A potential slowdown in public expenditure and private investments could have a slight dampening effect on growth. We advocate a two-pronged strategy, focusing on banks with defensive qualities (Pbank) and those that have been excessively sold down due to sentiment rather than material changes in fundamentals (CIMB). Maintain MARKET WEIGHT as modest top-line growth is being mitigated by stable asset quality trends and healthy capital buffers.

WHAT’S NEW

Lower scope for NIM upside given BNM’s latest monetary policy statement. The overall outperformance of the banking sector in 2017 coincided with an increase in the momentum of the Federal Reserve (Fed) rate hike cycle (3 hikes in 2017 vs 2 hikes in 2016) coupled with lower provisions helping to fuel an earnings recovery. However, as shown in the right hand chart, Bank Negara Malaysia (BNM) had only raised its policy rate by 25bp (1x) in 1Q18 and with Overnight Policy Rate (OPR) remaining unchanged since 2015 vs 7 hikes that the Fed had initiated since late-15. As such, the scope for potential upside in NIM that the market may have anticipated for the sector did not materialise.

BNM signalling a more neutral to dovish tone. In its recent monetary policy committee statement, BNM has kept the OPR unchanged at 3.25%. The tone of the statement was expectedly neutral to slightly dovish. Given the prospects of potentially lower headline inflation from the abolishment of the 6% GST (replaced with sales and service tax) and implementation of targeted fuel subsidies, BNM may in fact have room to ease monetary policy if needed.

Ample domestic liquidity ensures a more modest increase in future rates. The 3- month KLIBOR has remained relatively steady at 3.69% since Feb 18 despite the 10-year MGS yield having risen 22bp over the same period, underpinned by relatively healthy domestic liquidity placed with BNM at RM189b. This, coupled with potentially slower-thanexpected headline inflation could mean a more neutral to moderate monetary policy tightening as compared to a few regional emerging market peers in the face of ongoing global monetary normalisation. We are expecting BNM to hold rates steady for 2H18, resulting in only a single 25bp rate hike for 2018 vs Indonesia’s and Philippines’ aggregate 100bp and 50bp rate hikes in 1H18 respectively.

ACTION

Maintain MARKET WEIGHT. Post-GE14 macro policy uncertainty could have a slight dampening effect on overall growth. As such, sector performance in 2H18 is likely to be more muted. However, earnings downside risk is partly mitigated by strong cost discipline (+2% to +3%) and manageable credit cost growth. Sector is trading at 1.20x 2018 P/B (- 1.0SD below 10-year mean) which is fair against the forecasted ROE of 10.2%

Defensive and oversold banking stocks. Given this scenario, we advocate a twopronged strategy to navigate the potentially volatile near-term sector outlook with a focus on banking stocks with defensive qualities and those that have been excessively sold down due to sentiment rather than material changes in fundamentals. In this respect, we like Public Bank (Pbank) for its defensive qualities and it being a favourable proxy to the consumer and SME segments. We continue to like CIMB as we opine that the selldown on its share price has been excessive with the group still expected to chart a double-digit earnings growth recovery in FY18 on the back of lower provisions coupled with its appealing valuations (0.97x FY18F P/B: -1SD below mean). We also like BIMB given its attractive valuations and it being a proxy to stronger consumer purchasing power (70% consumer loans books).

ESSENTIALS

NIMs disappointed in 1Q18 despite interest rate hike of 25bp. The sector’s 1Q18 NIM expanded a modest 1bp qoq despite the benefit of a 25bp OPR hike in Jan 18 as competition for fixed deposits had intensified. With fixed deposits expected to fully reprice upwards in 2Q18 and 3Q18, we expect NIM to decline sequentially, placing greater pressure on net interest income growth trends. CIMB, HLBank and Affin experienced qoq compression in 1Q18 NIM while the remaining banks experiencing an average 5bp qoq expansion which should normalise downwards in 2Q18.

