Affin Hwang Capital Research Highlights

Author: kltrader   |   Latest post: Thu, 17 Oct 2019, 8:56 AM


Banking (Neutral, Maintain) - A More Cautious Outlook

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Though the Malaysian banking sector continues to be backed by resilient and strong fundamentals such as adequate capital ratios, ample liquidity, a relatively low gross impaired loan ratio and healthy loan loss cover, we foresee the impact of higher external risks (moderating economic growth) and a more cautious business/consumer sentiment as two key factors, which may pose downside risks to our 2019E-20E earnings forecasts. Maintain NEUTRAL. Our stock picks: RHB, Aeon Credit and ELK-Desa.

Downside risks to our 2019-21E earnings forecasts

In this report, we highlight some downside risks factors to our earnings forecasts including: i) the risk of another 25bps interest rate cut – resulting in an aggregate 1.7% reduction in sector earnings; ii) a 1% decline in loan growth – resulting in a 1.1% decline in sector net profit; iii) a 10bps increase in net credit cost could result in a 6.3-6.4% decrease in net profit. Potentially, the commercial/residential property sector could pose some risks to the system, though impaired loans remain minimal to total loans,

Summary of key takeaways from 1H19 Financial Stability Review

Based on BNM’s 1H19 Financial Stability Review, the key takeaways amongst others are: - i) a high debt repayment capacity by households, based on the financial asset-to-debt ratio of 2.2x and liquid financial assetto-debt ratio of 1.5x as at 1H19; ii) household debt-to-GDP level of 82.2%; iii) the quality of business borrowings (GIL ratio remained steady at 2.6% vs. 2018) remained sound despite more challenging conditions; and iv) mismatch between property supply and demand, and price imbalances may persist over the mid-long term.

Maintain sector NEUTRAL We maintain our sector NEUTRAL call, noting that business and consumer outlook in 2H19-1H20 will likely stay cautious due to external uncertainties and a lack of domestic catalysts. For 2019, after some earlier revisions to our universe’s loan growth forecasts, we now set a 3.8% target for 2019E’s system loan growth. On our stock picks, we remain selective and prefer RHB Bank (BUY, PT RM6.60) for banking exposure. For non-banking stocks, we like AEON Credit (BUY, PT RM19.80) and ELK-Desa (BUY, PT RM1.98) due to their higher receivables growth and attractive ROEs.

Rising cautiousness may further impede growth

Core EPS forecasts: 2019E at -0.9% yoy;

2020E at +1.2% yoy For our Malaysian banking universe, we are currently projecting a core net EPS growth rate of -0.9% yoy for 2019E and a slightly modest growth rate of +1.2% yoy in 2020E and +1.6% in 2021E. Our slightly negative growth rate in 2019E is underpinned by: i) the negative impact of the OPR cut, which moderated banks’ fund-based income (we project a +1.2 yoy growth in 2019E); ii) a +2.2% yoy increase in operating expenses; and iii) a +15% yoy increase in impairment allowances (net credit cost at 26bps vs. 23bps in 2018). For 2019E, we are projecting a relatively flat pre-provision operating profit, as the overall net operating income growth remains muted.

Downside risks to our earnings projections for 2019E-21E

In this section, we look at potential downside risks which could cause deviation to our earnings projection:

i) Interest rate cuts. The risk of further interest rate cuts is exacerbated by recession fears in developed countries, whereby the Central Banks have resorted to cut rates (the Bank of Thailand, RBA, ECB, the Fed) and embark on more quantitative easing measures. Likewise, we believe that in order to boost our domestic economy, it is probable that BNM will potentially embark on the same measure. Based on our estimates, a 25bps cut in rates could potentially result in an aggregate reduction of 1.7% in our banking universe’s 2020E21E core net profit while banks’ NIM could see a compression of up to 6bps. A sensitivity analysis is laid out in Fig 2.

ii) Moderation in loan growth.

Based on the system’s latest loan growth as at July19 of 3.9% yoy, or at 1.35% year-to-date (annualized ~2.3%), this implies a very weak and cautious domestic sentiment despite seeing a more optimistic 2Q19 GDP growth of 4.9% yoy (1Q19: 4.5%). In fact, the key sectors driving domestic loan growth are none other than the household sector (+4.7% yoy; residential, personal financing, purchase of securities, credit cards), construction (+8.0% yoy), wholesale/retail (+7% yoy) and manufacturing (+6.9% yoy). A weak external sector will potentially dampen business expansion activities while the oversupply of commercial property and the high stock of unsold residential units will potentially discourage banks from being more upbeat in lending activities. Subsequent to the 2Q19 banks’ financial results announcement, we have made revisions to system loan growth from a target of 5% in 2019E to 3.8%. We currently forecast a growth rate of 4.1% and 4.2% in 2020E and 2021E.

