We take great comfort that the banking system has enough buffers to withstand extreme stresses (default rates that are 8x higher than normalized levels), which are more dire vs the historical worst experienced to date. From BNM’s updated stress tests, credit costs could increase to RM29b over 2020-21 while GIL ratio is projected to rise above 4%. Besides, sector CET1 ratio in 2021 is seen to fall by up to 3.1%. However, pain points from Covid-19 crisis are not behind us; this is balanced out by deflated valuations. Maintain NEUTRAL and the only banking stock that we like now is RHB (TP: RM5.80), primarily for its strong CET 1 ratio, large untapped FVOCI reserves, and undemanding valuations.

Yesterday, BNM published its 1H20 Financial Stability Review Report. In this write-up, we collated the key highlights relevant to the banking sector.

In position of strength. Although the Covid-19 pandemic has exerted considerable stress on the economy and financial system, our banks are thus far resilient and have absorb rather than amplify macro shocks, thanks to ample capital and liquidity buffers: (i) strong CET1 ratio of 14.6% (2019: 14.6%) and (ii) robust liquidity coverage ratio of 149.2% (2019: 149.1%). From BNM’s updated stress tests, we gathered credit costs could rise to RM29bn over 2020-21 while GIL ratio is projected to jump above 4% (from 1.6%); coincidentally, these are the sort of assumptions that we have baked into our financial models, implying conservative estimates. In 1H20, banks have shored up provisioning buffers of RM2.7bn. Besides, sector CET1 ratio in 2021 is seen to fall by up to 3.1% to 11.5%, which is still comfortably above the 4.5% minimum level; we understand banks have enough buffers to withstand default rates that are 8x higher than historical levels (this is more severe than our worst experience during the Asian Financial Crisis where impairments rose 3-5x from initial levels).

HHs are borrowing within their means. The total household (HH) debt-to-GDP was still high at 87.5% (2019: 82.9%) but generally HHs are borrowing within their means; median debt service ratio for outstanding/new loans are 35%/43% respectively (2019: 37%/43%). Also, aggregate financial asset-to-debt stood at 2.2x (flat vs 2019) and if only liquid financial asset is considered, the debt cover is 1.4x (flat vs 2019). Besides, BNM estimates HH borrowers who may face repayment difficulties due to income and unemployment shocks are not likely to account for more than 15% of total borrowers. Under BNM’s updated stress tests, HH’s GIL ratio is anticipated to double in 2021 as impairments are set to emerge in 2H21 (given extended repayment programs that will remain in place through 1Q21).

More Biz segment pains. For businesses (Biz), interest coverage ratio has fallen to 3.7x (2019: 4.8x) and the share of listed firms with less than 2x multiple has rose to 32.1% (2019: 28.1%). Also, banks have approved 6.3x more Biz R&R applications vs the total outstanding R&R Biz exposures as at end-2019. On a more optimistic note, debt-to-equity ratio fell to 23.8% (2019: 25.4%) while the cash-to-short-term-debt ratio was stable and healthy at 1.0x (2019: 1.0x). Regardless, 76% of the expected rise in 2021’s GIL ratio is due to higher Biz impairments, driven by defaults of maturing bullet repayments of firms operating in vulnerable sectors as well as exposures to several large borrower groups with weaker financials

Maintain NEUTRAL. We are comforted that the banking system has sufficient buffers to withstand extreme stresses, which are more dire vs the historical worst experienced to date. However, pain points from Covid-19 crisis are not behind us, especially when infection cases have been escalating again. That said, this is balanced out by deflated valuations. The only bank we like now is RHB (BUY, TP: RM5.80) given its appealing risk-reward profile, thanks to: (i) undemanding valuations, (ii) strong 16.6% CET1 ratio (sector: 14.6%), and (iii) fairly large untapped FVOCI reserves.

Source: Hong Leong Investment Bank Research - 15 Oct 2020