Cost-Income Ratio is a useful performance indicator we can use to guage the efficiency of a bank’s operations.

In Malaysia currently, the Cost-Income Ratio for our banking sector varies from between 30% – 50%. The most efficient bank in terms of Cost-Income is still Public Bank which last year brought its CI down to just 31%. Here’s a snapshot:

Public Bank: 31%
Hong Leong Bank: 42%
AMMB: 49%
Bumiputra Commerce: 52%
Maybank: 44%
Affin: 50%

Calculation of Cost-Income Ratio
Cost Income Ratio is essentially a bank’s Operating Expenses (excluding goodwill amortization) divided by its Operating Income (comprising of its Net Interest Income, Islamic Banking and Other Income).

=                                 (Operating Expenses – Goodwill Amortization Expense)
      —————————————————————————————————————
        (Interest Income – Interest Expense + Islamic Banking Income + Other Op Income)

Example 1: AMMB 2009 (YE 31/3/09)
Other Operting Expenses: RM1,612.1 million
Amortization Expense: NIL
Net Interest Income: RM1,776.3 million
Islamic Banking Income: RM572.6 million
Other Operating Income: RM922 million

Cost-Income Ratio = 1612.1 / (1776.3+572.6+922) = 49.3%

Note: In its recent quarterly results, AMMB showed a dramatic improvement in its Cost-Income Ratio, bringing it down to under 40% for the June-09 quarter. AMMB attributes the improved figure to higher revenue growth for that quarter.

Example 2: HONG LEONG BANK 2009 (YE 30/6/09)
Operating Expenses: RM876.6 million
Amortization Expense: NIL
Net Interest Income: RM1,353.1 million
Islamic Banking Income: RM176.3 million
Other Operating Income: RM569.5 million

Cost-Income Ratio = 876.6 / (1353.1+176.3+569.5) = 41.8%

Example 3: BUMIPUTRA COMMERCE 2008 (YE 31/12/08)
Operting Expenses: RM4,121.8 million
Amortization Expense: RM122.9 million
Net Interest Income: RM4,660.6 million
Islamic Banking Income: RM437.8 million
Other Operating Income: RM2,642.1 million

Cost-Income Ratio = (4121.8-122.9) / (4660.6+2642.1+437.8) = 51.7%

As I write this post PBBANK is trading at RM7.55, up around 50-60 sen from its recent low.

Is the sell down really overdone?

PBBANK has always traded at a premium to its peers. It trades at around 2.7 times its Shareholders Funds compared to Malaysia’s banking sector average of less than 1.5x.

Regionally banking stocks trade between 0.6 to 2.0x.

Indeed PBB is one of the most expensive banking stocks around (perhaps in the whole world) in terms of Price to Book Value. The article in TheStar highlights Public Bank’s dividend yield and loan growth and briefly touches on Capital Adequacy.

The Capital Adequacy aspect is worth a closer look.

Public Bank’s loan book is considered top quality, but from a capital adequacy point of view its core Capital Adequcy Ratio (CAR) of 7.7% is among the lowest in the region.

Source: CLSA Asia Pacific Markets – Research on Public Bank 9/3/09

Its core Tier 1 ratio stood at 6.5% as at Dec-08. In contrast AMMB has Core Tier 1 of 8.3% and Maybank of 7.8% (post-rights).

Source: UOB Kay Hian – Research Report on Public Bank 6/3/09

What is Tier 1?
In a nutshell Tier 1 comprises of the Net Assets of the bank less Intangibles such as Goodwill and Deferred Tax Assets plus certain Hybrid Securities. Hybrid Securities are semi debt-equity in nature and are classified as Liabilities in the bank’s balance sheet.

So basically Tier 1 is the Net Tangible Assets that are attributable to Shareholders & Hybrid Security Holders.

Source: Public Bank Annual Report, Note 51

Under the Bank Negara’s guidelines, banks are allowed to raise hybrid securities of up to 50% of total Tier 1 capital.

Public hybrid securities currently comprise around 15% of its Tier 1 capital which gives it some room to move.

