This article first appeared in The Edge Malaysia Weekly on August 17, 2020 - August 23, 2020

INVESTORS are bracing for a particularly weak financial performance from banks when they release their April-June report card later this month, with lenders expected to set aside markedly higher provisions for loans that may sour.

“Early signs from the banking statistics suggest that pre-emptive loan provisioning may see an acceleration in 2Q,” says Kenanga Research banking analyst David Chong.

This is the quarter in which the economy contracted 17.1% year on year, compared with the marginal growth of 0.7% in the first quarter, as the full impact of the Movement Control Order (MCO) imposed on March 18 was felt. Banks may take the opportunity to bite the bullet and do kitchen sinking this quarter, analysts say.

This is also the quarter when banks will see a further squeeze in net interest margin as a result of Bank Negara Malaysia’s 50 basis point (bps) cut in the overnight policy rate on May 5 — the sharpest of the central bank’s four cuts totalling 125bps so far this year.

Additionally, banks will have to recognise in this quarter a one-off provision, or what is known as a Day 1 modification loss (ML) under the MFRS 9 accounting standard, arising from non-accrual of interest/profit on deferred instalments of hire purchase and Islamic fixed-rate financing under the six-month loan moratorium that started in April.

“So, there are quite a few hits on the banks in the second quarter,” Chong tells The Edge.

Nevertheless, the silver lining for banks is that they may record strong investment gains, which could boost non-interest income and partially offset the weak earnings.

“I think it [earnings] could be held up by investment gains, given the decline in bond yields [and thus, the rise in bond prices] during the second quarter. So, mark-to-market gains could be higher as well. And considering the fact that we had mark-to-market losses in the first quarter for quite a few banks, technically, it means that the second quarter could make up for it on that front,” a senior banking analyst tells The Edge.

While the size of the ML for each bank remains to be seen, the analyst says it may not be as hefty as initially expected as there are some offsets that could help ease the hit on lenders.

“The reality of it is that, yes, the elephant in the room would be the ML itself. But if guidance [from the banks] is anything to go by, then it may not be as large as people think it is,” the analysts adds.

AMMB Holdings Bhd, for instance, guided for a lower ML of RM80 million as opposed to earlier estimates of RM400 million, due to modification gains from concessionary rate funding.

“That the group’s net ML loss is much smaller than expected is because the loss is expected to be offset by a modification gain. The [gain] arises from the fact that up to 80% of the SME loans that AMMB has extended under the Special Relief Facility Scheme are guaranteed by Credit Guarantee Corporation, which thus significantly reduces the cost of providing such loans,” explains Maybank Investment Bank Research in a July 7 report on AMMB.

The ML is the difference between the present value of the cash flows under the original and modified terms of the loan. 

Meanwhile, of the Malaysian banks’ 2Q performance, Hong Leong Bank Bhd is likely to have the highest potential to surprise on the upside, says Maybank Kim Eng Research. This is because its provisions may not be as large as anticipated given its proactive management of accounts thus far.

On the flip side, CIMB Group Holdings Bhd is seen as the bank with the highest potential to surprise on the downside. 

“Another RM500 million provision against an oil trading account [is] expected, so it is unclear if credit costs will be worse than expected,” Maybank Kim Eng says in a July 21 report on Asean banks.

A few months ago, CIMB Group had indicated that it may make a provision of about RM530 million — if provided in full — in the second quarter for an oil and gas trader, which analysts believe to be Hin Leong Trading Pte Ltd. Singapore-based Hin 

Leong ran into problems with loan commitments after the recent collapse in crude oil prices.

Banks have been beefing up provisions in anticipation of more troubled loans surfacing once the blanket six-month loan moratorium expires in September.

In 1Q, the average credit cost ratio of Malaysia’s eight banking groups rose to 62bps from 18bps a year earlier (or 25bps after adjusting for a one-off item), according to RAM Ratings.

Malaysian banks would certainly not be alone in seeing a spike in provisions in 2Q. Higher provisions were a key trend observed in banks globally.

Two weeks ago, Singapore’s three banks reported sharp declines in 2Q earnings as they set aside more money for potential loan losses that could come about from the Covid-19 pandemic.

DBS Group Holdings Ltd, the biggest lender by assets in the island state as well as in Asean, saw 2Q net profit drop 22% year on year to S$1.25 billion as allowances for loan losses more than tripled to S$849 million from S$251 million a year 

earlier. United Overseas Bank Ltd’s net profit fell 40% y-o-y to S$703 million, while Oversea-Chinese Banking Corp Ltd’s net profit also fell 40% y-o-y to S$730 million.

Farther away, US lenders set aside higher provisions than in Europe in the second quarter, with more than US$75 billion across JPMorgan, Wells Fargo, Citigroup and Bank of America alone. The four lenders booked their highest quarterly loan loss charges since the global financial crisis more than a decade ago, according to Financial Times.

Given the uncertainties in the sector, most analysts are still keeping a neutral investment stance on banks for now. RHB Bank Bhd and AMMB were among the most frequently cited as top buys.

“We think it is too early to upgrade the sector as asset quality uncertainties persist, with banks still unable to accurately estimate the level of provisions required post-loan moratorium, which has now been extended to end-2020-1Q2021 on a targeted basis. As such, we think that the overhang in the sector could persist until 1Q2021,” says UOB Kay Hian Research in an Aug 13 report. The research house has a “market perform” call on the sector.

Its top pick for the sector is RHB Bank. “[This is] given its highest CET-1 of above 16%, which significantly minimises the risk of an equity cash call; sizeable unrealised gains on investment securities that it can capitalise on to help buffer the impact of lower net interest margins and rising provisions; and, highest dividend yields (cash) among peers,” UOB says.

Investors will be keeping a close watch on whether banks will cut or refrain from declaring dividends in 2Q. Last month, Bank Negara told analyst that bank dividends would be assessed on a case-by-case basis.

“We would not be surprised if interim dividends across the banks are deferred given the still uncertain operating environment,” says AllianceDBS Bank Research in a July 29 report, pointing out that banks may want to be more prudent in managing capital despite their capital levels being above and beyond the required regulatory minimums.
 

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