Of late, we saw a few interesting developments, which could change the landscape of the banking industry in the long-run. However, in the short-term, the impact to banks could be fairly neutral. All in all, we maintain our NEUTRAL call in the Banking despite fairly decent valuations. The sector is trading at c. 11.8x to its CY14 numbers as compared to FBMKLCI’s >16.0x. Our unchanged concerns are: (i) potential moderating in loans growth, (ii) continuing decline in NIM, (iii) potential weaker non-interest income due to higher uncertainties in capital market, and (iv) potential hike in credit cost. We are maintaining our MARKET PERFORM calls on AFFIN (TP: RM4.60), AMBANK (TP: RM8.10), BIMB (TP: RM4.74), CIMB (TP: RM8.10), HLBANK (TP: RM15.20) & PBBANK (TP: RM18.20). CIMB has now become fairly valued (vs. under-valued in late-Dec13) as per our PBV-ROE Regression Study after taking into the recent 500m new share placement into consideration. Meanwhile, our OUTPERFORMs are AFG (TP: RM5.62), MAYBANK (TP: RM10.40) and RHBCAP (TP: RM8.75). We continue to see value in RHBCAP as per our Regression Study, hence making it our Top Pick for 1Q2014.

Introducing an all-new Reference Rate Framework. Bank Negara Malaysia (BNM) has issued an industry consultative paper to the financial industry on a new Reference Rate Framework (RRF) to replace the current Base Lending Rate (BLR) quoted by financial institutions in the pricing of retail loans. Financial institutions are given until 14 February 2014 to provide feedback to Bank Negara Malaysia on the proposed reference rate framework.

Under the proposed RRF, the new reference rate will be determined by the respective financial institution’s funding costs which reflect its specific (i) funding structure, (ii) business strategy, and (iii) statutory reserve requirement. Other components of pricing such as (i) borrower credit risk, (ii) liquidity risk premiums, (iii) operating costs and (iv) profit margins are proposed to be reflected in the spread to the reference rate as well. The new reference rate will be used for the pricing of new retail loans and the refinancing of existing loans after the effective date of the new framework. Existing loans, on the other hand, will continue to be referenced against the BLR. However, when a financial institution makes any adjustments to the new reference rate, a corresponding adjustment will also be made to the BLR. Thus far, the movement of BLR mainly hinges on changes in OPR with less emphasis on the above mentioned risk factors.

Paving way for risk-based pricing? While we believe the proposed RRF will be fairly NEUTRAL to banks in the near-term, it may have more significant long-term implications and the proposed RRF could pave way for risk-based interest pricing (RBIP) going forward. Although the idea of RBIP is not new, it has not been actively adopted by banks. For instance, mortgage borrowers with shorter-term tenure and lower loan-to-value (LTV) are paying similar interest pricing vis-à-vis borrowers who have longer mortgage tenure and higher leverage. Under this market practice, borrowers with lower credit risk seem to have subsidised borrowers with higher credit risk, theoretically speaking. As such, the proposed RRF could promote financial prudency among consumers and may benefit prudent borrowers. Should RRF materialise, impacts to banks could be mixed. However, in general, we reckon that banks that have more prudent and lower credit risk borrowers may see further squeeze in net interest margin.

Change in auto financing landscape? The much awaited revised National Auto Policy (NAP) that was unveiled by the Minister of International Trade and Industry (Miti) Datuk Seri Mustapha Mohamed on Monday Jan 21 has a five-year plan until 2018 to reduce car prices. The targeted lower prices of cars by at least 20% to 30% would be brought about by further liberalisation of the auto sector instead of lower excise duties. While consensus, including our auto analyst, is NEUTRAL, we are concerned over the growth prospect, lending direction and asset quality of banks that have large exposure in auto segment such as AFFIN and AMBANK.

However, in the short-run, we understand that impact of NAP is still manageable. In terms of growth prospect, applications for auto loans have seen a sharp decline in the last two months ahead of NAP announcement. As the reduction in car prices is expected to be at a gradual pace, it is believed that the growth in auto segment will slowly improve henceforth. Besides, we also understand that there is no major concern over deterioration in asset quality as (i) principal repayment is faster in a low interest environment and (ii) the decline in collateral value is evenly-paced.

Nonetheless, we still concerned over the growth prospect and asset quality of auto loans in the long-run. While car prices are expected to decline gradually in the next five years, (i) the price adjustments in used cars could be faster-than-expected and (ii) due to the longer tenure of auto loan, which is over five years, collateral value could deteriorate at a quicker pace over time. Coupled with the proposed RRF, auto loans could be priced at a higher rate, which could dampen credit demand and growth going forward.

Source: Kenanga