We formulated a new ESG scoring model and find that the average rating for the banking sector was 3.8 points (+70bp vs previous methodology); we saw most banks did well for Governance but performed below par for Environmental while scoring averagely for Social. That said, we did not see any major annual rating improvement trend, which indicates the level of commitment towards ESG has stayed largely the same from a year ago. Overall, the sector has a balanced risk reward profile, in our view (dissipating tailwinds are soothed by undemanding valuations). Retain NEUTRAL; the two BUY calls we have are RHB and BIMB.
New ESG scoring methodology. After receiving constructive feedbacks from various stakeholders, we opted to change our ESG scoring methodology. To recap, we earlier assigned 1-8 points to banks under our coverage, based on 16 parameters, using the ‘1224’ ranking system. After that, we totalled up the points, scoring them out of 5, and performed a relative comparison. Although we reckon this was an objective method to assess and rate ESG performance, it is not without flaws; for some ESG parameters, we noticed lower ranking banks were unjustly penalized (in terms of scoring) despite having close to sector average performance while higher ranking ones were too amply rewarded.
Instead, we now appraise them from 1-5 (on an absolute basis) according to our new proprietary scoring bands to fix this issue and also, we widened our ESG assessment to 20 parameters. Furthermore, we added Disclosure & Transparency to be part of our new rating consideration to reward banks that furnish more in-depth ESG information. However, each components we evaluate carry different weighting to the overall score, tuned to the level of importance, determined by us: (i) Environmental - 20%, (ii) Social - 20%, (iii) Governance - 50%, (iv) Disclosure & Transparency - 10%; the large weight ascribed to Governance is because good corporate practices are essential to ensure and bolster long-term sustainability of a bank. Besides, it could help in setting the tone for the other components to flourish.
ESG results round-up. Based on our latest compilation with the new proprietary ESG scoring model, the mean rating for the banking sector was 3.8 points (+70bp against previous methodology); we observed most banks did well for Governance (>4 points) but performed below par for Environmental (< 3 points) while just scoring averagely for Social (~3 points). On an individual basis, Maybank still posted the highest ESG grade of 4.1 while Alliance came in bottom of the rankings at 3.3 points. The former excelled in the areas of Governance (4.8 points) and Social (3.2 points), whereas the latter was dragged down by poor scores at the Environmental (2.0 points) and Social segments (2.3 points).
Retain NEUTRAL. Even though there was an uplift in ESG grading due to the change in scoring model, we did not see any major annual improvement trend in rating for the banking sector - this indicates that the level of commitment towards ESG has stayed largely the same from a year ago. Overall, we continue to believe the banking sector has a balanced risk-reward profile. Tailwinds which were supposed to be enjoyed by banks (like big NIM expansion, strong credit growth) over FY22-23 have instead been frontloaded to last year, turning the next 12 months to be less exciting. Besides, banks may now have to grapple with possibly steeper cost of funds, smaller NOII, and loans growth. However, undemanding sector valuations and decent dividend yield of 5% are consolations that would provide downside support to share prices. Currently, we only have two BUY ratings under our coverage, namely RHB (TP: RM6.60) and BIMB (TP: RM3.00). The former is liked for its high CET1 ratio and attractive price-point while the latter is adored for its laggard share price performance and bright structural long-term growth prospects.
Source: Hong Leong Investment Bank Research - 16 Feb 2023
