BNM’s engagement session yesterday provided analysts some high level overview and updates, with asset quality being a key area of focus. Among the key messages were: (i) banks are still keeping liquidity flowing; (ii) take-up rate for targeted assistance lower than expected, but expect applications to continue coming in; (iii) various relief measures are supporting asset quality for now. Impact on asset quality, especially HH, could be delayed to 2H2021; (iv) GIL risk skewed to business segment and expected to make up 88% of cumulative credit cost over 2020F-21F, based on stress testing; and (v) fiscal policies more impactful to drive recovery as monetary policies are already accommodative. Overall, the key messages appear largely consistent with our view that the true impact of the economic downturn on asset quality has been pushed back; giving banks time to build up loan loss reserves. Also, BNM’s stress test flagged out the business segment as the driver of rising impaired loans and higher credit cost, which helps reaffirm our investment thesis and preferred picks – HLBK and PBK, i.e. banks with strong asset quality and skewed towards the retail segment. We also like RHB for its solid capital position. We keep NEUTRAL on the sector.

BNM held an engagement session in conjunction with the release of its Financial Stability Review 1HCY20. Below are the salient points from the meeting.

Assessment of household (HH) segment – HH debt/GDP jumped to 87.5% at end-1HCY20 as compared to 82.9% at end-2019, although this was mainly a reflection of the contraction in GDP. BNM expects most households to remain resilient due to healthy financial buffers, as well as the relief measures. That said, BNM also noted that leverage among borrower with

Assessment of business segment. The recovery among businesses is, not surprisingly, expected to be uneven. Vulnerable sectors include tourism-related (7% of business loans), wholesale and retail (18%), construction (15%), real estate (18%), and oil & gas (1%). For now, gearingrelated ratios appear manageable while the assistance extended via the various SME funding programmes and loan assistance would help SMEs bridge through the tough period. R&R applications approved thus far have reached 6.3x total outstanding R&R loans at end-2019.

Stress test outcome. Under BNM’s stress test (with conservative assumptions), system GIL ratio is forecasted to rise from 1.5% at end-2019 to 3.1% in 2020 and further to 4.1% in 2021, mainly underpinned by higher business GIL (defaults from maturing bullet repayments of firms operating in vulnerable sectors, as well as chunky corporate loans). On the other hand, household impaired loans are expected to double by end-2021, with the deterioration accelerating in 2HCY21 after the impact from the various repayment assistance programmes starts to fade. Overall credit cost to banks may rise to RM29b or 140bps over 2020 and 2021 (we project 129bps cumulative credit cost over 2020-2021 for the eight banking groups). According to BNM, banks have thus far booked in an average of 16% of banks’ projected stressed credit losses over the next 12 months, based on their internal stress tests. Provisions are expected to rise further as banks gain more visibility on the outlook. The impact to CET-1 ratio is 1.4%-pts to 3.1%-pts, which is manageable for most banks.

Update on targeted assistance programme. 514k applications had been received as at 25 Sep with an approval rate of 98%. These are mainly HH and SMEs, with 40% relating to the three-month extended moratorium. BNM highlighted that 3m borrowers were estimated to be exposed to the vulnerable sectors, but after engagement with the borrowers, take-up rates have been much lower than expected as affected borrowers appear to have retained their capacity to service their loans. Nevertheless, BNM does not discount the possibility that some of these borrowers may come forward and request for assistance at a later date.

Dividends – Largely similar to the previous engagement session, where BNM said it will take into account various factors such as stress testing, capital plans, economic conditions, capital buffers available as well as impact from capital conservation measures such as DRP programme.

Banks able to keep funding flowing. BNM was keen to highlight that banks are able to continue supporting lending activities during this period, given that banks had entered this downturn from a position of strength, while capital levels are still strong and liquidity buffers ample. Although funding under the Special Relief Facility (SRF) programme has been fully utilised, there are still other lending programmes available. Also, BNM can upscale some of these programmes if need be.

Maintain NEUTRAL sector call. Our investment thesis is unchanged, where we think asset quality will likely be the key swing factor to earnings in the coming quarters and thus, prefer banks with solid asset quality such as HLBK (OP; TP: RM17.00) and PBK (OP; TP: RM18.00). Their asset quality track records suggest that the pre-emptive loan provisions required should be lower relative to peers while the smaller exposure to the corporate space would shield them from chunky loan impairments, i.e. these banks offer investors better earnings predictability and “safer” dividend yields. We also like RHB (OP; TP: RM5.75) for its capital strength. While this may not translate to higher dividend pay-outs vs peers in the near term, RHB should be able to resume with its capital management plans relatively quick once the pandemic is past (vs. peers that may need time to rebuild their capital positions). AMMB (OP; TP: RM3.60) is our laggard pick.

Near-term key upside risks to our sector call are a liquidity-fuelled rally and/or rotation into value/cyclicals. Key near-term downside risk is another nationwide economic lockdown following a huge resurgence in Covid-19 outbreak.

Source: Kenanga Research - 15 Oct 2020