Tuesday 25 September 2012

Hong Leong Bank - Setting Softer Targets


We  recently  met  up  with  Hong  Leong  Bank  (HLBank)’s  management, which remains cautious on the group’s overall growth outlook  amid  increasing  risk aversion.  Given  its  immediate  focus  on  managing  costs  and  sustaining  balancesheet  liquidity  rather  than  aggressively  driving  growth,  its  immediate  term earnings growth is unlikely to materially surprise on the upside. Efforts to realize meaningful revenue synergy  are now likely to unfold over a longer horizon up to 2015, while its immediate term ROE may dip a tad below management’s target of 16%-17%  for  FY13.  We  maintain  our  NEUTRAL  call  and  RM14.57  FV  (2.1x  FY13 PBV, ROE: 15.8%).

Loans growth likely to stay below industry average. Management remains mindful of the  overall  macro  headwinds  and  is  likely  to  retain  its  cautious  stance  well  into  FY13. Note  that  the  FY12  loans  growth  of  7.8%  was  well  below  the  industry’s 13% average, partially attributed to the group intentionally slowing down its auto loans growth as part of a portfolio rebalancing strategy. Moving forward, the drive for loans growth is likely to come  from  the  mortgage  and  SME  loans  segments,  with  management  retaining  its overall group loans growth targets at 7% to 8% respectively for FY13. Given the rather lacklustre growth and continued net interest margin (NIM) pressure, we believe that the group’s net interest income growth is likely to remain pedestrian.

Focus on maintaining liquidity. Management had earlier guided for an optimal loan to deposit  ratio  (LDR)  of  76%.  However,  given  the  tighter  industry  liquidity  and  growing aversion  to  risk,  management  remains  very  focused  on  maintaining  its  current  liquid balance  sheet  position  and  its  LDR  at  71.6%.  In  fact,  following  the  completion  its acquisition of EON Cap, the group’s LDR had declined from 74% to 71%. As such,  the group  is  unlikely  to  achieve  balance  sheet  optimization  by  allowing  loans  growth  to outpace  that  of  deposits  in  the  foreseeable  future,  which  would  thus  cap  any  NIM upside.
 
Overall asset quality solid. In terms of asset quality, the group has fared relatively well in:  i)  raising  the  loans  loss coverage  to  158%  from 149% in  3Q12,  and  ii)  successfully managing  credit  quality  despite  having  inherited  more  inferior  credit  quality  from  EON Cap’s  portfolio.  This  was  reflected  in  the  impressive  10.9%  q-o-q  decline  in  absolute impaired loans, which gave rise to an improvement in the gross impaired loans ratio to 1.7%  from  3Q12’s  2.0%.  Management  has  indicated  that  despite  the  currently challenging  economic  backdrop,  asset  quality  of  the  inherited  auto  and  SME  portfolio from EON Capital remains sturdy.
FRS139 write-back skewed towards the higher end. Similar to Public Bank, HLBank is likely to benefit from lower collective allowance (CA) provisioning upon full adoption of FRS139 given the group’s excess loans loss cover of over 158%  and  the  second  lowest  non-performing  loan  (NPL)  ratio  in  the  industry  after  Public  Bank.  With  its  current collective assessment provisioning hovering at 2.1%, which is significantly above Public Bank’s post-FRS139  0.8% level, there is certainly great scope to snip its CA provisions closer to 1.0%-1.6%. Although the group has not disclosed the exact quantum given that this is pending Bank Negara Malaysia (BNM) approval, management indicates that using Public  Bank  as  a  benchmark,  the  potential  quantum  of  excess  CA  to  be  written  back  is  likely  to  skew  towards  the higher end of estimates. For the purpose of calculations, we are using 1.3% as a potential base-case scenario vs the current 2.1% level, which prospectively gives rise to a one-off excess after-tax CA write-back of RM543m and a core Tier 1 equity (CTE1) capital ratio enhancement of 50bps to 8.6% at group level.
Addressing  capital  concerns.  There  have  been  concerns that the group’s borderline  8.1%  CTE1  ratios  could  potentially result in capital raising overhang if BNM were to impose the maximum 2.5% counter cyclical buffer over and above  the  minimum  7.0%  Basel  III  CET1  ratio.  However,  as  shown  in  Figure  2  below,  even  with  our  estimates  of  a one-off excess CA write-back of RM543.3m and an annual dividend payout ratio cap of 40%, the group would still be able to meet the most stringent minimum CET1 capital ratio of 9.5% by FY18. This is further based on assumption of a sustainable 11% Risk Weighted Asset growth p.a. As such, we do not see the potential of a capital raising overhang as a major risk, unless BNM imposed a total minimum CET1 ratio of above 9.5%.
Source: OSK

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