“Fitch’s Malaysian banking sector operating environment score is now back at its pre-pandemic level on account of banks’ improving revenue and profitability prospects and manageable asset-quality risks, amid higher interest rates and a firm economic recovery” – Fitch Ratings’ Malaysian Banks Peer Review 2022, October 17, 2022
The rating agency expects Malaysian banks to benefit from a robust economic recovery in the country and higher interest rates. Normalisation of economic activities and reopening of borders have accelerated loan and fee income growth, while moderately higher interest rates should widen banks’ net interest margins without exerting excessive pressure on borrowers’ ability to repay debt. Impaired-loan ratios are likely to rise modestly with the end of loan relief, but we expect major banks’ asset quality to remain stable on the improving job market and the strength of the economy, which we forecast to expand by 6.5% in 2022 and 4.3% in 2023. Better revenue and profitability prospects led us to revise our Malaysian banking sector outlook for the remainder of 2022 to ‘Improving’, from ‘Neutral’, in June 2022. Fitch has also recently revised the sector’s operating environment(OE) score to the pre-pandemic level of ‘bbb+’, from ‘bbb’, with a stable outlook.
Financial Metrics to Remain Steady
Inflation in Malaysia has been manageable relative to that of its regional peers, which enabled Bank Negara Malaysia to raise its policy rates at a more moderate pace than other global and most regional central banks. Intensifying global economic headwinds pose risks, but we project the policy rate to rise only another 50bp by end-2023, following a 75bp hike year-to-date. Higher interest rates will raise banks’ cost of funds, but the time lag in the repricing of liabilities relative to assets should improve lending margins in the near term. Earnings prospects are also improving, with moderately faster loan growth and credit costs continuing to ease from elevated levels over the past two years. Strong earnings support steady capitalisation even as banks expand their balance sheets slightly and resume higher dividends. Moderate interest-rate hikes and a firm economic recovery are likely to keep credit impairments manageable. Banks have rebuilt loan-loss reserves since the onset of the pandemic, and Fitch views these buffers as being adequate against expected credit losses. Competition for deposits could tighten liquidity, but we expect the rise in loan/deposit ratios (LDRs) to be marginal. Banks’ funding
profiles remain steady and liquidity coverage ratios are robust.
Rating Sensitivities
A sharp slowdown in global growth that weighs on Malaysia’s export-oriented economy may dampen banks’ operating incomes and worsen asset-quality metrics. This could pressure the banks’ Viability Ratings (VRs) if it remains protracted.
The OE score has limited upside as it is currently aligned with the sovereign’s (BBB+/Stable). The strong correlation between the credit profiles of the sovereign and banks constrains the OE scores and VRs.
Operating Environment
Accelerating Domestic Economic Recovery Malaysia’s economy has staged a robust recovery, with GDP expanding by 6.9% in 1H22 (2021: 3.1%), although the growth rates for 2023 and 2024 are likely to normalise to 4.3% and 4.8%, respectively. Unemployment has also declined to 3.7% by August 2022, which is the lowest since the onset of the pandemic. System loan growth accelerated to 5.7% yoy in August 2022 (2021:4.6%) on the back of strong household demand for credit. In addition, 75bp of overnight policy rate hikes have been rolled out since May 2022, and we project a further 50bp by end-2023. Fitch therefore expects banks to report solid revenue growth in the near term.
At the same time, the sector’s asset quality has remained relatively steady, with a system-average impaired-loan ratio of 1.9% at end-August 2022 (August 2021: 1.8%), even as loan forbearances were phased out. Asset-quality risks from rising interest rates are likely to be moderate, as inflation was relatively contained (8M22 average: 3.0%), enabling Bank Negara Malaysia to undertake gradual policy tightening.
Franchise and Business Model Underpin Business Profiles
The six largest banking groups in Malaysia collectively have around 70% of the system loans and deposits, as of end-2021. Malayan Banking Berhad (MBB), Public Bank Berhad (PBB) and CIMB Group Holdings (CIMBG) are the three largest banking groups, while the three mid-sized ones are RHB Bank Berhad (RHB), Hong Leong Bank Berhad (HLBB, BBB+/Stable/bbb+) and AMMB Holdings Berhad (AMMB, BBB-/Stable/bbb-). There is a discernible gap in size between the largest banks – which
each have 12%-18% of all loans and deposits – and the mid-sized banks, which have 6%-9% shares apiece as of end-2021.
