42_201_Malaysian Bank Report (Feb10)

8/7/2019 42_201_Malaysian Bank Report (Feb10)

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February 28, 2010

The following contributed to this report:

Siva Ramalingam [email protected]

Victor Valyaev [email protected]

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2/21

Central Banks in Asia may be tightening - Rate hike around the corner in Malaysia?

Slide 2

Executive

Summary

Rate hike supports overweighting the sector.

Imminent rate hikes mean margin expansion prospects for banks as the upward adjustment of the Base Lending Rates BLR is typically larger

than the change in fixed deposit rates. We estimate that every 25bp rise in BLR would mean 3-4% earnings accretion for banks, which would

outweigh any negative impact from rate hikes including slower loan growth, higher Non-Performing Loans NPLs and mark-to-market losses fortheir bond holdings. This reinforces our BUY stance on the sector. The potential re-rating catalysts for the industry include (1) rate hikes, (2)

strong earnings growth in 2010, (3) increase in investment banking income, (4) strong growth potential for the overseas operations of the larger

banks, and (5) potential General Provisions GP write-backs.

Most preferred: AMMB and Maybank

Rate normalization around the corner?

Bank Negara Malaysia (BNM) has signaled that interest rates could be raised sooner rather than later. The intention is to normalize

interest rates rather than cool down economic growth. Even if there is a 50bp hike to 2.50%, the Overnight Policy Rate OPR would still be one of

the lowest rates historically. For the upcoming rate hikes, we believe that the increase in deposit rates would be narrower than the BLR hike,

implying margin expansion for the banks.

Every 25bp hike to enhance net profit by 3-4%.

Our simulation shows that every 25bp rise in BLR accompanied by a 12.5% increase in fixed deposit rates would enhance the combined net profit

of the banks under our coverage by 3-4%. The biggest earnings impact would be on Alliance Financial Group (+7.9% for FY11) as it has the

highest proportion of floating-rate loans of 82% and a high proportion of low-cost deposits, which account for about 30% of its total deposits.

AMMB Holdings would be least affected with an impact of only 1.3%.

Higher funding costs may translate in slower loan growth?

In the last round of rate hikes in 2005-06, loan growth did moderate from 9% yoy in Nov 05 to 7.3% yoy in Nov 06. For the expected hike in 1H10,

we believe that the moderation would be smaller than the 170bp seen in 2005-06 because (1) the 50bp hike is lower than the 74bp

rise in 2005-06, (2) the BLR would only be 6% after the hike compared to 6.72% in 2006, and (3) supported by economic recovery, SME loan

growth is improving which will partly offset the slide in consumer loan growth.

Expecting stable NPLs despite rate hike.

In theory, NPLs would rise following the rate hike due to borrowers increased loan servicing burden. Ironically, banks gross NPL ratios continued

to slide after the last round of rate hike in 2005-06. Also, any negative impact from rate hikes would be largely offset by the economic recovery. As

such, rate hikes would not change our expectations of stable NPLs in 2010.


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Valuation

Sectorcomp

arisons

*Rate hike = a 50bp rise in Base Lending Rate BLR (and 25bp increase in FD rates) Note: above data as of Feb 23rd, 2010

Source: Company and Riedel Research

Slide 3

Our valuation opinion on the main banks in Malaysia, (including impact of a rate hike*)

Our top picks: AMMB and Maybank

AMMB Holdings (AMM MK) is one of our top picks for the Malaysian banks as we believe that its transformation program should help it raise its

ROE from 12.2% in FY3/10 to 14% in FY12. For the longer term, management is aiming for even higher targets of 17-20%, which will be one of thebest among the local banks. We base our RM6.30 price target on the Gordon Growth Model, with an average FY11-13E ROE of 15.0% and a cost

of equity of 10.5%.

Malayan Banking Maybank (MAY MK) - we forecast Maybanks ROE to expand to 16% in FY12 from our 12.8% estimate for FY10. We expect

the expansion to be driven by strong growth from Bank Internasional Indonesia (BII) and robust Malaysian operations due to the strong progress

achieved by the new management team on its transformation program, which is starting to bear fruit. We base our RM8.10 price target on the

Gordon Growth Model, with an average FY11-13E ROE of 16.7% and a cost of equity of 10.0%.

