This article first appeared in The Edge Malaysia Weekly on April 27, 2020 - May 3, 2020

AMID the historic crash in oil prices last week, massive losses hidden for years by Singapore’s oil trader Hin Leong Trading while it sold off inventory kept as collateral came to light. The oil trader owes close to US$4 billion to more than 20 banks.

One is homegrown banking giant CIMB Group Holdings Bhd. According to a report on theedgemarkets.com last week, market talk had it that CIMB’s exposure to Hin Leong could amount to between US$120 million and US$130 million — translating into an exposure of more than RM500 million in the bank’s loan book.

Hin Leong could be an isolated case but it is worth noting that many oil and gas companies are just getting back on their feet after the 2015 oil price crash, with high expectations of a ramp-up in activity this year as well as next year. With all this in mind, can local banks withstand more impairments from the sector?

The silver lining in this bleak situation is that Malaysian banks have reduced their exposure to oil and gas companies significantly since the previous oil price crash. Analysts estimate their exposure to be an average of 2% of total business loans.

Malaysian Rating Corporation Bhd (MARC) ratings senior vice-president Mohd Izazee Ismail says banks have been more cautious in their lending to the O&G sector since 2016, when the banks’ asset quality took a hit after oil prices dipped to US$29 per barrel.

“Exposures have remained low at less than 2% of total business loans as compared with about 3% in 2015,” he says in an email reply to The Edge.

He believes that at that figure, the banks would be able to comfortably absorb the potential impairments from the sector.

According to Bank Negara Malaysia’s 2019 Annual Report, the loan loss coverage of banks stood at 126.4% of impaired loans as at end-2019. This, says Izazee, reflects the strong ability of banks to absorb losses in normal times.

“However, under a shock situation, the loan loss coverage level may be insufficient. Nevertheless, the strong capital base will allow the banks to absorb the potential losses,” he adds.

A sensitivity analysis — which assumes a hypothetical 100% loan loss coverage against the O&G impaired loans — done by Maybank Investment Bank Research in March for banks under its coverage saw negligible impacts on Alliance Bank Bhd, AMMB Holdings Bhd, Hong Leong Bank Bhd and Public Bank Bhd. However, additional provisions could amount to a 15% impact on the research house’s FY2020 forecast of CIMB Group’s net profits and a 10% impact on its FY2020 net profit forecast for RHB Bank Bhd (see table).

Malayan Banking Group Bhd (Maybank) was not part of the analysis. Nevertheless, in terms of exposure to O&G loans, the group has the highest percentage at 2.8% of total loans, followed by RHB (2.4%) and CIMB (2.3%).

However, in terms of the status of its O&G borrowers, according to the research house, CIMB is estimated to have the highest percentage of gross impaired loans at 30% (RM2.55 billion), followed by RHB at 23% (RM966 million) and Maybank at 17% (RM2.48 billion).

While the reduced exposure to the O&G sector will help mitigate any potential risk, an analyst opines that the sector will be harder hit this time by the oil price plunge if it is prolonged. “During the 2014/15 oil price crash, crude oil was trading at US$110 per barrel, meaning that companies had thick margins then. The situation is different now; many companies are entering this plunge in oil price on thin margins, so I foresee that it will be rougher for them this time.”

But this time round, it is not just the oil price crash and its impact on the O&G sector that banks have to worry about, it is also the impact of the Covid-19 pandemic and the extended Movement Control Order (MCO), which has caused business activity to stall and potentially lead to defaults.

“It is possible that the confluence of factors may impact the ability of businesses and individuals to repay loans, but it depends on the length of the MCO and the economic impact. The loan moratorium will certainly help in terms of repayment and Bank Negara has relaxed some of the regulatory requirements.

“Demand could also return post-MCO and the lifting of lockdowns in other countries should stabilise the price (of crude oil),” says MIDF Research analyst Imran Yusof.

Izazee says the banking sector remains well capitalised with sizeable liquidity buffers in place. The common equity tier-1 and total capital adequacy ratio stood at 14.4% and 18.4% respectively at end-February.

“This indicates excess capital buffers of around RM120 billion before breaching the minimum regulatory requirements, which will occur at around 8% gross impaired loans ratio,” he explains.

As at end-February, the gross impaired loan ratio for the banking sector stood at 1.57%.

Nevertheless, one thing that seems certain is that banks can expect to see an increase in non-performing loans and credit cost this year.

“With the moratorium of six months, we will only see the NPLs happening later on, probably in 2021. We will also see many businesses requesting for refinancing and restructuring as well. I believe credit cost will shoot up,” says an analyst.

MARC has changed the outlook for the banking sector from stable to negative. Izazee says that the impact on the industry largely depends on the length of the coronavirus outbreak as well as the recovery of the global economy.

That said, he reiterates that the banks’ fundamentals remain strongly supported by resilient capital and liquidity positions, which are key essentials for riding out the storm.

Izazee opines that banks will be more risk averse due to the heightened credit risk and margin compression, which will impact lending growth. Many are expecting another rate cut of 50 basis points as early as 2Q2020 and this will bring the overnight policy rate to the lowest level since the 2008/09 global financial crisis.

He also sees gross impaired loans coming under stress as businesses face tighter cash flows and adjust to the new normal of doing business.

“Bank Negara’s stress test results show that financial institutions should remain resilient under severe market, credit and liquidity shocks. That being said, we note that some banks are more vulnerable to the shocks, given their weaker financial standing and capacity to absorb losses,” he adds.

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