Hong Leong Investment Bank Bhd - 2012

MARC has affirmed its AA-/MARC-1 financial institution (FI) ratings on Hong Leong Investment Bank Berhad (HLIB) with stable outlook. The affirmed ratings and outlook take into account the improving diversity within HLIB’s income stream with higher contribution from its expanded investment banking operations, its established mid-sized retail stockbroking business and adequate capitalisation level in relation to its risk profile. The FI ratings incorporate a one notch rating uplift above HLIB’s stand-alone credit profile based on MARC’s view of a very high probability of parental support from Hong Leong Financial Group Berhad (HLFG) in light of the franchise inter-linkages between HLIB and other group entities. HLFG’s senior debt ratings were recently affirmed at AA/MARC-1 with a stable outlook. HLIB’s long-term FI rating is constrained by the intense competition in the domestic investment banking and stockbroking segments as well as the inherent potential for operating performance volatility of its investment banking and stockbroking businesses.

Formed in 2009, HLIB had absorbed the stockbroking operations of HLG Securities Sdn Bhd, core stockbroking entity of HLFG Group, and SBB Securities Sdn Bhd. HLIB, which has remained predominantly a retail player, was ranked eleventh largest in 2011 based on its market share of total value of equities traded on the local bourse. HLIB’s market share increased to 3.63% for the first five months of 2012 (full year 2011: 3.27%) on the back of the improved institutional business segment in the domestic stock market during the first quarter of 2012. However, the total value of its trades was lower compared to the corresponding period in 2011, due to the lower average trade size. The acquisition of MIMB Investment Bank Berhad (MIMB) by Hong Leong Capital Berhad (the immediate holding company of HLIB) in June 2012 and the impending merger between HLIB and MIMB is expected to bolster the merged entity’s market share in the stockbroking business to 4.03%

HLIB posted declines of 15.0% and 14.4% respectively in brokerage commissions for the quarter ended March 31, 2012 (3QFY2012) and nine-month period ended March 31, 2012 (9MFY2012) compared to the corresponding prior year periods. The decline in monthly average trading volume on Bursa Malaysia in the second quarter of 2012 is expected to translate into lower equity brokerage volume and equity broking revenue at HLIB in 4QFY2012. Total broking revenues accounted for about 54% and to 44% of HLIB’s non-interest income for the full fiscal year ended June 30, 2011 (FY2011) and 9MFY2012 respectively, and remain an important driver of the investment bank’s earnings momentum. Credit impairment of stockbroking customer receivables and margin loans made to retail customers has remained modest, suggesting prudent management of credit risks. Additionally, MARC notes that share margin financing and stockbroking customer receivables comprise less than 10% of bank’s total assets. Meanwhile, the bank’s proprietary holdings of quoted shares remain negligible, limiting market risk arising from adverse market movements.

HLIB’s investment banking operations have a relatively short track record; however, this is mitigated by its experienced management team. On the investment banking front, HLIB has expanded its treasury and money market activities in recent periods, as notably evidenced by the significant increase in financial assets on its balance sheet and interest income generated from treasury and money market activities. Apart from higher revenue from treasury operations, the investment bank also reported significantly higher arranger fees, corporate advisory fees and underwriting commissions in FY2011. Investment banking operations contributed 54% of the bank’s total income during 9MFY2012 (9MFY2011: 51%). The improving diversity within HLIB’s income stream should help the investment bank to partly mitigate the inherent volatility and competitive pressures in its retail stockbroking and investment banking businesses. Further, MARC believes that the contained risk taking in HLIB’s investment banking activities should limit adverse change in the bank’s overall risk profile. The bank’s net interest income which increased by 16.8% to RM13.7 million in 9MFY2012 (9MFY2011: RM11.8 million) on the back of a larger securities portfolio helped offset lower broking revenues and unrealised losses on derivative contracts. The bank’s pre-tax profit for 9MFY2012 came in 7.8% lower compared to the corresponding prior year period, in part due to higher employee costs.

As at end-March 2012, HLIB’s risk-weighted capital ratio (RWCR) had declined to 19.4% from 36.1% as at end-June 2011 due to a sharp increase in risk-weighted credit exposures over the nine-month period. The bank’s credit risk-weighted assets (determined using the standardised approach) increased to RM734.4 million, largely due to the bank’s increased holdings of foreign currency bonds and domestic debt securities. MARC notes that the investment bank did not distribute any dividends for FY2011 to conserve its capital for its growth needs as well as to prepare for increasingly demanding regulatory capital requirements. At its current level, HLIB’s RWCR remains well within its internal target range of 15% to 20%.

The merger between HLIB and MIMB will be accomplished via a transfer of HLIB’s business, assets and liabilities to MIMB. The credit profile of the merged entity is expected to be substantially similar to HLIB’s given MIMB’s modest asset size and operations relative to HLIB’s. Hence, MARC believes that the financial metrics of MIMB, which will be the surviving legal entity after the close of the merger, will remain relatively unchanged from HLIB’s. The rating agency expects to withdraw its ratings on HLIB and assign similar ratings and outlook to the newly merged entity, MIMB, upon completion of the merger.

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