Banks expected to gain from investment in fixed income securities

This article first appeared in The Edge Financial Daily, on March 17, 2020.
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Banking sector
Maintain neutral:
The banking sector’s net profit declined by 0.9% year-on-year (y-o-y) for the fourth quarter of 2019 (4Q19), primarily dampened by the 212.3% y-o-y surge in loan loss provisioning. Meanwhile, non-interest income grew a strong 14.4% y-o-y for 4Q19, driven by robust investment income which is volatile in nature. 

We lower our projected loan growth for banks in 2020 forecasts (2020F) from 4-4.5% to 3-4% due to: i) lower 2020 gross domestic product forecast by our economist from 4.4% to 3.6% on Feb 27, which reflects bleaker growth in business activities and credit demand; and ii) the slowdown in the loan growth from 3.9% y-o-y at end-December 2019 to 3.5% at end-January 2020. The above is based on the assumptions of about 4% rise in household loans and 2-3% increase in business loans. 

We think that banks will face three key challenges for 1Q20F: i) the negative impact of two overnight policy rate (OPR) cuts (of 25 basis points each) for 1Q20 on banks’ net interest margins; ii) a slowdown in loan growth; and iii) a potential increase in gross impaired loan ratio. However, these could be partly offset by the expected robust investment income arising from the gains from banks’ holdings of fixed income securities as bond yields fall following the OPR cuts. We estimate this could lead to net profit growth of mid-to-high single-digit rates for banks under our coverage for 1Q20F, partly due to lower base in 1Q19. 

Due to the earnings risks mentioned above, we think that it will be more challenging for banks to report positive earnings growth for 2Q-4Q20F, especially when the strong growth in investment income fizzles. We are projecting a 0.2% drop in 2020F net profit of banks under our coverage. The drag would come from the projected 31.6% surge in LLP in 2020F; we forecast banks’ revenue to expand by 3-4% in 

2020F. 

We reiterate our “neutral” call on banks as we see challenges in 2020F from: i) the OPR cuts, which are detrimental to banks’ margins; ii) a potential rise in gross impaired loans; and iii) lethargic loan growth. However, we deem the sector’s 2020F dividend yield of 5.2% attractive. Our top sector picks are RHB Bank Bhd and Public Bank Bhd. — CGS-CIMB Research, March 13