We prepared a comparison of key financial information on the main banks, in Appendix #1.

The purpose of this project on Malaysian Banks was to quantify the implications of an imminent rate hike; and not on the potential implications of

the proposed Basel III regulations. Nevertheless we presented in Appendix #2 this issue which we are well aware of and will try to quantify in the

future its effects on the Malaysian banks.

The top nine local banks in Malaysia are listed below and ranked by market cap. We derived their corresponding target price through

the Gordon Growth Model. The other banks operating on the local market are HSBC, OCBC, Stan Chart, Citibank and UOB.


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Rate Hike Around the Corner?

Ratenormalizationin1H

10?

Bank Negara Malaysia (BNM) kept the overnight policy rate (OPR) at 2% in the latest monetary policy committee (MPC) meeting

on 26 Jan 10. That was the seventh time that BNM has kept the OPR at the 2.00% level since Apr 09 after cuts totaling 150bp

between Nov 08 and Feb 09. However, the latest policy statement signaled that the central bank may begin to normalize

rates sooner than previously thought.

Due to the change in BNMs tone on the interest rate policy, we currently expect interest rates to be raised at a measured pace and

sooner than previously expected, possibly in 1H10, therefore the OPR could be raised by 25-50bp in the next MPC meeting on

Thursday March 4, 2010. If this does not materialize, then rates could be raised in May.

The following is the schedule for MPC meetings for 2010:

March 4, 2010 (Thursday)

May 13, 2010 (Thursday)

July 8, 2010 (Thursday)

September 2, 2010 (Thursday)

November 12, 2010 (Friday)

Slide 4

BNM signals normalization of interest rates

Note: The lowest Statutory Reserve Requirement SRR ratio was 2.5% in Jan 1959

Prior to 2004, the policy interest rate was the intervention rate. After 2004, the policy rate is the overnight policy rate.Source: Bloomberg, BNM


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Interest Rates Still Low After Rate Hike


10?

Interest rates will still be low after rate hike. Even if rates were raised 50bp

to 2.50%, OPR would still be one of the lowest in history. Since 1997 and

before the 150bp rate cuts between Nov 08 and Feb 09, OPR ranged

between 3.5% and 11% (see table to the left). Hence, interest rates, assuminga 50bp hike in OPR, would still be conducive for healthy credit expansion.

How about the movement in BLR and FD rates? We use previous rate

hikes as a guide of the movement of banks BLRs and FD rates in reaction to

changes in OPR. As shown in the table to left, since the financial crisis in the

late 1990s, there has been only one round of OPR hikes, which took place in

Nov 05 and May 06. The increases during that round were 30bp on 30 Nov

05, 25bp on 17 Feb 06 and another 25bp on 22 May 06, leading to a total

increase of 80bp.

Deposit rates are stickier. The figure below shows the changes in the

various interest rates from Nov 05 (before the rate hikes) to Aug 06 (threemonths after the conclusion of the rare hikes). During that period, BLR

increased by 74bp, close to the 80bp rise in OPR. Meanwhile, FD rates

advanced only by 7-48bp for tenures of between one and 12 months. The

average increase in FD rates of circa 24bp is only about one-third of the 74bp

hike in BLR, suggesting that deposit rates are stickier than BLRs.

Slide 5

Note: * The lowest SRR ratio was 2.5% in Jan 1959

Prior to 2004, the policy interest rate was the intervention rate. After 2004, the policyrate is the overnight policy rate.

Source: BNM

Historical policy interest rate and

Statutory Reserve Requirement SRR ratio

Focus on previous rate hikes

Source: Bank Negara Malaysia

Note: ALR Average lending rate


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Impact on Banks


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Flush liquidity to result in low deposit rates. For the upcoming rate hikes, we believe that the increase in deposit rates would still be narrower

than the BLR hike. Our view is predicated on the flush liquidity in the market, reflected by the loan-to-deposit ratio of 77.9% as at end-Dec 09. In

this case, most banks do not have to increase their FD rates significantly to attract more depositors. However, the risk is that Bank Negara may,

through moral persuasion, require banks to increase FD rates by a higher magnitude in order to protect the interest of the depositors.

