Asiamoney Top 10: bank stocks (includes profile of Hang Seng)

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Asiamoney, February 2008

Pakistan has a lot to worry about at the moment, but you wouldn’t know it from looking at its banking sector. Despite the crippling political uncertainty that afflicts the place today, greatly exacerbated by Benazir Bhutto’s assassination, Pakistan’s banks boast the highest return on equity of any in the region.

This month’s top 10 looks at the banking sector, and it has a very subcontinental feel. Six of the top eight names on the list are from India and Pakistan, including the leader, which for the second consecutive year is Pakistan’s MCB. Only one developed-market name, Hang Seng Bank, makes the top 10, with the remainder coming from Asean countries. There’s none from Singapore, or Korea, and none from mainland China.

The fact is, despite the political problems, Pakistan as a country is doing exceptionally well. Foreign investment inflows were $8.4 billion for the 2006-7 financial year, an 88% year on year increase, according to Pakistan’s Board of Investments. The economy has been growing at or around 7% a year for five years now and the country has enjoyed one of the most successful privatisation programs in the region. The banking sector has thrived in this environment, aided by a population which is growing in wealth but lacks the sophistication to explore many other savings options outside of bank deposits. For several years the net interest margin – the difference between what banks pay customers on deposits, and what they charge them on loans – has been  by far the highest in the region.

But there is a feeling this golden period can’t last. This time last year State Bank of Pakistan governor Shaukat Aziz told Asiamoney how she wanted to rein in the difference a bit for the sake of the consumer (she called it “moral suasion”); and although her efforts are not yet reflected in ROE numbers, which by their nature are always historical, things may well look a bit different in another year.

The State Bank now requires banks to make greater provisions against loan losses, which is likely to cause a headline hit to numbers, if only for a year. Competition is increasing as foreign banks enter the market through acquisition – Standard Chartered and ABN Amro being the biggest recent examples – and there is already evidence of softening lending rates. And in November the Pakistan Banking Association announced what it calls “a consensus view of the industry” to raise deposit rates for savings accounts to a minimum of 4%, which will naturally cut the net interest margin. It will take a while for these shifts to come through in reported return on equity numbers, but when they do, Pakistan’s banks may fall back to looking healthy rather than invincible.

It is interesting that many of the other banks in our top 10 have specialisations in areas like microfinance, agribusiness and rural areas. Bank Rakyat Indonesia, for example, pledges to put over 80% of its loans to microfinance or small and medium businesses. Among its strategies is the Agriculture Revitalisation Program, in which investment loans are made directly to farmers or through plantation companies to support development of alternative energy projects, with farmers paying 10% loan interest and any excess being subsidised by the government.

Then there’s Syndicate Bank, founded in the unlikely financial centre of coastal Karnataka in India’s south. This bank was founded to serve the local weaving industry and now, more than 80 years on, maintains a small business and rural focus. Its flagship product is called the Pigmy Deposit Scheme, which dates back to the late 1920s; through a network of over 3000 agents the bank collects as little as a rupee a day at the doorstep of deposits for a savings scheme. Today the scheme collects over Rs26 million a day. On the agriculture side, the bank has offered credit products ever since launching the Agri Card in 1967, and has consistently brought new offers for the farming community, most recently a scheme to provide need-based credit to tenant farmers through a joint liability group approach.

You don’t hear the global heavyweights of banking talking about these areas, but it’s clear they can support sustainable and profitable businesses. While they seem risky, Credit Suisse analyst Mirza Adityaswara notes that at Bank Rakyat, non-performing loans are declining (from 5.5% in June to 5% in September) and that “provision coverage is high at 154%”. Bank Rakyat’s net interest margin has been declining, from 11.4% in the second quarter to 10.8% in the third, but that’s still an impressive margin by any standards.

Some analysts believe Asean offers the best banks from an investment perspective. Macquarie Research strategist Tim Rocks reckons they are more immune from a global slowdown than economies further north in Asia, and the group’s bank analysts agree: “We consider Asean banks to be the best play on the reflation theme,” says a late November report. “Strong currencies, low interest rates, healthy domestic demand and manageable inflation marking these economies suggests a strong likelihood for this trend to continue.” The bank particularly likes Indonesian, Malaysian and Thai banks, and thinks Indonesia is the best way to play the reflation theme. Indonesia, it says, has the second fastest loan growth in the region after India (it should be mentioned that Macquarie doesn’t cover Pakistan); the lowest loan penetration; good liquidity; high margins, with the scope to rise; and the highest profitability.