It looks like Public Bank doesn’t have plans for an equity issue but may consider a further issue of Tier 1 hybrids. According to director Tan Sri Tay Ah Lek:

“The bank continues to assess its capability to support its CAR with various forms of debt and capital securities under Bank Negara’s capital adequacy framework…. in particular, the bank is assessing the market for non-innovative Tier-1 capital instruments which qualify for capital adequacy purposes.”

Tan Sri Tay was also cited as saying that PBB will maintain its “liberal dividend policy”, which provides comfort to some people I guess.

However all things said, the scenario for Public Banks shareholders could be choppy over the next two years.

PBBANK is priced at a premium traditionally because of its superior earnings growth, asset quality, top notch management. But we are in a period of:

• Increasing NPLs
• Slowing loan growth
• A more competitive landscape
• Increasingly competent competitors

No doubt Public Bank is fundamentally sound, but we are going through testing times and it will affect every bank. Public Bank’s expensive valuation makes it vulnerable to the changing market forces.

I am talking about the 13-Feb Profit Announcement by AMMB Holdings Berhad, Malaysia’s fifth largest banking group by total assets.

In that Announcement, it was obvious that the bank is increasingly negative about the Malaysia economy and its operating landscape.

If I can just digress for a moment, it’s worth extracting what they said about the economy because it more or less sums up the scenario now:

“The full effects of the global economic downturn on Malaysia are yet to be felt to date but are imminent. The export market has slowed down considerably amid weakening demand and falling commodity prices, and this is starting to impact on the unemployment rate. Consumer spending in the last quarter of 2008 remained positive, but will begin to moderate, especially post – festive season in January 2009. Given the scale and momentum of the global economic downturn, the consensus national real GDP forecast for 2009 is projected at 0.5%, with downward bias. Industry lending growth is forecasted to taper off to circa 5% in 2009…. The economic slowdown may not be a short term phenomenon, and any rebound is unlikely until early to mid 2010.”

The economy does look bad. Consider:

• In December 2008, Malaysia’s industrial production contracted by 15.6% yoy as manufacturers cut production to prevent inventory build up.
• Recent data in the Asia region looks ugly. In Taiwan export fell 44.1%. In South Korean exports fell 32.8% yoy in January and China reported a 17.5% drop in exports.
• Many tech companies in Malaysia are believed to be operating at 20-25% capacity and reduced work week. The global contagion is starting to reach us. So if you think that you are paid too little by your boss and deserve much more, do think twice before voicing your demands too loudly!

OK back to AMMB.

Sometime ago it signalled to the investment community that it was setting impressive targets – 20% ROE, 20% Compounded Annual Growth Rate, 40% Cost-Income Ratio etc. You can see the KPIs in my earlier article.

In fact AMMB is so serious about these headline KPIs that they make their top guns sign on a big banner to display in their corporate office. …. A big banner signed by Tan Sri Dato Azman Hashim, Cheah Tek Kuang, Dato James Lim etc.

I saw it myself when I was there. What was I doing there? I was being a busybody actually. Since I have a few shares in AMMB, I wanted to stress test their Investor Relations. I went to see if I can get a hard copy of their 2008 Annual Report. Believe it or not, there was only one copy lying around! And the nice chap wasn’t about to let it go… he was holding on to it like his own precious fixed deposit cert haha! But he was kind enough to give me a CD version – so he should be commended for saving us money

OK sorry… back to my point. From the Profit Announcement, it is clear that management will not make their 20% ROE target for quite a while yet. See what they had to say:

Amidst deteriorating global and domestic economic conditions, operating landscape will become tougher. In order to achieve its medium term aspirations, the Group will continue to de-risk, diversify and focus on differentiated growth within its various businesses. AMMB Group, whilst committed to its medium term aspirations, recognize that achieving these aspirations will now take longer, given the material changes to the macroeconomic conditions.

And guess what happened after the profit announcement?

Yep, their share price went up, up and away!

As I write this, AMMB’s share price is up 12% from the price before its result announcement.

While the broader market is still doing its flatliner act (no pun intended).

Surely there is a lesson here?

