Moody’s: Banks stable but not out of the woods

This article first appeared in The Edge Malaysia Weekly, on March 19, 2018 - March 25, 2018.

Chen: The pace of new non-performing loans will remain slow over the next 12 to 18 months

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MALAYSIAN banks’ asset quality will likely remain stable over the next 12 to 18 months, with the one key risk being their exposure to the commercial real estate sector, says a senior analyst from Moody’s Investors Service.

Previously, the concern had been on the oil and gas (O&G) sector, the main source of high loan loss provisions for banks in 2016 as global oil prices fell to new lows.

“All this while, the focus has been on the asset quality profiles of the O&G book, but I think that has stabilised already. We still see a lot of ‘watch list’ loans — loans that have the potential to turn sour — in the O&G book. But, I think the risk has largely been identified and is being closely monitored by the banks. So, to a large extent, the issues within that portfolio are stabilising,” Simon Chen, Moody’s vice-president and senior analyst for financial institutions, tells The Edge in an interview.

But he observes the glut in the office sector is cause for worry.

“We are increasingly concerned about the commercial real estate sector, where there is quite a strong pipeline of new supply of office buildings and shopping malls. We’re seeing high vacancy rates and there is potential that the vacancy rates will increase further when the new supply comes onstream, and that may impact the fundamentals of the commercial real estate sector. So, that may create some asset quality pressures for some of the banks.”

Most banks have exposure to the commercial real estate sector, which accounts for an estimated 3% to 4% of overall banking system loans in Malaysia.

“I would say that all the banks are exposed, to some extent, to that sector and the issues are likely to be idiosyncratic to the developers that they are lending to, and the projects they are lending to. But, by and large, the risk should be manageable, given that the exposure is around 3% to 4% of total loans on the average,” Chen says.

He is less concerned about the banking sector’s exposure to mortgages than commercial real estate. Mortgages make up the largest portion of banks’ property exposure.

“I think their exposure to the mortgage portfolio is more diversified, in the sense that they are lending to a broad spectrum of the market … they’re not just lending to the luxury space but also to the mass affluent and the more affordable segments.  

So, the fundamentals are more sustainable over the longer period,” he says.

“Also, the central bank’s macro prudential measures since 2010 has helped tighten the underwriting standards among banks and incorporated more discipline in lending to new mortgage borrowers.”

However, lower-income household loans could be an issue should interest rates increase further.

But, on the whole, Chen believes that after a difficult 2016, banks’ asset quality will stabilise further this year on the back of improving macroeconomic conditions.

The industry’s gross impaired loan ratio improved to 1.53% as at December 2017, compared with 1.61% a year ago.

“What we mean by stabilising asset quality is that the pace of new non-performing loans (NPLs), which slowed last year compared with 2016, will remain slow over the next 12 to 18 months,” he says.

“Although the NPL ratios of some banks have crept up in 2017, the pace of increase has moderated from a slower NPL formation rate.”

According to Chen, stable employment and income levels are mainly supporting asset quality and that is not expected to change over the next 12 to 18 months.

“So, by and large, household asset quality issues are well contained for now,” he adds.

Some analysts believe the provisions of the banking sector may creep up this year as a result of the new MFRS 9 accounting standard. Chen says overall credit costs will likely increase slightly from 2017, driven mainly by higher credit charges required under the new accounting rules.

“As banks transition to the new rules, those with outstanding allowances and reserves that are short of the requirement will need to make up for the shortfall by taking a charge against their retained earnings on the first day of the fiscal year. Some banks have said that MFRS 9 implementation will reduce CET-1 capital ratios by 20 to 80 basis points. Nonetheless, the accounting change does not alter our credit assessment of the Malaysian banks because the underlying economics of bank assets remain unchanged.”



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