Rising rates are mildly positive for bank earnings

A 25 basis point (bp) hike in the key overnight rate (OPR) last week – the second this year – is positive for bank earnings but, on the other hand, could dampen loan growth and affect asset quality.

Still, analysts believe the benefits of the RPO hike on bank earnings will outweigh any potential downsides.

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 seeks to normalize rates amid inflationary pressures. The first hike was 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 September 8. .

“The latest interest rate hike will likely be part of a continuing series. credit costs, as some borrowers may find it difficult to meet their payments amid higher funding costs.That said, Malaysian banks are well capitalized and well prepared to manage these risks, making it a worthwhile proposition. attractive investment in an uncertain economic environment,” Ray Choy, head of economics and research at Opus Asset Management Sdn Bhd, told The Edge.

“Rising interest rates can also lead to mark-to-market losses for banks, but more strongly for banks with large bond portfolios and investment banking operations. Fortunately, most Malaysian banks are pulling a larger share of their income from commercial banking,” he adds.

Shortly after Bank Negara announced the widely expected rate hike last week, a slew of banking groups announced a corresponding 25 basis point hike in their base rate and base lending rates. These include Malayan Banking Bhd (Maybank), whose new rates took effect 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 of Thursday (July 7), Hong Leong Bank Bhd, AMMB Holdings Bhd, Bank Islam Malaysia Bhd and Malaysia Building Society Bhd had yet to announce rate hikes.

“We expect the rise in the RPO to be positive for banks, as their total variable rate loans are greater than their total fixed deposits, both of which would be revised upwards. [following] rise in OPR),” says Winson Ng, an analyst at CGS-CIMB Research.

Bank Islam, first beneficiary

Analysts see Bank Islam as the biggest beneficiary of the RPO hike, given that it has the highest floating rate loan ratio among banks. Bank Islam’s ratio stood at 91.8% at the end of March.

“Based on our analysis, the RPO increase would have the largest positive impact on Bank Islam’s FY 2023 net profit (7.1% for each 25 basis point increase), as its ratio variable rate loan of 91% that year (projected by us) is the highest in the sector. Conversely, the increase in the RPO would have the smallest impact on the net profit of the Public Bank for the 2023 (1.3% for each 25 basis point increase) because its current and savings account (CASA) ratio of 24.3% [that year is seen] among the lowest in the industry,” Ng said in a July 7 report.

On the other hand, RPO hikes also lead to higher borrowing costs and increased monthly loan repayments, which some borrowers might struggle with. This could be negative for bank loan growth and asset quality. As it stands, the moratoriums and repayment assistance programs that banks have been offering borrowers since the Covid-19 pandemic have eased.

CGS-CIMB forecast a deterioration in banking system loan growth to 4% to 5% for this year, from 5% at the end of May, and a slight increase in the gross impaired loan ratio to 1.8% to 2%. by the end of the year against 1.64% at the end of May.

It nevertheless continues to maintain an “overweight” bet on the banking sector. “For RPO increases, we believe their positive impact on banks’ net interest margin (NIM) would offset the potential negative impact on loan growth and asset quality,” the research house says. , which expects another 25 basis point rise in OPR ahead of the year. end.

Hong Leong Investment Bank (HLIB) research analyst Chan Jit Hoong agrees. “When inflation sets in and interest rates are also higher, loan growth and asset quality are likely to suffer. However, when it comes to loan growth, I’m not that concerned [as] sensitivity to banks’ bottom line is not as large compared to other profit and loss variables,” he told The Edge.

“With regard to asset quality, banks have already undertaken significant precautionary provisioning in 2020 and 2021 to cushion weak asset quality during the Covid-19 pandemic. I would say these would be [continue to] provide buffer to banks now. In fact, reversals could be possible, since loss coverage for vulnerable loans related to Covid-19 is above 100%, on average,” he adds.

HLIB Research estimates that every 25 basis point rise in OPR would increase the NIM of the banking sector by 5-6 basis points, which, in turn, would increase its earnings forecast for the sector by 4%-5% – without taking into account potential mark-to-market losses and higher default values. He sees Bank Islam and Alliance Bank being the biggest winners from the RPO hike, and Affin Bank and Public Bank being the smaller winners.

“However, any acute substitution of CASA for term deposits will limit the expansion of NIM; each reversal of the CASA ratio by 1% would drive the sector NIM by 1-2 basis points and a profit of 1%,” he says.

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

“Looking further into the January 2018 OPR hike, we saw the NIM rise 4 basis points sequentially and contract over the following two quarters due to the upward revision in deposits,” he points out.

Positive calls to the sector remain

HLIB Research also has an “overweight” call on the sector. “Overall, we view the banking sector positively and believe 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 new rating,” he says.

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

RHB Research also has an “overweight” call on the sector. “The path to monetary policy normalization would be moderately positive for bank NIMs, providing a cushion for any downside risk from mounting macro challenges. basis points in May would boost the net profit of the banking sector in 2022 by 1.8%.A third rate hike of 25 basis points in September would improve the cumulative increase in profits to 2.2%”, says its analyst Fiona Leong. in a report.

It currently forecasts 5% year-on-year revenue growth for the sector for this year.

“The sector’s earnings growth at 5%, while unattractive, is decent, as are dividend yields. We continue to favor defensive names over market volatility,” she says, quoting Hong Leong Bank, AMMB Holdings and Maybank as preferred picks.

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