Comparing to Similar Events in the Past, We Believe the Impact of Covid-19 and Oil Price Crash May Not be Overwhelmingly Negative for Banks. Furthermore, We Are Seeing a More Cohesive Effort to Lessen the Pressure From the Outbreak and O&G Firms Are in Much Better Shape Than Before. Nonetheless, Bad Sentiment Is Hard to Shake Off and the Already Muted Sector Growth Outlook Is Not Helping. However, We Are Consoled by Inexpensive Valuations (sector Trading Below -2SD to 5-year Mean P/B). Retain NEUTRAL on the Sector and We Advocate Selective Stock Picking. Our Preferred Pick Is CIMB (TP: RM5.50). Other BUY Ratings Are RHB (TP: RM6.00), BIMB (TP: RM4.50), and Alliance (TP: RM3.05).

The year 2020 is off to a bad start with one bad news after another. In this report, we take a closer look at the impact of Covid-19 and the recent oil price crash to banks.

Covid-19. We believe the wholesale, retail, restaurants and hotels (WRRH) sector is the most vulnerable to this outbreak; from Bank Negara Malaysia’s (BNM) statistics, it makes up 7% of system loans. However, if we were to only look at industry’s SME loans, the exposure to WRRH rises to 28%. That said, banks have generally guided a lower 1-3% of their total loans book being at risk to be potentially hit by Covid-19.

Oil price. Reminiscent to the oil crisis of 2014-16, prices have plunged 30% (earlier this week) as Saudi Arabia initiated a hostile price war after Russia snubbed OPEC’s request to jointly cut supply just when demand is beginning to be stifled by Covid-19. We find the oil & gas (O&G) sector accounts for less than 3% of total loans but retail centric banks such as Public and Hong Leong have less than 1% exposure.

Net credit cost (NCC). We estimate that every 0.1% of loans turning bad could raise NCC by 10bp and reduce sector earnings by 5%. Currently, we are projecting NCC to increase 5bp in 2020 followed by another 1bp in 2021; this brings our 2020 -21 NCC to 27-28bp (above its 5-year mean of 23bp). To recap, NCC inched up 2bp to 127bp during the 2003 SARS epidemic while the 2014-16 oil crisis saw this jumped 10bp to 24bp. We do not expect drastic escalation this time around due to: i. More cohesive effort to rein in Covid-19 impact - banks are offering financial relief to existing borrowers affected by the outbreak and BNM has allocated RM2b to support afflicted SMEs in sustaining their business operations. Similar measures were taken in the past to deal with SARS (but smaller in scale) have proven to be effective. Back then, WRRH and air passenger travel segments recovered rapidly in a short 3-6 months. Besides, the restructuring & rescheduling (R&R) of loans affected by Covid-19 will not be tagged as impaired. ii. O&G companies now mostly have a stronger balance sheet compared to 2014-16 when there was also an oil shock; this is thanks to a combination of cash call, debt restructuring, and deleveraging efforts (the median leverage ratio fell to 37.7% in Jun-19 from 51.4% in Dec-18). Also, the O&G sector’s debt-servicing capacity has improved where interest coverage ratio stood at 3.0x in Jun-19 (vs 1.5x in Dec-18). Furthermore, banks have pared down their O&G loans exposure over the past 3 years by c.1-2ppt. In addition, oil prices are falling from a lower base. iii. The 3 overnight policy rate (OPR) cuts in less than a year (totalled to -75bp) should help borrowers to uphold their financial obligations better when fall due. Although only 25bp of the OPR cut is attributed to tackling Covid-19, the overall 75bp reduction is still higher vis-à-vis the 50bp deliberate drop in 3-mth intervention rate when BNM dealt with SARS. Also, throughout the oil price slump between 2014-16, there was just 1 OPR cut of 25bp.

Forecast. Our 2020 profit forecasts of flat growth have taken into account 2 OPR cuts (our economics team expects another reduction as early as May MPC meeting) and some negative Covid-19 impact on NCC. However, we have not imputed meaningful asset quality decline in the O&G portfolio; this may present some downside risk to our earnings projection (but as mentioned earlier, a significant rise in NCC is unlikely). We flagged Public and Hong Leong as the 2 most insulated banks from an oil shock given their focus on retail customers.

Retain NEUTRAL. Covid-19 and weak oil prices further exacerbate concerns on the already challenging and soft macroeconomic climate. However, we find impact of both events may not be overwhelmingly negative. Nonetheless, bad sentiment is difficult to shake off and the already muted sector growth outlook is not helping the situation. For now, we are consoled by inexpensive valuations (sector trading below -2SD to 5-year mean P/B). Preferred pick is still CIMB (TP: RM5.50) given the stock’s above average growth and undemanding valuations vs larger peers. Other BUY ratings are RHB (TP: RM6.00), BIMB (TP: RM4.50), and Alliance (TP: RM3.05).

Source: Hong Leong Investment Bank Research - 12 Mar 2020