Domestic Market Share
The banks’ market positions and pricing power are correlated to their size. For example, MBB enjoys strong market leadership in multiple product segments as Malaysia’s largest bank, and has had one of the lowest cost of deposits. This gives it superior pricing power and higher pre-provision operating profit (PPOP)/risk-weighted assets (RWA) than its peers. In contrast, the smaller AMMB tends to have higher deposit costs and lower PPOP/RWA than its larger peers.
Cost of Deposits
Domestic lending – mainly household loans – accounts for the bulk of the major banks’ loan portfolios. However, MBB and CIMBG also have substantial international operations accounting for about 37% of total lending, while RHB’s overseas lending constituted about 12% at end-2021.
PPOP/RWA
Household loans form a majority of the major banks’ loan portfolios, but PBB and HLBB have a higher concentration than their peers, at 67% and 65% of total loans, respectively. These loans are typically centred around secured lending such as mortgages and auto finance, which typically have stronger credit performance than business loans. This partly explains their superior asset quality compared with that of their peers.
Retail Lending Dominates Banks’ Portfolios
The banks’ different business models are similarly reflected in the level and volatility of their earnings. Retail-focused banks such as PBB and HLBB tend to exhibit lower earnings volatility, while CIMBG had experienced larger volatility from asset-quality weaknesses in its corporate and commercial portfolio, many of which originated overseas.
Underwriting Standards Vary Across Banks
The major Malaysia banks’ asset quality over time reveals the consistency of their underwriting standards. PBB’s and HLBB’s
impaired-loan ratios have perennially been the lowest among the six banks, typically keeping under 1%, compared with the system average of around 1.6% in the past decade. We believe this partly reflects both banks’ stringent client selection over the years. AMMB’s and RHB’s impaired-loan ratio tends to track the system average through credit cycles, as does MBB’s domestic impairments, which Fitch believes reflect reasonably good underwriting standards and risk controls. However, MBB’s ratio is higher on a group basis due to weaker loan quality overseas. CIMBG’s impaired-loan ratio has historically been higher, which reflects a higher risk appetite than its major peers. This is evident from its larger-than-peer exposure to cyclical sectors and larger proportion of overseas loans in markets with lower operating environment scores, such as Indonesia. Recent strategic changes have sought to pare back risks by rationalising some riskier overseas portfolios, and early results appear positive.
Expecting Faster Loan Growth
Malaysia’s system loan growth has been growing at a moderate pace, averaging only 4.7% of CAGR during 2016-2021. Domestic-oriented banks have been growing their loan books steadily and more quickly than banks with a higher proportion of overseas loans, such as MBB and CIMBG, which saw challenges associated with commodity prices since 2016 that prompted them to recalibrate some of their portfolios.
Moderate Loan Growth in Recent Years but Likely to Pick Up
Fitch expects system loan growth to recover to around 6% in 2022 before moderating to sub-5% in 2023. Domestic household loans are likely to remain the main growth driver, particularly for CIMBG, as restructuring of its Indonesian and Thailand portfolios continues. Higher interest rates are unlikely to slow growth substantially, as rate hikes have been relatively moderate amid a firm economic recovery.
Asset Quality – Impairments to Rise but Remain Manageable
Malaysian banks’ asset quality has remained relatively stable, even as the application window for loan relief – under Malaysia’s second moratorium programme that started in July 2021 – closed in December 2021. We estimate that the proportion of loans under relief across the top six banks (including their overseas portfolios) has fallen to around 5% on average as of end-July 2022, from 21% a year ago.
Loans under Relief Have Fallen Significantly
Fitch expects impaired-loan ratios to rise marginally in 2022 across the major banks as debt-relief measures are phased out and more impaired accounts are recognised. Recent and anticipated rate hikes are likely to worsen these modestly, but Fitch believes the strengthening economic environment and labour market should limit the scale of impairments.