Here’s what Rachel Huang of Affin Investment Bank says:

We like the new realistic stance – Unlike previous economic downcycles in 1997-98, 2001 and 2003, we sense that the company is now much more realistic – negative and pessimistic. We like the new tone, and we view this positively as it indicates: (a) a more realistic stance, unlike previous economic cycles where guidance tends to be hopefully optimistic; (b) likely more positive influence from major shareholder ANZ which came on board in 3Q06; and (c) thereby a more vigilant monitoring on its loan book and operations.
Source: Affin Investment Bank, Results Note 16-Feb-09: AMMB Holdings

Personally for me, it always feels good to read AMMB’s quarterly and annual reports (since ANZ came in). It shows the great length to which Management goes to detail their strategies, operating landscape, achievements and so on.

Download a copy for yourself here.

If you compare their press release with that of other companies, you will know what I mean. Truly they are a model for most to follow.

Chances are that AMMB may not achieve 20% ROE by 2012 but before I become too critical, I’ll be the first to admit that my own 15% p.a. investment target is looking like a long shot in this economic climate.

So what I’m looking for is NOT a “Gee Whiz” set of results but rather, an honest evaluation by management of how they are coping in the face of this downtrend.

Let’s look at what went down in AMMB as an example:

AMMB: We made a profit of RM248 million for the quarter ending Dec 2008, up 25.3% from last year.

Larry: Yes but you also said there is a one-off gain of RM95 million from the sale of your insurance business. So actually your profit is more like RM150 million. But that’s OK because it looks like you’ve hiked up your loan loss provision to RM142 million which is probably RM70 million more than what it really is… which means that you will most likely make RM800-850 million for the whole year. And that’s what everyone is expecting.

AMMB: Net loans grew 10.7% yoy to RM56 billion.

Larry: That’s great but qoq, loan growth was only around 1%. It’s pretty obvious that things are slowing down but hey, I think you guys have got it figured out talking about de-risking, improved credit control, recoveries management and so on. It’s all about quality right now, not quantity.

AMMB: We have a strategy to grow our low-cost Deposit base. Besides expanding direct deposits sales team, we will also expand our branch network. We already have 186 commercial bank branches, 551 ATMs and 107 electronic banking centres. 172 ATMs are placed at 7-Eleven stores, and we will put in another 228 machines over the next 2 years.

Larry: Guys all this is music to my ears. Tell me next year how it goes and show me how it has increased profit. After all you’ve been holding back on your dividend payout for so long compared to other banks, I’d like to think the money is invested somewhere useful.

AMMB: Whilst committed to our medium term aspirations (to hit our KPIs), we recognize that achieving these aspirations will now take longer, given the material changes to the macroeconomic conditions.

Larry: That’s OK, even if you need another 3-4 years extra. But I would really be happy if you can increase your Dividend Payout Ratio to 50% of EPS. I’m sure you’ll agree that it’s good for the share price. Just look at your friend Public Bank… they’re not that fantastic really, your big brother ANZ can trump them any day.

AMMB: We’ve done really great. Record Profits. All our strategies are in place. We will weather the economic storm.

Larry: Well done guys, I think you’ve done a commendable job. You guys should be worth the RM7 billion or so that the market is putting on you. I notice too that your Cost-Income ratio is getting closer to your 40% target and has been consistently improving over the last 5 years. This KPI is something that you can’t really blame on the economy so I’ll be watching this figure like a hawk to see if you have done what you said you will do. Hey do you guys have any failures? If so maybe you can share some of it too, would make us humans feel better.

Summary
As Warren Buffett suggests, what needs to be reported is accurate data. That helps financially literate readers answer three key questions:
1) Approximately how much is this company worth?
2) What is the likelihood that it can meet its future obligations?
3) How good a job are its managers doing, given the hand they have been dealt with?

If there’s a problem with Investor Relations and financial reporting for Malaysian companies, it would be that companies always try to make themselves look so good, warts and all. I really haven’t come across anyone who said “We’ve done something wrong, we’re sorry about that, we’ve learned from our mistakes, here’s how we’re gonna do it better next time.”

