We are keeping our OVERWEIGHT stance on the sector. Despite further rise  in  household  indebtedness,  BNM  appears  comfortable  with  bank lending  to  households,  as  the  rise  in  debt  is  supported  by  higher income  and  household  financial  asset  levels,  as  well  as  stable employment  and  income  conditions.  A  new  interest  rate  framework takes effect from 2 Jan 2015, but this is largely neutral to the banks.

Household indebtedness rose further to 86.8% of GDP in 2013. This is  compared  to  2012’s 81.3%  (2011:  76.2%).  Nevertheless,  the  various macroeconomic prudential measures that Bank Negara Malaysia (BNM) has  put  in  place  in  recent  years  appears  to  be  taking  effect,  as evidenced  by  the  moderating  growth  in  household  debt  (2013:  +11.7% vs  2012:  +13.5%)  and  pace  of  expansion  in  lending  by  non-bank financial  institutions  (NBFIs)  (2013:  +9.6%  vs  2012:  22%).  While  the central  bank  expects  the  level  of  household  indebtedness  to  remain elevated  over  the  next  few  years,  BNM  believes  the  risks  are  well-contained  as  the  balance  sheet  and  debt  servicing  capacity  of households  remains  intact  while  credit  underwriting  standards  of  the financial institutions are still sound.  

Residential  property  prices  continue  to  rise  but  cooling  measures to  mitigate.  BNM  expects  house  prices  to  remain  elevated  and  will continue to be largely driven by the structural mismatch between supply and  demand.  That  said,  it  noted  that  speculative  buying  of  residential properties  remains  subdued  following  the  pre-emptive  measures introduced in 2010 involving loan-to-value limits on borrowers with three or  more  outstanding  housing  loans.  The  bulk  of  house  purchases continue to  be for own  occupation, with  84%  of  housing loan  borrowers only having one outstanding mortgage.

New base rate framework effective 2 Jan 2015. BNM also announced yesterday  that  the  base  rate  will  replace  the  base  lending  rate  (BLR) framework  as  the  main  reference  rate  for  new  retail  floating  rate  loans. The  former  will be determined by the financial institutions’ benchmark cost of funds and the statutory reserve requirement (currently 4%). Other components  of  loan  pricing,  such  as  credit  risk,  liquidity  risk  premium and operating costs, will be reflected in a spread above the base rate. As previously  mentioned,  BNM  does  not  expect  the  shift  to  the  new reference  rate  framework  to  impact  effective  lending  rates  charged  to retail borrowers.

Maintain OVERWEIGHT stance on sector. We remain OVERWEIGHT on  the  sector  as  banks  are  well-poised  to  benefit  from  the  expected pickup  in  GDP  this  year,  underpinned  by  the  various  economic programmes. Maybank, Hong Leong Bank and CIMB are our BUYs.

2013 Financial Stability And Payment Systems Report

Highlights

BNM  held  a  briefing  yesterday  in  conjunction  with  the  release  of  its  2013  Annual Report and Financial Stability and Payment Systems Report. Similar to the previous year,  the  two  areas  in  the  report  that  received  much  attention  were  household indebtedness and the domestic property market. We set out below the salient points from the briefing relating to the banking system.

Managing risks from household indebtedness

Household  indebtedness  rose  further  to  86.8%  of  GDP  in  2013  vs  81.3%  in  2012 (2011:  76.2%).  The  various  macroeconomic  prudential  measures  that  BNM  put  in place  in  recent  years  appears  to  be  taking  effect,  with  growth  in  household  debt moderating  to  +11.7%  in  2013  from  +13.5%  in  2012.  The  increase  in  household indebtedness  last  year  was  also  the  slowest  pace  of  rise  since  2009.  We  also  note that  the  pace  of  expansion  in  lending  by  NBFIs,  which  we  believe  were  the  main target of BNM’s measures  last  year  to  keep  a  lid  on  household  debt,  had  slowed down  to  9.6%  in  2013  from  2012’s 22%.  Nevertheless,  this  still  outpaced  GDP growth, leading to the higher household debt/GDP ratio.  The  central  bank  expects  the  level  of  household  indebtedness  to  remain  elevated over  the  next  few  years,  as  demand  for  credit  is  likely  to  remain  strong,  particularly from  the  young,  more  affluent  population  settling  in  urban  centres,  eg  demand  for houses and passenger cars. However, from a financial stability perspective, BNM did not  appear  overly  concerned  and  cited  the  following  mitigating  factors:  i)  household balance sheet remains healthy with the debt repayment ratio at 43.5% (2012: 43.9%), ii)  household  financial  assets  expanded  in  tandem  with  household  debts  –  both household  financial  assets  to  total  household  debt  and  household  liquid  financial assets  to  household  debt  were  largely  unchanged  at  2.2x  (2012:  2.2x)  and  1.6x (2012:  1.6x)  respectively  as  at  end-2013,  iii)  credit  quality  remained  sound  – underpinned  by  better  credit  risk  management  and  underwriting  practices  (eg  the average debt service ratio on new loan facilities approved remained prudent at below 40%),  iv)  stable  employment  and  income  conditions,  and  v)  the  various  measures that BNM has introduced to help contain the build-up in household debt, reinforced by fiscal  measures  and  other  initiatives  by  the  Government.  Furthermore,  the  bulk  of loans to households were for the purchase of assets.

