Banking : Double reduction again

· Most aggressive move yet
Bank Negara Malaysia, in its most aggressive move yet, reduced the OPR and SRR rates by 75bps and 150bps to 2.5% and 2.0% respectively in the Monetary Policy Committee meeting yesterday. Ceiling and floor rates have been for the OPR are correspondingly reduced to 2.75% and 2.25% respectively. The move was certainly unexpected, with market expectations of a 25-50bps cut, and could possibly point to a rapidly weakening economic environment.
· Margins obviously impacted
As to be expected, margins will obviously be impacted negatively as lending rates will be repriced downwards by a larger quantum than deposit rates. We estimate that banks’ earnings will be impacted by 5-13% on the assumption that BLR will be reduced by the similar quantum as with the OPR cut while deposit rates will be lowered by an average of 35-40bps. The key to a more concrete revision in estimates is management’s repricing decision, with net margins possibly being squeezed even further should deposit rates be repriced down by a lesser quantum.
· Net impact negative
While net interest margins will obviously be impacted, more so for the banks with larger exposures to variable rate loans, the fairly sizeable reduction in SRR rates will cushion this impact somewhat as financial institutions will now be able to generate additional interest income from the “released” funds. Based on the total statutory reserves of RM22.5bn in the banking system as at November 2008, the reduction in SRR will return additional funds of about RM9.7bn and could possibly earn banks approximately RM290m based on average yields of 3%. The cumulative positive impact to stocks under coverage from the SRR reduction will range between 1-2%, but will still result in a net negative impact when taking into account the sharp reduction in OPR.
Maybank and Bumiputra-Commerce will see net earnings for FY09-FY10 possibly reducing by 10-12% given their higher exposure to variable rate loans. Hong Leong Bank and Public Bank will see earnings come off by 4- 8% while AMMB Holdings will be the least affected, with earnings hardly changed given their large composition (65%) of fixed rate loans.
· Reduction in earnings and target prices
The resultant effect of the earnings changes above will be reductions in valuations and target prices for all stocks under coverage, by an average of 5-12%, which we will effect immediately though respective management’s decisions on the re-pricing of deposits are unknown as yet. We continue to favour Public Bank for its attractive dividend yields and strong management, AMMB Holdings and Bumiputra-Commerce Holdings for stronger recoveries upon improvement in market conditions. Hong Leong Bank is downgraded to a Hold.