• BNM affirmed that the banking sector remains resilient even under more adverse economic conditions, based on recent stress tests done. At this juncture, we do not think there is a need to recapitalize the banking system.
• Business sectors (affected by COVID-19) are expected to pose more risks to the system in 2021-22 compared to households. Based on a macro simulation done, total GIL ratio of the banking system could potentially rise to 3.1% by end-2020 and 4.1% by end-2021. Under a bottom-up scenario analysis, the system CET1 ratio could decline by 3.1pts by end-2021 from 14.6% (as at Aug20).
• We reiterate our NEUTRAL stance on the banking sector. We concur with BNM that there is still downside risks on the banking sector. In our 2020E- 21E sector earnings forecasts, we have factored-in a total net credit cost of 125bps (equivalent to RM21.9bn vs. BNM’s projection of RM29bn) to take into account impairments and pre-emptive provisions. Key upside/downside risks are a shorter/longer unemployment trend and less/more business closures.

Strong Loss-absorbing Capacity of Domestic Banking Groups

In the 1H20 Financial Stability Review (FSR), BNM reiterated that despite a challenging macroeconomic outlook with potentially an increase in asset quality risks, the domestic banking groups (DBG) has the balance sheet and sufficient buffers to absorb these potential shocks. Accordingly, vulnerable business sectors in the economy (tourism, wholesale/retail, real-estate, construction and oil & gas) in aggregate, account for 58.4% of domestic business loans or equivalent to 24% of system loans. Overall SME loans meanwhile, account for 43.7% of system loans. Meanwhile, vulnerable households account for 17.1% of system loans. Based on a macro simulation done by BNM (Fig 3-4) for the business and household sectors, the domestic banking system could potentially see a rise in the GIL ratio from 1.6% to 3.1% (end-2020) and to 4.1% (end-2021). The impact on banks’ capital ratios (CET1 -3.1pts and total capital ratio -3.4pts) (under a bottom-up scenario analysis) could be absorbed by the banks’ balance sheets, in our view.

Macro Simulation Assumptions for Business and Household Sectors

BNM had employed certain assumptions in its macro-simulation model (Fig 3-4). For the business sector, it is assumed that 9% of business loan exposures are more vulnerable by end-2021, 42% of the rise in defaults are from vulnerable sectors with maturing bullet repayment, 63% are from the services sector and 33% are by large corporate groups. For the household sector, it is assumed that 66% of borrowers who default earn less than RM3,000/month, 60% of the defaults would occur in 2H21 (accounting for 71% of new impaired debt) given the extended repayment assistance, 52% of impaired debt stems from RM5,000-10,000/month salary earners.

Debt-servicing capacity of businesses declined, due to impact of COVID-19

According to the 1H20 FSR, though overall debt-servicing capacity of the business sector remains above the prudent threshold (of 2.0x), however the number of firms with interest coverage of <2.0x has increased. As at June20, the interest coverage ratio of businesses has declined to 3.7x vs. 4.8x as at end 2019. On a more positive note, the liquidity position was sustained with a cash-to-short term debt ratio of 1.0x while current ratio at 2.0x.

Debt Service Ratios for Households Remain at Prudent Levels

Households continue to exhibit strong aggregate financial buffers, which are expected to help them buttress potential shocks. The household financial asset ratios are still healthy and above prudent threshold of 1.0x. As at June 20, the financial asset-to-debt ratio remained unchanged at 2.2x while the liquid financial asset-todebt ratio stood at 1.4x as compared to 2019. The unemployment rate is expected to remain elevated and was at 4.7% in July20.

Continuous Engagement With Borrowers Who Need Financial Assistance

According to the 1H20 FSR, banks have continued to offer targeted financial assistance to borrowers affected by the COVID-19 pandemic. The domestic banks have received a total applications of 514,300 for ‘restructuring & rescheduling’ (R&R) and out of which, the approval rate has been high at 98%. There were a total of 77,528 applications for AKPK counselling but 19,766 applications were being enrolled into AKPK’s debt management programme. 840,000 borrowers have opted-out of the automatic loan moratorium (as at 25 Sept 2020) with repayments at 69% March20 levels, which in our view, also indicates a deterioration. On the financial assistance for the SMEs, a total RM18.1bn has been allocated, with full take-up rate for BNM’s SRF funds while the rest are still available. (details in Fig 7)

Maintain NEUTRAL on the Banking Sector

We maintain our sector NEUTRAL call, as we do not believe that the banking sector is completely out of the woods. Though we expect a 20% yoy recovery in sector core net profit in 2021E, this is subsequent to a drastic decline of 32.7% yoy in 2020E. In our view, the banks’ balance sheets and liquidity positions will be subject to more stress in 2020-21E due to the moratorium period offered to borrowers as well as higher risk of defaults as economic circumstances remain uncertain. That said, we still take comfort in the strong capitalization levels (CET1 ratio at 14.6% and Total Capital Ratio at 18.3% as at end-Aug 2020) while the capital buffer (in excess of regulatory requirement) of RM127.5bn as at end-Aug2020, remains fairly robust.

Based on our assumptions for the banking sector for 2020E, we are expecting: i) system loans to grow by 2.5% yoy; ii) NIM of 1.93% (with 4 rate cuts in 2020); iii) net credit cost at 70bps; and iv) CIR at 51%.

Our preferred stock pick is Aeon Credit (ACSM MK, RM10.10, BUY; TP RM13.00 based on 13x CY21E EPS). We believe that Aeon Credit fits into a longer-term investment horizon, while in the near term it could be a beta stock due to the sharp correction in share price ytd. Although FY21 will be a lacklustre year, we expect to see an earnings recovery in FY22E, on the back of a rebound receivables growth (from 5.7% yoy to 7.9% yoy) and a lower net credit cost of 362bps (vs. 456bps in FY21E). AEON Credit remains a key player in consumer financing through credit cards, personal financing, motorcycle financing and used-car financing. Its 'valuechain transformation project' comprises: i) online loan applications/ approvals; ii) a B2C2B digital marketing strategy; iii) the use of AI in its credit assessment model; and iv) process automation to help boost top-line growth and enhance operating efficiency. Aeon Credit's high ROE of 16.1% in FY22E is underpinned by the use of leverage and ability to generate an EIR at 16-17%, vs. traditional banking players at 5%. Downside risks to our call: rising unemployment rate and increased defaults.

Source: Affin Hwang Research - 18 Oct 2020