RHB maintains overweight on banking sector

Banking sector
Maintain overweight: Singaporean banks adopted FRS39 back in 2005, and with the economy having gone through a full economic cycle during this period, we have turned to the recent experience of the banks there to serve as a rough guide on the potential impact ahead of FRS139 on the local banks.

Generally, despite the switch to the “incurred loss” model, the experience of the banks in Singapore appears to suggest that the current loan loss model is procyclical. This would help lend support to our view that credit cost should remain relatively benign if economic conditions hold up.

Similarly, portfolio allowances (or collective allowances, CA) for Singapore banks were low during the growth cycle and picked up only during the downturn.

In Malaysia, the adoption of FRS139 has resulted in the banks (except for Public Bank Bhd) maintaining a higher level of CA compared to Bank Negara’s required minimum of 1.5%. However, this suggests that as economic conditions and historical default and loss rates improve, these banks may be able to write back the excess provisions and/or grow loan base without having to provide for further collective allowances (ie run down the CA coverage).

Banks with higher exposures to the SME and corporate segments could now also be harder hit with impairment allowances when credit conditions deteriorate, compared to banks that have a higher exposure to the retail segment. This is because the corporate sector has, historically, had a higher default rate (versus household segment) and loans to businesses and corporates are typically given out on a clean basis. In mitigation, we believe the banks have taken the opportunity to beef up provisioning levels as the implementation of FRS139 has allowed banks to restate opening balances.

To address the issue of procyclicality, IASB plans to move towards a more forward-looking provisioning model to help banks build up their reserves over time, resulting in higher reserves being held when entering periods of deteriorating credit quality.

The implementation of the expected loss method may lead to higher provisioning levels required. The availability of data may also pose an operational challenge as to determine expected losses, banks must now forecast expected credit losses and the timing of such losses over the life of the loan.

We are maintaining our overweight rating on the sector. We like Malayan Banking Bhd, CIMB Group Holdings Bhd, AMMB Holdings Bhd and Public Bank for an exposure to large-cap banking stocks. Affin Holdings Bhd and Alliance Financial Group Bhd are also rated as outperform while EON Capital Bhd and Hong Leong Bank Bhd are both rated market perform. — RHB Research Institute, July 26

This article appeared in The Edge Financial Daily, July 27, 2010.