Banking blues

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THE expected rise in non-performing loans (NPLs) in the region, coupled with margin compression, will have an adverse effect on bank earnings. This will, in turn, lead to severe cost-cutting, including a hiring freeze and, some say, the possibility of job cuts in the sector.

“It will be a tough year. We have to use our money efficiently. Banks will be actively cost-cutting this year and a big cost base is manpower, which for some banks can be over 50%,” observes the managing director of a local banking group.

“So, what some banks will do is to stop hiring or hire less to keep the headcount down. The attrition rate for the sector could range from 8% to 15% ... when the staff leave, some banks will not replace them.”

He says in severe cases, the banks may even consider voluntary separation schemes.

“It will be challenging to grow our top line, so we have to look at managing our cost. In banking, there are three major parts to revenue: interest income, treasury and fee income. Interest income is large and can range from 55% to 80%, but it has a lagging effect. What will be hit the hardest is fee income.”

ong_18_1051OCBC Bank (M) Bhd CEO Ong Eng Bin says it is essential for banks to manage their asset quality well, especially in the current challenging environment.

“The banking sector encountered rising operational and funding costs and slowing business momentum for the most of last year. Coupled with the recent slide in the ringgit and oil prices, the environment continues to be challenging and banks are taking prudent steps to manage their asset quality,” he tells The Edge.  “It is vital for them to maintain discipline in their risk management process during this period when complexity and risk-taking are both under great scrutiny.

“We expect to see the banks come up with innovative products and solutions to gain a competitive advantage and differentiate themselves. Operating in a high-cost environment will force them to work more effectively and increase productivity to achieve cost optimisation.

“New areas of growth will be on their priority list but in view of the current economic condition, most banks will be wary of any huge investments as returns may not be foreseeable. Looking beyond Malaysian shores should be a key consideration for all banks but then again, this comes with new risks,” Ong adds.

Deteriorating asset quality is a concern for the industry, especially for banks with exposure to foreign loans, say bankers and analysts. “The asset quality of loans in Malaysia remains stable. It is the NPLs of foreign operations that the banks are worried about,” says a senior banker.

As it is, CIMB Group Holdings Bhd (fundamental: 1.35; valuation: 2.1) held an analyst meeting last Wednesday and shared that its 4Q2014 and 1Q2015 results will likely show a spike in provisions and that there will be a group-wide “spring cleaning” (see accompanying story).  

On the same day, CIMB released the FY2014 ended Dec 31 results of its 93.71%-owned subsidiary CIMB Thai PCL. Net profit was down 33.6% to THB988.8 million, gross NPLs stood at THB6.4 billion and the gross NPL ratio was at 3.3%, up from 2.5% as at Dec 31, 2013.

“The increase in NPLs was mainly due to economic disruptions, which affected the borrowers’ repayment ability and an increase in certain sizeable corporate accounts and retail segments,” CIMB noted in a statement last Wednesday.

Tough banking this year

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The tell-tale signs of a challenging environment for banks emerged in the September quarter of last year with half of the eight listed Malaysian banking groups — CIMB, Affin Holdings Bhd (fundamental: 1.10; valuation: 2.10), Malayan Banking Bhd (fundamental: 1.50; valuation: 1.30) and RHB Capital Bhd (fundamental: 1.50; valuation: 2.10) — registering lower year-on-year quarterly earnings.

Interestingly, for the cumulative nine months ended Sept 30, 2014, three of the five banks that saw lower earnings were Affin, Maybank and CIMB. Public Bank Bhd (fundamental: 2.8; valuation: 1.2) and RHB stood out from the crowd, registering year-on-year net profit growth of 7.4% and 15.5% to RM3.296 billion and RM1.56 billion respectively.

Meanwhile, banking analysts have started to cut their earnings projections for the industry.

UOB Kay Hian Research, in a Jan 6 note, acknowledges that there is a potential risk of earnings disappointment.

“We are projecting aggregate FY2014 and FY2015 earnings growth of 1.9% and 7.8% for the banking stocks under our coverage. We see an earnings downside risk in both consensus and our earnings recovery expectations for 2015 because much of it is premised on relatively stronger investment banking non-interest income growth recovery, which remains uncertain given the current volatile capital market condition. In addition, we are only at the early stage of an upward reversal in the provision cycle,” it notes.

“The sector will continue to be plagued by slower-than-expected loan growth, persistent net interest margin compression and pockets of NPL stress translating into earnings disappointment. The sharp drop in oil prices will contribute to slower corporate loan growth. In contrast to earlier expectations, the implementation of the base rate, which replaces the base lending rate, did not have the intended effect of alleviating yield pressure on consumer loans.”

In a Jan 13 note, Affin Hwang Research note says it maintains its “neutral” rating on the Malaysian banking sector, given concerns of cascading macro risks for the economy from 4Q2014 to 2Q2015, ranging from concerns of defaults in the commodity-related industries, the risk of a major scaling down of government projects and worries of foreign selldown on Malaysian bonds.

“For sector exposure, we favour Public Bank and Hong Leong Bank Bhd (fundamental: 2.8; valuation: 2.2), given a more stringent track record in credit underwriting standards and niche in the retail financing market,” the research house adds.

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Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Go to www.theedgemarkets.com for more details on a company’s financial dashboard.

This article first appeared in The Edge Malaysia Weekly, on January 26 - February 01 , 2015.