Investment Research

• BNM’s January statistics all but confirms it
Loan applications, approvals and disbursements contracted -21.0%, -35.6% and -10.0% annually in January 2009. Both business and house-hold loan application numbers fell -21.1% and -20.8% y-o-y. At this rate of decline, growth in total loans outstanding is on pace to hit the 4-5% growth
anticipated by the market.
Net NPL ratio was unchanged at 2.2% on a 3-month basis, and we do expect this to the be the beginning of the end of the asset quality improvement cycle that we have seen over the last few years, more so with the country’s GDP growth having fallen so sharply from 4.7% in 3Q08 to 0.1% in 4Q08 and most likely bringing with it rising delinquencies in business-related loans. The system’s capitalization remains strong however, with a risk-weighted capital ratio (RWCR) and core capital ratio of 12.6% and 10.7% respectively.

• Another double reduction
In yet another surprising move, Bank Negara Malaysia reduced the overnight policy rate and statutory reserve requirement again in its Monetary Policy Committee meeting on Feb 21st, by 50bps and 100bps respectively to 2.0% and 1.0%. Ceiling and floor rates for the OPR are correspondingly reduced to 2.25% and 1.75% respectively. While this move had been anticipated, the timing wasn’t quite. BNM cited the fast-deteriorating economic and financial environment globally and its impact on the country for its decision to act, in support of domestic demand until conditions in the global economy show signs of normalization. Just to re-cap, the Central Bank has reduced the OPR by 150bps in its last 3 consecutive policy meetings.

• Valuations undemanding, but sentiments still cloudy
Public Bank remains our preferred choice for the sector for its attractive dividend yields and asset quality. Bumiputra-Commerce Holdings, while posibbly showing much weaker earnings in the coming quarters, is poised to recover strongest when market conditions improve and is best accumulated when its share price weakens further. AMMB Holdings will share similar-type recoveries as with BCHB Holdings, though not particularly to the same degrees.
Maybank’s overhang right now are the potential impairments on its overseas acquistions and continue to concern us, despite its current weak share price. Hong Leong Bank’s prospects, while continuing to remain solid, is unexciting at this point in time. Both shares continue to be rated Hold.

LOANS GROWTH NUMBERS “DISTORTED”, FORWARD NUMBERS WEAK
Bank Negara’s January 2009 statistical bulletin all but confirmed expectations of a weak operating environment this year with key lending indicators registering continued declines against the backdrop of recessionary-like economic conditions. Loan applications, approvals and disbursements contracted -21.0%, -35.6% and -10.0% annually in January 2009. Both business and house-hold loan application numbers fell -21.1% and -20.8% y-o-y. At this rate of decline, growth in total loans outstanding is on pace to hit the 4-5% growth anticipated by the market.
Overall banking loans registered a +11.7% growth in January, lower than the previous month’s +12.8%. Taking a closer look at the 4 key sectors that constitute about 80% of total loans outstanding, only loans for working capital purposes have shown some signs of weakening on a m-o-m basis. Household-based loans (hire purchase + mortgage) continue to register growth, weak nevertheless. With loan applications falling so sharply, it will only be a matter of time before monthly numbers start to contract. While loans growth is an important component in banks’ earnings, what poses greater risks now are the potential rise in delinquencies of those large numbers of loans approved and disbursed during that particular “high growth period”. Cumulative loans approved as at December have fallen 2.3% as compared to the corresponding period in 2007.

The January 2009 bulletin release had no current updates on non-performing loans as they are only reported on a quarterly basis. We feel that it is important to highlight Figure 3 again though it has already been shown in our recent month’s review, as the greatest risk to banks’ profitability in the coming year or two are the higher loan loss provisions as a result of rising delinquencies more than weak growth numbers.
The industry’s gradual shift towards household-based loans will mitigate any wide-spread and big-ticket delinquencies as seen during the 1997-1998 period. Continued economic weakness however, will put strains on consumers’ disposable incomes and ultimately affect repayment capabilities. It is therefore imperative that jobs are not lost, otherwise this could quite as easily end up as a double-edged sword.
While still a small proportion to the entire industry’s loans book, what is of increasing concern to us is the rising demand for credit card loans, which if let unchecked, could potentially give rise to delinquencies in the coming months as economic conditions remain weak. Figure 3 gives a slight indication of such, and highlight the strain possibly being seen on the household sector (purchase of transport vehicles, residential properties and credit card usage have seen increases in NPLs).

While it is still a little too preliminary to conclude a widespread in delinquencies, we do recognize that the risks persist. This is however mitigated by the improving coverage levels of the banking systems’ non-performing loans, which is now more than twice the recent crisis years of 1997/1998 and 2001.

