This article first appeared in The Edge Malaysia Weekly on April 13, 2020 - April 19, 2020

HONG Leong Bank Bhd (HLBB) is currently one of the preferred banking stocks among analysts as the lender is seen to be in a better position to weather tougher times amid the Covid-19 pandemic. At least five of eight research houses surveyed by The Edge cite the stock as one of their top picks for the sector.

“With its strong asset quality (gross impaired loan [GIL] ratio of 0.8%), liquid balance sheet (loan-to-deposit ratio of 85%) and strong capital position (CET-1 ratio of  14% if it frees up regulatory reserves), HLBB is a safe harbour in such volatile times,” says Maybank Investment Bank Research. It has a RM15.10 target price on the stock, which suggests further upside from its closing price of RM13.34 last Friday.

Additionally, the bank has low exposure to sectors that are deemed the most vulnerable to the coronavirus outbreak.

According to HLBB group managing director and CEO Domenic Fuda, only “a small portion” — about 3% or roughly RM4 billion — of its total loan portfolio will be directly impacted by the pandemic.

“This covers retail consumers that are employed in aviation, tourism, retail and the food and beverage sectors while the impacted sectors for business customers are manufacturers, freight forwarders/transporters, hotels and restaurants. Additionally, we have very little direct exposure to airlines in our corporate portfolio [while] our exposure to the oil and gas [sector] is small, at below 0.4% of our gross loans,” he tells The Edge.

The fifth largest of eight local banking groups by assets, HLBB made a core net profit of RM1.39 billion for the six months of its financial year ending June 30, 2020 (FY2020), up 6.6% year on year, excluding a one-off gain from the divestment of a joint venture. This came in within analysts’ expectations. The bank declared an interim dividend of 16 sen a share for the period.

Being a retail bank, its consumer and SME loans account for more than 80% of its total loan portfolio. This implies that the bulk of its loan book is open to the six-month moratorium on repayments that banks are offering retail and SME customers. “We have structured our moratorium to ensure that we comply with Bank Negara Malaysia’s announcement [on the moratorium] as well as provide maximum flexibility to our customers. We have asked our customers to opt out of the moratorium if they so wish by notifying us. The response to this has been very encouraging with a good response rate since the last week of March 2020, and we are continuing to see a good daily response rate,” says Fuda.

“The other option we have provided borrowers is the flexibility for them to continue paying whatever amount that they feel they can afford during the six-month period and in whatever frequency they want to (weekly, monthly and so on). Payments made will go towards payments/repayments deferred and, hence, help customers save on interest that accrues on the loan/financing.”

Fuda believes more borrowers will, over the six months, opt to make payments according to the amounts and frequency that they can.

“Clearly, we are at the beginning of the moratorium period, but we do believe that as borrowers reassess their situation during the course of this six-month moratorium period, more and more will make payments in the frequency and amounts that they feel comfortable with and in doing so, will adequately manage their loans/financing arrangements,” he says.

“For those who would rather wait to recommence payments in October 2020, we will be here to help them along the way to ensure that repayments/payments can restart smoothly and, hence, their credit record is not adversely impacted, post the six-month moratorium period.”

Fuda downplays concerns about the possibility of a strong uptick in impairments from its 18%-owned Chinese lender, Bank of Chengdu Co Ltd (BOCD). China was where Covid-19 first hit, with the earliest known cases in December last year.

“With regard to BOCD, we apply equity accounting as they are our associate, therefore we do not consolidate their balance sheet. At the start of the outbreak in China, BOCD was rather insulated due to Sichuan province taking early precautionary measures, coupled with BOCD’s operations being mainly domestic-centric. We have been in constant communication with them, and feedback so far has been very positive, with no adverse impact to portfolio quality/non-performing loans. In fact, there are good signs that China is returning to some level of normality and, hence, impact on the overall business from the Covid-19 first-quarter 2020 event should not pose any [threat to] operational and business quality in the coming quarters.”

Nevertheless, Maybank IB Research has cut its BOCD earnings growth expectations to 5% for FY2020 and FY2021 from earlier expectations of 12% to 15%. BOCD accounted for 18% of HLBB’s pre-tax profit of RM1.7 billion in 1HFY2020. Its profit contribution during the period improved 10.3% y-o-y to RM306 million.

Fuda indicates that HLBB should be able to sustain dividend payout levels to shareholders.

“Any application for approval of dividends for banking institutions will continue to be guided by existing regulatory expectations, one of which is the banking institution’s financial strength and capital position. The six-month moratorium is a temporary relief measure and, as of now, we do not expect it to materially impact our ability to pay dividends at the normal level. We will continue to evaluate prudently dividend payouts, as we always have done. Such proposals will be subject to regulatory approvals as per existing requirements.”

Fuda points out that the bank showed a resilient set of numbers in its second quarter and is entering the current crisis from a position of strength. “While we are facing the evolving issues surrounding Covid-19 and the slower domestic and global growth, we are facing these from a position of strength with low NPLs, resilient lending/financing portfolios and very solid capital buffer.”

With HLBB’s share price down some 23% year to date, its price-to-book value has come down to one times, from 1.4 times in early January. This has priced in risks from BOCD, says RHB Research. The research house has a “buy” call on HLBB, saying it fits its preference for banks with strong asset quality and robust capital strength that will better withstand economic downcycles.

“Like all banks, HLBB will experience asset quality stress during this economic downturn, but the rise in its GILs should be manageable, given the solid quality of its loan book. Its GIL ratio was at a low 0.84% in December 2019, versus a 2.5% peak during the global financial crisis. We have conservatively factored in a higher credit cost of 11 basis points (from 9bps) for FY2021 and 8bps (from 6bps) for FY2022,” RHB Research says. It pegs a RM16.20 target price on the stock.

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