This article first appeared in The Edge Malaysia Weekly on July 11, 2022 - July 17, 2022

A 25-basis-point (bps) rise in the overnight policy rate (OPR) last week — the second this year — is positive for banks’ earnings but, on the flip side, may crimp loan growth and hurt asset quality.

Nevertheless, analysts believe the benefits of the OPR hike on banks’ earnings will outweigh any of the potential negatives.

The OPR hike to 2.25% last week is the second of at least three similar-quantum hikes that economists anticipate for this year as Bank Negara Malaysia looks to normalise rates amid inflationary pressures. The first hike came on May 11 — it was also the first expansion since January 2018 — and most economists expect a third to come after Bank Negara’s next monetary policy meeting on Sept 8.

“The latest interest rate hike is likely to be one in a continuing series. This would be beneficial to bank earnings over the long term as interest margins expand. Nonetheless, some of this may be offset by credit costs as some borrowers may face difficulties meeting payments amid higher funding costs. That said, Malaysian banks are well-capitalised and well prepared to manage these risks, making them an interesting investment proposition amid an uncertain economic environment,” Ray Choy, head of economics and research at Opus Asset Management Sdn Bhd, tells The Edge.

“The rise in interest rates may also cause some marked-to-market losses for banks, but more greatly on banks with large bond portfolios and investment banking operations. Fortunately, most banks in Malaysia derive a greater share of income from commercial banking,” he adds.

Shortly after Bank Negara delivered the widely expected rate hike last week, a slew of banking groups announced a corresponding 25bps rise in their base rate and base lending rates. These included Malayan Banking Bhd (Maybank), whose new rates became effective on July 8, CIMB Group Holdings Bhd (July 13), RHB Bank Bhd (July 13), Affin Bank Bhd (July 8), Public Bank Bhd (July 8) and Alliance Bank Malaysia Bhd (July 13).

As at last Thursday (July 7), Hong Leong Bank Bhd, AMMB Holdings Bhd, Bank Islam Malaysia Bhd and Malaysia Building Society Bhd had yet to announce a hike in their rates.

“We expect the OPR hike to be positive for banks as their total floating rate loans are larger than their total fixed deposits, both of which would be repriced upward [following] the OPR hike),” CGS-CIMB Research analyst Winson Ng says.

Analysts see Bank Islam being the largest beneficiary of the OPR hike, given that it has the highest floating-rate loan ratio among the banks. The ratio for Bank Islam stood at 91.8% as at end-March.

“Based on our analysis, the OPR hike would have the largest positive impact on Bank Islam’s FY2023 net profit (7.1% for every 25bps hike) as its floating rate loan ratio of 91% that year (projected by us) is the highest in the sector. Conversely, the OPR hike would have the smallest impact on Public Bank’s FY2023 net profit (1.3% for every 25bps hike) as its current and savings account (CASA) ratio of 24.3% [that year is seen] among the lowest in the sector,” Ng says in a July 7 report.

On the other hand, OPR hikes also result in higher borrowing costs and increased monthly loan repayments, which some borrowers could struggle with. This could be negative for banks’ loan growth and asset quality. As it stands, moratoriums and repayment assistance programmes that banks had offered borrowers since the Covid-19 pandemic have eased off.

CGS-CIMB has projected a deterioration in the banking system’s loan growth to 4% to 5% for this year compared with 5% as at end-May, and an uptick in gross impaired loan ratio to 1.8% to 2% by the end of the year from 1.64% as at end-May.

It, nevertheless, continues to maintain an “overweight” call on the banking sector. “For OPR hikes, we believe that their positive impact on banks’ net interest margin (NIM) would outweigh the potential negative impact on loan growth and asset quality,” says the research house, which expects another 25bps hike in the OPR before the year end.

Hong Leong Investment Bank (HLIB) Research analyst Chan Jit Hoong agrees. “When there’s inflation kicking in and you have higher interest rates also, loan growth and asset quality are likely to suffer. However, when it comes to loan growth, I am not so concerned [as] the sensitivity to banks’ bottom line is not as much compared with other profit-and-loss variables,” he tells The Edge.

“As for asset quality, banks have already made heavy pre-emptive provisioning in 2020 and 2021 to cushion asset quality weakness during the Covid-19 pandemic. I would argue that these would [continue to] provide a buffer to banks now. In fact, write-backs might be possible, since the loss coverage for vulnerable Covid-19-related loans is more than 100%, on average,” he adds.

HLIB Research estimates that every 25bps OPR hike would expand the banking sector’s NIM by 5bps to 6bps which, in turn, would bump up its earnings forecast for the sector by 4% to 5% — without taking into account potential marked-to-market losses and higher defaults. It sees Bank Islam and Alliance Bank being the biggest gainers of the OPR hike, and Affin Bank and Public Bank being the smaller gainers.

“However, any acute CASA substitution to fixed deposits will limit NIM from expanding; every 1% CASA ratio reversal would drag sector NIM by 1bps to 2bps and profit by 1%,” it says.

It notes that after the May 11 OPR hike, banks’ weighted base rate and base lending rate increased 25bps and 24bps respectively, in line with the official 25bps uptick. For deposits, rates climbed by a similar quantum for fixed deposits — one- to 12-month fixed deposit rates jumped 21bps-24bps — but savings’ rates only rose 6bps.

“Looking further back at the January 2018 OPR hike, we saw NIM rise 4bps sequentially and contract in the following two quarters due to upward repricing in deposits,” it highlights.

HLIB Research too has an “overweight” call on the sector. “All considered, we view positively the banking sector and opine that the risk-reward profile is skewed to the upside; the combination of robust earnings growth and undemanding valuations will be the impetus to drive a rerating,” it says.

It suggests an investment strategy of buying selectively on weakness as the market is likely to remain volatile going forward. “For large-sized banks, we like Maybank for its strong dividend yield. For mid-sized banks, RHB Bank is favoured for its high Common Equity Tier-1 ratio and attractive price point. As for small-sized banks, Bank Islam and Affin Bank are preferred. We like the former for its laggard price showing, while the latter has special dividends potential and strong financial metric,” it says.

RHB Research also has an “overweight” call on the sector. “The path to monetary policy normalisation would be moderately positive for banks’ NIMs, providing cushion for any downside risks from rising macroeconomic challenges. Based on our estimates, the latest rate hike together with the first 25bps increase in May would raise the banking sector’s 2022 net profit by 1.8%. A third rate hike of 25bps in September would improve the cumulative earnings uplift to 2.2%,” its analyst Fiona Leong says in a report.

She is currently projecting 5% year-on-year growth in the sector’s earnings for this year.

“Sector earnings growth at 5%, although unexciting, is decent as are dividend yields. We continue to prefer defensive names to weather market volatility,” she says, citing Hong Leong Bank, AMMB Holdings and Maybank as the preferred picks.

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