2H18 sector performance to be more muted. Post GE14, policy uncertainties may pose downside risk to GDP growth and consequently overall sector growth in 2H18. The sector in general benefited from net foreign equity inflows of RM3.7b from Jan-Apr 18 which was well reflected in the rise in foreign shareholdings among the large cap banks (May: +1.7ppt, Public Bank: +1.3ppt and CIMB: +1.3ppt) as foreign funds may have been positioning ahead of the GE14. The surprise election results, escalating trade tensions between China and the US and global monetary tightening will be key factors prompting foreign funds to adopt a more cautious approach post GE14. Consequently, the sector outperformance in 1H18 is unlikely to repeat itself in 2H18, until investors are able to gain greater clarity of the unfolding policy changes of the new government on near-term growth. In fact, the sector had underperformed the FBMKLCI after the GE14, declining 9.5% vs the FBMKLCI’s 8.4%.

Loans growth recovery driven largely by construction loans which are now at risk. The mild recovery in overall loans growth from 4.1% in 2017 to 4.9% as at end-May 18 was largely attributed to strong growth traction in construction-related loans which grew from 4.5% in 2017 to 9.5% yoy currently. Working capital loans growth remained relatively muted at 2.2%, while residential property loans growth was stable at 8.8% (2017: 8.9%). Given the deferment/scaling down of a number of mega infrastructure projects, we are expecting a sharp slowdown in construction-related loans growth which will offset the potential positive effect from stronger consumer spending during the 3- month “tax holiday period”. This has prompted us to retain our 5.0% full-year 2018 loans growth assumption with a slight downside bias.

GIL ratio relatively benign. On balance, the banking system’s gross impaired loans (GIL) ratio has remained relatively benign, improving from the peak of 1.67% in Sep 17 to 1.60% in May 18. In fact, consumer GIL ratio has improved to the historical low of 1.00% while business GIL ratio has remained largely stable, partly driven by the recovery in oil prices. Only non-residential property loans continued to exhibit asset quality deterioration with its GIL ratio reaching a new six-year high of 1.32% in May 18 (Dec 17: 1.06%). That said, we do not discount the possibility of a slight uptick in GIL from the deferment of various infrastructure projects and the unwinding measures undertaken by the new government to deal with the previous government’s excesses.

Pbank remains our top sector pick. As the new government’s policy changes are still in the early stages of implementation, we believe that there could still be some time lag before any downside risk to loans growth and upside risk to NPLs emanating from the review/cancelation of various infrastructure projects will be more visible. Banks that have lower exposure to construction and a government agency-related loans composition and a relatively higher consumer and SME loans base could be more insulated (Pbank, Hong Leong Bank and Alliance Bank). However, among the three banks, Pbank has a strong foothold in both consumer and SME loans segments (87% of overall loans base) which places the group in a strong position to ride out the current period of uncertainty.

Maybank - Awaiting clarity on Hyflux provision risk. Despite the sharp retracement in share price (-16.1% since GE14), its valuation at 1.30x FY18F P/B is still expensive relative to CIMB’s at 0.97x P/B and with the stock price having declined to -2SD below mean P/B in 2015 when the group was impacted by O&G provisions vs current levels of - 0.5SD. Although current dividend yield of 6.2% should provide share price support, upside is limited by potential provision risk from the group’s exposure to project financing to Hyflux Ltd in Singapore on which we should get greater clarity when it releases its 2Q18 results. We have only incorporated a potential RM200m (2.3% of FY18 earnings) in provisions to our FY18 forecast against Maybank’s potential loan exposure from Hyflux Ltd of between RM1.4b to RM2.1b, representing a LLC of only 10%. As such, there could be upside risk to our provisions assuming if Hyflux Ltd is unable to resolve its debt issues by disposing of its Tuaspring plant in a timely manner. We understand that Hyflux Ltd has faced an uphill task in disposing the plant since 2017 and with current cash flows not sufficient to service the interest cost of the debt.

Source: UOB Kay Hian Research - 13 Jul 2018