The CEO who misleads others in public may eventually mislead himself in private.
Warren Buffett, Berkshire Hathaway 1986 Annual Report (page 5)

Malayan Banking (MAYBANK)
Shareholders Funds RM19.3 billion & Net Profit of RM2.9 billion, FY ending 30-Jun-08
- Top Earning Director: RM2.7 million
- 2nd Earning Director: RM1.3 million

Bumiputra-Commerce (COMMERZ)
Shareholders Funds RM15.2 billion & Net Profit of RM2.8 billion, FY ending 31-Dec-07
- Dato Nazir Razak: RM9.3 million
- Dato Mohd Shukri: RM1.1 million
- Dato Robert Chelm: RM1.7 million

Public Bank (PBBANK)
Shareholders Funds RM9.3 billion & Net Profit of RM2.1 billion, FY ending 31-Dec-07
- Dato Tay Ah Lek: RM6.5 million
- Dato Lee Kong Lam: RM4.8 million
- Tan Sri Teh Hong Piow: RM6.0 million

RHB Capital (RHBCAP)
Shareholders Funds RM7.0 billion & Net Profit of RM713 million, FY ending 31-Dec-07
- Managing Director: RM3.6 million

AMMB Holdings (AMMB)
Shareholders Funds RM7.1 billion & Net Profit of RM669 million, FY ending 31-Mar-08
- Top Earning Director: RM3.5 million
- 2nd Earning Director: RM2.5 million

Hong Leong Bank (HLBANK)
Shareholders Funds RM5.1 billion & Net Profit of RM742 million, FY ending 30-Jun-08
- Total Director remuneration of RM4.4 million (individual earnings undisclosed)

There is an article in TheStar today saying AMMB is planning 10 new branches in Malaysia this year. This will clearly make it the fourth largest bank in Malaysia in terms of branch network. I suspect AMMB is using its strong retained earnings position to fund growth in its retail business, a far-sighted move that will build its position in the Malaysia market, most probably at the expense of the other smaller players. What better time to expand than in an economic slowdown!

1. Loan growth of 12.8% year-on-year, driven by business and mortgage loans. This is as the strongest showing since 1998.

2. Industry NPL ratio stood at 4.1% (down from 5.6% last year). NPL is now at its lowest since 1998.

3. Liquidity is strong with Loan-to-Deposit Ratio at 74.7% (from 76.7% in Nov-08).

However there are some headwinds to face. Leading indicators suggest that growth is slowing. Loan approvals and applications are down significantly (around 20%), with loan applications shrinking for the fourth consecutive month.

• AMMB Holdings (AMMB)
• Hong Leong Bank (HLBANK)
• Malayan Banking (MAYBANK)
• Bumiputra-Commerce (COMMERZ)

Overall AMMB and HLBANK threw in pretty good results, while MAYBANK and COMMERZ not so good. After digesting some of the Press Releases and Analyst Reports, I’m summarizing my take of it on this blog. First, let’s look at AMMB:

AMMB HOLDINGS BHD
Second Quarter Net Profit for Jul-Sep 2008 came in at RM230 million, bringing the Half-Year Net Profit to RM433 million. AMMB is on track to reach a full year Net Profit of around RM850 million as previously foreshadowed by its management. This means it is trading at a current PE Ratio of 7.2x.

The Jul-Sep 2008 quarter was a record performance for the group, powered by loan growth and lower bad debt provisions. AMMB’s gross loans grew by 8.5% overall yoy driven mainly by its Business Banking division. On a net basis it grew by 11.8% to RM55.3 billion which makes AMMB the fifth largest lender in Malaysia and just a stone’s throw from RHBCAP. AmBank’s Business Banking team is headed by Dato James Lim (ex-Hong Leong Bank MD) and includes several other ex-HLB key performers. The current results is a great affirmation for this team.

The strong performance was partially offset by a trading loss of RM84 million and one-off loss of RM68 million from some sort of hedge accounting transaction. This was absorbed in the “Non-interest Income” line.

Notably, Operating Expenses increased by around RM108 million during the current half as compared to pcp. This has put a dent in AMMB’s cost-income ratio. It will be a while before it can reach its 40% target

Overall these negatives should not be a cause for too much concern for now. AMMB is doing what it said it wanted to do. It is well-positioned to weather the current downturn and also capitalize on market opportunities.