Rate hikes to result in margin expansion. In the event of rate hikes, the BLR is expected to be repriced upwards by a larger quantum than FD

rates, leading to margin expansion for banks. The benefits will even be larger in the initial period of 3-6 months following the rate hikes as the BLR

will be re-priced upwards faster than the FD rates. We have run a simulation of the rate adjustments assuming increases of 25-50bp for BLR and

12.5-25bp for FD rates, (i.e., half of the increase in BLR). We assume a full year impact.

Every 25bp hike to enhance net profit by 3-4%. Our simulation shows that for every 25bp rise in BLR (and 12.5bp increase in FD rates), banks

net profit would be enhanced by 3-4%. The bank that will see the greatest uplift in their earnings from the rate hike is the bank that has (1) a higher

percentage of floating-rate loans (lending rates to be re-priced upward), (2) higher proportion of low-cost deposits (cost of funds will only be

increased marginally), (3) higher loan-to-deposit ratio, and (4) lower noninterest income ratio.

Alliance the biggest beneficiary. The earnings impact would be greatest for Alliance Financial Group (AFG MK) at 7.9% in FY11 because it hasthe highest proportion of floating-rate loans of 82% and a sizeable portion of low-cost deposits, which account for about 30% of its total deposits.

AMMB Holdings (AMM MK) would be the least affected as its net profit would only be lifted by about 1.2%. The group has the lowest proportion of

floating-rate loans of 39.3% and low-cost deposit ratio of 10.2%.

Slide 6

Impact of rate hikes on banks net profit (RM m)

Source: Companies, Riedel Research


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Every 25bp Hike to Increase Net Interest Margin by 7bp


10?

The benefits of rate hike on banks are the expansion of net interest margin as we expect the adjustment of BLR to be higher than

for FD rates. We estimate that for every 25bp hike in BLR and 12.5bp increase in FD rates, the net interest margin for Malaysian

banks would be lifted by 7bp.

Slide 7

Floating-rate loans as a % of total loans for Malaysian banks

Source: Company, Riedel Research

Note: The figure is based on our FY10 forecasts

Source: Company, Riedel Research

Note: The figure is based on our FY10 forecasts

Banks low-cost deposit ratio (%)


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Any Negative Impact?


10?

(1)Potential slowdown in loan growthHigher funding costs could result in a slower loan growth? The general expectation is that loan growth would ease off following

any rate hike as higher interest rates would reduce affordability of the funding and make some investments or businessundertakings less attractive. Taking a flashback to the last round of rate hikes in 2005-06, we know that after the increase in interest

rates, loan growth did moderate from 9% yoy in Nov 05 (before the hike) to 7.3% yoy in Nov 06 (6 months after the rate hike). This

represents a 170bp moderation in momentum.

Smaller impact on loan growth in 1H10. For the expected rate hike in 1H10, we believe that the moderation would be smaller than

the 170bp in 2005-06 because (1) we are anticipating a 50bp hike in BLR in 1H10, lower than the 74bp total increase in 2005-06,

and (2) BLR would be only 6% after a 50bp rise compared to 6.72% following 2006s hike. Furthermore, our projected loan growth

of 8-9% for 2010 is not far off from the 7.3% level after the rate hike in 2005-06.

Downside to consumer loan growth. Notwithstanding the economic downturn, there was pent-up demand for consumer loans

primarily due to the all-time low interest rate regime. Consumer loan growth was sustained at 8.4-10% yoy in 2009 (vs. 9.1% yoy)

while business loan growth plunged from 13.2% in 2008 to 2.6% in 2009. In the event of a rise in rates, we see downside risk to

consumer loan growth to probably the 7-8% level in 2010. However, given the economic recovery, business loan growth should

improve to 5-6% as SME loans are expected to reverse the 4.5% slide seen in 2009. This would partly offset any slide in consumerloan growth.

