Another OPR cut will hit banks’ earnings further

Banks’ earnings in 2H20 would depend on the prospect for OPR cuts as well as possible asset quality deterioration, says analyst

by ASILA JALIL / pic by TMR FILE

A FURTHER cut in the Overnight Policy Rate (OPR) this week by Bank Negara Malaysia (BNM) will greatly impact banks’ net interest margin (NIM) and affect earnings in the second half of 2020 (2H20), observes research firms.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said the central bank has the policy space to slash the benchmark lending rate further in the upcoming meeting on Sept 10 in light of low inflation rate.

“Banks’ earnings in 2H20 would depend on the prospect for OPR cuts as well as possible asset quality deterioration which then will have an impact on the financing loss provision.

“If there is an additional reduction, NIM will be impacted especially for variable-rate financing, which will be adjusted almost immediately,” he told The Malaysian Reserve (TMR) recently.

The central bank has reduced the OPR four times this year bringing it to 1.75%, the lowest level recorded since the introduction of the policy tool in 2004.

BNM said the last reduction in July was due to concerns over weak economic conditions caused by the Covid-19 pandemic and it provided additional policy stimulus to accelerate the pace of economic recovery.

Mohd Afzanizam said another cut may not be necessary as the economy is indicating signs of a gradual recovery.

Non-fund-based income will also help to buffer the loss in NIM, especially in areas relating to the bond market where bond or sukuk prices are inversely related to interest rates, he said.

He added that going forward, banks’ profitability should pick up in the future as the economy is expected to record a decent recovery particularly in 2021.

“If the recovery becomes sustainable, the OPR will need to be adjusted upward at some point in the future, perhaps in 2022.

“So the big picture, it is not all too bad for banks. Plus, the ‘new norm’ narrative will force the banks to be more nimble in their approach for customer retention as well as acquiring new customers,” Mohd Afzanizam added.

Bank earnings, which were significantly hit in the second quarter (2Q) due to hefty modification loss and preemptive provisions as well as markedly thinner NIM, may remain tepid for 2H20.

The average pre-tax return on assets and return on equity of eight selected local banks fell to an annualised 0.7% and 6.8% respectively in the same period (1Q: 1.1% and 10.7% respectively), according to RAM Rating Services Bhd (RAM Ratings).

While expecting their earnings to improve in 3Q and 4Q, banks’ profit performance is likely to remain subdued through the rest of the year amid the economic downturn and highly uncertain operating landscape, the rating firm noted.

NIMs were severely crimped by the aggregate 75 basis points (bps) cut in the OPR in 2Q, which was compounded by modification charges arising from non-accrual of interest (or profit) on deferred instalments of fixed-rate auto and Islamic financing under the six-month moratorium.

The rating agency said although it expects some respite in NIM as deposits are progressively repriced at lower rates, the 25bps OPR reduction in July along with the likelihood of more cuts on the horizon, will limit the extent of this recovery.

RAM Ratings added that the recently announced targeted extension of the loan moratorium beyond September for selected borrowers could trigger another round of modification losses, although to a much smaller degree.

With a large proportion of loans on payment holiday, the banking system’s gross impaired loan (GIL) ratio clocked in at an all-time low of 1.43% as at end-July 2020 (end-December 2019: 1.53%).

The true underlying asset quality will only become apparent after the expiry of Covid-19 loan relief measures. Despite the still benign GIL ratio, banks have been proactively building up their provisions in anticipation of heightened defaults next year.

The industry recorded a 4.5% year-on-year loan growth in July 2020 (2019: 3.9%), underscored by the automatic six-month moratorium for individual and SME loan repayment and various government funding programmes.

Public Bank Bhd registered a drop in its net profit by 24.84% in 2Q to RM1 billion from RM1.33 billion a year ago due to modification loss amounting to RM498 million.

The group also did not declare an interim dividend for the period as opposed to 33 sen per share in 2Q of 2019.

Malayan Banking Bhd’s net profit fell 51.5% to RM941.73 million in 2Q from RM1.94 billion last year due to high impairment allowances and modification loss.

JF Apex Securities Bhd head of research Lee Chung Cheng said the outlook for banks in 2H20 is not too promising as the industry is still affected by NIM compression, along with loan provision amid better loan growth.

Earnings in the sector are also expected to record a mild recovery in 2H20 as the uplift of the six-month loan moratorium will also pose problems to the sector.

“Earnings recovery will perhaps be single-digit at most in 2H20,” he told TMR.