On our estimates, should there be a 1% decline in loan growth, the banks’ net profit is likely to be affected by -1.1% for 2020E/21E on aggregate.

iii) Mismatch between property supply and demand;

price imbalances also continue. According to the National Property Information Centre (NAPIC), the oversupply condition of office space and shopping complexes (OSSC) are expected to persist, with a sizeable 36.3m sq ft of incoming supply. Meanwhile, the annual supply of 4.4m sq ft p.a; (expected between 2019-2021) far outstrips the annual demand of 2.3m sq ft p.a. As the market may remain soft over the medium term, we foresee rising risk of default in the OSSC segment. Nonetheless, downside risk is capped by banks’ exposure totalling 3.4% of total outstanding loans (with 0.3% classified as being impaired) and 4.6% of holdings of bonds/sukuk.

On residential properties, the high stock of unsold residential units (1Q19: 177,200 units, +5.3% ytd) are mostly properties above the maximum affordable house price of RM300,000, while 67% of these unsold units are in the high-rise segment. Continued strong demand for properties in the affordable segment and the gradual rebalancing of new launches (over the longer term) towards properties priced. below RM500,000 should mitigate risks of a sharp and broad-based decline in house prices. Banks’ exposures to property developers with unsold housing units remained minimal at 2.0% of system loans (0.1% classified as impaired) and 2.9% of holdings of corporate bonds/sukuk.

iv) Rising gross impaired loans year-to-date.

Ytd July19, our system gross impaired loans have increased by 9.3% ytd. Though the rise in the GIL ratio from 1.48% in Dec18 to 1.6% in July19 appears immaterial at this juncture, we want to highlight that weakness in certain market segments (such as property, agriculture, construction, manufacturing, household) could potentially drive up default rates. A 0.1% increase in the GIL ratio could potentially translate into a net credit cost of 10bps, which is equivalent to 6.3%-6.4% of our banking universe’s 2020E and 2021E net profit forecasts.

Business and consumer sentiment remained below 4Q18’s levels

According to a survey done by the MIER, 1H19 Business Conditions Index (BCI) and Consumer Sentiment Index (CSI) remained below levels last recorded in 4Q18. There is also a growing apprehension on rising cost-ofliving while spending on non-discretionary items may be more cautious. 2Q19: BCI slid further;

CSI saw marginal improvement qoq

The MIER BCI saw a marginal decline from 94.3pts in 1Q19 to 94.2pts in 2Q19 on the back of poorer overall sales. According to MIER, though the CSI rebound by 7.4pts qoq, it remains below the optimistic threshold level of 100. On the ground, domestic production is expected to continue expanding on the back of domestic demand and external sales, while supported by a stable labour force (labour force participation rate at 68.5% in July19; unemployment rate at 3.3% in July19).

Positive key takeaways from BNM’s 1H19 Financial Stability Review

That said, despite rising cautiousness on the domestic and global outlook, we also take comfort in the strong fundamentals of the Malaysian banking sector, as reflected by high capital adequacy, ample domestic liquidity, stable funding and robust household financial buffers against household debt. Based on Bank Negara’s 1H19 Financial Stability Review report, we have summarized some positive key takeaways at its briefing yesterday:

i) Our banking sector remains resilient against macroeconomic and financial shocks as implied by strong capitalization levels (CET1 ratio at 13.4%; Total Capital Ratio at 17.4% as at June19. The excess capital buffers (above minimum regulatory requirement) stood at RM103.3bn as at June19;

ii) Even with a more adverse scenario stress test (based on BNM’s Adverse Scenario 2, in Fig 10) on the banks, CET 1 ratio fell from 13.4% to 10.5% (decline of 290bps) and is above regulatory requirement of 4.5% (for CET 1) and a 2.5% for countercyclical buffer;

iii) Household debt levels though remain elevated, and saw a marginal uptick in the household debt-to-GDP level to 82.2% (in 1H19) from 82% (2018). Nonetheless, we take comfort that the growth rate of financial assets, at 6.8% yoy, is well ahead of the pace of growth in household assets at 5.1% yoy. Meanwhile, the financial asset-to-debt ratio of 2.2x and liquid financial asset-to-debt ratio of 1.5x as at 1H19 continues to support a high repayment capacity by households.