1. MCB, Pakistan: 32.5%

Profiled in last year’s feature, MCB (formerly Muslim Commercial Bank) is one of the leading banks in Pakistan and continues to grow strongly. Like many of its peers, it has had a convoluted history – formed at partition in 1947, nationalised 1974, privatised 1991 – but has emerged as one of the most professional outfits in the region, acting as something of an ambassador for the country when it launched a successful GDR issue in 2006.

2. Hang Seng Bank, Hong Kong, 31.7%

Hong Kong’s largest locally-incorporated bank, and increasingly a Greater China play, with 23 outlets across China. Two years into a new strategy focusing heavily on wealth management, commercial banking and the mainland; interim profits were up 43.2% year on year, to HK$8.87 billion, suggesting it’s working. See profile.

3. HDFC, India, 31.3%

Financial services group founded in 1977 to promote home ownership by providing long term finance to households. Perfectly positioned to benefit from the immense demand for housing in India (around two million units per year, according to the National Building Organisation). 2006-7 net profit, at Rs15.7 billion, is four times higher than at the start of the decade.

4. Allied Bank, Pakistan, 29%

Another Pakistan bank, Allied Bank actually predates the country itself. Privatised in 1991 like MCB; acquired by Ibrahim Group in 2004 and amalgamated with Ibrahim Leasing the following year. Universal bank with emphasis on retail; claims the largest on-line network in Pakistan.

5. Bank Rakyat Indonesia, 28%

Indonesian bank with a strong focus on microfinance and on agribusiness. Net profit grew 17.43% year on year in the first half of 2007 to Rp2.36 trillion with growing contribution from fee based income and increasing penetration in agribusiness and other infrastructure projects. Committed to keeping at least 80% of total loans for micro, small and medium clients.

6. United Bank, Pakistan, 24.8%

Another major Pakistani bank. Enjoyed 14% growth in assets (to Rp498 billion) and 13% growth in advances (to Rp288.7 billion) between December 2006 and September 2007, although full year headline profit numbers are likely to end up looking weak after the bank changed its method of calculating provisions in order to come in line with new State Bank of Pakistan requirements. This will have a full year impact of Rs3.95 billion to the total portfolio, split between the last two quarters of the year; United is the first bank in Pakistan to take the charges into its accounts.

7. Syndicate Bank, India: 24.6%

Indian bank historically most active in lending to the rural sector. Its flagship product is the Pigmy Deposit Scheme; it recently added a new doorstep banking facility, SyndSmallCredit, to encourage entrepreneurs lacking capital. Aggressively building branch network, but is increasingly profitable too: net profit went up 11% year on year to Rs2.27 billion in the September quarter.

8. Kotak Mahindra, India, 24%

Indian financial services group covering commercial banking, stock broking, mutual funds, life insurance and investment banking. Employs about 15,300 people worldwide and serves 3.2 million customer accounts. Now going it alone after severing a long-standing partnership with Goldman Sachs. See profile.

9. Bank Central Asia, 24%

A far cry from the institution that had to be bailed out in the Asian financial crisis a decade ago, BCA today has seven million customer accounts and 796 branches. Net profit was Rp3.4 trillion for the first nine months of 2007, up 7.7% year on year, with third quarter loan growth up 28.2% (to Rp68.8 trillion) and consumer lending in particular doing well, driven by new mortgage products.

10.  Public Bank, Malaysia, 22.4%

One of Malaysia’s largest banking groups, and the largest not linked to the government. Core business is retail banking but it is also active in commercial and investment banking, insurance and other financial services. Took over Asia Commercial Bank in Hong Kong in 2006, giving it greater regional reach.

Ones to Watch

Just outside our top 10 was Indonesia’s Bank Danamon, with a 22.4% return on equity. Danamon’s third quarter numbers were impressive: net profit up 75% year on year to Rp1.6 trillion; loans up 22% to Rp50 trillion, driven by the mass market and retail businesses; and a net interest margin of 11.1%. Danamon is 68.16% owned by a consortium called Asia Financial (Indonesia), in which Fullerton Financial Holdings (owned by Temasek) holds 85% and Deutsche Bank 15%. The rest is publicly held.

