Investment Highlights

• We continue to be OVERWEIGHT on the banking sector in 2018. We expect the sector's core earnings growth to improve to 10.1% in 2018 (2017: 6.8%), underpinned by higher non-interest income of 5.4% YoY from stronger capital market activities coupled with a modest loan growth. Also, we project an improvement in net interest margin (NIM) to drive the growth in banks' interest income by 6.1% YoY in 2018.

• For 2018, we are anticipating a loan growth for the Malaysian banking industry at a modest 5.0% on the back of a GDP growth of 5.5%, resulting in a loan-to-GDP multiplier of close to 1.0x. This compares to our expectation for 2017 of a range between 5.0% and 6.0%, premised on a projected GDP growth of 5.7%. Domestic demand and improvement in external trade will be the drivers for economic growth in 2018.

• We forecast NIM of banks to improve by 3bps YoY in 2018. We foresee a modest improvement in NIM from banks' repricing of loans to compensate for higher provisions under MFRS 9 as well as a milder pressure on banks' funding cost from deposit competition. The latter is due to the delay in implementation of the net stable funding ratio (NSFR) to no earlier than 1 January 2019. Deposit competition is still expected to exist but to a lesser extent now in terms of intensity. BNM's tone has turned hawkish after the recent monetary policy meeting in November. The central bank hinted that the strong economic growth locally and abroad may prompt it to review the degree of monetary accommodation. This implies a potential revision of 25-50bps to the OPR, which may happen next year. We expect this to occur only if the domestic inflation rate has been driven largely by an increase in demand rather than cost push factors. In the event that this occurs, it would have a temporary positive impact on banks' NIM as loans will be repriced higher, adjusting to the hike in the OPR ahead of deposit rates.

• We expect a gradual improvement in banks' asset quality in 2018. This is particularly on the asset quality of banks' overseas operations. Meanwhile, the domestic asset quality is expected to remain stable. OPEC and Russia have recently agreed to extend oil production cut until the end of 2018. Against a potentially higher shale oil extraction as oil prices improve, this should keep oil prices stable. We expect banks' asset quality which was earlier impacted by the weakness in oil & gas loans in Singapore and to some extent domestically, to improve. On allowances for loan losses, we see the sector’s provisioning to be higher in 2018. This is due to the implementation of MSFR 9 on 1 January 2018. However, the increase in provisions on Day 1 of the adoption of MFRS 9 will be charged directly to shareholders’ fund, and this will impact banks' CET1 ratios. Nevertheless, we expect the impact to banks' capital position to be manageable. Any increase in provisions from the adoption of the new accounting standard is expected to have a much larger impact on banks' balance sheets than their P&Ls. For now, we are maintaining our credit cost assumption of 30bps for the sector in 2018 vs. 31bps in 2017. We will review our assumption once banks have provided their guidance on the run-rate of their credit cost post-MFRS 9.

Source: AmInvest Research - 2 Jan 2018