Maybank’s strong earnings shroud growing loan book risk

Maybank recently announced a strong finish for its FY11 that ended in June 2011. The bank reported FY11 net profit growth of 16.6% year-on-year (YoY) on the back of 8.9% revenue growth. The growth was driven mainly by: a) exceptional corporate loan growth, b) lower allowances for losses on loans and loan impairment, and c) higher non-interest income from its insurance and takaful businesses. High corporate loan growth coupled with increasing non-performing loans (NPLs) highlight rising potential risk in the bank’s operations in a time when global markets and regulators are calling for enhanced risk management.

In contrast, both OCBC and Public Bank have strengthened their asset qualities while recording strong profit growth. The former reported a similar net profit growth of 15% YoY, underpinned by strong interest income from broad based loan growth and non-interest income, particularly from its insurance and wealth management businesses. Public Bank announced even stronger net profit growth of 21.9% YoY in the same period (July 2010 –June 2011). This was primarily driven by retail loans and non-interest income growth of its unit trust management business.

Figure 1. Loan growth (% YoY) and non-performing loans (% gross loans) of Maybank, OCBC and Public Bank in Q2 2010 and Q2 2011

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Figure 2. ROA (%) and ROE (%) of Maybank, OCBC and Public Bank in Q2 2010 and Q2 2011

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In terms of adjusted profitability measure, Maybank recorded lower ROE than Public Bank in Q2 2011. Additionally, Maybank’s ROE increase of 0.7% lagged behind that of OCBC (1.3%) and Public Bank (1%) during the same period, mainly due to the bank’s lack of growth in most retail banking business lines. In comparison, ROA growth was relatively smaller for all three banks.

The following sections outline a detailed analysis of the Maybank’s operations with respect to OCBC and Public Bank between June 2010 and June 2011. 

1. Net interest income

Maybank’s impressive net interest income growth of 14.4% was primarily driven by strong loan growth of 22.5%YoY in June 2011. Loan growth for its overseas business in Singapore and Indonesia was even stronger at 35.1%YoY and 24.7%YoY respectively. OCBC recorded similar net interest income growth of 15%YoY in June 2011, driven by a 21% increase in interest earning assets and 27% in customer loans. This was despite the decrease in domestic net interest margin by nine basis points from 1.96% in June 2010 attributed to: a) persistent low interest rate environment, b) strong growth in well-collateralised lower-yielding loans linked to trade and c) price competition, particularly in the housing loan segment. In Malaysia, Public Bank reported strong but lower net interest income growth than Maybank of 11.8%YoY in June 2011 to $1.6 billion. The bank loan growth stabilised at an annualised growth rate of 13.6% to $55.3 billion in the first half of 2011. In particular, domestic loans grew 14.5%YoY, leading to an increase in the Group’s domestic lending market share to 16.4%.

Figure 3. Loan Growth (%YoY) and Loan to Deposit Ratio (%) of Maybank, OCBC and Public Bank in Q2 2010 and Q2 2011

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In terms of business segment, corporate loans contributed a stunning 120.2%YoY growth in pre-tax contribution for Maybank in Q2 2011. However, this huge expansion of corporate loans contributes significant risk as they lack the risk pooling capabilities of smaller retail loans. In contrast, the lending activities of Public Bank remained retail centric, with loans to mid-market commercial enterprises as well as loans for the financing of residential properties and purchase of passenger vehicles accounting for 85% of the total loan portfolio of the Group as at the end of June 2011. OCBC’s loan books also measure lower risk than that of Maybank, as the growth was generally broad based across all segments.Moreover, the huge growth in corporate loans has outpaced deposit growth, leading to an increase in Maybank’s high loan to deposit ratio from 86.8% in June 2010 to 90.1% in June 2011. This increase in loan to deposit ratio indicates increased balance sheet risk of the bank’s core business, which might negatively impact shareholders’ and regulators’ perception of its risk profile. In comparison, OCBC and Public Bank have both seen a decrease in their loan to deposit ratio by 5.4% and 1.3% respectively in the same period despite increased loan growth.     

2. Non-interest income

All three banks have reported strong non-interest income in 1H2011 alongside growth in net interest income. This has resulted in the stabilisation of non-interest income as a proportion of total operating income in the reported period. Amongst the three banks, OCBC’s non-interest income is the most sustainable due to its diverse sources. 

Figure 4. Non-interest income of Maybank, OCBC and Public Bank in 1H 2010 and 1H 20

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Non-interest income for Maybank increased 11.4%YoY in June 2011 on the back of a12.8%YoY rise in fee income, as well as a 50.1% jump in net investment gains to offset higher unrealised losses for securities held for trading and derivatives. Sustainable fee income growth was mainly driven by insurance and takaful business contribution, which grew 21% to $160 million in June 2011. On the other hand, net investment gains have a significantly lower probability of continuing in the next year. Similarly, Public Bank recorded huge increase in non-interest income of 22% to $1.5 billion primarily from a single source—its unit trust management subsidiary, Public Mutual. Pre-tax profit for the business grew of 24% in the first half of 2011. It maintained its market leadership position with Assets Under Management (AUM) growing 21.7% to $14.7 billion in June 2011, accounting for an overall market share of 44% in the same period.

