News that the Finance Ministry and the banking industry have agreed to waive HP interest during the moratorium period could see banks incurring an upfront “Day One” accounting adjustment to earnings on 1 Apr. In some cases, the amount appears sizeable and could pose near-term headwinds to the sector. Hence, we cut our bank coverage FY20E-21E earnings by up to 20% for and downgraded our sector call to NEUTRAL from OVERWEIGHT. RHB (TP: RM5.15) and ABMB (TP: RM2.30) are our top picks.

Banks agreed to waive moratorium HP interest... According to news reports, the Finance Ministry (MoF) and the banking industry have agreed to waive additional interest and profit charges for hire purchase (HP) loans during the six-month moratorium period. These means that the monthly repayments will remain unchanged after the end of the moratorium period, with only the HP loan tenure being extended for six-months. Loans for the purchase of transport vehicles made up c.9% of system loans while for the individual banks, the proportion of domestic HP loans (to total group loans) ranged from just 2% (ABMB, RHB) to 23% (Affin).

…that could lead to banks taking an upfront negative accounting adjustment. According to accounting standards, banks will need to carry out modification assessments on these loans by comparing the net present value of the new cash flows against the existing gross carrying amount of the loans. The moratorium coupled with banks now being unable to charge interest during these six months would lead to a shortfall between the carrying value of the loans and the NPV of the new cash flows. This shortfall will need to be recognised as a modification loss on Day One (i.e. 1 Apr) in the income statement, impacting net interest income. Do note however that this is an accounting adjustment that banks are recognising upfront (hence, a significant impact for some banks).

Estimating Day One impact. Based on the following assumptions: (1) HP loan amount of RM50k, (2) fixed interest rate of 2.7%, and (3) tenor of 5 years; we estimate a modification loss rate of 2.5% on the portfolio. Assuming this to be the average loss rate on the portfolio for the banks, we set out our estimate of the Day One impact in Table 1.

Forecasts. We have cut our FY20E-21E net profit forecasts by up to 20% for the banks under coverage (see Table 2). Note that the extent of our earnings revisions are not as severe as our analysis in Table 1 suggest as we had already revised down our earnings significantly over the past two months and we believe, for example, our earlier assumptions of 10-15bps NIM compression in 2020 have some “buffer” to absorb developments such as this. Also, we await further updates from the banks with respect to the issue.

Downgrading sector call to NEUTRAL from OVERWEIGHT. The significance of the earnings revisions together with some of the changes in stock recommendations prompted us to downgrade our call on the sector to NEUTRAL from OVERWEIGHT. The reopening of the economy and recent OPR cut has helped to clear some overhang for the sector, but the recent development on HP interest will likely put further near-term pressure on banks’ income and this, by our calculations, could be impactful. Further out, focus remains on asset quality, which at this juncture is still a question mark. Our refreshed top picks are RHB (OP, TP: RM5.15) and ABMB (OP, TP: RM2.30), given that their earnings appear relatively shielded from the developments within the HP space.

Source: Kenanga Research - 8 May 2020