Hong Leong Financial Group Bhd - 2008

MARC has upgraded the ratings on Hong Leong Financial Group Berhad’s (HLFG) RM800 million commercial papers and medium term notes (CP/MTN) facilities [2007 to 2014], and RM300 million CP/MTN facilities [2002 to 2009] to AA-/MARC-1 from A+/MARC-1. The ratings outlook is stable. The upgrade reflects the consistent and improving profitability of the financial services group which has allowed HLFG to maintain very strong credit protection measures at parent company level. Upstreamed dividends from the group’s established core operating entities, Hong Leong Bank Berhad (HLB) and Hong Leong Assurance Berhad (HLA), continue to represent the main source of funds for HLFG’s debt service obligations. HLB is expected to maintain its revenue and earnings momentum, good asset quality profile and strong capitalization while Hong Leong Assurance Berhad (HLA) continues to record overall growth in premiums and earnings.

Offsetting these considerations are the near term challenges the group faces operating in a highly competitive financial services environment as well as potential operational and execution risks associated with its planned foray into investment banking. Its proposed acquisitions of Southern Investment Bank Berhad and stockbroking company, SBB Securities Sdn Bhd, are expected to increase HLFG’s double leverage ratio (as measured by the ratio of HLFG’s investments in subsidiaries and associates to its equity base) to between 1.25 and 1.30 times from 1.2 times currently.

The group recorded double digit revenue growth in 2006 and 2007 while its profit before tax grew by 14.7% (2006: 7.3%). The group’s banking arm, HLB, continued to account for the bulk of the group’s profit, contributing 86.9% of the group’s pre-tax profit in FY2007.

HLB’s financial condition and performance continues to be far better than the norm for domestic banks. Notwithstanding the increasing competition in the banking sector, HLB’s strength and focus in consumer financing and to a lesser extent financing for Small and Medium Enterprises (SMEs) should continue to support its revenue and earnings momentum. Its housing loans comprised 37.7% of its total loans base as at end 2007. HLB’s housing loans growth continues to outpace the average for the banking sector. Consumption credit increased as a percentage of the bank’s total loans to 11.8% as at end-2007 from 8.7% in FY2006 in contrast to working capital loans which have declined on a relative basis. The bank’s asset  quality  compares favourably  with  that  of  its peers, reflecting  HLB’s conservative credit culture.

HLB’s bank level gross and net NPL ratios decreased to 3.1% and 1.7% respectively (industry 2007: Gross NPL 5.6%, Net NPL 3.2%). Net addition to NPLs for the six-month period ending 31 December 2007 was RM57.1 million. Under current economic conditions, the bank’s NPLs and credit costs are likely to be maintained at relatively low levels. HLB is a well-capitalized bank with a Tier 1 ratio of 13.1% and a total capital ratio of 16.4% as at December 2007. The bank’s funding is primarily from deposits generated via the bank’s retail network.

HLA, the composite insurer of the group, is the sixth largest domestic composite insurer based on asset size. At the company level, it achieved net premiums of RM977.0 million and profit before tax of RM97.5 million in FY2007. The life business wrote new premiums of RM250 million in FY2007. The 8.7% decline in gross new premiums written was offset by an increase in its retained premiums resulting in relatively flat net premiums of RM695 million in FY2007. HLA ranks as the second largest fire insurer. Whilst general insurance premiums have grown consistently, underwriting surplus and profit from operations continue to be under pressure as reflected by lower operating profit at the company and group levels compared to a year earlier.

The stable outlook reflects MARC’s expectation that future free cash flow available for dividends at both HLB and HLA will provide ample coverage relative to HLFG’s annual debt service obligations in respect of the rated facilities. Additionally, HLFG’s current ratings level anticipates reduction in HLFG’s double leverage ratio over the medium term to more moderate levels.

Strengths

• Sustainable revenue and earnings momentum of core operating entities;
• Well-established domestic financial services, retail banking, and insurance franchises; and
• Good asset quality.

Challenges/Risks

• Increasingly competitive domestic banking environment;
• Further acquisitions without significantly affecting double leverage; and
• Execution risks associated with foray into investment banking.