Domestic banks can escape credit crunch

Banking sector in stronger position to weather current crisis

MALAYSIAN banks are not threatened and they will be spared the global credit crunch which has caused the collapse of several US and European banks.

Loans quality, risk profile and system capitalisation are strong, while the liquidity is still high.

Since the 1997/98 Asian financial crisis, the banking system has been restructured and the sector is in a stronger position to weather the current global financial crisis, given its:

·A stronger capital buffer, with a risk-weighted capital ratio (RWCR) of 13% at September 2008 versus a low of 10.1% in August 1998.

The 13% RWCR implies an “excess capital” of RM41bil.

·Sufficient liquidity, with system loans-to-deposits ratio at 74.3% at September 2008 against an estimated 98% at August 1997.

Net interbank placements with Bank Negara were RM169bil at September 2008.

·Stronger loans profile, with household loans making up 54% of system loans as at September 2008 versus 25% as at August 1997.

Household loans are smaller in size compared to corporate loans, and this diversifies the risk of chunky loans turning non-performing.

·Stronger asset backing, as loans for properties (which tend to be better collateralised) have grown to account for 35.3% of the system’s gross loans at September 2008 versus 18.4% at August 1997.

Loans for the purchase of securities have fallen to make up just 4.5% of gross loans now compared with 9.7% previously.

Slowdown inevitable

Being an open economy, Malaysia will not be spared the ongoing global financial crisis, which is feeding the global economic slowdown.

Global prospects are weakening as leading economic indicators for the Organisation for Economic Cooperation and Development, BRIC (Brazil, Russia, India and China) and East Asia ex-Japan point to worsening recessions in the advanced economies, and a further slowdown in key emerging and developing countries in first quarter 2009.

The challenges for the banking sector are: slower loans growth, rising default rates, and a slowdown in the capital markets.

Since the big chunk of sector loans are for mortgages and are household-based, the key risks of these loans turning non-performing are unemployment and asset/property prices.

Bank earnings slow

The first wave, in the form of weaker capital markets, have already hit banks’ earnings in the third quarter 2008, as the combined core net profit of the six banking groups that we monitor (Maybank, BCHB, Public Bank, RHB Capital, AMMB and EON Capital) fell 12.6% quarter-on-quarter.

The combined non-interest income plunged 39% quarter-on- quarter as treasury and investment income and related fee-based income (including brokerage) weakened. Also, most banks reported marked-to-market losses (net) on trading securities and derivatives.

The net interest income was, however, unaffected – flattish (+0.7% quarter-on-quarter) on a combined basis, but up 6.6% year-on-year due to strong lending activities in the past year.

Focus on asset quality

We expect the second wave, in the form of slower loans growth and the inching up of non-performing loans, to kick in from the first quarter of 2009.

Based on our 3.5% gross domestic product (GDP) growth forecast for Malaysia’s economy in 2009, we expect system loans growth to slow to 4%-5% for the year, from an estimated 8%-9% in 2008.

The recent lowering of the overnight policy rate by 25 basis points by the central bank would lower banks’ lending rates by a similar quantum.

A lower interest rate environment, when placed alongside efforts to restructure potentially troubled loans, may help mitigate rising default rates and hence a sharp deterioration in asset quality.

Profits to contract

We had, on Nov 3, cut banks’ cumulative earnings by 16% (2009) and 20% (2010), assuming lower sector loans growth of 4%-5% (previously 7%-8% growth) and higher credit charge-offs.

As the third quarter 2008 results reporting season for banks under our watch ended last week, we have lowered cumulative earnings by a further 2% for 2008-2010.

Sector earnings are now expected to contract by 6% in 2009, with more downside risk as we review our assumptions on the broader economy.

Our forecast for 3.5% GDP growth in 2009 is under review with downside bias, in view of a more painful, prolonged global recession.