Impairments Likely to Pick Up Modestly As Loan Reliefs Fully Phased Out
Any incremental credit costs are likely to be manageable, as banks have steadily increased their provisions over the past two years in anticipation of asset-quality weakness upon the expiry of loan relief. Loan-loss coverage ratios have been maintained at above 100% at each of the major banks (1H22 average: 173%), with PBB and HLBB having the most robust level at 389% and 212%, respectively.
Earnings and Profitability: Earnings Upside from Economic Recovery and Rate Hikes
The major banks’ net interest margins (NIMs) have largely recovered towards pre-pandemic levels, and we expect further
upside in 2H22, benefitting from recent policy rate hikes. The NIM tailwinds are likely to persist into 1H23, since deposits are repricing less quickly compared with assets. Fitch expects banks’ operating profit/RWA ratio to continue improving alongside NIM expansion, faster loan growth and higher fee income. This is also likely to offset rising operating expenses and lower banks’ cost/income ratios. We expect credit costs to continue to ease but remain above pre-pandemic level, as most banks remain cautious about releasing general provisions during the current global uncertainties.
Capitalisation and Leverage: Higher Dividends Likely, but Near-Term Capitalisation to Remain Steady
Banks have generally sustained higher capital buffers in 2020-2021 through cautious loan growth and dividend suppression. As domestic and regional economies recover and the risks of worst-case scenarios abate in the OE, Fitch expects banks to post higher loan growth and raise cash dividend pay-outs. Nevertheless, Fitch views that a recovery in earnings should keep banks’ common equity Tier 1 (CET1) ratios stable in the near term.
CET1 ratios at HLBB and AMMB have typically been lower than that of their larger peers over the past few years. However, Fitch believes the risks HLBB faces are mitigated by its lower-risk business model, focused on secured retail lending, and by its ample loan-loss buffers. AMMB’s capitalisation fell by about 250bp from the settlement charges associated with 1MDB in FY21, but it had rebuilt the ratio to 12.0% by end-June 2022, from 10.4% at end-March 2021. This was a result of a private share placement in April 2021 and improved earnings over the past quarters. Fitch believes AMMB’s capitalisation will be further supported by earnings growth, its divestment of AmGeneral Insurance Berhad, and the application of internal ratings-based approach to its credit risk model, despite its plan to normalise dividend payouts to the 35%-40% range (FY22: 11%, FY21: nil) in the medium term.
Funding and Liquidity: LDR to Inch up Further
Banks’ LDRs have ticked up in recent quarters and we expect them to rise further, as loan growth improves and some funds flow out of deposits into higher-yielding assets. However, the increase in LDR is likely to be marginal, as we do not expect banks to be overly aggressive in credit expansion in the near term. The balance sheets of the major Malaysian banks are primarily funded by customer deposits, which constitute around 80%-90% of total funding.
Expecting Marginal Rise in LDR
Current account and savings account (CASA) ratios remain at record highs, but this is likely to ease as the economy recovers, consumer spending and capex resume, and depositors shift to higher-yielding term deposits. AMMB’s funding profile is weaker than that of its larger peers, as evident from its historically higher LDR (close to 100%), lower CASA ratio (June 2022: 33%) and a higher proportion of corporate depositors, which tend to be more volatile than granular retail and
small business deposits. Liquidity coverage ratios were robust across the major Malaysian banks, with each being comfortably above 130% at end-June 2022.
Support Assessment: State Support Influenced by Systemic Importance, Ownership
Fitch believes that extraordinary support from the Malaysian authorities to the major banks is highly probable, if needed. This is underpinned by the sovereign’s moderate ability to provide support, as reflected in its ‘BBB+’/Stable rating, and the likely absence of bail-in provisions of senior debt at resolution. Systemic importance and state ownership also have a significant bearing on the likelihood of government support. Fitch assesses that there is a higher probability of extraordinary support being extended to the three largest banks (MBB, CIMBG and PBB), which are officially designated as domestic systemically important banks, compared with the mid-tier banks. Majority state ownership, whether directly or via government-linked investment companies, is also a positive factor in our assessment of the sovereign’s propensity to support a bank.