Positive outweighs negative. Assuming a 170bp easing of loan growth after the rate hike, the impact on banks FY10-11 net profit

would be about 1-2%. In this case, the positive impact from the margin expansion following the rate increase of about 50bp

(between 2.3% and 15.8% for the local banks) would outweigh the 1-2% negative effect from the slower loan growth.

Slide 8

Loan growth before and after the rate hikes in 2005-06



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Any Negative Impact? cont.


10?

(2) Hike in NPL ratios

Rate hike to result in higher NPL ratios? In theory, NPLs would rise following the rate hike due to the higher loan servicing burden

on borrowers. In this instance, highly geared borrowers with limited liquidity would default on their loans should the repaymentsexceed their income after the rate hike.

NPL declined after the last rate hike. To gauge the impact of rate rises on banks NPLs, we take a flashback to the last round in

2005-06. At that time, (as shown in graph below) banks gross NPL ratio continued to slide following the 2005-06 rate hike, except

for a 10bp uptick in Jul 06. On this note, we believe that NPL ratios would be stable in 2010, if not lower, even after our expected

50bp hike in OPR. Banks gross NPL ratio fell from 4.8% to 3.7% in 2009 despite our projected 2.8% contraction in GDP. In 2010,

even if there were a negative impact from the rate hike, it would be offset by economic recovery, leading to stable, if not

lower NPL ratios.

Slide 9


3-month gross NPL ratio before and after the rate hikes in 2005-06

The trend in 3-month gross NPL ratio after the last rate hike in 2005-06



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Any Negative Impact? cont.


10?

(3) Mark-to-market losses from bond holdings

Rate hike may lead to mark-to-market losses for bond holding. Bond prices are inversely correlated with interest rates, (i.e., bond prices fall when

interest rates are raised, leading to mark-to-market losses for banks). However, we are not able to quantify the potential losses due to the lack of

information on the average duration (the sensitivity of the bond prices to the movement of interest rate) of banks bond holdings and the details of

the hedging position for interest rate risks. Furthermore, the composition of the bond holding and hedging position is also fluid.

Banks only need to mark to market securities held-for-trading. Based on BNM guidelines and FRS 139, banks only need to mark to market the

securities held-for-trading. As such, the size of the securities held-for-trading would give us a hint on the potential mark-to-market losses.

However, this is not conclusive because (1) banks can transfer the bond holding from securities held-for-trading to securities available-for-sale, in

which case the mark-to-market losses would be realized directly in shareholders funds without flowing through the profit and loss statement, (2)

banks can enter into hedging contracts to partly offset the mark-to-market losses, and (3) banks can sell down their bond holdings in the securities

held-for-trading to limit the mark-to-market losses.

Securities held-for-trading less than 5% of most banks assets. For a simplified analysis to gauge the mark-to-market losses, we look at the size

of the securities held-for-trading (see table below). Our analysis is based on the information as of the end of September 09 while the mark-to-

market losses will hinge on banks bond holdings during the rate hike, probably by Mar-May 09. In our view, the mark-to-market losses would notbe significant as securities held-for-trading account for less than 5% of most banks total assets. Furthermore, part of this is hedged against

interest rate risks. Alliance and Affin would be the least affected as their securities held-for-trading totaled less than RM20 m (below 5% of FY10

net profit and 0.5% of shareholders funds). In the next few months, some banks may transfer part of their bond holdings out of the securities held-

for-trading to limit any mark-to-market losses following the rate hike.

Slide 10

The trend in 3-month gross NPL ratio after the last rate hike in 2005-06

Source: Companies, Riedel


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Other Implications of a Rate Rise


10?

Capitalizing on the timing mismatch...

In the event of a rate rise, BLR would be repriced upward instantly but interest rates for fixed deposits (FD) would only be adjusted

upon maturity (tenors generally range from 1 month to 12 months). In this case, banks will enjoy temporary margin expansion in the

initial stage following the rate hike, on top of the differences in the increases of BLR and FD rates.

...by frontloading the interest sensitivity gap.To capitalize on the above phenomenon, banks have been proactively readjusting the interest rate sensitivity of their assets and

liabilities to frontload the interest sensitivity gap.

