Considering that European banks have been asked by their financial regulators to freeze dividends in 2020, one may begin to question whether BNM will follow suit and imposed such ruling on Malaysian lenders. We are optimistic and think it is unlikely to happen, seeing that: (i) our local banks are more conservative in running their operations and can better weather the Covid-19 crisis, (ii) NPL can undergo R&R exercise to thwart massive flare up and ensure high loan recovery rates, (iii) write-offs and bad loan provision are non-cash items, which should not undermine the fundamental ability of local banks to distribute dividends, (iv) GLC coming in to fill the country’s revenue gap and its banking investments will play an indirect role to contribute to government’s coffers, (v) majority of banks under our coverage did pay dividends even during trying times like the AFC and GFC. Nonetheless, even if we are wrong with our view, any dividend suspension is temporary, at most only for a year. Retain NEUTRAL and we like banks that were acutely bashed down; preferred picks are CIMB (TP: RM4.70) and Alliance (TP: RM2.35). Other BUY ratings are RHB (TP: RM5.40) and BIMB (TP: RM3.70).

Financial regulators in Europe have asked EU banks to freeze dividends and share buybacks in 2020; the move was intended to increase banks capacity to absorb losses and support lending to those affected by the Covid-19 crisis. On the contrary, American banks were not pressured to do so by the Federal Reserve; Chairman Jerome Powell finds that US lenders have strong capital buffers to absorb financial shocks. In this report, we argue why Malaysian banks will be allowed to continue paying dividends, albeit at reduced amounts.

Prudence is rewarding. We think there is more behind the dividend suspension in Europe. While the top 10 banks over there have fairly robust average CET1 ratio of above 13% (vs Malaysia: >14%), they tend to engage in riskier financial activities and thus, leave them more vulnerable to black swan events. Based on our observation, Malaysian banks have 4-13x lesser trading derivatives and financial assets in their books compared to European peers; income generated from held for trading assets is highly volatile and the composition of this to total income is 4x more in Europe. Besides, the gross impaired loans (GIL) ratio of Malaysian banks is 40bp lesser than western counterparts; moreover, loan loss coverage (LLC) is 15ppt higher, indicating that our lenders are generally more prudent. Also, Malaysian banks were historically more discipline vs the Europeans in handing out dividends, where they plowback a larger fraction of their annual profit to retain earnings (18ppt higher). Considering sound banking practices over the years, we reckon Bank Negara Malaysia (BNM) would not stop domestic banks from dishing out dividends, so long as their payout ratio are similar or lower vis-à-vis to historical levels.

Cocktail of antidotes. We acknowledge investors’ concern on non-performing loans (NPL) flaring up as many are suffering financially from Covid-19 circumstances; there are wild imagination of banks running into deep losses and halting dividend payments. However, steps are taken to prevent massive defaults. In the interim, we believe the 6-month loan deferment will help to ease asset quality pressures while in the medium to longer term, troubled loans can be rescheduled and restructured (R&R). Seeing the unprecedented nature on how Covid-19 hit us economically, we think banks possibly will be granted more leeway to help rescue wounded businesses; in our opinion, BNM and the government would be inclined to keep these companies afloat as it would be easier to jump start the economy. In addition, we expect BNM to cut the overnight policy rate (OPR) by another 50bp to 2.0% this year, bringing it back to the lowest level seen during the global financial crisis (GFC); partly, the move lowers borrowing costs and also assist to restrain NPL from ballooning out of control.

Rain or shine, they paid. We performed an NPL stress test exercise; results showed that almost all of the banks under our coverage could go into the red (save for Public, RHB, and Maybank) if their GIL ratio were to double from 4Q19’s levels. That said, we see low likelihood of this transpiring given the above measures taken by BNM and the government to maintain order. In any case, write-offs, impairment, and provision for bad loans are non-cash items, and since brought upon by Covid-19 events, can also be viewed as one-offs. Thus, these should not affect the ability of banks to distribute dividends, especially if hybrid scrip payouts are a norm (CIMB, Maybank, BIMB, and Affin have dividend reinvestment schemes). During the Asian Financial Crisis (AFC) and GFC, system NPL ratio was as high as 20% and 8% respectively vs our current GIL ratio of less than 2%. However, many of the banks under our coverage remained profitable throughout both periods (except for Alliance, AMMB, and RHB in AFC and only AMMB in GFC). This time around we believe it is no different, considering banks are entering the laborious phase from a position of strength.

A helping hand. The recent drop in oil prices does not bode well for Malaysia as our government is still fairly dependent on petroleum-related revenue. Hence, this makes combating the Covid-19 crisis and jump starting the economy later on, a much trickier and difficult task. To fill the gap, we see a series of revenue enhancement moves, originating mainly from government linked companies (GLC). As such, we speculate Khazanah Nasional to be one of the GLC coming to aid and its investments will play an indirect role to contribute to government’s coffers. In light of the situation, we expect banks like CIMB will continue with its dividend distribution, seeing that it is 25% owned by Khazanah. Separately, shares of other banks are also substantially held by government linked investment companies (GLIC), making them key stakeholders that cannot be sidelined, given their respective mandate to ultimately enrich the rakyat. Moreover, in recent weeks when the KLCI was battered down, we noticed GLIC have been net buyers of banking stocks. Besides, majority of the banks that we cover did pay dividends even during trying times like the AFC and GFC (save for Alliance).

Too big to fail. In an absolute worst-case scenario if NPL spirals out of control, we do not think banks will go belly up as the government will revisit the past and come up with repertoire of solutions. Back during the AFC, Pengurusan Danaharta Nasional was 1 of the 3 special purpose vehicles established to facilitate economic recovery; its key role was to acquire NPL (with gross value above RM5m) from the banking system as an asset management company. While it may seem like a bailout, it was in fact a win-win for the government and banking sector; this is because the move allowed the latter to switch attention from rehabilitating NPL to resume lending and help revive the economy. That said, today’s banking system is in a much better shape and it is well positioned to absorb potential damage from the Covid-19 crisis, given prudent capital and liquidity buffers built up over the years. Also, the debt-at-risk from the household (HH) sector remained low at 5% of total HH debt. In addition, banks’ exposure to large borrowers in 2019 has fallen to 38.4% (2018: 42.7%) of total business lending (see our 6 Apr-20 report, titled ‘Strong enough to take damage’ for elaborated insights).

Retain NEUTRAL. With the above findings and arguments, we believe banks will still be allowed to pay dividends, albeit at reduced amounts (in tandem with the decline in earnings); at least there is some form of consolation over the short-term for investing in banks, unlike some other stingier sectors. Even if we are wrong with our evaluation, any dividend suspension is temporary, at most only for a year. Upon recovery, it is easy to envision banks transforming into excellent yield play bets; the 10-year MGS yield has again fallen below the 3%-mark. However, it is not the right time to upgrade the sector yet; for now, uncertainties will continue to dampen investors’ appetite and cap overall performance. As such, we like banking stocks that were acutely bashed down and especially those with P/B below 1.00x, GFC’s trough, and -2SD, to protect downside risk; two of our BUY calls meeting this criteria are CIMB (TP: RM4.70) and Alliance (TP: RM2.35), making them our preferred picks. Other BUYs are RHB (TP: RM5.40) and BIMB (TP: RM3.70).

Source: Hong Leong Investment Bank Research - 28 Apr 2020