Net NPL ratio was unchanged at 2.2% on a 3-month basis, and was also at an unchanged 1.7% on a 6-month basis. We do expect this to the be the beginning of the end of the asset quality improvement cycle that we have seen over the last few years, more so with the country’s GDP growth having fallen so sharply from 4.7% in 3Q08 to 0.1% in 4Q08 and most likely bringing with it rising delinquencies in business-related loans. The system’s capitalization remains strong however, with a risk-weighted capital ratio (RWCR) and core capital ratio of 12.6% and 10.7% respectively.

Deposits within the banking system kept pace with a 9.2% y-o-y growth (December: 11.9%), aided in part by continued payment of government outlays and net inflows from the external trade sector. The continuing build-up in consumer deposits indicate a growing risk aversion during these trying times.
The loans deposit ratio dropped to 73.4% in January, while the financing-to-deposit ratio (loans and holdings of PDS by the banking system to deposits of the banking system) fell to 80.9%, another sign of the growing risk aversion of borrowers as demand for credit wanes while savings levels increase. The plus side to all this is that there is ample liquidity in the system to spur economic growth should the need arise as compared to the previous periods of 1997/1998 and 2001.

ANOTHER DOUBLE REDUCTION
In yet another surprising move, Bank Negara Malaysia reduced the overnight policy rate and statutory reserve requirement again in its Monetary Policy Committee meeting on Feb 21st, by 50bps and 100bps respectively to 2.0% and 1.0%. Ceiling and floor rates for the OPR are correspondingly reduced to 2.25% and 1.75% respectively. While this move had been anticipated, the timing wasn’t quite. BNM cited the fast-deteriorating economic and financial environment globally and its impact on the country for its decision to act, in support of domestic demand until conditions in the global economy show signs of normalization. Just to re-cap, the Central Bank has reduced the OPR by 150bps in its last 3 consecutive policy meetings.
In the recent OPR move, banks did not reduce lending rates (BLRs) by a similar quantum, most only opting to cut it by 55bps on average. Banks with a higher amount of floating rate loans will obviously be impacted more negatively as it will be re-priced lower almost instantaneously while deposits will have a lag before they are adjusted. Net interst margins will contract, depending on the adjustment in deposit rates and the respective banks’ interest rate gap profiles.

The cut in SRR is expected to release another RM5.7bn to the system, one which is now flush with liquidity. It will naturally lower the banks’ cost of funds, and minimize some of the impact of the OPR and BLR cut (c. 3-5bps).
The expectations are that the lower interest rate environment will help sustain domestic consumption and mitigate rising loan defaults in the system as the economy visibly weakens. Recent quarterly reportings by some of the banking groups have shown surprising resilience in asset qualities, though some are starting to show signs of strain.

EPF CONTINUES TO BE ACTIVE IN THE MARKET
Without surprise, the Employees Provident Fund (EPF) was the most noticeable market participant for the month, continuing on its active accumulation of AMMB Holding’s shares, and stepping up the purchase of Public Bank Berhad shares. Bumiputra-Commerce was the other name the EPF was seen actively accumulating, adding another 7.4m shares to its portfolio for the first 19 days of February.
Temasek was seen reducing its shareholdings in Alliance Financal Group again, selling another 1.6m shares in the first 11 days of February. Share buy-back activity was muted during the month.
Share prices of stocks under coverage meanwhile, had rather mixed performances during the month. Our three preferred choices in the sector, Bumiputra-Commerce Holdings, AMMB Holdings and Public Bank registered +7.8%, +8.3%, +4.0% (adjusted for dividends) gains respectively, while Maybank lost 2.9% in value.

MAY MK, Hold, RM6.20. The Group’s 1HFY09 net profit of RM1.3bn came within our expectation, accounting for 48% of annualised estimates. But in light of the weakening operating environment however, we do expect that full year core profits may fall a little short of forecasts, though not by much. It was business as usual in the current financial quarter, as there were no “extraordinary” items as reported in the recent 1QFY09 results (impairment losses, markedly higher personnel cost owing to one-off salary increases and arrears of unionized staff, reversal of provisions).
Domestic loans registered a 12.1% y-o-y growth, while overseas loans grew a markedly higher 47.7% y-o-y aided by the consolidation of BII’s numbers. We do however expect these numbers to drop more rapidly as the economy weakens, already evidenced by the sharp drop in the country’s GDP (3Q08: 4.7%, 4Q08: 0.1%), and the continued weakening of loans applications numbers (Dec 08: -18.8%, Jan 09: -21.0%).
The Group has grown in a hurry in the recent year, which could ultimately take a toll on its balance sheet and profitability, more so in the current trying times. A 9-for-20 rights issue has been announced, with the aim of raising close to RM6.0bn in fresh capital which will improve the Group’s core equity ratio to 8.1% and Tier-1 capital ratio to 11.0% post the exercise, from 5.2% and 8.1% respectively. Management has already voiced their expectations that delinquencies will most likely be on the rise in 2HFY09. We continue to remain cautious of the Group’s prospects in the intermediate term given their larger offshore exposures.

