This article first appeared in The Edge Financial Daily on October 1, 2018

Banking sector
Maintain neutral: Banking system remained resilient in first half of 2018 (1H18) under severe stress test scenarios. On the domestic front, the surprise outcome of the 14th general election resulted in various policy uncertainties on the back of massive reversals of non-resident portfolio flows. On external factors, the escalating trade tensions between the US and China, rising interest rate in the US, and a stronger US dollar will pile more pressure on Malaysia’s financial stability.

Household debt to gross domestic product ratio trended lower to 83.8%. However, household debt in 1H18 rose higher by 5.2% (4.9% as at end-2017), caused by rising residential purchases by 8.4% (8.6% as at end-2017) mostly for houses priced between RM250,000 and RM500,000 and purchases of securities rising by 8.4% (1.8% and end-2017). The higher household debt reflected a strategy of shifting towards more secured lending and this represents minimal risk as the loan is backed by asset-based and principal-guaranteed investments. Based on the severe stress test by Bank Negara Malaysia (BNM), the result was encouraging as banks had excess reserves of RM138 billion to absorb the potential losses, mostly contributed by the lower-income segment (RM5,000 below), which accounted for 40% of the potential losses.

BNM acknowledged the mismatch between demand and supply for residential properties, especially in the affordable segment (only 23% of newly launched houses between 2016 and 1Q18 were priced below RM250,000). However, the risk remained low on several factors: i) the demand for affordable segment remained solid but supply is lacking; ii) first-time buyers of houses priced below RM500,000 remained strong; and iii) contained speculative buyers.

However, risk persisted in the non-residential segment. Market conditions in the non-residential segment remained subdued given the excess supply in office space and shopping complexes as the vacancy rates for both deteriorated further to 17.2% and 19.8% respectively from 16.7% and 18.7% as at end-2017. For the retail segment, the addition of new shopping complexes in Kuala Lumpur, Penang, and Johor is expected to put more pressure on the occupancy and rental rates.

Despite heightened uncertainty in business conditions, there were no sign of credit tightening by banks as it was merely the firms adopting a further wait-and-see approach. Among the affected sectors were construction, real estate, and mining and quarrying, which witnessed higher rejection rates. In addition, due to weaker credit outlook in selected segments, debt servicing capacity declined to 8.2 times from 9.1 times as at end-2017 in anticipation of subdued earnings performance.

We reiterate our “neutral” rating on banks as near-term headwinds are emerging. Our top pick of the sector is Public Bank Bhd. (buy, target price: RM26.00). — Hong Leong Investment Bank Research, Sept 28