Improving asset quality concerns banks amid slowing economy

Any adjustments in OPR will usually ‘normalise’ in between 3 and 6 months after the banks have reset their loan and deposit rates


THE banking sector foresees headwinds in improving its asset quality that have taken a hit since the implementation of Movement Control Order (MCO) to combat the Covid-19 pandemic in March.

Although the MCO restrictions have been eased, it will take time for economic activities to recover to normalcy, said MIDF Amanah Investment Bank Bhd senior analyst Imran Yassin Mohd Yusof.

“All this will have a downside impact on the economy and this will affect the banks through higher credit costs.

“However, we do not foresee exacerbated stress to the banking sector as it faces current headwinds on a position of strength. Our top picks are the three Domestic Systemically Important Banks due to their solid fundamentals, scale and size,” he said.

The firm favours Malayan Banking Bhd (‘Buy’ call and target price (TP) of RM8), CIMB Group Holdings Bhd (‘Buy’ call and TP of RM4.30) and Public Bank Bhd (‘Trading Buy’ and TP of RM17).

“Additionally, the attractive dividend yield will also cushion any downside risk. A rerating catalyst would be faster than expected recovery of the economy,” he added.

Bank Negara Malaysia (BNM) in a statement last Wednesday said the banking system asset quality remained sound in March with overall gross and net impaired loan ratio sustained at 1.6% and 1% respectively.

BNM said banks continued to set aside ample provisions to buffer against potential losses based on forward-looking assessments.

The central bank added that outstanding loan growth in March was sustained at 4% compared to 3.9% in February while outstanding corporate bond growth declined to 7.6% from 8.2% in February due to lower issuances amid higher redemptions.

BNM has also retained its less- than-sanguine view on domestic economic conditions with its outlook on growth continuing to be subject to a high degree of uncertainty, particularly with respect to developments surrounding the pandemic.

In response to the slowing economic climate, the central bank has cut its Overnight Policy Rate (OPR) by 50 basis points (bps) to 2% — a level last seen during the 2008 global financial crisis.

Independent financial consultant and investment analyst Leong Hoe Kit told The Malaysian Reserve that this is possibly the last OPR cut for the first half of the year (1H20) but at the same time, this also reflects BNM’s pessimism on the current economic scenario indicating that the OPR could be further cut in the second half if the economic condition worsens.

“It looks like BNM is in a more aggressive mood and cut 50bps last Tuesday (a total cut of 100bps so far for 2020) to bring OPR down to 2%, demonstrating that they want to do this quicker and earlier,” he said.

The OPR has been cut three times so far in 2020 and only once in May 2019 when it was reduced by 25bps.

“With a 25bps cut in OPR, net interest margin of banks could fall four-five bps on average resulting in banks’ bottom line contracting at least 3% on average.

“Banks with higher levels of rate-sensitive balance sheets (like those with higher proportions of variable rate loans in their books) would naturally be more adversely affected. I am not highly enthusiastic about banks’ upcoming quarterly results,” he said.

Leong noted any adjustments in OPR will usually ‘normalise’ in three-to-six months’ time after the banks have reset both their loan and deposit rates, so the case for investment in the banking sector would be more dependent on its valuation.

“Valuations for banks have come off somewhat but at this moment, we have yet to know the full extent of potential non-performing loans (NPLs) that may arise subsequent to the economic turmoil caused by the Covid-19 pandemic as well as the crash in oil prices.

“As such, it could be advisable to wait until there is further clarity on the effects of NPLs to banks’ balance sheets and evaluate the effects on the sector’s valuation,” he said.