Bank Mandiri is Macquarie’s top banking pick for Indonesia and the region; Macquarie estimates its 2008 return on equity as 21.3%. It also likes Kasikornbank in Thailand and AMMB in Malaysia, among others.

The highest ranked Korean bank is Industrial Bank of Korea, with a 21.7% ROE. It seems an unlikely champion: 51% government-owned (or 67% if you include indirect state holdings through KEXIM or Korea Development Bank), it is mandated to serve public policy in promoting small and medium sized enterprises in Korea, and reports annually to the Minister of Finance and Economy. But total assets have grown from KW77.6 trillion in 2004 to KW123.1 trillion in the third quarter of 2007; earnings per share have almost quadrupled, to KW3,101, over the same period.

Hang Seng Bank

When Hang Seng delivers its annual results next month [MARCH 3] it is expected to build on a period of outstanding recent performance that has put it among the region’s leaders in terms of return on equity. The largest Hong Kong-incorporated bank, increasingly styling itself as a Greater China enterprise, is two years into a new growth strategy, and so far it appears to be working.

The roadmap for the future was set out at the time of the 2005 annual results, and boiled down to a handful of priorities: growing wealth management and commercial banking; expanding personal and commercial lending; and extending the business in mainland China.

The interim results for the first half of 2007 showed progress on all these fronts. In a great result in which attributable profit rose 43.2% to HK$8.87 billion, and earnings per share 43.2% to HK$4.64, it was wealth management and commercial banking that underpinned the improvement. Securities turnover, sales of investment funds and of structured products all set records; wealth management income was up 58.2% year on year, to HK$3.42 billion; and pre-tax profit in the private banking division was up 62.4% to HK$459 million, putting the bank on track to achieve a five-year target of doubling 2005 pre-tax profit three years early.  Commercial banking is travelling well too, with average customer deposits rising 19.5% and average customer advances 22.7%.

But it’s China that must be the driver of future earnings. Hang Seng investor presentations tend to have the tag-line “a leading financial institution in Greater China”, but is still predominantly a Hong Kong institution, with 150 branches and automated banking centres in Hong Kong and another in Macau.

The 12 months have been important for Hang Seng’s China presence, with the formal incorporation of a wholly owned mainland subsidiary, Hang Seng Bank (China), a particular highlight in May. Today the bank has 23 outlets on the mainland, including nine branches; within them are 22 prestige banking centres, again reflecting a focus on wealth management. It has Shenzhen rep offices in both investment management and insurance, and has won approvals from the State Administration of Foreign Exchange for both QFII and QDII services (covering flows of capital into and out of China). Total operating income from mainland operations grew 86% in the first half to HK$225 million; analysts expect this to be maintained for the full year.

Hang Seng, in its quiet period ahead of the annual result, declined a senior interview, but chief executive Raymond Or gave some indication of his thoughts in his address to the CLSA Investors Forum in late 2007. He spoke of the dangers of US subprime and inflation but said he was optimistic about opportunities in China, saying the bank will focus on the Pearl and Yangtze river deltas and the Bohai Economic Rim, “as well as exploring potential opportunities in western China.”  He said Hang Seng aims to have more than 2000 staff and over 50 outlets on the mainland by 2010.

“Our strategy for the long-term expansion of our business is already yielding encouraging results and has prompted the market to reassess its perception of Hang Seng as an ex-growth stock,” he said.

Analysts agree: ABN Amro’s Simon Ho, for example, raised his 2008-9 financial year forecasts by 7-8% in October based on expectations of higher wealth management income. He rates the stock a buy, despite the fact that following a major re-rating since the interim results the stock trades at a 30% PE premium to Bank of China Hong Kong. At Macquarie Research, Chris Esson upgraded his own price target back in July and still rates the stock an outperform. The first half result, he said, “has demonstrated the value of Hang Seng’s affluent Hong Kong customer base while expansion into China adds a new source of growth.”

Chris Wright
Chris Wright
Chris is a journalist specialising in business and financial journalism across Asia, Australia and the Middle East. He is Asia editor for Euromoney magazine and has written for publications including the Financial Times, Institutional Investor, Forbes, Asiamoney, the Australian Financial Review, Discovery Channel Magazine, Qantas: The Australian Way and BRW. He is the author of No More Worlds to Conquer, published by HarperCollins.

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