Political uncertainty poses risks for banking system

Moody’s Investors Service cautioned that uncertainty over future policy changes by the new government will weigh on investor and business sentiment over the course of 2018.

The international ratings agency in a June 18 note highlighted this on the back of reaffirming a stable outlook for the banking system in Malaysia (A3 stable) over the next 12 to 18 months.

Macroeconomic conditions will remain robust, Moody’s added, as it forecast Malaysia’s real Gross Domestic Prodict (GDP) to expand by 5.4 per cent in 2018, with loans pegged to grow six or seven per cent in the same period.

“The removal of the goods and services tax (GST) could boost private consumption and benefit domestic businesses in the near term,” it said in its statement.

A key supporting factor of the stable outlook, it said, is the robust macroeconomic conditions in and outside Malaysia.

Moody’s vice president and senior analyst Simon Chen said this factor will result in a favourable operating environment for Malaysian banks and help stabilise their asset quality and profitability.

“At the same time, while we will see faster loan growth, such growth will remain at a pace that is slower than the banks’ profit retention, which will lead to stronger capital buffers,” he said.

Moody’s conclusions are contained in its just- released report on Malaysian banks titled “Robust macro conditions and improving capitalisation support stable outlook,” and is authored by Chen.

The stable outlook is based on Moody’s assessment of six drivers: operating environment (stable); asset quality (stable); capital (improving); funding and liquidity (stable); profitability and efficiency (stable); and government support (stable).

Moody’s said that the banks’ asset quality will stay stable, against the backdrop of easing stress among troubled corporates and slowing growth in household debt levels.

New non- performing loans formation will remain slow amid a moderate rise in interest rates, as corporate profitability improves and growth in risky household loans eases.

As for capitalisation, such levels will improve, as capital generation exceeds asset growth, and prove sufficient to cushion one-time adjustments to capital ratios to meet the MFRS 9 standard.

Moody’s also said that the banks’ funding and liquidity will stay stable. In particular, the banks’ loan-to-deposit ratios will rise as loan growth accelerates, but such ratios will remain below 100 per cent.

In addition, the banks will remain well positioned to comfortably meet minimum requirements under Basel III liquidity and funding rules.

On profitability, revenue improvements — driven by faster loan growth — will underpin the banks’ profitability profiles, it said. Faster loan growth will boost pre-provision income, although stiffer deposit competition will limit improvements in net interest margins.

Moody’s also saw that credit costs will rise because of the new MFRS 9 standard, but only slightly because of continuously benign credit conditions.

“Government support for the banks in times of stress will continue to prove strong,” it continued. “Recent legislative reforms have not suggested any shift in the government’s policy for the resolution of troubled banks outside liquidation, with a lack of legislation to force bank creditors to bear the cost of any bank bailouts.”

Moody’s rates 11 banks in Malaysia: eight conventional commercial banks, one investment bank, one Islamic bank and one government-owned development financial institution.

The rated commercial banks accounted for some 85 per cent of total loans and deposits in the Malaysian banking system at the end of 2017.

Moody’s has maintained a stable outlook on the Malaysian banking system since 2010.

While policy uncertainty, following the surprising outcome of the recent 14th General Election (GE14), has a negative impact on the Malaysian banking sector, the downside risk to the sector’s earnings will likely be mitigated by cost discipline and stable credit growth.

According to UOBKayHian Research, post-GE14, most banks in Malaysia are unlikely to perform as well as they did prior to the May 9 polls, hence the brokerage would maintain its “market weight” on the sector.

“Post- GE14, macro policy uncertainty could have a slight dampening effect on the banking sector’s growth.

“As such, we believe the sector is unlikely to chart the same degree of outperformance prior to GE14. “However, earnings downside risk is partly mitigated by

strong cost discipline and a manageable credit cost growth environment,” UOBKayHian explained.

“Given this scenario, we reckon the sector could mirror the FBM KLCI performance in the second half of 2018, with a slight upward bias as asset quality remains stronger than expected,” the brokerage wrote in its report.

