Bank Negara Malaysia (BNM) has raised the OPR by 25 basis points to 3.25%. While we expect a muted impact as the market had widely anticipated the move, we are more concerned on subsequent rate hikes. Meanwhile, Budget-2015 remains a question mark. Clearly, 3Q14 is clouded with uncertainties and lack of sector news flow while the risk-reward ratio is less attractive after the rebound in 1H14. We maintain NEUTRAL on Developers.

Our recent Property Sector report (3 July 2014) addressed the possibility of an interest rate hike, although our in-house Economist was expecting no hike this time around. We had highlighted that a 25bps hike in OPR will not have a material impact on: (i) developers’ earnings and (ii) property sales. Our sensitivity analysis indicates that monthly instalment commitments will only go up by 3% for a 25bps hike in lending rates, which is easily digestible by existing loan owners and new home buyers. Additionally, our Banking analyst views that banks still have rooms to widen lending spreads to BLR to ensure that lending rates remain competitive.

Our in-house Economists is of the view that this rate hike will be met with at least another 25bps hike during the next MPC meeting in Sept-2014 i.e. a total of 50bps hike, which is still manageable. What we are concerned about is that there may be a series of hikes as opined by our Economists from observing BNM’s historical trends, which may cause more buyers to continue their ‘wait-andsee’ stance and more importantly, affect lending abilities. Our analysis indicates that if rates are hiked by more than 50bps, it will have a real negative impact on the sector’s demand as affordability will weaken to a 10-year high while existing borrowers will feel more significant impact. It will also increase developers’ costs, which will exacerbate affordability issues.

If this is a one-off hike as widely anticipated; we had highlighted that much of this has been priced-in. Hence, we expect no major corrections for property stocks or at worst, a very short knee-jerk reaction. If there is another 25 bps rate hike in Sept-14 and indications of no other hikes thereafter, then it will be very similar to a one-off hike, although buyers’ sentiment may not be as strong as if there were no hikes. In these two cases, we believe the sector has higher probability of a quiet Budget-2015 and thus, a very positive 4Q14.

However, until the next Sept-14 MPC meeting, we reckon the sector may likely remain range bound. If there are indications of more than a 50bps hike in the next 6-12 months, it will be extremely negative for the sector; we believe this is an unlikely event but positively, Budget-2015 will be very quiet for developers then. We also believe that Budget-2015 also depends on how well the House Price Index is faring i.e. whether its growth rate is seen to be moderating over a longer period of time. We reiterate NEUTRAL on developers for 3Q14. We believe the risk-reward ratio has become less favourable as it will be clouded by uncertainties and lacks news flow excitement this quarter, particularly after many property stocks have rebounded in 1H14. Most of us will be monitoring new launches and take-up rates, but will only expect it to at best, meet our expectations or targets, which may not warrant strong share price excitement since this mantra of a ‘stronger 2H14’ has been exhausted throughout 1H14. The broad market is also expected to correct as well, which does not bode well for high-betas like developers.

We recommend that investors be stock-selective in 3Q14 as it is likely a range-bound quarter. Our TOP PICK is SUNWAY (OP; TP: RM3.70) for its strong construction news flow and higher valuations arising from SREIT while our other preferred pick is MATRIX (OP; TP: RM4.80) for its affordable housing play in the Greater Klang Valley space and decent dividend yields of 5.9%. Laggards (UEMS, IOIPG, SPSETIA, MAHSING) may not be appealing during this period unless investors are taking a long-term view given bottomed-out valuations or trading buy positions on M&A angles (e.g. SPSETIA). Other CALLs/TPs: UEMS (OP; TP: RM2.40), IOIPG (OP: TP: RM2.95), SPSETIA (MP; TP: RM3.30), IJMLAND (ACCEPT OFFER; TP: RM3.55), MAHSING (OP; TP: RM2.45), UOADEV (MP; TP: RM2.13), TROP (MP; TP: RM1.65), CRESNDO (OP; TP: RM3.15), HUAYANG (MP: TP: RM2.15).

Investors should also look into RNAV expansion plays or turnaround stories in the small-mid cap space for trading plays. We have Trading BUY calls from our OR products: Global Oriental (FV: RM1.23), SBC Corp (FV: RM3.24), SUNSURIA (exall FV: RM1.22 / cum-FV: RM2.93), and TITIJAYA (FV range: RM2.95-RM3.32).

Excerpts for our recent Property Sector Report (dated 3 July 2014) “An increase in 25 bps in the OPR will see a similar increase in BLR. Assuming average lending rates (AVL) increase by 25 bps, monthly instalment commitments will increase by 3% which we think is a digestible amount. But as highlighted earlier, it may be a series on small incremental rate hikes. In our worst case scenario, if rate hikes over the next 12 months of up to 100 bps, this will increase monthly instalments by 12% which is a significant impact. To illustrate this, Person A, a first home owner, who has bought a RM500k/unit house prior to a 25 bps rate hike should be drawing a net pay of RM4.6k/mth assuming 50% mortgage-net income ratio. If Person A buys a RM500k/unit home after the 25 bps (100 bps) rate hike, the buyer should be earning RM4.7k/mth (RM5.1k/mth) to qualify for the loan. It is clear that more than a 50bps rate hike will price out many first home buyers, which does not bode well for the mass housing sector as affordability issues will be exacerbated. Also, note that rate hikes will squeeze existing home loan owners’ ability to buy other homes; BLR does move in tandem with OPR, implying higher effective interest payment required for those with home loans. While we think that the initial 25 bps will not impact the physical market significantly, it will affect property stock sentiment especially if it strongly hints that there will be subsequent hikes and if so, we can expect property stocks to take a beating.

Affordability has weakened. Over 2013, we observe that Malaysia’s overall affordability has declined as the increases in house prices have outpaced that of income levels. Malaysia’s home affordability has weakened against its 10-yr average of 24.5%. If there is a 25bps hike in lending rates, the affordability index remains below the conventional levels (mortgage being 30% of gross income) but will breached +1SD@10-yr average at 26.5%. In Klang Valley, where average house price transactions are 57% higher than the national average, affordability of double-income households are also seeing similar trends as Malaysia. However, in Klang Valley, a 50bps hike in lending rates will see affordability index breach the +1SD@10-yr average at 21.3% Note (i) for urban areas like Klang Valley, we have assumed a double-income household. For overall Malaysia, we have based our analysis on individual income households (ii) our analysis assumes that CY14E average house price transacted rise by an average of 5% (below the 10-yr average of 6% p.a.), monthly individual income for Malaysia (or monthly household income for Klang Valley) rises by 3%, 90% margin financing.

Will lending rates change if there is an OPR hike? Not necessarily. It is normal to assume that a hike in OPR will have a similar impact on BLR and thus, lending rates. This was the case back in 2008-09 when BNM lowered OPR from 3.5% to 2.0% while AVL also fell from above 6.0% to a low of 4.8% during the same period. However, when BNM raised OPR to 3.0% over 2010-11, AVLs trended below 5.0% and has remained below this level since late 2010. From 2010 to today, we have been seeing wider lending spreads as banks became increasingly competitive. Currently, lending spreads to BLR are at a high of -2.0ppt vs. the last 2 year’s average of -1.9ppt. If banks maintain lending spreads to the BLR, it would mean that an OPR hike will result in higher lending rates, which would have a negative impact as highlighted above. If banks decide to widen lending spreads further, it will be good for new home buyers. There is a possibility that banks will widen their lending spreads to maintain AVLs at current levels to drive loans growth. But as mentioned earlier, it will still impact those with existing home loans, which limits their ability to take on another loan.

Source: Kenanga