Banking Sector Focus Report From HWangDBS

Pricing rationality

• We understand mortgage rates are set to increase to remove irrational price competition. Rate hikes are positive for banks.
• For now, we gather that the pricing change affects the secondary property market, leaving primary property market unscathed.
• Pricing power depends on banks cost structure and incidences of default.We believe banks will price products based on risk.
  

Margins are extremely thin. Banks are barely breaking even with irrational competitive pricing for mortgage products. At BLR-2.4%, it effectively takes banks at least 2-3 years to breakeven. BLR currently stands at 5.55%, while average cost of funds for banks are 2%. Taking into account implied costs set aside for credit default (can range from 20-30bps) coupled with overhead costs (agent’s commission and fees) estimated at another 30bps, net yield gain on a mortgage loan is merely 1%. Rate levels are already at an all time low. We believe it is a
matter of time before rates pick up.

Pricing power depends on banks. Every bank would be
able to price products depending on their respective cost structure and also incidences of default. While we agree that mortgage pricing has reached a level of irrationality, we believe banks would price products based on risk. For a customer with a healthy credit profile, it is possible for the bank to offer him/her an attractive rate. From our checks, we understand the pricing change affects the secondary market while the primary market is left unscathed at this juncture.

Evolving banking landscape. We expect OPR to rise in 3Q10 inline with the stronger than expected growth (our forecast of 5.0% versus official forecast of just 2-3%) as well as inflation trending toward 2.30-2.50% by Jul 10. We are looking for 25bps in 3Q10 and another 25bps in
4Q10. With the re-pricing of loans quicker than deposits, the impact would generally be positive on NIM. Banks with positive impact on rate hikes are Hong Leong Bank (Buy, TP RM8.00) and RHB Cap (Buy, TP RM6.60) by virtue of their higher proportion of variable rate loans. As for Public Bank (Buy, TP RM12.20), while mortgage loan volumes may dwindle, we expect higher rates should more than neutralize the impact.