MARC AFFIRMS ITS MARC-1/AA RATINGS ON HONG LEONG FINANCIAL GROUP’S CP/MTN

Aug 30, 2012 -

MARC has affirmed its MARC-1/AA ratings on Hong Leong Financial Group Berhad’s (HLFG) RM1.8 billion Commercial Paper and Medium Term Notes (CP/MTN) programme with a stable outlook. The ratings are based on the improved domestic market position and core earnings capacity of commercial banking subsidiary, Hong Leong Bank Berhad (HLB), after the completion of the bank’s merger with EON Bank Group (EBG), the group’s stable consolidated operating performance and risk profile, and HLFG’s recurring access to debt capital markets. The ratings are, however, moderated by pressure on the financial services holding company’s double leverage arising from its debt-funded participation in HLB’s rights offering to shore up its capitalization following the latter’s acquisition of EON Capital’s assets and liabilities.

The HLFG Group is one of the largest financial services groups in the country with total group assets amounting to RM169.7 billion as at end-March 2012. The HLFG Group consists of three principal sub-operating groups: HLB Group, HLA Holdings Group and Hong Leong Capital Group (HLC) which respectively represent the group’s commercial banking business, its insurance business, and its investment banking and asset management business. The commercial banking segment accounted for 90% of the group’s assets as at end-March 2012 and has been its principal dividend contributor.

HLB is now the fourth largest commercial bank operating in the Malaysian banking sector; it had total assets of RM156.7 billion on March 31, 2012. HLB’s recent entry into the country’s top four was aided by its May 2011 merger with EBG. The merger bolstered HLB's total loan market share and deposit market share to 8.9% and 9.5% respectively on June 30, 2011, from approximately 4.7% and 6.1% respectively excluding EBG’s loans and deposits. EBG has augmented HLB’s customer base of mostly middle market business enterprises and more affluent retail customers with its larger mass retail and SME customer base. The merger with EBG has provided HLB with a more balanced loan portfolio and a significantly larger retail and commercial deposit franchise, strengthening the bank’s long-term competitiveness and its capital generation capacity. MARC’s current view of HLB's asset quality remains favourable as the bank's loan-loss experience continues to compare well to that of the Malaysian banking sector. The bank's gross impaired loan ratio stands at 1.96% as at end-March 2012 while its loan loss coverage ratio remained robust at 149% as of the same date as compared with 2.5% and 92.1% for the banking sector, respectively. The HLB Group saw a 55.7% increase in its pre-tax profit to RM1.6 billion for the nine-month period to March 31, 2012 (9MFY2012).

MARC notes the franchise inter-linkages between HLFG’s banking and insurance operations, and views positively the recent establishment of the strategic partnership between its life insurance operating company, Hong Leong Assurance Berhad (HLA), and foreign strategic partner, Mitsui Sumitomo Insurance Company, Limited of Japan (MSIJ). MSIJ owns a 30% equity interest in HLA, which writes mainly traditional life insurance and distributes primarily through an expanding pool of tied agents, while HLFG holds the remaining 70% equity interest via HLA Holdings Sdn Bhd (HLAH). MSIJ is also the controlling shareholder of HLAH’s 30%-owned associate MSIG Insurance (M) Berhad (MSIM), a leading domestic general insurer. MARC believes that the strategic partnership has enhanced the long-term sustainability of HLA’s life insurance franchise and improved the overall earnings profile of its HLFG’s insurance operations. Excluding one-off elements, the underlying profitability of HLFG’s insurance operations has remained relatively stable, based on the 9MFY2012 consolidated financial results posted by HLAH.

The rating agency also notes progress made in increasing the investment banking revenues and earnings of HLC’s investment banking subsidiary, Hong Leong Investment Bank Berhad (HLIB). MARC expects the capital markets-driven nature of HLIB’s investment banking and retail stockbroking businesses to continue to be reflected in a higher degree of earnings volatility compared to HLFG’s other business segments. Compared to the corresponding period in FY2011, HLC posted a smaller 9MFY2012 pre-tax profit on account of lower investment banking revenue, pressure on asset management fees and increased overhead costs.

At the holding company level, HLFG’s double leverage ratio surged to 152% as at end-March 2012 from 88% in FY2011 due a significant increase in external borrowings to fund its additional equity investments in HLB. Holding company level current debt remains above historical norms in spite of HLFG’s efforts to mitigate strain on its capital position and debt service capacity through deleveraging; net debt repayments for the financial quarter ended March 31, 2012 amounted to RM603.0 million. The holding company’s bank and capital market borrowings stood at RM1.6 billion as at end-March 2012 as compared to RM2.2 billion as at end-June 2011 (end-June 2010: RM720.3 million).

In the coming quarters, MARC anticipates an increased reliance on HLB to upstream dividends as the rating agency expects dividend distributions from HLFG’s other operating subsidiaries to be constrained in the near to medium term by their need to maintain satisfactory regulatory capital buffers. (HLFG had already received a capital repayment amounting RM937.5 million from HLAH in FY2011.) At the same time, MARC is mindful that HLB's ability to upstream dividends will also be dependent on its need to maintain its capital strength and to address its growth needs. The rating agency foresees that capital build-up at HLFG will be reliant on retained earnings in the absence of new equity.

The stable rating outlook reflects the expected resilience of the stand-alone credit profiles of the group’s banking and insurance operations as well as MARC’s expectation that HLFG will make substantial progress towards lowering its double leverage ratio to its target level of 130% in the next 15 months. Any deterioration in the asset quality, underlying earnings or capitalisation of HLFG’s core banking and insurance operating entities will exert pressure on the consolidated credit profile of the group to the extent that the financial flexibility of HLFG remains intrinsically linked to the stand-alone credit profiles of the group’s banking and insurance operations. The stable outlook also assumes HLFG’s recurring access to debt capital markets given the relatively high level of short-term debt capital market funding within its balance sheet.

Contact:

Sharidan Salleh, +603-2082 2254 / sharidan@marc.com.my.