Challenging outlook for banks in 2014

THE EDGE WEEKLY ISSUE#993

THE WEEK OF DECEMBER 16 – DECEMBER 22, 2013

By: Adeline Paul Raj

The banking sector will find it a challenge to post higher earnings growth next year, given concerns that economic activities could be impacted by a pullback in fiscal spending and that loan growth could slow.

“The banking industry is very closely related to the macro economy and most people are forecasting slightly slower growth all around.  I think we will also have to manage through bouts of financial market volatility, basically because of the quantitative easing tapering (by the US Federal Reserve) and so on.  So, one must be agile there,” Datuk Seri Nazir Razak, CEO of CIMB Group Holdings Bhd, tells The Edge.

Asked where growth would come from, he says: “We can always grow by eating market share.  We can drive new products.  I mean this year, CIMB has done very well in consumer banking.  How?  We have cut down costs, we’ve grown in new segments like ASB (Amanah Saham Bumiputra unit trust), we have grown back in SME banking and in hire purchase, and wealth management.”

At least four banking analysts say they expect loan growth to come down in 2014 – probably for the first time in two years – as a result of Bank Negara Malaysia’s ongoing moves to tighten consume lending as well as the government’s recently announced measures to cool the property market that kick in next year.

These will drag down growth in consumer loans, especially residential mortgages, says CIMB Research’s Winson Ng.  He expects overall loan growth to slow to 9.5% to 10.5% in 2014 compared with an estimate growth of 10% to 11% this year.

Some analysts, including Ng, however, believe bank earnings will likely grow at a stronger pace of 11.6% next year compared with an estimated 9% this year.

“The improvement in earnings will come from an expected narrower margin contraction and smaller increase in overheads.  But ….. we remain “neutral” on the sector because the improvement is anticipated to be small and growth will merely recover to 2012 levels,” Ng says.

While most research houses have a “neutral” call on the banking sector, at least two – Alliance Research and RHB Research – are taking a contrarian view with an “overweight” call.

Malaysia’s economy is expected to stay flat or at best post marginally higher growth next year.  Nomura Equity Research, for instance, sees Malaysia’s GDP growing 4.5% next year compared with 4.3% this year.

Cheah Kim Yoong, banking analyst at Alliance Reseach, expects loan growth to slow to 9% next year from 10.5% this year.  Last year, loan growth was 10.4%.

“The rule of thumb is that loan growth is twice your GDP growth rate.  In the last two years, it was more than twice because of easy credit, but now it should go back to normal or just below (GDP), given the loan tightening measures.

“With some of the new policies and measures introduced and rising cost of living, there could be some stress on household debt.  We don’t think there will be an uptick in delinquent loans, but that’s always a wildcard” he explains.

Bank earnings could grow 10% next year after 8.5% this year, Cheah forecasts.

Net interest margin (NIM) – the difference between what banks earn from loans and what they pay on deposits – is expected to remain under pressure, given the highly competitive environment.

However, the magnitude of decline could be smaller than 2013.  thus, analysts are projecting stronger growth in net interest income next year.  CIMB Research, for instance, is forecasting a 10.1% growth in net interest income for banks at the top-line level.

NIM may be given a slight boost as there is a possibility that Bank Negara may raise its overnight policy rate (OPR) next year to combat inflation.  Most economists see that central bank raising the OPR, which determines banks’ lending rates, by at least 25bps to 3.25% sometime in the second half of 2014. 

“If this materialises, banks’ NIMs could expand without suffering material deterioration of asset quality as we are optimistic that the economic fundamentals remain strong enough to absorb such hikes.

“We are anticipating a single-digit drop in NIM on a y-o-y basis for banks under our coverage in 2014 compared with a double-digit drop experienced by some banks over the last two years,” says Alliance’s Cheah.

The banks’ latest quarterly results as at end-September show that NIM fell 17bps y-o-y to 2.12%, but improved marginally by 1bps on a q-o-q basis.  Most banks recorded a y-o-y decline in NIM with the magnitude ranging from 11bps for CIMB Group to 91bps for Islamic banking group BIBM Holdings Bhd.

Ng observes that only two banks managed to maintain their NIMs – RHB Capital Bhd, at 2%, and Affin Holdings Bhd, at 1.78%.

Gross impaired loan ratios dropped or remained largely stable for all banks in 3Q2013.

“We don’t see a spike in impaired loan ratios due to the still healthy economic climate, banks’ tight control of their loan portfolios and BNM’s proactive tightening of several consumer loan segments.  Thus, we expect the industry’s gross impaired loan ratio to be stable (versus 2% in Sept 2013) with a downward bias to our projected ratio of 1.8% to 2% for end-2013 and end-2014,” says Ng.

Meanwhile, if there is a pick-up in GDP growth next year, it should be positive for banks in terms of capital market activities and non-interest income.  Banks, particularly the larger ones, are increasingly looking at deriving a bigger portion of their income from non-interest income as margins in the lending space narrowed over the years.

Non-interest income, which banks derive from, for example, fees and bancassurance, makes up about a third of the banking system’s total income.

CIMB Research sees non-interest income growing 5.5% in 2014.  “Non-interest income for banks will continue to be robust in the teens in 4Q2013, benefiting from the consolidation of newly acquired entities by two banks.  However, the pace could normalise to mid to high single-digit rates in 2014,” says Ng.

Bigger banks like CIMB, Maybank and RHBCap, which have active investment banks, have all indicated that they have a strong pipeline of deals. 

Companies are increasingly keen on raising funds in the bond market ahead of the expected increase in OPR next year.  Thus, the bond market should remain buoyant, analysts say.  As for the equity market, there are a number of large initial public offerings that are slated for next year, such as 1Malaysia Development Bhd, Medini Iskandar Malaysia and Iskandar Waterfront Holdings.

“The deal pipeline is strong, but whether they materialise depends on whether the capital markets find some stability next year,” warns an analyst, pointing out that the QE tapering, which is widely expected to start next year, may dampen emerging markets.

Analysts see banks’ returns on equity (ROE) generally trending downwards with most large banks in a capital conservation mode.  One analyst projects marginally lower ROE of 15.2% in 2014 compared with 15.3% this year.

Analysts also say there will continue to be more mergers and acquisitions to spice up the banking sector.  These will be apparent particularly in the brokerage, insurance and Islamic banking space.

As it stands, there is the pending take-over of Hwang-DBS (Malaysia)  Bhd’s key businesses by one of the country’s smaller banking groups, Affin Holdings.  This is expected to be completed in 1Q2014.

Bigger banks like Maybank, CIMB and RHBCap have all got regionalisation agendas and will be watched for how they expand into markets they not yet in.  RHBCap, for example, has been trying to buy Indonesian lender PT bank Mestika Dharma since 2009.

All eyes are also on Islamic banks BIMB Holdings Bhd – which owns Bank Islam Malaysia Bhd – and Maybank Islamic Bhd to see whether they expand in the region.

Valuation-wise, Malaysian banks’ 2014 PER of 12 times is still higher than the PER of 9 to 10 times for banks in Indonesia and Thailand, says CIMB Reseach.  “We see this as reasonable for now, given the near-term economic risks for these two neighbouring countries,” says Ng.  His top picks in the sector are RHBCap, Maybank and BIMB Holdings.