The Financial Stability Review highlighted the soundness and quality of the domestic banking system. However, concerns still prevail from property market imbalances, and rising impaired loans. Our view of moderate loans (with a downside bias) ahead still holds due to the absence of clear catalyst with volatile domestic and external conditions still prevailing; thus, we maintain a Neutral outlook for the sector. Most of the stocks in our banking universe are rated as MARKET PERFORM except for AMMB (TP: RM4.50), BIMB (TP: RM4.90) and MBSB (TP: RM1.40) which are at OUTPERFORM.

BNM released its 1H18 Financial Stability Report yesterday highlighting the soundness and quality of the domestic banking system. Despite the heightened uncertainties in both the domestic and external front, BNM views that financial stability remained intact, with the Malaysian financial system resilient, supported by well-capitalised institutions with ample liquidity in the markets. Although impaired loans are trending upwards, household debt to GDP moderated due to prudent measures in place. While business lending risks are a concern due to external factors, BNM views that interest coverage ratio and cash to short-term debt are more than comfortable enough with excess capital buffers in the banking system adequate to absorb the most severe downturn.

Household debt levels moderated but civil servants' debt and impaired loans rising. From 2015 onwards, household debt to GDP is trending downwards, with the 1H18 banking system debt-to-GDP and Total debt-to-GDP at 69.1% and 83.8% respectively (vs CY2015: 73.5% and 89.0% respectively) largely driven by sustained demand for affordable housing. New household borrowings remained of high quality as about 75% of new loans approved, were to borrowers with a debt-service ratio (DSR) of <60%. Despite slower financial asset growth, households are able to maintained ample financial buffers with financial asset-to-debt and liquid financial asset-to-debt remained stable at 2.1x and 1.4x since 2015. On a positive note, share of debt of lower income households was reduced further from 2014 with 5ppts drop to 19.6% in 1H18 for the

Civil servants’ debts on the rise. The report pointed out higher indebtedness of civil servants, accounting for 20% of household debt with 47% of borrowings for consumption of which 62% are loans from non-bank financial institutions (NBFIs). 64% of these borrowers earned <RM5k/month. Civil servants' DSR is generally higher than the national average at 52% vs 32%. Despite the high indebtedness, BNM views that impact to financial institutions are limited given the automatic salary deduction arrangements with impaired loans at 1.3% from civil servants of which two-thirds were for personal use and Debt-at-Risk is only 2.2% of total household debts. Based on BNM’s assessment of limited impact and low debt-at-risk, we view banks will still be comfortable in growing their personal loan and credit card segments given the higher yields.

In terms of asset quality, BNM observed uptick in deterioration as total impaired loans grew 2% YoY for 1H18 (2017: +1.9% YoY), with impaired loans from personal, residential and non-residential properties in the banking system rising at 7.5% YoY, 4.4% YoY and 20.4% YoY respectively. The uptick in mortgages was mostly from properties valued >RM500k. It was also observed that higher incidents of impairments from self-employed borrowers with personal loans impairments coming from the <RM5k salary bracket.

Risk from property market imbalances continues to be a concern as the number of unsold units (mostly priced >RM250k) continued to increase from 85.2k to 146.2k. The bulk of it (39.6%) coming from the RM250k-RM500k bracket. Incoming supply of affordable housing continued to lag demand with only 25% of newly-launched houses (priced 70% <RM250k) vs. 35% of households whose incomes can only afford such units. However, risk of significant correction in house prices is assessed to remain low by BNM with outstanding financing to first-time buyers (<RM500k unit) accounting for 71% of total residential loan buyers (<RM250k: 54%). Approval rate remained at >70%, but we understand that, at present, it has dropped to ~65%.

Non-residential property market remains sluggish. Market conditions in this segment remained subdued. End-financing for purchase on non-residential properties grew 2.6% YoY to RM216.5b as at 1H18 (2017: +2.3% to RM213.4b) accounting for 26% of banks’ exposures to the property market or 13% of the banks’ total outstanding loans. Not surprisingly, loan approvals for the construction and purchase of office space & shopping complex remained low at 63.5% and 69.5%, respectively, for 1H18 (vs. 2017: 72.5% and 75.8%, respectively).

Overall, BNM views that asset quality for both residential and non-residential markets remained sound with no significant deterioration with impaired loan ratios for both residential and non-residential segments at 0.9% and 1.4%, respectively, for 1H18 (2017: 0.9% and 1.2%, respectively). The Banking system has sufficient and excess capital buffers (of up to RM135b with system’s total capital ratio and CET1 ratio at 17% and 13%, respectively) to absorb any shocks arising from severe property price correction. BNM view that sustained demand for affordable housing (particularly from first-time buyers) and prudent lending to the property market and other sectors will mitigate the risk of a broad-based price correction (from our understanding, BNM is still in favour of the current responsible lending guidelines). From their assessment, BNM expects potential losses based on severe assumptions (interest rates rising >150bps) amount to RM65b with household income

Business exposures supported by healthy financials. Risks from external financing are largely mitigated with debt servicing capacity remains intact even under potential severe ringgit depreciation. BNM assessed that in a post-shock scenario, the interest coverage ratio (ICR) will fall to 6.2x (with a prudent threshold of 2x) from 6.9x (pre-shock). The low fallout due to twothirds of the financing is medium-to-long term debts with low roll-over risk with 30% being inter-company loans typically granted under flexible and concessionary terms. Although debt servicing continued to be well supported, O&G and construction sectors continued to face headwinds with capex and contracts by oil majors remained slow despite improving oil prices while construction players are affected by review of projects by the government. Cash-to-short-term debt ratio for O&G, property and construction are at 0.5x, 0.7x and 0.8x, respectively, vs. 1.5x for the business sector. In terms of ICR, O&G has a coverage of 1.5x, followed by construction ands property at 5.3x and 6.5x, respectively, vs. the business sector ratio of 8.2x.

No change in our views of moderate loan growth ahead given the on-going trade friction and uncertainties ahead. While the upcoming new government policies are expected to boost lending ahead (especially corporate) the on-going uncertainties on the external front might put a dampener on business sentiments as softer business loans and applications might still linger into 2019. The dampening credit demand might be exacerbated by an increase in corporate bonds as upside pressure on interest rates lessens. While we still maintain our view that banks will still maintain selective asset quality, the improved system asset qualities will see support demand from the resilient households ahead especially on demand for residential property and personal financing.

Source: Kenanga Research - 27 Sept 2018