Managing developments in the domestic property market

The  Malaysian  house  price  Index  rose  11.3%  in  2Q13,  with  house  prices  rising across  the  board  for  all  property  categories,  especially  for  detached  and  high-rise properties.  BNM  expects  house  prices  to  remain  elevated  and  will  continue  to  be largely driven by the structural mismatch between supply and demand. Other factors include Malaysia’s relatively young population and labour force as well as increasing urbanisation.  The  central  bank  noted  that,  while  investment  demand  for  properties stayed healthy, the bulk of house purchases continued to be for own occupation with 84%  of  housing  loan  borrowers  only  having  one  outstanding  mortgage.  Speculative buying of residential properties remains subdued following the pre-emptive measures 
introduced in 2010 involving  on loan-to-value limits on borrowers with three or more outstanding housing loans.

Managing credit risk exposures to businesses

As for credit risk exposures to businesses, the likelihood  of a systemic asset quality issue  appears  low  at  this  juncture.  Balance  sheet  strength  of  businesses  remains intact  with  aggregate  debt-to-equity  ratio  of  39.7%  as  at  end-2013  (2012:  41.3%) while  the  interest  coverage  ratio  stood  at  7.7x  (2012:  5.4x).  Improving  economic prospects ahead should also help keep asset quality in check. Finally, BNM believes the  banks  should  have  sufficient  capacity  and  liquidity  to  meet  the  higher  future financing  demand  of  businesses  due  to,  for  example,  the  Economic  Transformation Programme (ETP), without crowding out other private sector funding needs.

Managing contagion from external developments

BNM’s view regarding contagion from external developments was largely unchanged from last year, ie contagion risks are well contained. As for the potential impact from deleveraging  by  overseas  financial  institutions,  this  remained  low  and  further subsided amid improving economic conditions, according to BNM.

New reference rate framework to take effect from 2 Jan 2015

BNM also announced yesterday that, effective 2 Jan 2015, the base rate will replace the BLR framework as the main reference rate for new retail floating rate loans. The base rate will be determined by the financial institutions’ benchmark cost of funds and the  statutory  reserve  requirement,  which  currently  stands  at  4%.  Other  components of loan pricing, such as credit risk, liquidity risk premium and operating costs, will be reflected in a spread above the Base Rate. As previously mentioned, BNM does not expect the shift to the new reference rate framework to impact effective lending rates charged to retail borrowers. Recall that the reasons for the shift to the new framework are, among others: i) to address the issue of negative spreads between retail lending rates  on  new  loans  and  BLR;  ii)  improve  the  transmission  mechanism  of  monetary policy; and iii) to promote a more transparent pricing of floating rate retail loans.

Risks

The risks include: i) slower-than-expected loan growth, ii) weaker-than-expected  net interest margins (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

Overall, yesterday’s briefing suggests that BNM remains comfortable with household and  business  leverage  levels,  especially  given  that  the  various  measures  that  have been put in place to rein in household indebtedness appear to be filtering through the system.  Hence,  while  we  would  not  discount  the  possibility  of  pockets  of  impaired loan incidences, we do not expect this to be systemic. In any case, we have factored in a higher credit cost of 25bps for 2014 (vs 2013’s 20bps), but this is a reflection of normalising  credit  cost  as  recoveries  taper  off,  rather  than  asset  quality  issues.  We believe BNM will continue to keep a close watch on key trends relating to household indebtedness  and  this  will  likely  be  taken  into  account  when  determining  whether further  tightening  measures  will  be  introduced.  That  said,  judging  from  the  central bank’s tone yesterday, we do not expect further tightening measures for the property sector (if any) to be as significant as those introduced in recent years.  We  remain  OVERWEIGHT  on  the  sector,  as  the  banks  are  well-poised  to  benefit from  an  expected  pickup  in  GDP growth  this  year,  underpinned  by  the  various  ETP initiatives. We see both Maybank and CIMB as excellent proxies to the ETP and key beneficiaries as capital markets improve. As for Hong Leong Bank, we expect growth to accelerate now that its post merger restructuring activities are largely done.

Source: RHB