Investment Highlights

• Potentially another cut of 25bps in overnight policy rate (OPR) to 2.25% on 5 May 2020. YTD, Bank Negara has reduced the OPR by 50bps to 2.50% leading to a cumulative rate reduction of 75bps since 2018. We see the potential for another cut of 25bps, thus lowering the OPR further to 2.25% from 2.50%. This could occur in the next Monetary Policy Committee (MPC) meeting on 5 May 2020. Most central banks have cut interest rates to address impact of the Covid-19 pandemic and Malaysia is not spared from this (see Exhibit 6). Recently, the Bank of England has reduced its benchmark rate by 50bps to 0.25%. On 15 March, the US Federal Reserve announced an emergency rate cut of 100bps on top of the earlier rate reduction of 50bps which saw the Fed rate lowered to 0.25% from 1.25%.

• Stronger signals for another rate of 25bps cut based on the decline in KLIBOR and increase in spread between the KLIBOR and interest swap rate. Following the 25bps OPR cut to 2.50% on 3 March, we continue to observe a drop in the 3-month KLIBOR rate to 2.78%. Also, the rate on interest swap has declined. This has widened the spread between the KLIBOR and interest swap rate, signalling that the market has priced in another interest rate cut (see Exhibit 5).

• Lesser monetary flexibility for Bank Negara to further cut the OPR after the next rate reduction in May 2020. This is in view of the weaker ringgit which has been impacted by the weakness in oil prices. There remain external uncertainties (unresolved trade tension, Covid-19, collapse in oil prices with Russia’s reluctance to join Opec members) and domestic political uncertainties that could weigh on domestic GDP growth for 2020. We see some resemblance to the 2008–2009 financial crisis impacted by the fallout in the mortgage subprime market in US which oil prices also slumped though not entirely similar to the factors affecting the global economy now. The 2008–2009 crisis saw the OPR being trimmed by a total of 125bps from 3.25% to 2.00% in 2009 before rising by 75bps the following year (2010). Meanwhile, the SRR was also reduced by 300bps to 1% from 4% between 2008 and 2009.
• With another rate cut of 25bps in May 2020, the cumulative reduction in OPR will be 100bps since 2019. This will be close to the 150bps rate cut observed during the 2008–2009 crisis. With the lower oil prices weakening the ringgit, we see limited options from the fiscal and monetary side to address the external uncertainties. There will be lesser monetary flexibility to further reduce the OPR as this will further weaken the domestic currency, consequently adding pressure to inflation from a higher import cost. The ringgit now stands at 4.37 vs. the USD compared to an average of 3.38 during the 2008-2009 financial crisis. Nevertheless, the possibility of further cuts to the SRR in addition to the 50bps reduction seen in Nov 2019 will not be ruled out.
• Further downside risk to the interest income and NIM of banks from another rate cut in May 2020. The 25bps reduction in the benchmark rate will mildly impact banks’ earnings of 1–2% while NIMs of most banks will be impacted by 2–4bps. The impact of any OPR change will depend on the timing of its occurrence and it will be short term (estimated 1 to 2 quarters) with FD rates eventually repriced down to catch up with the changes in lending rates.
• Potential downside risk to provisions of banks should Covid-19 and weaker oil prices play out longer. Most banks have guided that their exposure to sectors directly impacted by Covid-19 (tourism, hospitality, airlines, wholesale, retail trade and manufacturing) as a percentage of total loans ranged between 2% and 3%. The 2–3% exposure appear to be comforting. Nevertheless, we are concerned on banks’ indirect exposures to sectors which are not commonly identified that could also be impacted by the outbreak of the virus. These borrowers may not have access to the relief BNM facility which is capped at RM2bil in total, offering a low interest rate of 3.75% or to be allowed a moratorium period of 6 months permitted by BNM to defer repayments or even be restructured and rescheduled. For the oil & gas sector, most banks have already been vigilant and monitoring the sector closely after the earlier plunge in oil prices with exposure to this segment gradually declining. Among the larger cap banks, Maybank’s exposure to the sector has been reduced to 2.8% as the Dec 2019 (Dec 2018: 3.57%) while CIMB has an exposure of 2.3%. RHB Bank’s exposure to this sector has been lowered to 2.4% in Dec 2019 compared to 2.8% in Dec 2018. Meanwhile, Public Bank, Hong Leong and Alliance Bank’s exposure to the oil & gas sector is minimal, making up less than 1.0% of their respective total loans.

• Still a low visibility on how Covid-19 and the lower oil prices will last but we have conservatively imputed an additional 10bps credit cost onto all banks’ earnings for FY20/21. As shown in Exhibit 9, we have raised our credit cost assumptions by an additional 10bps for all banks. We expect upticks in impaired loans and a rise in provisions for banks in FY20/21 from a slower economic growth for 2020. Together with the penciling in of another 25bps cut in the OPR, we have reduced banks’ earnings for FY20/21 by 6.2%.

• The sector’s calendarised core earnings growth for 2020 is now revised to -4.1% from 1.2% after factoring in another rate cut of 25bps and an additional 10bps credit cost into our banks’ earnings. For FY2021, we project the calendarised core earnings for the sector to grow by 3.5%.

• We maintain our NEUTRAL stance on the sector in view of the headwinds to interest income from rate cuts and potentially higher credit cost from the external and domestic political uncertainties. Taking into account of these uncertainties, we continue to favour banks with: i) lower foreign shareholdings for stability; ii) higher dividend yields; iii) larger securities book to benefit from marked-to-market gains with the decline in bond yields to mitigate the OPR cuts on NIM; iv) the ability to recover fast from the repricing of deposits to lower rates from cuts in benchmark interest rates; and v) stable asset quality (higher security coverage for loans).
• Our top picks remain Maybank (FV: RM8.60/share) and RHB Bank (FV: RM5.80/share). We continue to like Hong Leong Bank (FV: RM15.90/share) for its strong security coverage for loans, low foreign shareholdings of 10.7%, faster recovery from OPR cuts and its valuation, which is trading at a low 0.9 PB/V well below the 2008-2009 trough valuation of 1.5x P/BV. On Alliance Bank (ABMB), we see that the stock is already trading at a low P/BV of 0.4x (crisis through valuation) while its foreign shareholdings have declined to a low to 21.3% in Feb 2020. Hence, we upgrading ABMB to a BUY with a revised fair value of RM1.90/share. Most banks are already trading below the through PB/V during the 1997–1998 or 2008–2009 crisis. Nevertheless, market sentiment remains fragile with selling in the equity market still heavy by foreign investors.

Source: AmInvest Research - 19 Mar 2020