ROEs Fall as Margins Squeezed

Malaysia Banks: Consumer Business: ROEs Fall as Margins Squeezed

§ Aggressive Central Bank rate cuts present NIM challenge - Our recent channel checks show, post OPR cuts, the declines in lending rates for mortgages and auto loans have outpaced deposit rates. This will shrink the ROEs on mortgage and auto loans, even before accounting for the likelihood of higher credit losses as unemployment rates mount, in our view.

§ Mortgage ROEs to fall to 9% from 13% - NIMs have shrunk c20bps as the effective cost of funds decline of 60bps lagged the BLR cut of 80bps, on our estimates. If credit costs were to double, say from 20bps to 40bps, the effective ROE would collapse to just 4%. In spite of this, domestic banks continue to pursue this segment of the market and are willing to take on new loans at BLR minus 2.0-2.2%, near the historical low.

§ (Unadjusted) Auto ROEs fall to 14% from 24% - Our channel checks with car dealers and banks reveal that non-national car lending yields have fallen more than 150bps from the peak of 6.5% in August 08. By comparison, national car rates have fallen about 50bps over the same period. However, adjusting for 4-year cost of funds (using Government securities' yield as proxy) to match duration, auto ROE would be just 3%.

§ We have imputed an average NIM decline of 5bps this year - Banks with high exposure to housing loans (Public) and a high CASA base (Maybank, Alliance, RHBC) would see narrower margins, in our view. At the other end, AMMB should benefit from falling rates as >50% of its loans are on a fixed-rate basis. Even though auto ROEs will decline, we view positively AMMB's cautious stance and price discipline to minimize the squeeze in margins.

§ Maintain Underweight on MY banks - Despite the marked deterioration in global economic conditions, credit spreads in the mortgage and auto loan markets have not widened, which is surprising to us. We view that sector credit costs will rise this year to 137bps from 81bps in 2008, which will add pressure to bottom lines. AMMB remains our top pick in the sector as it benefits from interest rate cuts.