based on the capital management exercises  taken,  management  expects  that  OCBC's  CET-1  capital  ratio  would  be lowered  to  13.2%  from  14.7%  (June  2014)  after  consolidation  of WHB's  financialsand taking into account the SGD20.96bn goodwill arising from the acquisition.  On a fully-loaded basis, OCBC's CET-1 of 11.3% (June 2014) would be trimmed to 10.2%. OCBC's planned subscription for additional shares in Bank of Ningbo Ltd to rai se its stake  from  15.34%  to  20%  -  which  would  involve  investment  of  SGD383m  (or USD298m) - could lower fully-loaded CET-1 below 10% vs the minimum requirement of  9%.  However,  management  believes  that  with  its  Script  Dividend  Scheme  and other capital management plans, there would not be need for another rights issue. EPS and ROE  accretive in Year 3.  Management  reiterated  its  earlier guidance that the  WHB  acquisition  would  only  be  EPS  and  ROE  accretive  in  Year  3  (ie  2017). Management  did  not  provide  any  details  on  expected  revenue  and  cost  synergies except that it had budgeted integration costs of SGD40m-50m that would mainly be investments in systems and technology.  Management believes the low-hanging fruit from the acquisition would include cross-selling of treasury, wealth management and bancassurance products and services. 

Assuming  WHB's  FY13  net  profit  of  HKD2.19bn  is  sustained  in  2015  (excluding merger synergies and integration costs),  the 12% increase in OCBC's issued capital would  dilute  FY15F  EPS  by  3%  to  SGD0.94,  while  ROE  would  fall  from  12.7%  to 
11.6%.

 

Rationale For Acquisition
Acquisition to augment Greater China strategy.  Currently, OCBC has one branch in  Hong  Kong  and  another  in  Taiwan,  while  its  wholly -owned  OCBC  Bank  (China) has  16  branches  and  sub-branches  in  China.  Its  private  banking  unit,  Bank  of Singapore, has a branch in Hong Kong.The acquisition of WHB ties in with management's strategy to grow  OCBC's business by riding on Asian mega trends of increasing intra-Asian trade flows, Hong Kong's growing importance as a financing centre for China, and rising wealth among Asians. For management, the rationale for the acquisition includes: 
i) WHB's expertise in SME banking in Greater China  (China, Hong Kong, Taiwan and Macau) would complement OCBC China's current focus on corporate banking; 
ii)  WHB's  stronger  presence  in  Hong  Kong  would  provide  OCBC  with  significant opportunities in private banking for Bank of Singapore; 
iii) WHB would  offer OCBC an established franchise and a sizeable platform to grow its CNY-denominated businesses; 
iv) OCBC would  have expanded scale in terms of product capability, network size, customer base and market coverage with minimal duplication; and

v) Opportunities for cross-selling wealth and bancassurance products and services to 
WHB's affluent retail customers and SME clients.

WHB focuses on retail banking in HK and Macau, SME financing in China. WHB is the eighth-largest bank in Hong Kong and sixth -largest in Macau by total loans. It has a network of 95 branches in Hong Kong (67 branches), Macau (13) and Mainland China (15). In FY13, the bank derived 77.5% of pretax profit from Hong Kong, 16.6% from Macau and 6.8% from China. In Hong Kong, retail banking accounted for 54.6% of its total profit, while treasury comprised 32.7%  and corporate banking 12.7%. In Macau, WHB is focused mainly on retail banking while in Mainland China, it has a good  franchise  in  SME  financing.  WHB  has  also  carved  a  niche  in  auto  and equipment financing in Hong Kong and Macau.

As at end-2013,  Hong  Kong accounted for  66.5%  of gross loans, Mainland  China at 19.1%,  Macau at 13.7%  and others  at 0.7%.  In Hong Kong, WHB has high exposure to  the  property  sector  -  home  mortgages  made  up  28.6%  of  loans,  property investment  at  22.6%  and  property  development  at  2 .6%.  However,  asset  quality appeared healthy with  the  sector's gross impaired loans ratio at a low 0.01% at end-2013. Instead, Mainland China loans had a higher impaired loans ratio of 1.5%.

Profit from Greater China could rise to  16% from 6%.  Based on its financials  for year ended 31 Dec 2013, WHB would expand OCBC's Greater China gross loans by c.81% to SGD49.13bn (or 26% of the enlarged entity's gross loans) and lift pretax profit contribution from Greater China to c.16% from 6% in FY13. 
OCBC's Greater China loans grew at a  CAGR of 31.6% between FY08 and FY13, while pretax profit from Greater China increased at a CAGR of 83% between FY10 and FY13. In FY13, Greater China accounted for 16% (FY08: 8%) of OCBC's loans and 6% (FY10: 1.2%) of group pretax profit. DBS Group derived 26% of group profits from Greater China while loans from this region made up 36% of its total loans.

 

Source: OSK-DMG