Hong Leong Financial Group Bhd - 2009

MARC has affirmed the ratings on Hong Leong Financial Group Berhad’s (HLFG) RM800 million Commercial Paper and Medium Term Notes Programme (CP/MTN) (2007 to 2014) and RM300 million CP/MTN (2002 to 2009) at AA-/MARC-1. The affirmed ratings continue to reflect the group’s successful banking and insurance franchises, the consistent and resilient earnings performance of its principal banking and insurance operating subsidiaries, the group’s prudent expansion plans and HLFG’s sound credit profile at holding company level. However, the rating also incorporates the intense competition in Malaysia’s financial services sector and the structural subordination of debts at the holding company to that of its operating subsidiaries. The rating outlook is stable.

The HLFG Group is the sixth largest domestic financial services group with total group assets amounting to RM86.4 billion as at end of March 2009. HLFG’s principal operating subsidiaries are its 64.3%-owned commercial bank, Hong Leong Bank Berhad (HLB), and wholly-owned composite insurer Hong Leong Assurance Berhad (HLA). Since FY2005, HLB and HLA have contributed over 90% of the total annual dividends received by HLFG from its subsidiaries. The strong dividend paying capacity of HLFG’s principal operating subsidiaries continue to underpin the holding company’s resilient cashflow and sound debt protection measures.

The principal operating subsidiary, HLB, has established a track record for strong and consistent earnings performance which MARC believes will help mitigate the negative effects of a more difficult operating environment. HLB’s retail focus, granular nature of its consumer loan portfolio, prudent underwriting standards and low risk tolerance remain key underpinnings of its good asset quality and stable recurring earnings. At the bank level, HLB’s net profit for the nine-month period ended March 2009 was 3.1% lower than that for the corresponding period a year earlier, notwithstanding lower fee income and higher impairment losses. The bank’s gross and net non-performing loan (NPL) ratios which stood at 2.6% and 1.5% respectively as at end-March 2009 are among the lowest in the domestic banking sector. The bank’s capitalisation is considered robust with a risk-weighted capital ratio (RWCR) of 14.7% as at end-March 2009 while its deposit base remains well diversified, supported by the bank’s network of 187 branches. In recent years, HLB has sought to expand beyond its home market, as evidenced by its acquisition of a strategic stake in the Chinese bank, Bank of Chengdu Co Ltd (formerly known as Chengdu City Commercial Bank Co Ltd) (Bank of Chengdu), and its plans to operate a wholly-owned banking subsidiary in Vietnam. These overseas operations allow some measure of geographical diversification and exposure to emerging and immature markets while requiring moderate financial commitments. HLB’s cautious approach to expansion and diversification ensures that its international expansion strategy continues to have a neutral impact on the bank’s very strong credit profile.

Its other key operating subsidiary, HLA, is a major life and general insurance provider and a household name in Malaysia, and ranks fifth in life and twelfth in non-life insurance currently based on premiums. The composite insurer has broadly maintained its share of the domestic insurance market, although strong competitive pressures in the sector pose an ongoing challenge to management. HLA’s life operations managed a 5.7% growth in gross premiums for the financial year ended June 30, 2008 (FY2008). HLA’s overall operating performance remained sound, notwithstanding the negative effects of unrealised investment portfolio losses, higher impairment provisions and lower profit on the disposal of investments during the period. The insurance segment’s contribution to group pre-tax profit fell to RM103.8 million in FY2008 from RM120.1 million a year earlier but HLA was, nonetheless, in a position to resume upstreaming dividends to HLFG. HLA had refrained from paying dividends in FY2007 to conserve its capital in preparation for the implementation of the new risk-based capital (RBC) framework effective January 1, 2009. HLA’s capitalisation is strong with a capital adequacy ratio of 222% under the RBC framework as at end-June 2008. MARC believes that HLA’s cautious investment strategy should help reduce its exposure to large declines in investment values under the current uncertain investment environment. 

HLFG’s sub-subsidiary Hong Leong Investment Bank Bhd (formerly known as HLG Credit Bhd and HLG Credit Sdn Bhd) completed its acquisition of the identified assets and liabilities of Southern Investment Bank Berhad in January 2009, paving the way for the group to become a complete financial services provider. Nonetheless, MARC believes that establishing a meaningful presence in the intensely competitive domestic investment banking sector will be challenging and will remain a long-term objective.

HLFG reported a fairly strong consolidated earnings performance in FY2008 on the back of higher net interest income and non-interest income as well as lower loan loss provisioning in FY2008. Its results for the nine-month period ended March 31, 2009, however, indicate some loss of earnings momentum. Meanwhile, growth in overall net interest income as well as non-interest income continued to sustain the group’s profit before allowances for the nine-month period ended 31 March 2009, which grew by 0.2% compared to the previous year’s corresponding period. Lower loan loss provisioning of RM66.0 million compared to RM86.2 million recorded for the corresponding nine-month period in FY2008 partially offset its RM33.2 million impairment loss. HLFG maintained a robust debt and interest cash flow coverage of 1.6x and 10.5x respectively in FY2008. HLFG’s double leverage level improved during the nine-month period on the back of growth in retained profits to 1.2x as at end-March 2009. MARC believes that the strong dividend paying capacity of HLFG’s subsidiaries should help to alleviate pressure on its double leverage ratio going forward.

The stable outlook reflects MARC’s expectation that while the near-term earnings of HLB and HLA will continue to be affected by the ongoing weakness in the overall economic environment, the financial fundamentals of both entities would remain sound and support a sufficient level of distributions to HLFG for the latter’s debt service. HLFG is expected to remain cash flow positive and retain strong financial flexibility.

Strengths

Challenges/Risks