iv) Household risks are largely contained as implied by an impairment ratio of 1.3% (vs. a 5-year average of 1.5%). Total debt-at-risk (DAR) stood at 5.2% of household debt and consist largely borrowers with negative financial margin. Most incidents of default are largely in housing loans price >RM500,000 and variable income earners. The share of borrowings by vulnerable borrowers (i.e. income level at below RM3,000/month) declined to 18.5% as at 1H19 vs. 19.3% in 2018;

v) Banking sector liquidity and funding conditions remain supportive of financing activities. June 2019 loan-to-fund ratio stood at 82.6% (vs. 83.1% in 2018) while the June 2019 liquidity coverage ratio at 153% (vs. 143.2% in 2018). Banks continue to have limited reliance on external (7.5% of total banking system funding liabilities) and crosscurrency funding (5% of non-resident deposits in our banking system);

vi) Banking sector loan loss coverage stood at 126.9%, while the GIL ratio remained stable at 1.6% as at June19;

vii) There was some marginal deterioration in banks’ overseas operations. The ROE for overseas operations have dipped to 8.8% as at 1H19 vs. 10.7% in 2018 while the GIL ratio deteriorated further to 2.3% (from 2.0% in 2018). Total capital ratios for overseas operations remain firm at 19.1% as at 1H19

viii) As at 1H19, the quality of business borrowings remained sound despite more challenging conditions. The GIL ratio for business loans stood at an average of 2.6% (steady yoy). The total non-financial corporate (NFC) debt-to-GDP ratio stood at 102% with external debtaccounting for 25% of total NFC borrowings. About 51% are intercompany loans and trade facilities while 75% of approved offshore borrowings are hedged;

Maintain NEUTRAL. Top picks – RHB Bank, Aeon Credit, ELK-Desa

We maintain out NEUTRAL stance on the sector, noting that business and consumer sentiments are not expected to turn more optimistic in Malaysia in 2H19 and 1H20 against 1H19, largely due to rising cautiousness driven by escalating geopolitical tensions, slower global growth, expectation of slower trade activities and the unresolved US-China trade tensions. On a more positive note, our strong economic fundamentals – resilient consumer spending, business growth and low unemployment rate, are holding up. We expect consumer sentiment and business activities to gradually improve in 2H20 as the trade tension issue may dissipate.

Our sector top picks include:

RHB Bank (RHBBANK MK, RM5.62, BUY, TP: RM6.60 based on 2020E P/BV target of 1.0x), is on track to achieve better ROEs in 2019-21E, on the back of its FIT22 initiatives to focus on the affluent SMEs, mid and large cap companies. RHB’s NIM outlook is likely to improve in 2H19, on the back of effects of repricing down of fixed deposit rates and expiry of some senior debt securities/hybrid capital (of which, would not be renewed). Dividend payout is expected to be increased, based on a higher target ratio of 40%.

Aeon Credit (ACSM MK, RM15.20, BUY, TP: RM19.80 based on CY20E target PER of 13x), is on track to deliver a solid performance over FY20- 22E, arising from positive outcomes of its value-chain transformation project which is focused on: i) cost-reduction initiatives; ii) improving staff productivity/efficiency; iii) boosting receivables’ returns through change in target markets; and iv) enhancing credit recoveries. Aeon Credit remains an attractive alternative (to banks) financial play, and its projected ROE of c.18-19% over FY20-22E is one the highest among the financial stocks in our universe.

ELK-Desa (ELK MK, RM1.65, TP RM1.98 based on 13x CY20E EPS. We remain upbeat on ELK-Desa’s prospects, being a prudent massmarket used-car financing player in the Klang Valley. We see room for growth even in the Klang Valley alone, coupled with strong support from car dealers. Ultimately, as management gears-up its balance sheet (gearing ratio 0.31x), the group would be able to maintain its receivables growth of 16-20% p.a. without the need to raise equity capital. We see this as a key re-rating factor for the group, in-line with peer's strategy, such as the Aeon Credit Group (which has a gearing ratio of 3.66x).

Source: Affin Hwang Research - 19 Sept 2019

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