Banks' biggest challenges in 2003

  • Business
  • Saturday, 11 Jan 2003

Banks in Malaysia are in for a challenging year. In its recent 2003 market Outlook Strategy report, RHB Research Institute maintains a "neutral" weighting on the sector and has forecast an anaemic 9 per cent growth in net banking profits for financial year 2003. The research house gives its outlook on the sector. 

THE banks’ biggest challenge in 2003 is to sustain operating profitability against a backdrop of stagnating to declining top-line revenue. Loan growth is modest but net interest margins (NIM) are under further pressure. Cost management becomes crucial in sustaining operating profits as revenue base comes under intense pressure. 

On a more positive note, the banking system's non-performing loans (NPL) have moderated since the first quarter of last year and are projected to improve in 2003. 

Hence, lower loan loss provisioning (LLP) ahead remains the primary driver of earnings growth this year, similar to the scenario in 2002, but the difference being the magnitude of reduction in LLP. 

The challenging operating environment ahead will feature loan growth of 5 to 6 per cent per annum. This will be amidst continuing disintermediation in the banking system as corporate borrowers tap the debt market for their long-term funding requirements. 

Relative strength in new loan growth remains within the residential property and personal consumption sub-sectors. We expect some pick-up in new lending to the manufacturing sector. 

Average NIM of listed banks narrowed from 3.2 per cent in 2000 to 3 per cent in 2001 and 2.9 per cent in 2002, and is projected to compress to 2.7 per cent in 2003.  

One reason for the sharper erosion in NIM is the competitive pricing on new housing and hire purchase loans as banks jostle for business volume and market share. 

Another factor is the realignment of finance company’s base lending rate (BLR) (7.4 per cent) with bank-based BLR (6.4 per cent) following the mergers of banks and finance companies, which are expected to take place in the second half of the year. There could be some relief, by way of a one-year grace period to implement the BLR realignment. 

There is also the probability of an intervention rate cut to trim BLR in the first half of the year. The likelihood and timing of an intervention rate cut is dependent on the economy. 

A slower-than-expected economic recovery will increase the probability of an intervention rate cut. The adverse financial impact of a BLR cut on banks’ earnings could be moderated by adjustments in retail deposit rates and increased availability of government-subsidised funding for promoted industries. 


Keeping costs down  


A modest growth in fee-based income is expected this year. This will be partly driven by higher cross-selling of financial products (unit trusts, bancassurance, stockbroking, wealth management). Higher volume in financial advisory and debt market activities will also push growth in fees. 

Cost management in terms of raising operating efficiency of staff and infrastructure will be an important theme. In 2002, overheads fell year-on-year (y-o-y) on account of the absence of one-off voluntary separation scheme cost (taken in 2001). 

However, overheads this year will, at best, be contained. It is improvements in operating efficiency that will help mitigate the impact of declining NIM on the banks’ asset base. Banks’ cost-income ratios are not expected to improve significantly. 

The merger of banks and finance companies, which should result in branch and staff rationalisation, is not expected to substantially reduce overhead costs, especially with respect to staff costs. This is because staff “right-sizing” is to be phased out over 12 to 18 months with excess staff re-deployed to marketing functions. 

On a more positive note, system NPLs are projected to improve further in 2003, especially in the first half, when the restructuring (led by the Corporate Debt Restructuring Committee) of the Lion group, Land & General Bhd, and the Pahang State Economic Development Corp are to be implemented. 

Gross and net NPL ratios (3-month classification) are projected to ease to 15 per cent and 9 per cent respectively by the year-end. In comparison, these stood at 16.4 per cent and 10.2 per cent as at end Oct 2002. 

Hence, as with last year, lower LLP burden will be the primary driver of earnings growth in 2003. The main difference between 2002 and 2003 is the magnitude of the y-o-y decline in LLP. 

Whilst the 2002 earnings recovery benefited from a “high 2001 base effect” with LLP coming off -23 per cent y-o-y, 2003 earnings would see a more muted effect as LLP expenses are projected to come off by -16 per cent y-o-y. 

With the need to manage return on equity, listed banking groups are not expected to make significant cash calls on existing shareholders. 

AMMB Holdings Bhd might make a small rights issue to part-finance repayment of a Danamodal Nasional Bhd sub-debt at AmBank, but largely, banks will tap the sub-debt market to beef up capital base or refinance acquisitions. The bank/finance company mergers should enable banks to better manage funding structure and release excess capital to support future growth or raise dividend payouts. 


Stocks to watch  


Our stock picks for long-term investors are those banks with strong retail franchises. For index-pegged investors, we recommend Malayan Banking Bhd (Outperform) and Public Bank Bhd-F (Outperform) as core holdings. Both banks have strong balance sheets and sound asset books, coupled with a management track record for delivering reliable earnings. 

For investors less concerned with stock liquidity, there is Hong Leong Bank Bhd (Outperform), whose price-earnings ratio valuation is attractive after a recent price correction. Also, the newly re-listed EON Capital Bhd (Outperform), with its undemanding 1.1x P/NTA (price to net tangible asset), is a strong retail-based banking group. 

The investment case for finance companies is based on their impending privatisations. Public Finance Bhd (Outperform) offers a cheaper entry into Public Bank Bhd-L, while minorities of AMFB Holdings Bhd, the most valuable part of the AmBank group, should benefit from the finance company’s privatisation. 

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