Investment Highlights

BNM released the Financial Stability Review for 2H19 and held a video conference briefing on Friday. Below are the key highlights:

• The central bank highlighted that the banking sector remained resilient, supported by total capital ratio of 18.4% and an excess capital buffer of RM121bil capable of withstanding potential credit and market losses. Total provisions, including regulatory reserves held against credit losses, were 125.0% of impaired loans as at the end of Feb 2020.

• The banking sector recorded a CET1 capital ratio of 14.4% and gross impaired loan ratio of 1.6% in Feb 2020. Liquidity continued to be ample with an LCR of 148.0%.

• Household debts expanded at a faster pace of 5.3% in 2H19 (1H19: 5.1%%) contributed by the expansion of loans for purchase of residential property during the Home Ownership Campaign. Also, it was supported by higher growth of personal financing and credit cards. Household debt-to-GDP ratio increased slightly to 82.7% in 2H19 vs. 82.2% in 1H19 amid the slower GDP growth.

• Growth in household assets continued to outpace expansion in debts. The financial asset-to-debt and liquid financial asset-to-debt ratios remained stable at 2.2x and 1.4x respectively for the household sector.

• The share of borrowings by borrowers with income below RM3,000 per month (vulnerable segment) to the total household debts fell to 17.6% (1H19: 18.5%). This will lower the risk of loan defaults from this segment. Leverage of the vulnerable borrowers remained high at 9x with a liquid asset-to-financial debt ratio of 0.7x, which is lower than 1x (the prudent threshold). Household sector debt at risk remained low at 5.2% of the total household loans.

• 70% of the newly approved household loans have a debt servicing ratio (DSR) of below 60.0%.

• GIL and NPL ratios for household sector loans are stable at 1.2% and 1.1% respectively.

• House prices grew modestly in 3Q19 on the back of steady demand for affordable high-rise properties. Market transactions in terms of volume picked up in 3Q19, clearing some of the unsold properties under developers’ inventory. Nevertheless, the average transacted prices of properties fell in 3Q19. Developer discounts and rebates, the home ownership campaign and stamp duty exemption helped sustain property market transactions in 3Q19. A mismatch between housing supply and demand persists as house prices remained unaffordable. Demand was firmer for properties below RM500,000, accounting for 83% of the total transactions for 9M19. Meanwhile, the oversupply condition of office and retail spaces in the non-residential property market has not improved. We understand that the growth of e-commerce and changing customer preferences to shopping online have resulted in retailers reducing their physical footprint. Meanwhile, competition for tenants of office and retail spaces particularly in Klang Valley has lowered the effective rental rates.

• BNM conducted a sensitivity analysis on housing loans borrowers. It was found that with banks’ excess capital buffers, financial institutions were still able to absorb shocks to home prices and income of mortgage borrowers.

• With challenging business conditions, growth in non-financial corporate (NFC) debts was flat at +0.8% in 2H19 vs. 1H19 of +3.6%. This was due to the cautious sentiment due to uncertainties in the business outlook with loan repayments exceeding disbursements. Meanwhile, external debts of NFCs fell by 4.4% in 2H19 (1H19: +2.9%) due to redemptions of matured bonds, and settlements of intercompany loans by oil & gas companies.

• Interest coverage ratio for businesses was only marginally lower at 4.6x in 2H19 (1H19: 4.7%). Debt servicing capacity for the oil & gas, plantation and construction sectors improved while that for the property, wholesale and retail trade sectors decreased in 2H19 vs. 1H19. Operating conditions in the near term will be more challenging owing to the Covid-19 outbreak. The tourism business and manufacturing sectors will be impacted by travel and supply disruptions. These segments make up 44.0% of banks’ business loans and 16.0% of the banking system’s total loans.

• Leverage of oil & gas borrowers has decreased to 37.5% (1H19: 42.8%) while loan impairment ratio has declined though it remained elevated. Banks’ exposures to borrowers in this sector stayed low at less than 2.0% of the total business loans. We believe that provisions for loan impairments in the oil & gas sector would have already been largely provided for by banks.

• Banks’ overall loan exposure to the construction sector has remained stable, accounting for 14.0% of the total business loans.

• Overall, the business sector’s debt-to-equity ratio remained stable at 25.1% with a marginally improved operating margin of 5.7% in 2H19 vs.5.4% in 1H19.

• Impaired loan ratio of the overall business sector was kept at 2.5x in 2H19.

• The risk of domestic banking group’s overseas operations from weaker economic conditions remained low with earnings of banks driven largely by operations in Malaysia.

• We gather that the risk of banks’ exposure to large borrowers will be mitigated by repayment contracts secured against long-term contracts, collaterals, government guarantees and measures by borrowers to conserve cash flows. Banks’ exposure to large borrowers in the vulnerable sectors reeling from the effects of the Covid-19 pandemic classified under stage 2 and 3 was less 4% of the total loans in the banking system. A sensitivity analysis was also done by the central bank on large borrowers. These borrowers still had interest coverage ratios of above 1x after applying shocks with a 15% depreciation to our domestic currency, 100bps increase in the borrowing cost, and 50% decline in their operating profits.

• We retain our NEUTRAL rating on the sector with headwinds to interest margins from further rate cuts and potentially higher provisions over the short term. The Covid-19 pandemic has caused supply chain disruptions as well as impacted consumption expenditures. Nevertheless, we see a pent-up demand after the pandemic subsides with a gradual recovery in banks interest margins from the OPR cuts.

Our top picks are Maybank (FV: RM8.60/share) and RHB Bank (FV: RM5.80/share). Also, we like Hong Leong Bank with an FV of RM15.90/share.

Source: AmInvest Research - 6 Apr 2020