We attended Bank Negara briefing on its 2011 Annual, andFinancial Stability and Payment Systems reports.  The session focused on:  (i) rising  household indebtedness,and  (ii) the  contagion from external  developments. However, an assessment  revealed that the  domestic financial  system was relatively sound, given therelatively small direct and indirect exposure to  the above-mentioned risks. This is reflected in the continued improvement  ofsystem impaired loans and still ample liquidity, with the domestic bankingsector  depending heavily on Ringgit-basedfunding, despite  some  effects from  the  deleveraging of  European banks. However, wemaintain our NEUTRAL call on the sector at this juncture in light of the moderationin consumer loans growth, which contributes a hefty 55% of overall systemloans, and continued pressure on net interest margins. Our top picks are CIMB(BUY, FV: RM8.05), Maybank (BUY, FV: RM9.60) and RHB Capital (BUY, FV: RM9.90).

Rising householdindebtedness under control.  The risein  household debt-to-GDP from 62.7% in2008 to 76.6% in 2011, spiraling property prices in  certain locations and the  double-digit spurt in unsecured personallending and credit card debts  have givenrise to concerns of rising household indebtedness, with total system householddebts now comprising 54% of the system's gross loans base. Despite theincreasing concerns, closer scrutiny reveals that  the  pressure on  income and inflationary shocksare more prevalent in the lower income segment (individuals with monthly incomebelow RM3,000) living in urban locations, with this segment of borrowers makingup a relatively small 13% of the banking system's total loans and 26% ofhousehold loans.

Large portion ofpersonal loans with non-bank financial institutions. The risk from thissegment is further mitigated by the fact that the personal loans taken fallunder two broad categories: (i) personal loans from development financialinstitutions and building societies under automated salary deduction schemes,and  (ii) purchase of securities linkedto capital guaranteed Amanah Saham Nasional investment unit trusts, which certainlyprovides a  buffer in  times of economic stress. Roughly 60% of thereported personal loans are from non-financial institutions.

Composition of higherrisk loans segment still manageable. The higher risk household lendingsegments like personal loans, purchase of securities and credit cards expandedby a relatively robust 18.8%, 20.2% and 8.4% respectively.  Despite this, the combined share of lendingfrom this segment has only inched up a marginal 1ppt to 13% of the system'sentire loans base. In terms of pure unsecured lending, total loans in the personalloans and credit cards segments combined inched up by 1ppts to 8%. As such, evenif we assumed a spike in impaired loans in these two  segments,  their relatively small composition relativeto the total loans base suggests that they should not pose any potentialsystemic risk to the banking system.