Investment Highlights

• There continues to be expectations of a mild and gradual rate hike cycle in developed economies. Meanwhile, BNM's more hawkish tone has hinted a potential review of monetary accommodation, which may see a revision of 25-50bps in the OPR in 2018. This could normalise the benchmark interest rate back to 3.50%.

• We are projecting 1 to 2 rate hikes (25bps each) in 2018, which will be mildly positive on banks' earnings.

• An interest rate hike will have a temporary positive impact on banks' net interest income (NII) as banks' loan rates will be repriced higher, adjusting to the hike in the OPR before deposit rates catch up. We expect the lagged impact of the deposit rates to be 2 to 3 months after the adjustment in loan rates.

• We have simulated the impact of rate increase on earnings of banks, assuming that a 25bps hike occurs in 2H2018. This simulation is based on assumptions of: i) 2 months’ lagged impact from the repricing of domestic deposit rates; ii) banks with financial year-end (FYE) December simulated with their FY18 numbers while banks with FYE March or June are assessed based on their FY19 earnings. From our estimates, a 25bp increase in the interest rate could increase banks' net profits by 0.9% to 2.4%.

• The extent of benefits to earnings will depend on the following in the respective banks: i) percentage of floating rate loans; and ii) percentage of domestic to total loans well as the timing of the rate hike relative to the bank's FYE. Alliance Bank (ABMB) with the higher floating rate and percentage of domestic loans will benefit most from the rate hike. This will be followed by RHB Bank (refer to Exhibit 2).

• We are rolling over our valuations from banks with financial year ending March (ABMB) and June (Hong Leong Bank) to be based on FY19 numbers from the present FY18 estimates.

• On ABMB, we are upgrading the stock to a BUY from HOLD, with a revised fair value (FV) of RM4.40/share (previously: RM3.90/share). We are pegging the stock to a higher PB/V multiple of 1.2x from 1.1x, based on a higher ROE estimate of 9.9% for FY19. ABMB will be the key beneficiary of an increase in interest rate due to the large composition of floating rate domestic loans. A larger portion of the group's expenses is on IT investments, streamlining of branch network, and restructuring is expected to be incurred in FY18. This is anticipated to result in a lesser drag on the group's earnings in FY19. With a substantial portion of the transformation expenses out of the way in FY19, we project an improvement to ABMB's CI ratio to 47.0% from 50.0% in FY18, and an improvement in earnings to 11.2% in FY19 compared to a decline of 5.4% in FY18. We expect ABMB's NII to improve, benefitting from its focus in growing Alliance One Account (a debt consolidating facility) and SME loans which have higher yields.

• On Hong Leong Bank, we have tweaked our FY18/19 earnings marginally higher by 2.0%/2.6% to account for higher contribution from its associate Bank of Chengdu and NII. This raises our ROE projection for FY18/19 to 9.9%/10.0% (previously: 9.7%/9.7%). We maintain HOLD on Hong Leong Bank but revised our FV to RM16.70/share (from RM15.00/share) after rolling over to FY19. This pegs the stock to a FY19 P/BV of 1.4x, supported by a higher ROE of 10.0%.

Source: AmInvest Research - 12 Jan 2018