Period

2Q16/1H16

Actual vs. Expectations

Hong Leong Bank (HLBANK)’s 1H16 Core Net Profit of RM847m (-23% YoY) is below our and consensus estimates, representing 42% and 40% of respective full-year forecasts, underpinned by allowances for impairment losses and a one-off mutual separation (MSS) scheme expense of RM172m executed in Dec 15. Excluding the MSS, CNP would have been RM978m and met ours/consensus estimates at 49%/47%.

Dividends

As expected an interim dividend of 15.0 sen/share was declared.

Key Results Highlights

1H16 vs.1H15, YoY

HLBANK’s CNP was down by 23% underpinned by: (i) a one-off MSS expense, (ii) allowances for impairment of RM84m (vs. write-backs of RM69m in 6M15), and (iii) lower contribution from its associates in China (-21.9%) to RM143.5m. The China operations contributed 11.8% at the pretax level (excluding MSS costs) vs. 13.0% contribution in 1H15.

Total income improved by 2.9% due to stellar performances from non-interest income (NOII) at +33.2% but mitigated by a drag in net interest income of -6.2% due to higher costs of deposits. On an annualised basis, NIMs fell by 21bps to 1.8%. NOII was bolstered by higher forex gains of RM100.9m (1H15: -RM23.6m) and from dividend income (+47%) from investment in wholesale funds. Both of the income contributed 33.7% of NOII (1H15: 7.2%)

Cost-to-Income Ratio (CIR) went up by 15ppts to 53.5% due to the one-off MSS expense. Excluding the MSS, CIR would have come to 45.3% (within our expectations of 43.1%). Industry CIR was at 45.5%

Loans grew at a faster pace of 8.4% (vs industry’s +7.9% while deposit growth was almost similar to loans with growth of 8.9% (vs industry’s +1.8%). Hence, Loan-to-Deposit Ratio (LDR) fell by only 40bps to 80.1%. (vs. industry’s LDR of 86.5%).

Asset quality improved as Gross Impaired Loans Ratio fell by 12bps to 0.86% while Loan Loss Coverage (LLC) fell by 4.2ppts to 125.5% (vs. the industry LLC of 96.2%)

Despite better asset quality, the credit charge ratio still registered at 15bbps vs. the 1H15 credit recovery of 13bps.

Capital level remained healthy with CET1, Tier 1 and Total Capital Ratios at 13.3%, 14.4% and 16.2%, (vs. 1H15 of 10.8%, 12.2% and 14.7% respectively) due to the renounceable Rights Issue of RM3b executed in December 2015.

Annualised ROE fell by 5.3ppts to 9.6% as net profit dipped (cum-Rights). Excluding MSS expense, ROE would have been 11.1%.

2Q16 vs. 1Q16, QoQ

Net profit continued to decline at 31.6% (1Q16: -18.2) due to MSS and contributions from its associates which fell by 28.6%. Excluding MSS expense, CNP would have been RM516.1m (+2.6%).

Total income improved by 5.9% bolstered by higher NOII at 11.8%.

NIMs improved by 2bbps to 1.8% while the credit charge ratio was up 21bps (1Q16: 9bps) due to higher impairment allowances. CIR was up by 16ppts to 61.3% due to MSS expense.

Loans outpaced deposits growth at 1.3% vs. 0.7%. (1Q16: +2.6% and +2.3%, respectively).

Asset quality deteriorated slightly with GIL up by 3bps to 0.86% (1Q16: -1bps) and total allowances to loans flattish at 1.08%.

Outlook

As earnings were within expectations (minus MSS) we maintain our assumptions for FY16E/FY17E such as: (i) loan growth at 8% for both years, (ii) deposits growth for both years at 7%, (iii) CIR at 43%/42%, and (iv) credit charge ratio of 30bps/29bps, respectively.

Change to Forecasts

Due to the one-off MSS expense and China’s weak contributions, we tweaked our FY16E/FY17E earnings by - 8.3%/-0.4% to RM1848m/RM2097m respectively.

Rating

Downgrade to Under Perform.

Persistent economic uncertainties domestically and in China may hamper share price performance. Furthermore asset quality may deteriorate further due to the economic uncertainties.

Valuation

We revised downwards slightly our GGM-TP to RM11.39 (from RM11.51 previously) as we roll over our valuation to FY17 based on 1.15x FY17 P/B (previously 1.2x CY16 P/B). We employed: (i) COE maintained at 9.7%, (ii) FY17E ROE of 10.4% (previously CY16 ROE of 10.7%), and (iii) terminal growth rate of 4.5%. The lower P/B is to reflect the lower ROE going forward.

Risks

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

Weaker contribution from its Chinese associate due to persistent economic slowdown.

Slower-than-expected loans growth and deterioration in asset quality.

Rising credit charge as result of an up-cycle in non-performing loans (NPL).

Source: Kenanga Research - 24 Feb 2016