Non-bank lenders are beating the market

AMID weak consumer sentiment and a stagnant market for loans, it may come as a surprise that investors are placing bets on an earnings recovery for non-bank lenders. Listed non-bank lenders have outperformed the broader market this year.

At the same time, valuations for these companies have become more attractive as they may no longer need to set aside hefty provisions to cover potential bad loans, say analysts.

Among the non-bank lenders that have recently gained buying interest are RCE Capital Bhd (RCE Cap), AEON Credit Service (M) Bhd and Malaysia Building Society Bhd (MBSB).

“The second-tier financial institutions are a proxy for loan growth recovery but without the hurdles faced by the less nimble big banking groups. There are opportunities for both capital appreciation in their share prices as well as for higher dividends,” says one banking sector analyst.

It is notable that the non-bank lenders are reporting solid income numbers despite the prevailing negative sentiment towards the loan market.

One explanation is that the shift in the lenders’ portfolio mix has spurred earnings growth as they have focused more on the corporate segment and away from personal financing, which makes up the bulk of non-performing loans (NPLs) and also contributes to household debt.

Others are capitalising on niches in the consumer financing segment such as in the civil service, with automatic salary deductions for repayments mitigating the risk of the loans turning bad.

It can also be argued that a substantial part of the hefty provisions for bad loans made over the past two years could be written back into the lenders’ books progressively in the coming years. However, this would be dependent on a sustained reduction in the lenders’ NPL figures.

According to a recent statement by the Association of Banks in Malaysia (ABM), the loan market remains robust as evidenced by outstanding business loans expanding by 5% year-on-year for the month of December.

“This growth was driven by the annual expansion of loans to most major sectors such as the wholesale and retail trade, restaurants and hotels, finance, insurance, business services, and transport. Businesses are operating in a stable environment with the ringgit stabilising,” it noted.

At the same time, outstanding loans for households grew by 5.3% in December, ABM added.

Shares of lenders such as RCE Cap broke new all-time highs last year and have kept climbing. On Feb 15, the group beat analyst expectations after reporting a 67% year-on-year increase in its third-quarter net profit to RM21.77mil from RM13mil during the corresponding quarter last year.

With a cumulative net profit of RM57.7mil for the nine months period ended Dec 31, 2016 (9M FY17), the group is on track to report its best full-year net profit in five years.

Its revenue for the period amounted to RM166.08mil, a considerable increase from RM118.08mil in 9M FY16.

In reaction to the latest results, Maybank IB Research has upgraded its price target for RCE Cap to RM1.95 from RM1.60 previously, citing undemanding valuations and continuing strong momentum in earnings.

In spite of moderate net loans growth, the research house says RCE Cap’s earnings improvement from a much lower effective tax rate during the quarter, which is the result of tax over-provision writebacks.

Meanwhile, AEON Credit has similarly outperformed expectations with its shares trading at the highest level in four years.

The group, which is primarily involved in the provision of easy payment schemes and personal financing schemes among others, saw a reduction in its NPL to 2.33% in the third quarter of FY17 from 2.68% the year before, thanks to a robust credit collection system.

RHB Research, which has a target price of RM18 for the stock, expects the group to maintain its strong growth into FY18, according to a Feb 15 report.

Aside from tightened lending requirements to manage its asset quality, AEON Credit has also made conscious efforts to diversify away from niches which are prone to asset quality stress such as the general easy payment and motorcycle easy-payment segments, says RHB.

There are several reasons as to why these non-bank lenders are favoured investments. For one, the large banking groups saw their NPLs rise last year partly due to bad loans arising from overseas corporate clients.

Furthermore, the safeguards and conservation buffers under the Basel III framework, which will become progressively more strict over the next three years, looms large over the banking groups.

The measures, which intends to protect their capital in times of stress, may stifle earnings and by extension their dividend payouts.

This is because banks are now obligated to operate more conservatively and maintain a large cash pile which cannot be plowed back into the business due to the Basel III liquidity requirements.

From a macro standpoint, analysts forecast a recovery in the earnings growth of financial institutions which should be reflected in the current fourth quarter earnings season.

“We expect positive year-on-year growth of banks earnings coming from tight control of operating expenditure and lower provisions due to the bulk of impairments being made earlier last year. We also foresee possible write backs on some of the performing loans accounts that was rescheduled and restructured,” says MIDF Research.

Despite the recent advances, the non-bank lenders seem undervalued relative to to its sector. According to Bloomberg data, RCE Cap’s shares is currently valued at a historical price-to-earnings ratio of 8.4 times, while another lender, AEON Credit Service (M) Bhd, is valued at 9.3 times earnings.

In comparison, the KL Finance Index, which comprises the major banking groups as well as second-tier financial institutions, is currently valued at 13 times earnings. As at Feb 17, shares of RCE Cap, AEON Credit and MBSB have all outperformed the FBM KLCI’s 4% increase year-to-date.

One outlier is MBSB which is trading at a whopping 29 times historical earnings. This was mainly down to depressed earnings arising from its impairment exercise over past two years which is expected to amount to more than RM1bil. Additionally, recent enthusiasm over a potential merger with Asian Finance Bank has triggered a strong rally in its shares, thus pushing up its PE ratio further.

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