BCHB MK, Buy, RM7.70. Cumulative 4Q08 results of RM1.95bn fell short of expectations, only making up 90% of consensus estimates. While some of the “blame” can be attributed to weaker non-interest income, the Group’s earnings was also impacted by an RM112m M&A charge in relation to its various corporate exercises during the year. FY08 results also saw the consolidation of 2 months results of ex-Lippo Bank and 42% equity accounting of 2 months BankThai results.
The Group’s Malaysian consumer banking division saw a turnaround in FY2008, turning in pretax profit of RM705m as compared to the loss of RM17m the previous year, helping
mitigate a sharp 37.3% and 20.2% drop in corporate and investment banking and treasury pretax profits to RM816m and RM986m respectively due to prevailing weak capital market conditions and widening of bond credit spreads.
The Group is well poised to benefit the strongest upon recovery in market conditions, as is one of our preferred choices for the sector.

PBK MK, Buy, RM9.80. Results were within expectations, and full year earnings would have come in within a whisker of our estimates if not for a RM200m goodwill income which was recognized pursuant to the regional strategic alliance with ING Asia Pacific Limited. The test will be in the current financial year where economic conditions will remain weak, and loans growth and asset quality are put to the test.
In line with the slowdown in capital market activities last year, certain fee-related activities of the Group were impacted somewhat while others exhibited admirable strength, chief of which were fund management activities despite the sharp 38% fall in the KLCI last year which would have impaired market values substantially and thereby reducing fee income. Corporate lending and investment banking profits, not surprisingly, shrank by -36.4% and -55% respectively. Of slight concern would be the decreasing profitability of its hire purchase business despite fair growth levels, owing to higher operating expenses.
Despite its above-average loans growth amid the current weak economic climate, asset quality continues to improve and bears testament to the Group’s credit management policies. 3-month net NPLs are currently 0.86%, and is 1/3 of industry average. Loan loss coverage now stands at 159.7%. General provisions stand at RM1.76bn, exceeding the total NPL amount of RM1.2bn despite that more than 90% of the NPLs are secure

HLBK MK, Buy, RM5.80. Cumulative 1H09 net profits of RM499.4m came in broadly within expectations, representing 64% of our recently revised full year forecast of RM774.1m. Nevertheless, we do expect a more challenging operating environment in the months ahead, and should see numbers falling more in line with expectations in the coming quarters.

Loans growth has weakened to +4.5% y-o-y, brought down by contraction in loans for the purchase of securities, construction and working capital purposes. Consumer loans continue to remain the thrust, making up 78% of the entire loans portfolio.
While the Group continued to register strong y-o-y improvements in terms of asset quality, qo-q changes tell a different story, with net NPLs increasing a tad from 1.29% in 1Q09 to 1.34% in 2Q09, while loan loss coverage has weakened from 109% to 106% during the similar period. While the group currently ranks alongside Public Bank with superior asset quality ratios, we believe this weakening is a sign of things to come for the coming few quarters as the operating environment gets increasingly challenging.

AMM MK, Buy, RM3.40. Results came in above expectations, with cumulative 3Q09 net profit rising 51.0% y-o-y to RM681.0m and accounting for 85% of consensus estimates. Growth was driven primarily higher net interest income (+30.7% y-o-y) and lower LLP of RM78.7m (-78.6% y-o-y). Earnings were however weakened by weak equity and capital market activities, as well as an RM80.6m loss it registered on revaluation of derivatives. The Group’s net loans growth has remained strong, driven by another strong set of numbers from the business banking division which registered a +40.7% y-o-y growth in numbers, from RM6.9bn to RM9.8bn. The retail banking division chipped in with a decent +3.1% y-o-y growth in lending activities. The slack in the Group’s waning growth (+1.5% y-o-y) in the hire purchase loan segment is currently being picked up by increased activity in the business segment with working capital loans growing +11.3% y-o-y and now making up 16% of its total loan portfolio. What is a little worrisome however is its recent weakening on a sequential basis, though it has also been shown to be rather erratic.
While net NPL ratios have continued to improve, falling to 2.7% (1Q09: 3.3%, 2Q09: 3.0%), we see it as more of a result of huge write-offs in the ensuing quarters post December 2007 than a marked improvement in recoveries or previous NPLs reclassified as performing. The one big positive however is the much lower levels of new NPL formation on a sequential quarter basis, with the only “blips” being 1Q08 and 1Q09. Loan loss coverage currently stands at 77.5%. Trying economic conditions in the near term however may put its asset quality at risk from a potential hike in delinquencies. While a slight increase will not be a surprise, we do not expect it to spike to historically high levels as we expect stricter credit risk management processes in place with the recent entry of ANZ.