To further explain: if a bank has RM50bn assets and RM40bn liabilities to be re-priced within one month after the changes in interest

rate, the interest sensitivity gap would be RM10bn. The sensitivity gap reflects the timing difference for banks for various timeframes

(less than 1 month, 1 to 3 months, 3 to 12 months etc.).

A positive interest sensitivity gap signifies the difference of the sensitivity of assets over the liabilities to interest rate changes within acertain timeframe. Hence, banks with positive interest sensitivity gap in the shorter term (1 to 6 months) would benefit from the timing

mismatch in the changes in BLR and FD rates during the rate hikes.

Increase in interest sensitivity gap in the 1-month period .

As the table on the next slide shows, the local banks interest sensitivity gap in the 1-month period jumped from a total of RM6.5bn as

at end-Dec 08 to RM55.2bbn as at end-Sep 09. In our view, this reflects active management of the interest rate profile of their assets

and liabilities to take advantage of the expected rate hikes. The increase mainly came from the reversal of Maybanks (MAY MK)

sensitivity gap from a deficit of RM12.9bn in Dec 08 to an excess of RM15.3bn in Sep 09. Also, CIMB (CIMB MK) cut its deficit for the

interest sensitivity gap from RM28bn in Dec 08 to RM9.1bn in Sep 09 while Public Bank (PBK MK) increased the excess from

RM14.3bn to RM21.6bn.

Slide 11


12/21


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Slide 12

Banks interest rate sensitivity gap

Source: Companies

Other Implications of a Rate Rise cont.


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Valuation and Recommendation


10?

Benefiting from rate hikes. Bank Negara has signaled the possibility of rate hikes in the near term, which could be as early as March

4th 2010 when the MPC meets. Banks are set to benefit from the rate increases as BLRs are expected to be re-priced upwards at a

larger quantum than for FD rates, leading to margin expansion for banks. We estimate that for every 25bp rise in BLR (and 12.5bp

increase in FD rates), banks net profit would be enhanced by 3-4% primarily lifted by an expected 7bp expansion in net interest

margin.

Not expecting a significant slowdown in loan growth. In the last round of rate hikes in 2005-06, loan growth did moderate from 9%

yoy in Nov 05 to 7.3% yoy in Nov 06. For the expected hike in 1H10, we believe that the moderation would be smaller than the 170bp

seen in 2005-06 because (1) the 50bp hike is lower than the 74bp rise in 2005-06, (2) the BLR would only be 6% after the hike

compared to 6.72% in 2006, and (3) supported by economic recovery, SME loan growth is improving which will partly offset the slide in

consumer loan growth.

Assuming that loan growth eased 170bp after the rate hike, the impact on banks FY10-11 net profit would be about 1-2%. In this case,

the positive impact from the margin expansion following the rate increase of about 50bp (between 2.3% and 15.8% for local banks)would outweigh the 1-2% negative effect from the slower loan growth.

Expecting unchanged NPLs despite rate hike. In theory, NPLs would rise following the rate hike due to higher loan servicing burden

on borrowers. Ironically, banks gross NPL ratios continued to slide after the last round of rate hike in 2005-06. Furthermore, any

negative impact from rate hikes would be largely offset by the economic recovery. As such, rate hikes would not change our

expectations of stable NPLs in 2010.

Reaffirm BUY: Banks are set to enjoy margin expansion as a result of the impending rate hikes as BLRs are expected to be re-

priced upwards by a larger quantum than fixed deposit rates. We estimate that for every 25bp rise in BLR, banks net profit would be

enhanced by 3-4%. This would outweigh any negative impact caused by rate hikes including slower loan growth, higher NPLs and

mark-to-market losses for bond holdings. This, coupled with favorable earnings prospects, reaffirms our BUY recommendation on the

sector. The potential re-rating catalysts including (1) rate hikes, (2) strong earnings growth in 2010, (3) increase in investment banking

income, (4) strong growth potential for the overseas operations of the larger banks,

and (5) potential GP write-backs.

Slide 13


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Valuation/Top Picks for the Sector: AMMB and Maybank


10?

