BNM plans to replace the existing BLR framework banks currently used for  the  pricing  of  retail  loans  with  a  new  reference  rate  framework, which  will  be  determined  by  the  respective  financial  institution’s funding  costs.  BNM  expects  effective  lending  rates  to  remain unchanged, which suggests that the impact on banks would be neutral. Maintain OVERWEIGHT on the sector.

• New  framework  for  retail  loans  pricing...  Bank  Negara  Malaysia (BNM) is issuing an industry consultative paper on a new reference rate framework  to  replace  the  existing  base  lending  rate  (BLR)  financial institutions  currently  used  for  the  pricing  of  retail  loans.  According  to BNM, the BLR may have become less relevant as a reference rate for the  pricing  of  retails  loans  given  that  retail lending  rates on  new  loans have  been  priced  at  a  substantial  discount  to  the  BLR.  The  prime example  is  mortgage  loans,  which  are  typically  being  priced  at  BLR minus 2.3-2.4% currently.
• …to  be  based  on  funding  costs.  Under  the  proposed  reference  rate framework, the new reference rate will be determined by the respective financial institution’s funding costs.  The new reference rate will be used for the pricing of new retail loans and the refinancing of existing loans once  effective.  BNM,  however,  does  not  expect  the  change  to  impact effective  lending  rates  for  borrowers.  Existing  loans  will continue  to be referenced against the BLR,  but any adjustments to the new reference rate should also lead to a corresponding adjustment  of  the BLR.  While not specifically mentioned by BNM in its press statement, the  Financial Daily reported that a prime financing rate has been proposed as the new reference rate.
• View  on  sector  NIMs  unchanged  for  now.  We  have  yet  to  see  the consultative  paper  but  based  on  BNM’s  press  statement  that  effective lending rates are not expected to change, our view with respect to a mid single digit decline in  sector net interest margins (NIMs) this year should still hold. Looking further ahead, we think that stiff competition and a lack of product differentiation (especially for retail loans) mean  that we may still see banks offering rather similar lending rates for retail loans despite the new reference rate framework. This appears to be consistent with the news article in the  Financial Daily  that the PFR set by the banks would likely end up being similar to one another’s, much like the current BLR.
• Investment  case.  We  like  Maybank  (MAY  MK,  BUY,  FV:  MYR11.40) and  CIMB  (CIMB  MK,  BUY,  FV:  MYR8.90)  as  excellent  proxies  to  the Economic  Transformation  Programme  (ETP)  and  key  beneficiaries  as capital  market  activities  improve.  As  for  HLB  (HLBK  MK,  BUY,  FV: MYR16.60),  we  expect  growth  to  accelerate  now  that  its  post -merger restructuring activities are largely done.

New reference rate framework for banks
Bank  Negara  Malaysia  (BNM)  is  issuing  an  industry  consultative  paper  on  a  new reference  rate  framework  to  replace  the  existing  base  lending  rate  (BLR)  financial institutions currently used  for the pricing of retail loans. According to BNM, the BLR may  have  become  less  relevant  as  a  reference  rate  for  the  pricing  of  retail  loans,given  that  retail  lending  rates  on  new  loans  have  been  priced  at  a  substantial discount to the BLR. The prime example is mortgage loans, which are typically priced at BLR minus 2.3-2.4% currently.

Under  the  proposed  reference  rate  framework,  the  new  reference  rate  will  be determined  by  the  respective  financial  institution’s  funding  costs,  which  reflect, among  others,  its  specific  funding  structure  and  the  statutory  reserve  requirement (currently 4%). Other components of pricing such as borrower credit risk, liquidity risk premiums,  operating  costs  and  profit  margins  are  proposed  to  be  reflected  in  the spread  to  the  reference  rate.  BNM  expects  the  new  reference  rate  framework  to eliminate negative spreads to the reference rate going forward and promote a more transparent  pricing  of  floating  rate  retail  loans  that  is  more  reflective  of  market conditions. It should also improve the transmission of monetary policy to both new and existing borrowers.

The  new  reference  rate  will  be  used  for  the  pricing  of  new  retail  loans  and  the refinancing  of  existing  loans  once  effective.  BNM,  however,  does  not  expect  the change to impact effective lending rates for borrowers.  Existing loans will continue to be referenced against the BLR but any adjustments to the new reference rate should also lead to a corresponding adjustment of the BLR. While  BNM  did  not  specify  the  reference  rate,  the  Financial  Daily  reported  that  a prime financing rate (PFR) was proposed to replace the BLR.

Potential impact
We have yet to see the consultative paper but based on BNM’s press statement that effective lending rates are not expected to change, our view with respect to a midsingle digit decline in sector net interest margins (NIMs) this year should still hold. Borrowers,  however,  will  need  to  get  used  to  how  rates  are  quoted  in  the  future.

Based on  the above example of BLR minus 2.3% for a housing loan , this  translates into a lending rate of about 4.2%.  Using the 3-month KLIBOR (currently 3.3%) as an example of the reference rate and assuming no change to the lending rate, mortgage rates would then be quoted as KLIBOR plus 0.9%. Thus, the spread quoted to the reference  rate  has  changed  from  -2.3%  to  +0.9%,  eliminating  the  negative  spread mentioned above.

Looking  further  ahead,  we  think  that  stiff  competition  and  a  lack  of  product differentiation (especially for retail loans) mean  that we may still see banks offering rather  similar  lending  rates  for  retails  loans  despite  the  new  reference  rate framework.  This appears to be consistent with the news article in the  Financial Daily that  the  PFR  set  by  the  banks  would  likely  end  up  being similar  to  one  another’s, much like the current BLR. It was also mentioned that the PFR is not expected to change frequently, unless there is a change in the OPR or SRR.

From  the  article,  it  appears  that  the  PFR  is  expected  to  remain  relatively  stable, similar to the BLR. As compared to earlier expectations that the KLIBOR could be used  as  a  reference  rate,  we  think  the  use  of  KLIBOR  would  have  been  a  more efficient  transmission of higher funding cost to  borrowers.  For instance, the 3-month KLIBOR has risen from 3.21% to 3.29% over the past year. Assuming the reference rate  and  spreads  remain  unchanged,  the  lending  rate  would  rise  by  8bps  as  well, when reset. This compares to the current regime based on BLR, which has remained stable and only tends to change when the OPR (and/or SRR) changes.

Risks
The  risks  include:  i)  slower-than-expected  loan  growth,  ii)  weaker-than-expected NIMs,  iii)  a deterioration in asset quality,  and  iv) changes in market conditions that may adversely affect investment portfolio.

Forecasts
No changes to our earnings forecasts.

Valuations and recommendations
We  see  both  Maybank  and  CIMB  as  excellent  proxies  to  the  ETP  and  key beneficiaries  as  capital  markets  improve.  However,  Indonesia’s  challenging  macro conditions remain a  bigger  dampener  for CIMB than Maybank,  as contribution from Indonesia  made  up  31%  of  9M13  pre-tax  profit  for  CIMB  vs  7%  for  Maybank. However, we continue to view any sharp selldown  in CIMB as  an opportunity to buy. As  for  HLB,  we  expect  growth  to  accelerate now  that  its post-merger  restructuring activities are largely done.

Source: RHB