We keep our NEUTRAL sector call with Public Bank as our Top Pick.BNM met analysts last Friday to discuss on its revised policy document on impaired loans, which should lead to more consistent practices among the banks with respect to rescheduled and restructured (R&R) facilities. System impaired loans will likely be impacted and possiblyloan provisioning as well, but the impact may not be too significant.

• Bank Negara Malaysia (BNM) conducted a discussion with analysts last Friday with respect to the revised policy document “Classification and impairment provisions for loans/financing”, which was issued last month. The main additional requirements in the abovementioned policy document were in relation to rescheduled and restructured loans, where a rescheduled and restructured loan facility following an increase in the credit risk of the customer will need to be classified as an impaired loan by a banking institution. This requirement is effective from 1 Apr 2015.
• Ensuring consistency in practice among banks. BNM mentioned that the main reason for the inclusion of these additional requirements w as to ensure a more consistent practice for the treatment of rescheduled and restructured facilities among banks. BNM had noticed uneven practices among the banks and there were instances whereby restructured and rescheduled facilities were not being classified as impaired. The key here would be whether credit risk has increased and we gather from the discussion that in most cases, a facility needs to be restructured or rescheduled typically because the borrower is facing repayment problems and this should trigger the “increase in credit risk” condition.
• Minimal impact on system impaired loans... The Central Bank does not expect the requirements above to lead to a significant increase in system impaired loans. Firstly, the requirements prospectively apply toloans that are rescheduled or restructured on or after 1 Apr 2015. Secondly, BNM said that some banks have already adopted such practices.
• …but any extra provisioning required will need to flow through the income statment. BNM also clarified that any increase in loan allowances required for restructured and rescheduled facilities will need to be made via the income statement (as compared to, for example, via regulatory reserves). Nevertheless, the Central Bank said it had no intention to regulate or set any specific level of loan loss coverage for banks.
• Investment case. Our discussion with some of the banks point to an uptick in impaired loans ahead, although the banks did not guide on the quantum of the increase as some were still in discussions with BNM. As to the impact on loan impairment allowances, the feedback has been mixed. Public Bank (PBK MK, BUY, TP: MYR21.00) already complies with the revisions above and remains our sole BUY for the sector.

Salient points from meeting with BNM BNM’s assistant governor, Jessica Chew, conducted a discussion with analysts last Friday with respect to the revised policy document “Classification and impairment provisions for loans/financing”, which was issued last month.

To recap, the main additional requirements in the abovementioned policy document were in relation to rescheduled and restructured loans. Essentially, for a rescheduled and restructured loan facility following an increase in the credit risk of the customer, a banking institution will need to classify such facility as rescheduled and restructured in the Central Credit Reference Information System (CCRIS). This facility will also need to be classified as an impaired loan by a banking institution. Exceptions to a rescheduled and restructured classification in CCRIS include: i) a moratorium is granted on loan repayments because, for instance, a customer is affected by natural disasters, ii) the loan is rescheduled or restructured by Agensi Kaunseling dan Pengurusan Kredit (AKPK), and iii) retails loans, where a banking institution opts not to increase the installment following an increase in the base rate/base lending rate whereby the increase is less than MYR50/month. For rescheduled and restructured loans classified as impaired, these loans should only be reclassified as non-impaired when repayments based on the revised terms have been made for a continuous period of at least six months. The above requirements apply to loans that are rescheduled and restructured on or after 1 Apr 2015.

Ensuring consistency in practice among banks. BNM mentioned that the main reason for the inclusion of these additional requirements was to ensure a more consistent practice for the treatment of rescheduled and restructured facilities among banks. BNM had noticed uneven practices among the banks and there were instances whereby restructured and rescheduled facilities were not being classified as impaired. The revised policy now explicitly states that rescheduled and estructured facilities following an increase in credit risk will need to be classified as impaired, whereas this was not explicit in the earlier document. The key here would be whether credit risk has increased and we gather from the discussion last Friday that in most cases, a facility needs to be restructured or rescheduled typically because the borrower is facing repayment problems and this should trigger the “increase in credit risk” condition.

Minimal impact on system impaired loans... The Central Bank does not expect the requirements above to lead to a significant increase in system impaired loans. Firstly, the requirements prospectively apply to loans that are rescheduled or restructured on or after 1 Apr 2015. Secondly, BNM said that some banks have already adopted such practices.

…but any extra provisioning required will need to flow through the income statement. BNM also clarified that any increase in loan allowances required for restructured and rescheduled facilities will need to be made via the income statement (as compared to, for example, via regulatory reserves). Nevertheless, the Central Bank said it had no intention to regulate or set any specific level of loan loss coverage for banks.

More administrative requirements for banks ahead. BNM also expects banks to revise the monthly repayment schedules of customers with floating rate facilities when the base rate or base lending rate changes. Hence, the banks will need to ensure that their customers are informed and aware of any such changes. Otherwise, these customers face the risk of having their loan facilities tagged as rescheduled and restructured in CCRIS.

Impact on banks At this juncture, our discussion with some of the banks point to an uptick in impaired loans ahead, although the banks did not guide on the quantum of the increase as some were still in discussions with BNM. As to the impact on loan impairment allowances, the feedback has been mixed. Maybank (MAY MK, NEUTRAL, TP: MYR10.00) indicated the possibility of loan impairment allowances being impacted as well whereas CIMB (CIMB MK, SELL, TP: MYR5.20) said that the revision will only impact impaired loan classification but not provisioning. Among the large banks, we understand that Public Bank’s (PBK MK, BUY, TP: MYR21.00) practice is already consistent with the revised policy document.

Forecasts No changes to our earnings forecasts.

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

Valuations and recommendations Maintain NEUTRAL on the sector with Public Bank our Top Pick. Given the challenging macroeconomic environment, our key sector picks are skewed towards a more defensive stance. We like banks that offer strong and predictable book value growth to continue creating shareholders value. This would entail a combination of superior returns, sound earnings predictability (eg less reliant on markets-related income) and/or solid asset quality. Also, banks with relatively lower m arket risk should aid in insulating book value against adverse interest rate/bond yield and foreign exchange rate movements. In our view, Public Bank meets the criteria above and is our sole BUY for the sector.

In addition, we would not discount the possibility that there could be concerns ahead regarding the impact of the revised policy document on asset quality and loan impairment allowances. Public Bank’s practices are already in compliance with the revised document and hence, should not be adversely impacted by the changes.