“Our earnings growth assumption is driven by the prevailing positive operating jaws ratio, underpinned by wellcontrolled opex growth of only three per cent versus revenue growth of six per cent, but partially offset by a mild increase in net credit cost to 35bps in 2018 versus 32bps in 2017,” it said.

The banking sector in general registered a decent earnings growth, in line with expectations, during the first quarter ended March 31, 2018.

Overweight outlook for 2H

Many research firms such as AffinHwang Capital thus reaffirmed their overweight sector stance, barring unforeseen circumstances.

AmInvestment Bank Bhd (AmInvestment Bank) in a June 26 report was also overweight on the sector with anticipation for the sector’s core earnings to grow by 7.6 per cent in 2018 after lowering its expectation for banks’ non-interest income.

This will be contributed by an increase in revenue and improvement in operating expenses.

“For 2018, we retain our loan growth expectation office per cent for the Malaysian banking industry supported by a GDP growth of 5.5 per cent.

“Domestic demand and improvement in external

trade remain the drivers of economic growth. We expect loan growth of banks to improve in 2H18, underpinned by a pickup in consumer loans.”

A stronger consumer spending is anticipated in the short-term period between the implementation of zero-rated GST and reintroduction of SST.

“We expect business loan growth to also improve, supported by the absence of large corporate loans repayments and a non-repeat of the forex translation impact seen in 1Q18.”

Loans to the manufacturing, wholesale and retail sectors benefitting from the improvement in consumer spending are anticipated to be stronger compared to loans to the construction and constructionrelated sectors.

This is in view of the fact that several major infrastructure projects have been terminated while some are under review, AmInvestment Bank said. The lagged repricing of banks’ deposit rates adjusting to the increase in OPR coupled with keener competition for deposits compared to 1H18 as the sector moves closer towards the implementation of net stable funding ratio ( NSFR) will be the contributing factors.

Also, the tapering of margin is also expected to be partly attributed to pressures on the asset yield of banks’ subsidiaries in Indonesia (Maybank Indonesia and CIMB Niaga).

“We expect bank’s net interest margins to expand by 2bps for 2018 against a projection of a 3bps increase previously.

“The OPR is likely to be maintained at 3.25 per cent in 2H18. This is based on the headline inflation which is still expected to be low, thus sustaining a positive real interest rate. We project the inflation rate for 2018 to be two to 2.5 per cent.”

Meanwhile, the implementation of zero-rated GST effective June 1 until the reintroduction of SST in September provides a three months’ tax holiday, hence lowering the prices of goods while the firm petrol prices -- both RON 95 and diesel until the end of 2018 -are likely to keep a lid on inflation pressure.

Moving forward, FundSupermart’s Lee opined that household loan -which accounts for more than 54 per cent

of the total loan applied -- is expected to further improve due to the several recent policies announced by the new government.

These include the zero-rating of GST, abolishment of toll collections, stabilizing the RON 95 Petrol price as well as the Hari Raya special assistance to civil servants and pensioners which are expected to return about RM 20.7 billion to the people pocket.

“Prior to the implementation of SST in September 2018, we believe the consumers are likely to utilize the window of opportunity to purchase the big-ticket items which would further drive the loan demand moving forward.

“This is exactly the reversal of what we have seen in the local private consumption when GST was first introduced in mid-2015.

“All in all, we believe that the fundamental for the Banking sector remains intact despite the recent sell-off due to the heavy foreign outflow.

“Although we are generally positive on the Banking sector, investors are reminded that there will be some potential risk especially the possible sovereign downgrade which could eventually trigger an even hefty sell-off by the foreign investors.

“On top of that, the recent decision made by the new government to cancel several mega infrastructure projects might also dampen the business loan growth moving forward.

“However, given the expectation that the economic activity is likely to remain healthy in the quarters ahead coupled with the improving loan demand especially and the decent fundamental of the banking sector, we believe the sector could outperform the broad index in the next few quarters.”