PublicInvest Research

Banking - Rate Normalization Begins

Publish date: Thu, 12 May 2022, 09:51 AM
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Bank Negara Malaysia (BNM) made a 25bps upward adjustment to its Overnight Policy Rate (OPR), citing improvements in labour market conditions and reopening of the global economy as major factors in supporting recovery of economic activity. While the military conflict in Ukraine, China’s strict containment measures and resultant supply chain disruptions, and elevation in global inflationary pressures are clouding the outlook somewhat, BNM opines that the Malaysian economy is on firmer footing and is therefore now timely to reduce the degree of monetary accommodation. With the overnight move, OPR is now at 2.00% (1.75% previously), with the ceiling and floor rates of the corridor correspondingly raised to 1.75% and 2.25% respectively.

Margin expansions are expected, though history (as per Table 3 and Table 4) suggests uneven impacts. In any case, banks have already anticipated this rate hike by BNM, though this move may have possibly come earlier-than-expected. We make no adjustment to our earnings assumptions, having already assumed eventual rate normalizations in our forecasts. An immediate overhang on the sector is still asset quality, given the potentially challenging economic conditions over the horizon due to the above-mentioned disruptions.

Short-term volatilities notwithstanding, the start of the rate normalization cycle and gradual economic recovery will bring about asset quality improvements, loans growth and margin expansions, all of these medium-term boons to the sector. While we maintain our NEUTRAL view on the sector, it continues to be with a positive bias given its lagging valuations relative to the broader market. For sector exposure, we like Maybank and CIMB Group.

  • Positive impacts, on face value, will be more notable on banks with higher levels of variable-based loans (ie. RHB Bank @ 87.6%, Alliance Bank @ 83.1%, Hong Leong Bank @ 82.5%) as loan rates are re-priced more immediately thereby lifting income faster. While CIMB Group also has a high proportion of variable rate loans (82.1%) in its portfolio, 37.0% of its total loans are overseas exposures not affected by this hike. It should however be noted that Indonesia, its 2nd largest interest income contributor, is also on track for upward adjustments in rates. 
    RHB Bank, AmBank and Affin Bank’s relatively higher levels of fixed-rate deposits should help sustain margin expansions over the near-term seeing that as these are presumably locked-in at lower rates. Local-sourced deposits are also a plus point, giving it fuller impact. Maybank and CIMB Group, while exhibiting similar portfolio make-ups, have higher levels of overseas exposures that may see effects muted. 
    On the balance, RHB Bank appears poised to benefit the most (on face value) from BNM’s rising OPR trend given its higher levels of variable-rate loans and fixed-rate deposits. While Affin Bank and Alliance Bank may also appear to benefit more, this rising tide will lift all boats and benefit all banking stocks through imminent margin expansions, though to varying degrees.
  • Loans growth momentum appears to be stabilizing at the +4.0% YoY level, still underpinned by household related loans. Any significant strengthening will have to come from business-related loans however given the elevated level of household indebtedness, though question marks remain over the strength of the economic recovery.
    Downward trend in applications shows no signs of flattening out, though it still remains very early days in sounding alarm bells to call out a possible disintermediation to capital markets for fund-raising. Applications (by quantum) has averaged an encouraging ~RM78bn since the March 2021-high of RM94.2bn nevertheless. Loan approval rates have seen slight improvements, though also not yet on a consistent basis. We reckon financial institutions are still continuing to balance between the need to protect asset quality, maintain sufficient liquidity while also driving growth in current times 
    The previous all-time OPR low of 2% during the 2009/2010 period did see demand for credit pick up about 9 months after the final OPR cut, which even accelerated despite rates being hiked gradually, though this was very much the result of improved economic conditions. 
    Whether history repeats itself is dependent on global conditions taking a decided turn for the better. At this point, we are cautiously optimistic and maintain our industry loans growth assumption of 4.5%.
    Any upturn in sentiment and/or activity may likely see banks with respective focuses on non-household loans (ie. Maybank, CIMB Group and Affin Bank) see greater penetration given already-elevated levels of household indebtedness.
  • Benefits to net margins (on a business as usual basis) vary amongst banks. Rate hikes are largely positive to most banks, in theory, as can be seen in the following tables (Table 3 and Table 4) that show net interest income (minor periods of adjustments notwithstanding) generally on an upward trajectory. The periods under observation are from March 2010 (2Q CY10) to March 2012 (2QCY12) during which the OPR was hiked by 1% from 2.0% to 3.0% (March 2010: +25bps to 2.25%, May 2010: +25bps to 2.50%, July 2010: +25bps to 2.75%, May 2011: +25bps to 3.00%).
    In the said observation period (2QCY10 to 2QCY12), loan-deposit ratios (LDR) of Maybank, CIMB Group and AmBank were relatively stable whilst that of Public Bank and Hong Leong Bank rose, providing an added lift. Conversely, the LDRs of RHB Bank, Affin Bank and Alliance Bank fell.
  • Asset quality concerns are likely to be adequately mitigated despite recent uptick in levels of impairment. Banks’ cumulative pre-emptive provisions in 2020 and 2021 should provide buffers to profitability against further economic deterioration, a global meltdown notwithstanding. (Note: 2020 impairment +RM1.8bn, provisions +RM7.2bn, 2021 impairment -RM979.5m, provisions + RM4.4bn)
  • Selective exposure. Share prices had improved recently, though easing off again amid the prolonging Russia-Ukraine conflict and global bond yield spike. All said, policy rate normalization (margin expansion), sustained economic recovery (improved loans growth and asset quality) are mixtures for a stronger 2022/23. For sector exposure, we like Maybank and CIMB Group.

Source: PublicInvest Research - 12 May 2022

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