AMMB Holdings (AMM MK) is one of our top picks for the Malaysian banks as we believe that its transformation program should help

it raise its ROE from 12.2% in FY3/10 to 14% in FY12. For the longer term, management is aiming for even higher targets of

17-20%, which will be one of the best among the local banks . The potential share price triggers include (1) value add from ANZ, (2)

benefits from the group revamp, (3) better-than-expected pipeline for investment banking deals to increase fee income from this area,

and (4) new growth avenue from the derivative and foreign exchange businesses. We base our RM6.30 price target on the Gordon

Growth Model, with an average FY11-13E ROE of 15.0% and a cost of equity of 10.5%.

Malayan Banking - Maybank (MAY MK) - We forecast Maybanks ROE to expand to 16% in FY12 from our 12.8% estimate for FY10.

We expect the expansion to be driven by strong growth from Bank Internasional Indonesia (BII) and robust Malaysian operations due to

the strong progress achieved by the new management team on its transformation program, which is starting to bear fruit.

However, our estimates could prove to be too conservative if: 1) domestically, the improvements in systems and the new talent in its

treasury and IB operations drive fee income growth higher than we expect; and 2) the process of turning around BII accelerates faster

than our expectations. We expect BIIs asset quality to remain stable given its significant loan write-offs and improved risk

management. We believe BII is on track for strong growth as we think the new management team will be able to strengthen BIIs corecompetencies and regain market share. We forecast loan growth of 18% for BII, while management is targeting 25% loan growth.

Maybank expects the contribution from BII to be around RM450m by 2012. We base our RM8.10 price target on the Gordon Growth

Model, with an average FY11-13E ROE of 16.7% and a cost of equity of 10.0%.

Our other picks for the sector are:

Public Bank as it has the best fundamentals among the Malaysian banks, as reflected by its superior ROE in the mid-20s, lowest netNPL ratio of below 1% and swift loan growth in the teens. Potential re-rating catalysts include (1) even stronger ROEs of 28-29% for

FY10-11, (2) increased contributions from Greater China, and (3) new growth avenue in banc-assurance.

Affin Holdings (AHB MK) because its financial performance will be driven by the robust loan growth and margin expansion. It istrading at an undemanding single-digit CY10 P/E of 7.9x.

The key beneficiaries.

Our simulation shows that Alliance Financial Group and RHB Capital stand to gain the most from rate increases as they have a higher

proportion of floating-rate loans (76-82%) and low-cost deposits (30-31%) than other local banks. For every 25bp rise in BLR (and

12.5bp increase in FD rates), FY11 net profit would be lifted by 15.7% for Alliance and 10.2% for RHB Capital. Despite being the key

beneficiary of a imminent rate hike, Alliance does not qualify for a top pick because of (1) the weak underlying trends in the past 3-4

quarters, with core revenue (excluding Islamic banking income) contracting and loan growth slowing down, and (2) the potential change

in its management following the internal investigation of several members of the top management team. This would disrupt the

implementation of the groups key strategies and potentially slow down the growth momentum. We will review our opinion of the stock

once the rate hikes are firmed up.

Slide 14


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Slide 15

AMMB Holdings

AMMB Holdings is the fifth largest banking group by assets among Malaysias nine local banks. It has the second biggest auto

loan book, owing to its roots as a finance company, and a top-three position in investment banking. Its biggest shareholders are

ANZ Banking Group (24%) and AmcorpGroup (17.6%).

Stockdataa

ndestimates


16/21

Slide 16

Malayan Banking

Maybank is Malaysias largest bank by assets. The bank traditionally had a domestic focus and has been viewed as a very

conservative institution with high capital ratios and prudent provisioning policy. However, in 2008, the company took steps to

expand through expensive acquisitions into Indonesia, Pakistan and Vietnam, as well as grow its presence in Singapore.

Stockdataandestimates


17/21

Slide 17

Appendix1Co

mparisonofbank

skeyfinancialin

formation

Key financial information



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Slide 18

Key income statement information and ratios


Appendix1co

nt.


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Slide 19

Key balance sheet information and ratios


Appendix1co

nt.


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Slide 20

Key information and ratios for loans and deposits


Appendix1co

nt.


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42_201_Malaysian Bank Report (Feb10)

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Transcript of 42_201_Malaysian Bank Report (Feb10)