Hong Leong Bank Bhd
(Jan 30, RM 14.02)
Maintain market perform with target price (TP) of RM15.04: With structural and cyclical headwinds weighing down the banking sector, Hong Leong Bank (HL Bank) believes its prudent growth approach in the past might pay off as 2015 should be a fairly resilient year.

To recap, its financial year ending June 30, 2015 (FY15) guidance is: (i) net interest margin (NIM) to contract (at most) by zero basis points [bps] to 8bps; (ii) non-interest income as a percentage of total income is targeted at 25%; (iii) cost-to-income ratio (CIR) to trend lower to 44%; (iv) credit charge ratio at 25bps to 30bps; (v) total loan growth of 10%; (vi) loan-to-deposit ratio (LDR) to be around 80% to 82%; and (vii) return on equity (ROE) of at least 14%.

System loan growth tapered to 8% to 9% last year (2013: +11%) and we are expecting it to decelerate further to 7% to 8% in 2015. Similarly, HL Bank saw its loans grow but a tad slower (by one to two points) during the same period; key segments are residential property (+15%) and small to medium enterprises (SME) lending (+10%).

Hence, we are keeping our FY15/FY16 loan growth projections for HL Bank at 6% to 5.5%. HL Bank expects the operations of its 20% associate company, Bank of Chengdu (BoC) to stay resilient as the “City of Hibiscus” is still playing economic catch-up with other parts of China. However, back in November 2014, People’s Bank of China had cut the one-year benchmark lending/deposit rates.

As a result, banks are likely to experience narrowing NIM (due to the asymmetrical rate cut), but asset quality may improve on the back of easing debt pressure. Hence, we reiterate our view that BoC’s growth should taper (+29%) — this is in consideration of the high base effect when it delivered a stellar performance last financial year (+40%).

To note, its fully loaded common equity Tier-1 (CET1) ratio as at end-September 2014 is 8.6% against Basel III minimum CET1 and capital conservation buffer requirement of 7% (by 2019). From our estimates, it could attempt to raise fresh capital of RM1 billion to RM1.3 billion to bring its fully loaded CET1 ratio to 10%; this is likely to be carried out by 2016. Consequently, its calendar year 2015 (CY15) return on equity (ROE) could be diluted to 13.4% from 14% and TP reduced to RM14.68.

No changes to our forecasts. The key risks are: (i) steeper margin squeeze; (ii) slower-than-expected loan growth; (iii) worse-than-expected deterioration in asset quality; and (iv) weaker-than-expected contribution from BoC.

With lack of rerating catalysts on the horizon, we maintain our “market perform” rating on HL Bank with an unchanged TP based on 1.61 times CY15 price to book value (P/BV), derived from the Gordon Growth Model (cost of equity of 9.8%, CY15 ROE of 14% and total growth of 3%). Notably, our valuation implies — one standard deviation (SD) below its five-year average forward P/BV.

We opine that the stock could potentially derate as future growth rate tapers causing ROE to fall. The only cheer for HL Bank is its low foreign shareholding structure (December 2014: 9.5%), which means less pressure in foreign fund sell-offs. — Kenanga Research, Jan 30

This article first appeared in The Edge Financial Daily, on February 4, 2015.