We take great comfort that the banking system is well-positioned to absorb the potential damage from Covid-19, given prudent capital and liquidity buffers built up over the years. From BNM’s stress test, CET1 ratio is projected to decline to 8.5% in a protracted recession setting, which is still comfortably above the 4.5% minimum level. However, near-term headwinds will put dent on profitability; this is compensated by the sector’s inexpensive valuations (P/B is now below -2SD and GFC’s level). Retain NEUTRAL and we like banks that were acutely bashed down; preferred picks are CIMB (TP: RM4.70) and Alliance (TP: RM2.50). Other BUY ratings are RHB (TP: RM5.40) and BIMB (TP: RM3.70).

Last Friday, BNM issued its 2019: (i) Annual Report, (ii) Economic & Monetary Report, together with the (iii) Financial Stability and Payment Systems Report. In this write-up, we collated the key highlights relevant to the banking sector.

On stronger footing. Although the impact of Covid-19 on the economy is significant, banks are entering this laborious period from a position of strength, with more than ample capital and liquidity buffers: (i) strong CET1 ratio of 14.3% (2018: 13.9%) and (ii) robust liquidity coverage ratio of 149% (2018: 143%). Overall, BNM views that our banks are capable of coping with the increased risks to financial stability given their better footing vs the Asian Financial Crisis and Global Financial Crisis. From BNM’s stress test, CET1 ratio is projected to fall to 8.5% in a protracted recession scenario, which is still comfortably above the 4.5% minimum level (this assumes GIL ratio rising to 8.4% from 1.5% - we do not see such deterioration happening, since troubled loans can be rescheduled & restructured, without being classified as impaired).

Household segment has low debt-at-risk of 5%. The total household (HH) debt-to GDP was still elevated at 82.7% (2018: 82.0%) but supported by income growth and adequate financial buffers; the aggregate financial asset-to-debt stood at 2.2x (flat vs 2018) and if we were to consider only liquid financial asset (LFA), the debt cover is 1.4x (flat vs 2018). Besides, the share of borrowings by vulnerable borrowers (income less than RM3,000 with LFA-to-debt of 0.7x) is now below one-fifth of total HH debt - this has been on a declining trend since 2012. Also, we understand the debt-at-risk from the HH sector remained low at 5% of total HH debt. Based on BNM’s sensitivity analysis that simulates impact of severe stress scenarios on borrowers’ debt servicing capacity, the potential losses to the banking system were estimated to be between 42- 68% of banks’ excess capital buffers.

Enough buffers to shield a business segment meltdown. For businesses (Biz), we observed an unpleasant climbing trend for debt-to-equity and falling interest coverage ratio. However, both were still at un-alarming levels of 25.1% (2018: 24.9%) and 4.6x (2018: 4.9x) respectively. On a more positive light, the cash-to-short-term-debt ratio was stable and healthy at 1.0x (2018: 0.9x). Moreover, banks’ exposure to large borrowers has fallen to 38.4% (2018: 42.7%) of total business lending. We gathered banks’ excess capital buffers were sufficient to cover between 2.5-3.6x of the potential credit losses from large borrower groups that are more likely to default under BNM’s assumed stressed conditions.

Maintain NEUTRAL. We take great comfort that the banking system is well-poised to absorb the potential damage from Covid-19, given prudent capital and liquidity buffers built up over the years. However, near-term headwinds will put dent on the profitability of banks; this is compensated by the sector’s inexpensive valuations (P/B is now below -2SD and GFC’s level). We like banking stocks that were acutely bashed down and especially those with P/B below 1.00x, GFC’s trough, and -2SD; two of our BUY calls meeting this criteria are CIMB (TP: RM4.70) and Alliance (TP: RM2.50), making them our preferred picks. Other BUYs: RHB (TP: RM5.40) and BIMB (TP: RM3.70).

Source: Hong Leong Investment Bank Research - 6 Apr 2020