Stricter provision for probability of default

-A +A

ALL banks need to adhere to stricter classification practices for provisions and the probability of default (PD) on their respective loan accounts, say banking sources.

This means that the cost of impaired loans to the banks would likely go up and eat into their earnings going forward.

“All banks need to have a PD of 100% post three months on their collective assessments. This is a stricter method,” says a senior banking official.

The tougher classification requires banks to make PD provision for the full sum of a three-month-impaired loan when borrowers fail to make repayment in the fourth month. Provisions are expected to be higher as a result of the more prudent policy.

“Most banks have started practising this and those that haven’t will have to get on board,” says the banker.

Banking analysts say most banks already have stringent practices in place when it comes to provisions for non-performing loans (NPLs).

“A lot of them are conservative. For example, some banks have already moved their SME loans to make [PD] provision of 100% and will start moving their retail loans to this stricter classification practice by this year,” says a banking analyst.

“The conservative provision for loans will impact the banks’ bottom line, especially those that have yet to start on this as they will have to make more provisions to catch up with this policy,” he adds.

According to him, Public Bank Bhd and CIMB Group Holdings Bhd have adopted this practice fully while RHB Capital Bhd is currently in the process of meeting the 100% target.

“This policy is a way to impose risk-informed pricing. When a bank prices loans, it is based on the expectation of return. If banks are overly bullish on the assumption that the borower will not default, then the loan will be priced very competitively. But if you underestimate loan default risks and price the loans too competitively, this will negatively affect the bank in the long term,” the analyst explains.

To prevent rising NPLs, says another senior management banking official, Bank Negara Malaysia is keeping a close watch on the practice of “ever-greening” defaulted accounts. Ever-greening is a term for NPL accounts that are restructured and taken out of the NPL category. Banks have to put in place policies approved by the board that have controls to avoid ‘ever-greening’ of loans. This includes situations where loans are restructured more than once.

“A bank has to ensure that borrowers are able to repay their loan — and prove that they can continue to pay the loan,” he says. “For instance, an account can only be removed from the NPL category once all its historical debts are settled and the borrowers can prove that they can meet their future repayments of more than six months. This is to ensure they can sustain their loan repayments and will not default again.”

According to guidelines issued by Bank Negara in November 2011, a repayment period (based on the revised and restructured term) has to be continuously observed before the rescheduled and restructured facilities can be reclassified as non-impaired.

There is no public data to show the value of impaired loans that have been reclassified as non-impaired, and how many eventually turned sour again. Nevertheless, the central bank is keeping a vigilant eye on this, making it tough for banks to engage in such practices, according to top banking officials.

Banks in Malaysia have generally maintained their respective asset qualities despite a challenging environment.

Total impaired loans dropped to RM22.4 billion as at July 31, 2014, from RM23.5 billion a year earlier — a marked improvement from the RM29.6 billion recorded in 2010. The amount is also substantially lower than the whopping RM52.3 billion six-month-impaired loans and RM76.9 billion three-month-impaired loans incurred during the Asian financial crisis in 1998.

Bank Negara statistics also show that the trend to allocate higher provisions for impaired loans among the banks has started. Data from the central bank’s website shows that provisions for total impaired loans increased to 104.2% as at July 31 this year, from 99.5% as at Dec 31, 2013. It was 98.7% at end-2012, 99.3% in 2011 and 89.2% in 2010.

Maybank Investment Bank Research, in a Sept 8 note, says that absolute gross NPLs have been stable year to date, with industry NPL ratios declining further. It points out that CIMB and AmBank Bhd saw a q-o-q upticks in NPL provision in the second quarter  

“CIMB’s Indonesian portfolio came under stress, particularly from some mining corporates, while AMMB’s asset quality was affected by a default on a property development loan,” it adds.

“Banks have generally been cautious on the auto sector, where there are signs of stress in lower-income segments. They have also turned cautious on credit cards and personal financing.”

“Although banks appear confident of provisions made to date, there is still a risk of higher credit charges here. Asset quality may also deteriorate in the aviation sector due to a difficult operating environment. As for property developers, those with a meaningful presence in Iskandar Malaysia will have to be monitored, given the large incoming supply of properties there,” says Maybank IB.

It also notes that there is some strain in the automotive sector for the household segment. “We also remain vigilant of more tightening measures for the property sector. For prudential reasons, we have imputed a rise in gross NPLs for the next two years.”

This article first appeared in The Edge Malaysia Weekly, on September 22-28, 2014.