In comparison, OCBC’s non-interest income growth of 13%YoY was supported by a wide array of sources, including higher fee and commission income, profits from life assurance and dividend income.  Fees and commissions rose 20%YoY to $243.6 million in June 2011, led by growth in trade-related income, service charges linked to renminbi-settled trade, fund management and other wealth management-related income.  Life assurance profits from Great Eastern Holdings (GEH) increased by 53%YoY to $86.3 million, reflecting strong underwriting profit and a better investment performance as compared to the same period a year ago. As a share of total revenue, wealth management contributed 24.8%, up from 21.9% a year ago.  OCBC’s private banking business continued to grow strongly, with assets under management increasing 12% in the first six months to $29.6 billion as at 30 June 2011. 

3. Risk management

Although Maybank, OCBC and Public Bank have recorded strong %YoY loan growth figures in Q2 2010 , Maybank has done so at the expense of deteriorating asset quality and loan loss coverage.  However, the bank did exercise caution by slightly strengthening its Tier1 and Total Capital Adequacy Ratio (CAR).

Figure 5. Non-performing loans and loan loss coverage for Maybank, OCBC and Public Bank in Q2 2010 and Q2 2011

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Maybank has seen deteriorating asset quality as a consequence of the rapid expansion in its loan books. Between June 2010 and June 2011, the proportion of loans classified as non-performing loans (NPLs) increased from 3.0% to 3.4% of total loans, above the industry average of 3.0%. This, combined with the huge decrease in loan loss coverage from 124.5% to 82.3% in the same period, significantly increases the risk of the bank’s core operations. The loan loss coverage of 82.3% is also lower than the average Malaysian banking industry’s coverage ratio of 92.2%.On the other hand, Public Bank has not only maintained its top ranking in asset quality amongst its peers, but also further improved its gross impaired loans ratio from 1.21% as at the beginning of 2011 to 0.96% as at the end of June 2011 despite growing its loan books. This is significantly lower than the Malaysian banking industry’s average gross impaired loan ratio of 3.0%.The Public Bank Group's loan loss coverage ratio also continues to remain one of the highest at 169.7%, despite the fact that more than 90% of the impaired loans outstanding are secured. 

Similarly, OCBC has acted prudently in its loan growth between June 2010 and June 2011. The Group’s asset quality improved and coverage ratios remained strong, with NPL ratio improving from 0.9% to 0.8% during the period. Total cumulative allowances represented 123% of total non-performing loans in 2Q 2011, up from 94% in 2Q 2010. In particular, total cumulative allowances as a percentage of unsecured NPAs was 311%, up from 272% in 1Q11. The huge increase in net allowances was recorded upfront to provide for the strong loan growth.

Figure 6. Capital Adequacy Ratio for Maybank, OCBC and Public Bank in Q2 2010 and Q2 2011

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However in terms of capital requirements, Maybank recorded higher figures than Public Bank, both on Tier 1 and CAR in Q2 2011. The former’s Tier 1 and total CAR increased by 0.3% and 0.2% between Q2 2010 and Q2 2011. This was partly due to its dividend reinvestment plan, which was well received by shareholders with a higher reinvestment rate. This plan allowed the bank to continue strengthening its capital position for future business expansion and Basel III capital requirements. Public Bank’s capital position saw a slight decline, with its Tier 1 capital ratio and risk-weighted capital ratio standing at 9.7% and 13.2% respectively as at the end of June 2011. This is partly due to the increase in loan loss provisions in the same period.

OCBC’s increase in CAR was primarily due to the Singapore’s regulations requiring 2% higher CAR than Basel III requirements. OCBC remained well capitalised, with a Tier 1 ratio of 15.4%, and total capital adequacy ratio of 17.0% as of 30 June 2011. These capital positions were well above Singapore’s regulatory minimums of 10.5% and 12.5%, respectively. The core Tier 1 ratio, which excludes Tier 1 preference shares, was 11.9%. 

4. Future outlook

The Malaysian economy is expected to grow by 5% to 6% in 2011. The outlook of the Malaysian banking sector, in which Maybank largely operates, remains positive, supported by strong economic fundamentals, robust domestic demand and the roll-out of the Economic Transformation Programme (ETP). However, external factors such as the debt issues of Europe and US, should they continue in the near future, might slowdown Malaysia’s economic and banking industry growth. 

Maybank’s management is aiming for an annualised loan growth of 12% for the remaining months to 31 December 2011, with growth driven mainly by strong double-digit growth from Indonesian and Malaysian loans, driven in turn by corporate and business loans on the back of ETP. In comparison, Public Bank is likely to experience lower loan growth than Maybank, due to their retail focus, harvesting less benefit from ETP. However, total interest income is not likely to grow as high as loan growth. Net interest margin (NIM) compression is likely to be a key concern of management as the price war for both loan and deposit products intensify in Malaysia. This is likely to lead to another 10 –15bp NIM contraction in the months to 31 December 2011. 

Maybank’s strong pick up in non-interest income come primarily from its enlarged investment banking presence and acquisition of Kim Eng brokerage as well as its Indonesian operations is expected to contribute considerably in its financial performance for the next two years. However, this is likely to be more volatile than Public Bank, which will continue with its efforts to further build the infrastructure to drive the expansion of its bancassurance business to increase its fee-based commission income in the long run.