What about the Global Financial Meltdown?
In its Press Release, AMMB management said:
“Amidst deteriorating global and domestic economic conditions, operating landscape will become tougher over the next year or two. In order to achieve its medium term aspirations, the Group will de-risk and diversify businesses for dynamic growth.”

AMMB remains optimistic in achieving its medium-term outcomes, barring major negative economic impacts lasting deeper and longer. AMMB is presently enhancing its risk infrastructure and will be implementing more rigorous risk-based pricing models and scorecards in its key lending sectors. AMMB will continue to target high growth in deposits and new business ventures such as the operations of Islamic insurance, and foreign exchange and derivatives.

What is Management’s Guidance?
Previously AMMB was aiming for ROE of 20% and Cost-Income Ratio of 40% by FY2011. The targets have been postponed by a year to FY2012.

If we extrapolate from this, we are looking at possible Net Profit of around RM1.2 to 1.4 billion by FY2012.

What are the Analysts saying?
CIMB Research has AMMB Net Profit at RM829 million for FY2009 and strangely enough, going down to RM705 million in FY2010. The FY2010 forecast is pessimistic (perhaps due to loan contraction and higher bad loans). As a side comment, AmResearch has just published it’s take on COMMERZ  results and were negative on them. Wonder if this has any bearing?

RHB Research puts AMMB’s Net Profit at RM898 million, RM946 million and RM1,025 million for FY2009, FY 2010 and FY2011 respectively. RHB presents a more consistent scenario compared with management’s guidance.

HONG LEONG BANK BHD
Hong Leong Bank result looks good on its face, headline Net Profit of RM242 million for its First Quarter Jul-Sep 2008.

But look into the notes (Note 18) and you’ll find that the result is boosted by a “Foreign Exchange Gain” of RM41.8 million. This is lumped into the “Other Operating Income” line.

I could not find anything in the Press Release explaining this item.

Disclosure in its Press Release remains vague and minimal. “Everything is fantastic” was the story by management.

What Are Analysts Saying?
RHB Research has HLBANK’s Net Profit at RM815 million for the coming year, building up to RM911 million in 2011. CIMB Research has its at RM841 million building up to RM959 million for the same period.

How Does it Stack Up?
HLBANK’s Deposit Growth must be the envy of the industry. Deposits grew to RM64 billion – 26% higher than compared with pcp. This bank sucks in a lot of deposits and lends out relatively little.

HLBANK and AMMB is a most interesting comparison. They are probably each other’s key competitor. HLBANK’S market cap is around RM8 billion compared to AMMB’s market cap of RM6 billion. HLBANK share price has taken a lesser beating in recent times compared to AMMB. Like Public Bank (PBBANK), HLB is perceived to be lower risk because of its loan portfolio composition and stringent credit control.

38% of Hong Leong’s RM36 billion loan book was in Residential Mortgages (its largest exposure). This contrasts with 40% of AmBank loan book in vehicle loans. Residential mortgages are a lot safer of course.

Unlike AMMB, HLBANK takes a minimalist approach in its reporting.

You can see for yourself and download the Press Releases here:

AMMB Press Release FY2009 Q2
HLBANK Press Release FY2009 Q1

Even the Analysts have less to write about HLB. In both its Annual Report and Press Release, HLB is rather vague on its operating strategies but notwithstanding this has successfully projected itself as a “lower risk” bank. This has helped to maintain its share price while everyone else takes a huge beating.

Basically AMMB has a much bigger loan franchise but HLBANK continues to attract deposits. AMMB has a larger Interest Income base, Non-Interest Income Base and Islamic Banking base. It has a leading position in Investment Banking. AMMB is very clear on what it wants to do and it is Malaysia-focused. HLBANK competes in external markets and will have its fair share of external distractions. Going forward I believe HLBANK earnings momentum will slow compared to AMMB. Its loan growth outlook is not fantastic.

Hence HLBANK share price premium is not justified.

