DBS announced a rights issue to raise net proceeds of $4bn, shortly after its $1.5bn preference shares issue in May 2008. The rights issue comprises of 760,480,229 rights shares on the basis of one rights share for every two ordinary shares. The rights price of $5.42 represents 45% discount to the last traded share price of $9.85 on 19 Dec and 35% discount to the theoretical ex-rights share price of $8.37. Its largest shareholder, Temasek intends to subscribe up to 33.3% of the rights issue.

Besides a boost investor’s confidence, a stronger capital position will give DBS an edge to take advantage of growth opportunities such as strengthening its customer relationships and to grow its loans book. The capital raising is mainly to be use for organic growth and not intended for any M&A or extraordinary provisions. This huge capital injection looks timely to ease the burden of a challenging earnings outlook ahead where loans and fee income are set to slow along with potential higher NPLs.

This $4bn capital raising will boost the group’s Tier 1 ratio from 9.7% to 11.8%, catching up with UOB and OCBC who have Tier 1 ratios that exceed 10%. In fact, DBS will likely surpass its peers to have the largest excess tier 1 capital among the Singapore banks post the rights issue. However, this comes with an adverse impact to its EPS and book values per share (BVPS). We estimated the rights issue to dilute DBS’s EPS by 33% and reduce its diluted BVPS (as at 9M08) from $12.69 to $10.28.

According to the group’s trading update as at 22 Dec 2008, its 4Q net profit before one-time charges could end up moderately lower than in the previous quarter. One-time items in 4Q are expected to comprise charges for the recent staff restructuring of approximately $45m and for a further impairment of the banks’ investment in TMB Bank. A review of the carrying value of DBS’s investment in Cholamandalam DBS finance Ltd (at $103m) is also being undertaken for the 4Q results in view of the liquidity stress experienced by non-bank financial companies in India.

Our target price has been lowered to S$10.70 (based on FY09 BVPS) after taking into account full impact of the rights issue. Lack of earnings catalysts, coupled with the dilution from rights issue will likely to depress the share price in the near-term.