It's been tough few weeks for one of Malaysia’s conservative banking groups. Public Bank has taken a ferocious hammering in the market. Its foreign shares slumped 4.3% to M$3.12 today (Monday), continuing the slide that began after it first unveiled its merger plans with Hock Hua Bank last June. The problem is in the fine print: the banks' intention to merge had been known for a long time, it was the details that shocked investors. Few were prepared to see Public Bank's commercial banking business transferred to another listed unit, or for its foreign shares to be tossed aside, analysts say.

“Investors aren’t happy to see the banking business stripped out, even if it gives shareholders a lot more options in future,” says a banking analyst in Kuala Lumpur.

These are the merger plans that have got investors steaming:

  • Public Bank will sell its commercial banking business and four subsidaries to Hock Hua Bank.   
  • Hock Hua Bank will issue 721 million shares – giving Public Bank an 85% stake in the smaller banking entity.   
  • Public Bank will make a general offer for the remaining shares – offering Hock Hua minorities either cash or shares in Public Bank.   
  • Hock Hua’s controlling shareholders, the Sarawak Ling family, pledges not to take the cash offer.   
  • Hock Hua will make a bonus issue and raise its paid-up capital to M$5 billion ($1.3 billion).   
  • Hock Hua will issue five new shares for every two existing Hock Hua shares.   
  • Public Bank redistributes 28% of Hock Hua shares to Public Bank shareholders, in order to maintain Hock Hua Bank’s listing status.

Investor dissatisfaction with Public Bank was unexpected. The bank has always been a firm favourite with foreign investors because of its conservative management style. Unlike other Malaysia banks, its consolidation process was expected to be smooth and painless – in contrast to Malayan Banking Bhd's trouble in taking over PhileoAllied Bank, and AMMB Holdings and Utama Bank's failure to agree on terms at all.

“Public Bank is one of Malaysia’s most prudent banking groups. But investors are taking a back seat now to see where all these bank mergers are going,” explains Soon Teck Onn, analyst at Nomura Securities in Kuala Lumpur.

In terms of culture, the Public Bank-Hock Hua Bank merger is synergistic – both are Chinese-run banks. And there’s value, analysts say: Hock Hua has a strong franchise in East Malaysia while Public Bank has a strong West Malaysia presence. An enlarged banking group would be able to reap more business from Malaysia’s Chinese community, as many of Malaysia’s smaller, well-run Chinese banks are taken over by bigger banking entities.

The devil is in the details

According to analysts, all the frustration is with the structure. Under the present proposals, Hock Hua would become an all-powerful banking unit while Public Bank would be reduced to an investment holding company – housing all its other units, including its securities arm, finance arm and Hong Kong investment units.

Under the merger proposals, Hock Hua’s issued shares would rise from 125.38 million to 846 million following the transfer of Public Bank’s commercial banking business to Hock Hua, and would increase to nearly 3 billion after the bonus issue.

Public Bank’s issued shares, meanwhile, would rise from 2.36 billion by another 366 million if Hock Hua shareholders take up the entire share option, or by just 105.3 million if only Hock Hua’s controlling shareholders take up the share offer. (That would mean a cash pay out of M$618 million to Hock Hua shareholders). So, at maximum, Public Bank's issued shares would rise to 2.8 billion – assuming a full share swap and conversion of options as well.

A big issue for foreign investors is the lack of compensation for holders of Public Bank's foreign shares. As part of its plans to maintain Hock Hua’s float, Public Bank will distribute three Hock Hua shares for every 10 Public Bank shares held. Some investors have a problem with that. Many bought Public Bank’s foreign shares when it was trading at a premium to local shares, and figure they should get more shares than local shareholders. Foreign investors hold more than 30% of Public Bank’s stock, so how they feel and act makes a huge difference to its share price.

Public Bank is also in difficulty over Singapore's Central Limit Order Book (CLOB). An estimated 17%-18% of Public Bank's entire stock is caught up with Singapore-based shareholders, the highest exposure of any Malaysian bank stock. The Singaporeans bought Malaysian shares over the counter (through CLOB) before such trades were deemed illegal in September 1998, when Malaysia imposed capital controls. After a two-year wrangle, Malaysia finally allowed those shares to be released – gradually – into the market. This has led to a sell off in Public Bank shares in the past two to three months, analysts say.

“There's nothing in the [proposed merger] structure that should stop the bank from performing in the long term," says Tony Raza, banking analyst at Prudential Bache. "But Malaysia’s banks are more expensive than their regional counterparts in Hong Kong and Singapore. Interest rate sensitive stocks have been hit all across Asia – Malaysia’s are the last to fall. And if you throw in the CLOB issue, there’s enough reasons why Public’s share price is falling hard.”

Investors too short term?

Bankers in Malaysia accuse investors of being too short-term in vision. As one banker told FinanceAsia.com, giving Public Bank's commercial banking business a separate listing status has tremendous benefits. It means the capital standing of the bank's commercial banking units won’t be impaired whenever there is an erosion caused by non-bank units - important given that nearly every banking crisis has been precipitated by the collapse of a bank's non-banking units. Korean banks have adopted a similar solution.

Public Bank has a strategy, at least. According to analysts in Kuala Lumpur, the management plans to expand and acquire more banks. In five years' time, bankers say, Malaysia could have just five banking groups. Public Bank has already decided it will be one of the survivors. It is unclear whether investors agree with that decision.