Rough weather but banks can ride out storm

Asset quality will be among the key metrics analysts and investors will be watching in the months ahead because the six-month automatic loan moratorium has masked the true impact of the economic downturn caused by the pandemic

PETALING JAYA: The banking sector continues to face headwinds with the likelihood of a rise in non-performing loans, given that the recovery among economic sectors is protracted. However, while local banks will see their earnings shrink, they will be able to ride the storm post-Covid-19, said analysts.

Asset quality will be among the key metrics analysts and investors will be watching in the months ahead because the six-month automatic loan moratorium has masked the true impact of the economic downturn caused by the pandemic.

The Bank Negara’s Financial Stability Review for the first half of 2020 stress test showed that banks are still resilient although financial stress among households and businesses has increased. The central bank’s stress test projects the system’s gross impaired loans ratio to peak at 4.1% in 2021.

The report, which was released on Wednesday, noted that financial repayment capacity remained manageable and borrowers in need of further assistance were lower than earlier estimated.

Although banks had generally weathered first-half 2020 with sustained buffers, the central bank’s report noted that most remained cautious on credit risk.

After September, when the loan moratorium ended, provisions are expected to rise and the central bank cautioned for downside risks and continued vigilance.

Amid the uncertainties, what more with a new wave of Covid-19 cases threatening to stall the recovery businesses have been charting since the recent reopening of the economy, analysts are keeping their “neutral” call on the sector.

Of the seven banking reports issued yesterday, six have a “neutral” on the sector, while CGSCIMB Research has an “overweight” rating. Public Investment Bank said it saw potential near-term weaknesses, although with a positive bias given the sector’s lagging valuations relative to the broader market.

“Banks will find the going a little tougher in 2020 from the effects of interest rate cuts and asset quality degradation, ” it said in a note to clients yesterday.

Kenanga Research, in explaining its “neutral” stance, pointed to asset quality being the key swing factor to earnings in the coming quarters.

“Thus, we prefer banks with solid asset quality such as Hong Leong Bank Bhd (HLB) and Public Bank Bhd.

“Their asset quality track records suggest that the pre-emptive loan provisions required should be lower relative to peers while the smaller exposure to the corporate space would shield them from chunky loan impairments, ” said Kenanga, adding that these banks offered investors better earnings predictability and “safer” dividend yields.

It also likes RHB Bank Bhd for its capital strength. While this may not translate to higher dividend payouts versus peers in the near term, it said RHB should be able to resume with its capital management plans relatively quickly once the pandemic is over. Some rivals, on the other hand, may need time to rebuild their capital positions.

In first-half 2020, banks reported a marked earnings decline weighed down by further margin compression from the overnight policy rate (OPR) cuts and higher provisions for credit losses.

Analysts noted that annualised credit costs rose from the low levels over the past decade to 56 basis points (bps) as compared with the 2010-2019 average at 20bps – a level last seen during the Global Financial Crisis of 2009.

Banks’ provisions for loans classified as Stage 2 under Malaysian Finance Reporting Standards 9 increased by RM1.7bil in first-half 2020, a rise of 27.9% year-on-year. Overlay provisions increased RM2.7bil to RM24.6bil, the central bank’s report highlighted.

Banks were also impacted by a one-off contract modification loss due to the waiver of additional interest charges for hire-purchase loans and fixed-rate Islamic financing under the repayment moratorium measures. However, income from treasury and trading activities managed to moderate this downside effect.

In anticipation of the challenging times, banks have been shoring up their buffers, either through new capital issuances or dividend reinvestment plans. Most banks have reduced or deferred dividend payouts to shareholders.

In terms of dividends, UOB Kay Hian (UOB KH) remains hopeful that banks would still be in a position to potentially pay out final dividends, which are typically paid out in the first quarter of 2021 for banks that have their financial year end on Dec 31.

By then, it said, banks should have a much stronger visibility on provision requirements for segments at risk.

“Based on our provision assumptions, we still expect banks to remain profitable in 2020, and as such, should be in a position to declare a final dividend, ” it said.

However, UOB KH said this was subject to the individual bank’s asset quality dynamics over the next six to 12 months and their capital strength.

Despite the sector trading at below -2 standard deviation (SD) to both its 5-year and 10-year mean price to book, this does not imply valuation is undemanding, added UOB KH. That said, at -2SD below mean, it thinks the downside risk to sector share price performance may be limited.

Given the ongoing uncertainty, it advocates a balanced exposure. Investors looking for a more defensive approach may consider defensive retail-centric banks like HLB, on which it has a “hold” given the stock’s recent strong share price outperformance. But it advises a buy on weakness strategy.

It also likes RHB as the bank provides a good balance between a high-beta recovery play with exceptionally strong capital buffers to absorb any potential shocks.

Meanwhile, CGS CIMB Research said its overweight rating is underpinned on 2021 earnings recovery prospects.

“We concur with the central bank that the industry’s gross impaired loan ratio would rise in fourth quarter 2020 and 2021, but we expect banks’ loan loss provisioning (LLP) to be lower in 2021 (versus what’s forecast for 2020), as most banks have front loaded the LLP, ” it said.

CGS CIMB said it projected this to catalyse a recovery in banks’ net profit growth to 14.8% in 2021, which could re-rate banking stocks.

Its picks for the sector are Public Bank, HLB, RHB and AMMB Holdings Bhd.

Should the protracted economic downturn extend into 2021, banks would have to grapple with a potential slowdown in loan growth and further increase in LLP.

CGS CIMB said it has factored in a total OPR cut of 150bps in 2020 for most Malaysian banks under its coverage.

“Hence, another downside risk could be OPR cuts wider than 150bps in 2020 (and 2021). Every 25bps cut in OPR would lower our calendar year 2021 forecast net profit forecast by circa 2%, ” it said in its report yesterday.

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