This article first appeared in The Edge Financial Daily, on June 6, 2016.

KUALA LUMPUR: Malaysian banks are faring not too badly against their Indonesia, Singapore and Thailand counterparts on a number of key financial metrics amid slowing economic growth in Asean, said regional analysts.

“Malaysian banks are showing generally stable performance in key financial metrics. We expect non-performing loans (NPLs) to go up and profitability to decrease. But capital buffers, liquidity and funding should remain strong,” Moody’s Investors Service vice-president and senior credit officer Eugene Tarzimanov told The Edge Financial Daily in an email interview.

NPLs are one of analysts’ top concerns for the region as stresses emerge in some segments, especially commodities-related ones.

The gross NPL ratio of Moody’s rated banks in Malaysia stood at 1.5% as at the end of last year, the lowest of the four markets after Singapore (1.05%).

Moody’s rates 10 banks in Malaysia — all eight of the local banking groups and two foreign banks.

“On average, Malaysian banks are posting lower NPL ratios in the currently challenging environment; this is despite some new NPLs coming from foreign markets such as Greater China and Singapore. Domestically, their NPLs remain relatively stable.

“Looking back at 2015 and at the first quarter of 2016, most Malaysian banks either maintained or improved their loan quality, while banks in Singapore, Indonesia and Thailand witnessed higher problem loan ratios and restructured loan ratios,” the Singapore-based Tarzimanov said.

“For 2016/2017, we expect Malaysian banks’ NPLs to increase moderately — namely in oil and gas, overleveraged households, and parts of real estate builders,” he added.

He noted that while the problem loan coverage in Malaysia is “good”, at around 90%, it is much stronger in Singapore, Thailand and Indonesia at 120% to 130%.

The loan loss coverage (LLC) ratio of Malaysian banks have been trending down as the pace of increase in impaired loans is faster than that of their loan loss reserves.

“In our view, this is not a necessary sign of trouble as the banks are bound by stringent provisioning guidelines. Although several banks reported historical low LLC ratios [in the recent reporting quarter], we are cognisant that collateral values remain high,” an AllianceDBS Research’s banking analyst said.

According to Moody’s, the share of bank loans related to the energy/commodities sector in Malaysia stood at around 5% in Malaysia compared with 11% in Indonesia, and 9% in Thailand and Singapore.

UOB Kay Hian Research, in a report on the Asean banking sector last week, noted that with the sluggish economic growth having descended on Asean countries, loan growth is likely to decelerate to the low single digits for Singapore, mid-single digits for Malaysia and Thailand, and the low teens for Indonesia in 2016.

Last week, Bank Negara Malaysia released banking data for the month of April, which showed that the banking system’s loan growth slowed to 6.4% year-on-year (y-o-y), the eighth straight month of loan growth deceleration. Interestingly, this is the longest stretch of deceleration since early 2009. On an annualised basis, industry loan growth stood at a mere 0.6%.

Compression in net interest margins (NIMs) will result in lacklustre net interest income growth in Malaysia, Thailand and Indonesia, said UOB Kay Hian.

In Malaysia, where banks face rising funding costs, it expects NIMs to be compressed by “a severe” 10 basis points (bps) this year as banks compete harder in chasing deposits. In Thailand, it expects a NIM squeeze of 10bps too after banks cut their lending rates by 25bps since March to ease pressure on the corporate sector.

Indonesian banks are expected to suffer the most, though, as the government has demanded that banks lower their lending rates to the single digits in a bid to spur economic activity.

“This would cut NIMs by 100bps to 150bps and return on equity by up to 2.5 percentage points in the next three years,” the research house said.

Singapore banks, on the other hand, could see NIMs expanding between one and six basis points this year, getting a boost from US interest rate hikes that could potentially materialise in the second half of the year.

From an investment standpoint, UOB Kay Hian is the most positive on Singapore banks as they are seen as beneficiaries of the potentially higher US interest rates. It maintained an “overweight” call on the banking sector there compared with a “market weight” in Malaysia, Thailand and Indonesia.

For Malaysia, its main concern is credit costs going up. “Loan growth has eased to 6.5%, and NIMs are expected to see a severe 10bps compression in 2016. Household leverage is elevated at 89% and deposit growth is muted at -0.8% y-o-y.

Credit costs would also normalise upwards as industry loan loss coverage is low at 94%. We expect paltry earnings growth of 3.4% due mainly to cost rationalisation exercises such as mutual separation schemes,” it said.

Its top stock picks in Asean are Singapore’s DBS Bank Ltd and OCBC Bank, Malaysia’s RHB Capital Bhd, Thailand’s Kasikornbank Pcl and Bank Negara Indonesia.

In the fourth quarter of 2015, gross domestic product growth slowed to 4.9% y-o-y for Indonesia, 4.2% for Malaysia and 3.8% for Thailand, and stagnated at 1.8% for Singapore.