Period

3Q15/9M15

Actual vs. Expectations

9M15 net profit of RM1.6bn (+3% YoY) was within estimates, making up 74-75% of our and consensus full-year forecasts.

Dividends

As expected, no dividends were declared. Payout is usually in 2Q and 4Q.

Key Results Highlights

9M15 vs. 9M14, YoY

The 3% increase in earnings was lifted by: (i) stronger net interest income growth (+5%) and (ii) higher writebacks (9M15: +RM76m vs. 9M14: -RM28m). Otherwise, its results would have been blemished by mark-tomarket forex losses from currency swap activities (9M15: -RM5m vs. 9M14: +RM112m).

Net interest margin (NIM) fell 6bpts as a result of stiff price-based competition in the market coupled with loans portfolio rebalancing (predominantly directed to mortgages; +16%).

Loans and deposits grew 9% and 7%, respectively. In turn, this drove up loan-to-deposit ratio (LDR) to 81% (+1ppts). Note that its loans growth was ahead of our 6% forecast but in-line with management’s target.

Current account & savings account deposits (CASA) rose 6%, making up 26% of total deposit base.

Cost-to-income ratio (CIR) was relatively unchanged at 44% as opex grew 1% while total income was flat.

Robust asset quality as gross impaired loans (GIL) and credit charge ratio fell 35bpts and 13bpts, respectively. Furthermore, loan loss coverage (LLC) stayed above 100%.

Profit contribution from Bank of Chengdu, its 20% associate company, grew 5%. It now makes up 14% of Group’s PBT, akin to last year.

Annualised core ROE declined 1ppts to 15%. This was in line with our and management’s expectations.

CET1, Tier 1 and total capital ratios were stable, growing in between 5-20bpts from last year.

Liquidity coverage and net stable funding ratios were above 100% as at end-March 15.

3Q15 vs. 2Q15, QoQ

Net profit declined 6% due to: (i) contraction in net interest income (-8%), (ii) weaker contribution from its Islamic banking unit (-6%), and (iii) lower write-backs (- 90%). However, these negatives were mitigated by a 5- fold increase in forex gains.

NIM contracted 17bpts on the back of declining yield (- 14bpts) and higher cost of funds (+3bpts)

LDR was flat at 81% as loans and deposits expanded by a same magnitude (+3%).

CIR was also flat at 45% given that opex and total income contracted by 3-4%.

Asset quality improved as: (i) GIL declined 9bpts while (ii) LLC remained above 100%. Furthermore, HLBANK was still chalking in write-backs during the quarter (credit charge ratio in the negative territory).

Share of profit from Bank of Chengdu increased 20%. We noticed that for the past three years, 3Q have traditionally been the strongest quarter, indicating some seasonal influence.

Outlook

In Malaysia, leading indicators for loans growth remains weak and we are only expecting system loans to expand by 7- 8% YoY this year (vs. 2014: +9.3% YoY). Furthermore, the industry’s relatively high LDR of over 80% makes bank lending more difficult than usual. As for asset quality, it should remain stable in 2015 as banks continue to seek out new, creditworthy customers. However, we believe that there will be an up-cycle in credit cost given that most of the bad legacy business loans were already restructured or recovered last year. On the other hand, NIM pressure is likely to persist on the back of stiff price-based competition for loans and deposits.

In China, the nation’s slower economic outlook does not bode well for HLBANK’s 20% associate company, Bank of Chengdu (BoC). Furthermore, with the People's Bank of China cutting the one-year benchmark lending/deposit rates by another 25bpts (third time in six months), banks over there are likely to experience narrowing NIM. Thus, we stand by our view that BoC’s growth should taper, in consideration of the high base effect where it delivered a stellar performance last financial year.

Save for items (ii) & (iv), no other changes were made by management to its FY15 KPI targets/expectations: (i) NIM to contract 0bpts-8bpts (9M15: -6bpts, Kenanga: -2bpts), (ii) Non-interest income as a % of total income is targeted at 21-22% (previously 25%) (9M15: 21%, Kenanga: 24%), (iii) CIR to trend lower to 42%-44% (9M15: 44%, Kenanga: 44%), (iv) Credit charge ratio at 10bpts (previously 25-30bpts) (9M15: -9bpts, Kenanga: 13bpts), (v) Total loans growth of 9% (9M15: +9%, Kenanga: +6%), (vi) LDR to be around 80%-82% (9M15: 81%, Kenanga: 81%), and (vii) ROE of at least 14% (9M15: 15%, Kenanga: 14%).

With regards to its capital raising exercise, we understand that management already submitted the necessary proposal to the regulators for approval. To note, its fully loaded CET1 ratio as at end-March 15 is 8.7% vs. Basel III minimum CET1, capital conservation and counter-cyclical buffer requirement of 9.5% (by 2019).

Change to Forecasts

Since the 9M15 results were in line with expectations, we make no changes to our FY15E/FY16E earnings of RM2,197m/RM2,289m.

Rating

Maintain MARKET PERFORM

We are vigilant over: (i) its ultra-low credit cost that is more susceptible to an up-cycle and (ii) slower potential growth from Bank of Chengdu. Also, HLBANK is looking to raise capital over the short-term. From our estimates, it could attempt to raise fresh capital of ~RM2.1bn-RM2.2bn to bring its fully loaded CET1 ratio to 11% (3Q15: 8.7%). Consequently, this could dilute its ROE by ~60-70bpts. That said, we opine that the above-mentioned negatives could have largely priced-in at current price.

Valuation

We revise down our GGM-TP to RM14.22 (previously RM15.04) based on 1.52x CY15 P/B (previously 1.61x CY15 P/B). We employed: (i) COE of 9.8% (unchanged), (ii) CY15 ROE of 13.4% (CY15 ROE of 14%), and (iii) terminal growth rate of 3% (unchanged).

Essentially, we lowered our CY15 ROE by 60bpts after taking into consideration of the dilution impact from the soon to be announced capital raising exercise.

Risks to Our Call

Steeper margin squeeze from tighter lending rules and stronger-than-expected competition.

Weaker contribution from its Chinese associate.

Slower-than-expected loans and deposits growth.

Higher-than-expected rise in credit charge as result of a potential up-cycle in non-performing loan (NPL).

Source: Kenanga Research - 27 May 2015