We upgrade our rating on Hong Leong Bank Bhd (HLBB) to BUY from HOLD, with a higher fair value of RM17.10/share (from RM15.90/share previously). We have rolled forward our base year to FY15F, with our fair value now based on an ROE of 14.5% for FY15F (from 14.5% for FY14F previously) and an unchanged fair P/BV of 2.0x.

- We believe that there is room for NIM enhancement ahead for HLBB. Base lending rate has been adjusted upwards by the same quantum of 25bps across the board by most banks following the recent rate hike, but what has been largely ignored is the different rate of adjustments for deposit rates. While bigger banks such as Maybank and PBB have raised fixed deposit rate by 23bps to 24bps, HLBB’s hikes has been much lower, averaging at only 15bps.

- We believe that HLBB may not need to raise its board rate aggressively due to two key reasons. First is HLBB’s relatively low LDR, with HLBB being ranked the best in terms of LDR among all the banks. HLBB’s LDR is lowest currently at 79.7%, while other banks’ LDR are hovering between 88% and over 90%.

- Secondly, HLBB has the highest proportion of contribution to deposits by individuals, which makes up 52.3% of its total deposit. For the other banks, it ranges between 27% and 45%. This indicates lesser competitive pressure for HLBB to participate in fixed deposit campaigns, which means that its board rates may be maintained at a lower rate than its peers.

-On that basis, we are assuming a lower rate of increase for fixed deposit for HLBB, at 20bps instead of 25bps for each round of rate increase. Note that our assumption is on the conservative side, given HLBB’s recent increase of only 15bps on average. Purely on this adjustment, our earnings is upgraded by 4.7% for FY15F and 12.2% for FY16F (assuming another 25bps rate hike in December 2014). Consequently, our ROE is uplifted to 14.5% for FY15F from 13.9% previously.

- HLBB’s share price had barely budged in the past two years. We believe that this is due to concerns over its low banking entity CET1 ratio (on a fully-loaded basis) as well as recent speculation that HLBB may need to do a rights issue. Given the upgrades to our earnings, our sensitivity analysis indicates that any possible capital shortfall by 2018 is now reduced to only RM1.6bil, from our previous estimates of RM3.0bil. This implies a much smaller rights issue, on a 1-for-12 basis (vs. our previously forecasted 1-for7-basis). This translates to a possible new fair value of RM16.30/share FY15F on an ex-rights basis, which still allows a decent upside.

Source: AmeSecurities