AMMB’s share price peaked at RM4.92 last year. At yesterday’s close of RM2.27 it is down 54% from its peak. Comparatively speaking at RM5.10, HLBANK share price is only down 27%  from its peak of RM7.00 last year. AMMB retains more of its earnings and has a lower dividend payout ratio. If you can take a little volatility and are looking to ride a recovery, AMMB would be a better bet.

Disclosure: The author holds shares in AMMB.

As at the end-August 2008, the industry’s loan to deposit ratio stood at 74.5% compared with close to 100% during the 1997 financial crisis.

A quick look at the latest balance sheets of leading banks support the ABM’s assertion.

See in particular the Net Loans/Deposits and the Net Assets/Total Assets line highlighted in red.

One of my favourite indicators is the Net Assets/Total Assets figure which is so simple to use. Anything over 8% is exceptionally high as I’ve learned from looking at Australian banks since 10 years back. In those days the Big 4 in Australia (National, Commonwealth, ANZ and Westpac) were running ratios of between 5-7% and were in their strongest financial position ever. As the economy grew and banks became more aggressive, the ratio declined to the 4% mark and we are now starting to see a credit crunch over there with banks announcing significant profit drops for the first time in 10+ years.

The Malaysian banks are probably where the Australian banks were 10-15 years ago. Despite the many gloomy forecasts out there, I personally believe we are at the threshold of a major growth phase here. This is also accompanied by improved practices across the industry, particularly so (I believe although I don’t have any proof) in AMMB (AmBank) and COMMERZ (CIMB Bank) where you need only walk into a branch to experience the improved level of service compared to 2 years ago.

Having said that COMMERZ is probably licking its wounds over the recent bond trading losses and its Thai acquisition. But this is a fraction of MAYBANK’s Indonesian woes, a foolish deal that has enriched a few while costing shareholders more than RM10 billion in lost market cap. What was once Malaysia’s leading retail bank is now (sorry to say) a little bit of a laughing stock in the industry. Just look at the recent launch of its new Maybank2u website and what some leading tech bloggers had to say about it.

There are some serious lessons here for Corporate Malaysia. And hopefully COMMERZ management will be forthright in their upcoming quarterly report….we shall see in the next 2 weeks

As I am writing this RHB Research has just published its Research Report. Some key points are:

1. Industry loan growth has slowed slightly in Sep 08 to 11.6% YOY (mainly at the business & SME segment), and is expected to slow further to 5% by 2009.

2. Despite the difficult operating environment, Non-performing Loans (NPL) continues its downtrend showing that the sector is well positioned to cushion the impact of the economic downturn, given its “solid asset quality as well as increased discipline of adopting improved risk management policies and credit scoring systems”.

3. RHB is still Neutral on the sector but is reviewing its recommendation following the sharp share price plunge recently:

“We are inclined to switch out from defensive stocks to companies with strong fundamentals which have suffered significant price depreciation. Stocks in the latter category are likely to outperform when the market resumes a more sustainable uptrend. Moreover, defensive banking stocks have outperformed the market which would limit their upside potential in the event of a rebound in the market.”

Hmmm… I’m not sure which defensive stock they meant but it’s probably Public Bank and Hong Leong Bank. Their recent price dips have been relatively minor and they still trade at large premiums to NTA. Think I would be inclined to agree with RHB Research on this one.

Note: In case you thought it took ages for me to compile the beautiful table above, think again! Learn how to do this quickly

Disclosure: The author holds shares in AMMB and COMMERZ.

There is an article in The Star, Saturday 27/9/08 which quoted Cheah Tek Kuang as saying that Malaysian companies are looking to borrow from banks because the domestic bond market has dried up. Most Malaysian companies are healthy and it does not make sense for them to issue bonds at current prices.

Basically AMMB’s performance targets remain unchanged:

• 20% ROE
• 40% Cost-Income Ratio
• 20% Compounded Annual Growth Rate
• 8 – 10% loans Growth
• 2.2 – 2.5% NPL for YE 31/3/09
• Position itself as Top 3 in their chosen business segments
• FY09 net profit in line with analyst estimates of RM800-900 million

70% of AMMB’s profits generated from its commercial banking business which remains strong although investment & brokerage business sluggish.

as per AMMB 2008 Annual Report