Hong Leong Bank - Impairment recovery catalyst

We met with Hong Leong Bank “HLBANK” management recently and came back with the view that the group is likely to see its earnings surprise, led by continuous recoveries in its impaired assets. The group is now focusing on restructuring EON Bank’s bad bank assets and this could result in asset write-backs over the next two quarter given a likely strong recovery in their values. Credit costs are likely to reach historical low in FY13 in our view. Post-meeting, we are maintaining our Market Perform rating on HLBank with an unchanged TP of RM15.20.

Strong impaired assets recoveries will underpin earnings rise. HLBANK is set to benefit from the recovery of its impaired assets going forward. We expect the credit cost rate at c.7-8bps in FY13 with management conservatively guiding for a normalised level of c.30-40bps. The improvement here is as a result of its success in restructuring previous EON Bank’s impaired loans where the borrowers have now shown improvement in their earnings and cash flows and the loans thus becoming overcollaterised by now. This rapid reduction in its asset impairment provisions will provide the group additional operational leverage.

An uphill task to grow top-line, nonetheless. However, there remains the question of whether it can repeat its strong 1Q13 revenue, particularly on forex trading gains. Note that the strong 1Q13 result was due partially to forex trading gains that contributed 25% (or about RM95m) of its non-interest incomes in 1Q13, which is not likely to be sustainable. On the overall, while it is still too early to say given the increasingly competitive environment, we do expect the top-line growth momentum to slow and to remain an overhang factor in the near term. A net interest margin compression is also likely to remain as the re-financing and re-pricing of the bank’s loans will bring down the bank’s asset yield and hence its net interest income growth.

Aided by tight cost control. That said, rises in its costs are likely to be muted as the group has strong cost management measures. Together with a moderate revenue growth, we see the operating cost to be sustained at a 45% cost-to-income ratio. The group expects lower personnel cost and adex expenditure in FY13. It has also continued to put in initiatives to extract efficiencies and synergies, resulting in the cost-to-income ratio declining to 45% in FY13’ from 49% in 4Q12.

In summary, we are seeing the positive impact from its merger synergies. Despite the low teens top line growth, say ~12%, the bottom line growth will however be at a higher mid-teens, say ~16% YoY due to a likely lower credit cost in FY13.

The improved outlook highlighted above is likely one of the reasons for the strong share price performance in the stock over the last two month. However, after the strong rally (+10.8%), we believe that the market has priced in its better prospect above. HLBANK is the best performing Malaysian bank YTD in terms of share price performance.

At the current share price level, the stock only offers a 5.6% upside to our new target price. Together with its projected dividend yield of 2.4%, the stock offers a less than 10% total return, hence our MARKET PERFORM rating. Our TP of RM15.20 is based on a targeted multiple of 2.0x the BV, implying a PER of 13.0x.

Source: Kenanga