BNM recently introduced two new liquidity metrics; (i) loan-to-fund ratio, and (ii) loan-to-fund-andequity ratio as alternative ratios to counter check on the commonly used loan-to-deposit ratio. The metrics parameters include debt instruments, shares, retained earnings plus deposits. The two new ratios resulted in lower ratios than the loan-to-deposit ratio indicating that there is ample of liquidity in the system and the underlying liquidity is not as constrained as negatively perceived. With ample liquidity, there will be less pressure for banks to intensify deposit-taking activities and less upward pressure on deposit rates as banks are able to finance their earnings assets via debt instruments as well. Thus, NIMs will likely be stabilised or even improved for small banks. All things considered, we still view the sector as NEUTRAL. While the view of constraint in liquidity might change with the new definitions, we maintained our view that structural and cyclical headwinds such as: (i) moderate economy, (ii) muted loans growth, (iii) narrowing NIMs, (iv) weak capital market activities, and (v) higher credit costs, continue plaguing the banking industry. Furthermore, there are no concrete catalysts and/or any game changer going forward. RHBCAP (TP: RM6.23) and MAYBANK (TP: RM9.33) and are the only OUTPERFORMs in our universe, while AFFIN (TP: RM1.68), HLBANK (TP: RM11.39) and CIMB (TP: RM4.04) are rated as UNDERPERFORMs. The others are labelled as MARKET PERFORMs.

BNM introduced new liquidity metrics. BNM in its December 2015 statistical bulletin introduced two new liquidity metrics; loan-to-fund ratio and loan-to-fund-&-equity ratio replacing the loan to deposit ratio. In this new metrics, loans are defined as loans excluding financing funded by Islamic Investment Accounts, fund is defined as deposits plus all debt instruments and equity comprising shares and retained earnings. It is interesting to note that whereas BMM’s definition of the Banking system loan-to-deposit ratio (LDR) was at 88.7% for December 2015, the loan-to-fund ratio (LFR) and loan-to-fund-&-equity ratio gave lower ratios of 83.0% and 75%, respectively, indicating that the banking system has more ample liquidity than expected for lending disbursements or an extra RM154b based on our estimations. The extra funding comes from debt instruments such as subordinated debts, debt certificates/sukuk issued commercial papers and structured notes.

Liquidity constraints. The banking system is experiencing liquidity constraint and the banks are feeling the strain. LDR in the banking industry has been trending up since October 2013 where it surpassed the 80% barrier mark, reaching 86% in Dec 2015. The upward trend is attributed to loans growth outpacing deposits growth where loans growth for Dec 15 was at 7.9% YoY compared to deposits growth of 1.8% YoY (Dec 14: 9.3% YoY and 7.6% YoY, respectively). The high LDR could limit loans growth and put downward pressure on margins. Net Interest Margin (NIM) has compressed by 13bps from Sep 2013 to 2.30% in Sep 2015 as banks competed for deposits with better and higher deposit rates. Meanwhile, overzealous compliance to the Basel III regulations of the liquidity coverage ratio pushed banks to shore up deposits more aggressively than before. The industry liquidity coverage as of December 2015 ratio stood at >100% vs. the Basel III regulated 60%.

Upward pressure on margins. From the 4Q15 results, LDR in the industry reached 96%, up 7ppts from 4Q13. During the same period, loan vs. deposit growth was at 24% and 19%, respectively. The slower pace of deposit growth vs. loans led to higher costs of funds, up by 23bps since 4Q13 to 2.72% whilst average lending yield rose by a mere 7bps to 4.80% during the period. At the same time, NIM was compressed by 14bps, on average, as pricing competition intensifies.

No cause for concern. In an interview with The Edge Weekly last December, BNM viewed that the current practice of using the LDR is not a suitable indicator for assessing liquidity as it does not take into account the ‘diversity present in the banks funding structure’. Deposits have been the staple funding of the banking system but ‘banks have gradually broadened their funding sources by raising funds in the capital market’. This can be seen by several capital raising exercise and issuance of debt securities as the banks strengthened their Capital Ratios which as at December 2015 stood at 16.1% (in the banking system) vs. Basel III requirements of 8%. In its 4Q15 report, BNM stated that ‘banks have increasingly tapped the deeper domestic capital markets to maintain a stable funding profile through issuances of medium term funding instruments’. The report also added that, ‘as at end of 2015, banking system placements and reverse repos, which can be unwound to meet liquidity needs, were in excess of RM100b, preserving comfortable buffers against comfortable buffers against unexpected cash outflow or adverse liquidity shocks.

Source: Kenanga Research - 9 Mar 2016