BNM released its Financial Stability Review (FSR) report for1HCY22. While macroeconomic uncertainties prevail, our local financial system is still able to demonstrate resilience.A more stable operating climate have allowed expansionary notes from business segments with more employment opportunities upholding household borrowing capacities.Industry gross impaired loan (GIL) readingshave yet to pose majorconcerns although some economic sectors are still deemed to be at-risk from slower economic spill-over.Meanwhile, BNM believesthat individuals with income below RM5,000/month could be the most at-risk frominflationary pressuresbutare expected to remain unaffected by OPR hikes given their higher inclination for fixed rate loans. Recent stress tests did rake up higher impairment readings but still linger at levels manageable by the financial system. We maintain our OVERWEIGHT call on the sector, with top picks favouring optimal loans (high SME, low fixed rate financing) and deposit (high CASA) books with added merits and defensive dividend prospects. Our stock picks are CIMB (OP; TP: RM6.35), MAYBANK (OP; TP: RM11.05) and ABMB (OP; TP: RM4.20).

Comfortable with current standing. In spite of pressures from volatile shifts in commodity prices and supply chain disruptions, the operating environment in 1HCY22 was still supportive of local businesses and households on the recovery and normalisation of economic activity. On the business front, SMEs are expected to be a key driver in loans growth, although it is noted that certain segments (hospitality, construction, real estate) are still struggling to pick up as sector activities have failed to recover meaningfully. This was only worsened by a weaker ringgit as well as unresolved labour issues. That said, overall impairment ratios in Jun 2022 stood at 2.8%, a fair base against pre-Covid average at 2.7%. Household loans did report a higher impairment reading of 1.2% in Jun 2022 against a pre-Covid average of 1.0%. These accounts could have been more subsceptible to income loss and is a segment that banks are remaining cautious on. Concerns may also arise from diminishing EPF withdrawals being used to fund repayments. On the flipside, the gradual return of employment rates and the highly collateralised nature of these loans could improve the banks’ appetite. It is noted that BNM has classified borrowers earnings below RM5,000/month to be those more at risk to rising living expenses. However, owing to their high proportion in fixed rate financing (over 50%, mainly hire purchases), further OPR hikes would not be detrimental to their financing ability.

Overall, capital and liquidity buffers are still firm, as industry Tier 1 capital ratios were only slightly lower at 14.9% (Dec 2021: 16.0%) and with liquidity coverage ratio at 148% (Dec 2021: 153%). While the lower numbers could be tied to tighter asset quality management, annualised credit cost readings of 18 bps in Jun 2022 (Dec 2021: 42 bps) is reflective of improved repayment habits and could continue to linger at such levels, with more banks likely to release management overlay in the coming periods.

Stressed GIL ratios of 5.8% containable. In light of growing pressures aside from Covid-19 concerns, BNM is wary that additional macro factors could press the financial system further, such as: (i) heightened US Fed Funds Rate, (ii) rising MGS yields, and (iii) worsening of Ringgit. The matters have been refined into BNM’s existing stress test model and would push industry GIL ratio to creep to 5.8% (from 4.6%) by Dec 2023. If this is to pass, industry capital levels would still arrive at 15.4% (Dec 2021: 19.2%), which is still much above the regulatory minimum requirement of 8%.

Coming out of the above 1HCY22 FSR briefing, we gather that BNM is assured by the strength and resilience of the financial system to face unexpected hurdles in the near term. The 1HCY22 FSR also notes a growing rate of financial literacy (2021: 59.0 pts vs.2018: 57.1 pts) which we believe is crucial in developing good quality customers in the financial system. Further in addressing concerns on security, BNM is cognizant of growing operational risks (i.e. processing errors, fraud) and seeks to deliver its Recovery and Resolution Planning framework to better guide financial institutions in safeguarding their intrastructure. We believe the increasing concerns are also inhibiting the aboption of digital assets locally but favourable developments in the global scene may change its stance.

Maintain OVERWEIGHT. In spite of the notes above, we continue to believe that the banks are still prudent asset quality management, which could serve as an additional merit in ensuring that growth tractions are still sustainable in nature. That said, growth tractions are expected to be buoyed by stronger loan demand from recovering economic prospects as well as margin expansion from the ongoing OPR upcycle (we anticipate two 25 bps hikes to occur in Nov 2022 and 1QCY23 MPC meetings). Noting SMEs to be a stronger performer, we recommend positioning in names with a higher SME mix. Meanwhile, a more optimised book of low fixed-rate financing and high CASA deposits could be beneficial to ride on higher interest rate repricing. Our sector top picks are banks with these in mind with additional boons. We like: (i) CIMB (OP; TP: RM6.35) for defensive NOII reporting as trading performances are supported by its regional entities,(ii) MAYBANK (OP; TP: RM11.05) which remains our dividend favourite (7-8%yield) and (iii) ABMB (OP; TP: RM4.20) for fundamentals so comparatively better than its larger cap peers in terms of ROE (10%) and dividend yields (6%).

Source: Kenanga Research - 6 Oct 2022