BNM announced another rate cut on the Overnight Policy Rate (OPR) from 2.75% to 2.5% yesterday, which was in-line with our expectation. We recently priced-in the impact of a 50bps cut in the OPR during the 4th quarter reporting season. Based on our estimates, a 25bps cut is expected to result in a 1%-6% reduction in banks' net profits in 2020E21E. Nonetheless, for the first 2 quarters subsequent to the OPR cut, the banks’ net interest margins (NIM) will be under pressure due to the immediate repricing effects of the variable loan rates. NIM will likely start to normalize after 6 months as deposit rates start repricing down. Among the banking stocks, we expect Alliance, CIMB and RHB to bear a larger negative impact on their net profits due to their more assetsensitive balance sheets. Hong Leong Bank, AMMB, Public Bank and Maybank may see minimal impact to earnings under a rate-cut scenario. We maintain our NEUTRAL on the banking sector.

Another 25bps Cut in the OPR, In-line With Expectations

On 3 March, BNM decided to cut the OPR by 25bps to 2.5%, in light of increased downside risks to global growth outlook, particularly in the near term due to the Covid-19 outbreak. Meanwhile, weaknesses are seen in the tourism, manufacturing and agriculture sectors. The reduction in the OPR is in line with our house view of a total cut of 50bps in 2020, in light of the moderating economic growth. This development has already been factoredinto the assumptions for all the banks under our coverage. Our Economist does not expect further rate cuts for the rest of 2020.

A Negative Immediate Impact on Banks’ Net-interest-margins (NIM)

Inevitably, banks will see an immediate negative impact on earnings arising from the OPR cut due to the downward revision of variable rate loans. We expect NIM compression of circa 1.8bps to 6.6bps for banks in our universe (Fig 1). Based on the respective bank’s fixed deposits (FDs) and NIDs maturity profile, this would determine how much interest-rate risk a particular bank is exposed to. We understand that between 50% to 80% of banks’ FDs and NIDs have maturities within 6 months, implying that NIM may start normalizing after a 6-month period.

Higher Impact on Banks With a More Asset-sensitive Balance Sheets

Based on our simulation of a 25bps cut in interest rates, the net profit impact ranged from -1.0% to -6.1%. Banks with a more asset-sensitive balance sheet, i.e., a greater proportion of variable-rate loans against fixed-rate loans in their portfolio, such as Alliance Bank, CIMB and RHB may see a higher adverse net profit impact of -6.1% (for FY21E), -4.4% (for FY20E) and -2.6% (for FY20E) respectively. Hong Leong Bank, AMMB, Public Bank and Maybank may see minimal earnings impact on earnings.

Simulation Effect Does Not Take Into Account Other Factors

Our simulation, however, is limited to NIMs and does not take into account:

i) the interest-rate risk hedging strategies in place and the possible increase in financial assets in the banks’ books;

ii) potential increase in loan growth as a result of the lower rates and government stimulus measures on the economy;

iii) management’s discretion when it comes to risk-based lending could also cushion the banks’ negative NIM impact.

Rate Cut Is Expected to Support Overall Domestic Growth in 2020

In summary, the OPR cut also represents a positive signal that BNM is ready to step in, whenever necessary, to maintain monetary accommodativeness in the system. Based on BNM’s January20 statistics, loan growth has stayed muted at 3.5% oy, with the household sector at 4.5% yoy while the business sector is at 2.5% yoy.

Maintain Sector NEUTRAL Weighting

We maintain our NEUTRAL sector call, noting that earnings catalysts are lacking as loan growth may moderate further to 3% in 2020 due to lacklustre business and consumer sentiment.

At this juncture, we foresee a contraction in sector core EPS of 4.5% yoy in 2020E and a marginal growth of 1.4% yoy in 2021E. Based on our forecasts, the sector is currently trading at a P/BV multiple of 1.02x 2020E, vs. the past10-year average of 1.5x and past 5-year average of 1.35x. It traded at -1SD or 1.2x during the last crisis in the period of October 2008-March 2009.

Key downside risks to our sector call: further cuts in the OPR (further NIM compression), moderation in loan growth, new NPL formation (with respect to commercial property, residential property, agriculture and construction loans) and higher overheads. Upside risks: a recovery in global growth.

Top Picks – AMMB, Hong Leong Bank, Aeon Credit and ELK-Desa

AMMB (AMM MK, RM3.70, BUY, TP: RM4.80 based on 2020E P/BV target of 0.8x), has shown decent improvement in its operating results, while its peers have shown signs of moderation. The recent 25bps OPR cut is not expected to affect AMMB’s earnings significantly due to its less asset sensitive balance sheet. Earnings outlook for AMMB is expected to be relatively steady, on the back of: i) its more robust targeted segment loan growth in SME, mortgage and business loans (offsetting the impact of corporate loan repayments); ii) improving NIM (1.9-2.0%); iii) low net credit cost (~16bps); and iv) sound loan book (GIL at 1.71%). We believe that higher dividends could be on the cards this year.

Hong Leong Bank (HLBK MK, RM15.60, BUY, TP: RM17.00 based on 2020E P/BV target of 1.3x) was recently upgraded to a BUY rating on valuation grounds (due to the sharp pullback in share price recently). The recent 25bps OPR cut is not expected to affect HLB’s earnings significantly due to its less asset sensitive balance sheet. Earnings outlook for HLB is expected to be relatively steady, on the back of: i) its robust pipeline of loan growth, though we are only projecting a 4-4.5% yoy growth; ii) steady NIM of circa 2.0% (vs. our more conservative projection of 1.95-1.98%); iii) low net credit cost (~4bps); and iv) cost-to-income ratio of 45%. Key downside risk for HLB is the sharper-than-expected decline in Bank of Chengdu’s earnings contribution (due to the COVID-19 outbreak in China and moderation in credit growth).

Aeon Credit (ACSM MK, RM13.60, BUY, TP: RM17.20 based on CY20E target PER of 13x). We expect receivable growth to remain robust at over 20% yoy as management shifts its market focus to the middle-income segment. With management relooking at its pricing strategy, we believe it would eventually boost interest income growth and lower its credit costs (which was elevated under the MFRS 9 adoption). Aeon Credit remains an attractive alternative (to banks) financial play, and its projected ROE of c.19-20% over FY20-22E is one the highest among the financial stocks in our universe.

ELK-Desa (ELK MK, RM1.61, TP RM1.82 based on 13x CY20E EPS). We remain upbeat on ELK-Desa’s prospects, being a prudent mass-market used-car financing player in the Klang Valley. We see room for growth in the Klang Valley, coupled with strong support from car dealers. Ultimately, as management gears up its balance sheet (net gearing ratio 0.46x), the group would be able to maintain its receivable growth of 16-20% p.a. without the need to raise equity capital. We see this as a key re-rating factor for the group, in-line with its peer's strategy, such as the Aeon Credit Group (which has a gearing ratio of 3.92x).

Source: Affin Hwang Research - 3 Mar 2020