Banking sector
Maintain overweight: Following the July 16 release of our report focusing on the expansion of Malaysian banks to Indonesia, we talked to 55 fund managers (FM) and buy-side analysts from 28 investment management firms in Malaysia and spent two days in Singapore meeting 13 FMs and analysts from nine firms. The key messages we conveyed during our roadshow included (i) Malaysia is a mature market with loan growth of 10% to 11% in 2010 and sustainable net interest margin of 2%+; (ii) Indonesian banks offer the best long-term growth prospects with loan growth of 17% to 18% in 2010 and lofty net interest margins of 6%+; and (iii) Banks with exposure to high-growth markets such as Indonesia have better prospects for long term growth.

Most investors concur with our view on the outlook for Malaysian banks and our investment themes. Apart from some technical questions, the major question or concern voiced by investors is whether the net interest margin in Indonesia is sustainable.

Our bullishness on Indonesian banks is primarily underpinned by their strong net interest margins of 6% to 7%, which are way above the 2% to 3.5% range for banks in other countries under our coverage. However, investors are wary about a possible downtrend in the net interest margin as the continuous development of the industry will drive down the margins for Indonesian banks. Our Indonesian banking analyst expects margins to drop from 6% to 7% to 5% to 5.5% over the next three to five years. However, this would still be more than double the margins earned in the more established markets such as Malaysia, Singapore and Hong Kong. Our analyst does not expect a swift contraction in Indonesian banks' margins given the low penetration of financial services in the country. Assuming annual GDP growth of 8% and loan growth of 18% for Indonesia in the next five years, its loan-to-GDP ratio would increase from 26% to 40%, still less than half the 100%+ ratio in
the developed markets.

One of the banking stocks that we promoted during our roadshow was Affin Holdings (outperform). Affin is one of the smallest banks in Malaysia but has shown strong improvement in its financial performance in the past one to two years. In 1Q2010, its net profit shot up 47.7% year-on-year (y-o-y) to a record RM135.3 million and it has been racking up 10% to 16% y-o-y loan growth since December 2008 (13.7% y-o-y growth in March).

However, investors are worried that the strong loan growth may mean excessive lending and could lead to higher NPL ratios in the longer term. But our checks with management confirmed that the bank adheres closely to stringent lending policies and has a robust credit scoring system. Management does not expect the brisk loan growth to lead to deterioration of asset quality. This appears to be borne out by the trend in 2008/09 when loan growth picked up from 1.4% y-o-y in 2007 to 10% to 12% y-o-y but the gross NPL ratio improved from 14.3% in December 2007 to 3.7% in December 2009.

Some investors brought up the underperformance of Maybank's share price, which has risen only 12.6% over the past year, lagging behind the 14.9% gain of the FBM KLCI and 26.5% rise for the KL Financial index. Maybank's share price has also underperformed CIMB Group Holdings (+38.3% y-o-y) and Public Bank ("outperform") (+22.6% y-o-y). Maybank's P/BV of 1.9 times is below its five-year average of two times, mainly due to the slide in its return on equity (ROE) from 17.6% in FY2006/07 to a projected 14.6% in FY2010 as a result of last year's rights issue. Given the likelihood of stronger earnings in the coming quarters and the pick-up in the momentum of BII, we expect this laggard to play catch-up.

We are positive on Affin's acquisition of 80% of Bank Ina Perdana as this will give it a foothold in Indonesia's high-growth market. However, we concur with the views of some investors that the contributions to the top and bottom lines will be minimal in the next two to three years. In FY12/09, the Jakarta-headquartered bank recorded a net profit of about RM4.8 million, which was only 1.3% of Affin's total net earnings.

As such, the catalysts for Affin in the next two years will still come from its domestic operations. We are projecting net earnings growth of 27% for FY2010 and 15.7% for FY2011, underpinned by (i) 7% to 11% increases in net interest income as a result of robust loan growth of 11% to 13% and margin expansion; and (ii) a 52.6% plunge in loan loss provisioning in FY2010. In FY2010/11, more than 98% of Affin's revenue and earnings will still be generated from its domestic operations. Its Indonesian unit will start to support the group's earnings growth from FY2012 onwards after the group completes the acquisition in 2Q2011 and spends six to 12 months to rejuvenate the earnings of this unit. As a result, we prefer Maybank for a play on Indonesian banks given the more meaningful contributions from BII compared with Affin, which will take at least two to three years to get to this stage.

We are encouraged by the good response to our roadshow in Malaysia and Singapore. The clients we met showed interest in Malaysian banks. None of them held particularly negative views on Malaysian banks or questioned our projection of 23% net earnings growth for 2010. Investors also concurred with our positive take on Malaysian banks' diversification to high-growth markets such as Indonesia.

Our roadshow did not alter our positive stance on Malaysian banks. In fact, it is heartening that most of the investors we met agreed with our positive take on Malaysian banks including their exposure to the high-growth markets. Given the favourable outlook, we reaffirm our overweight call on the sector, predicated on the potential re-rating catalysts of (i) strong earnings growth, (ii) higher investment banking income, (iii) brighter growth prospects for overseas operations, and (iv) potential general provisions (GP) write-backs.

Although AMMB Holdings has limited overseas contributions, it remains our top pick among the Malaysian banks as we believe that its transformation programme locally should help it raise its ROE from 11.6% in FY3/10 to 14.6% in FY2012. For the longer term, management is gunning for an even higher target of 18%, which will be one of the best among the local banks. Factors that could catalyse the share price include (i) value-add from ANZ, (ii) benefits from the group revamp, (iii) better-than-expected pipeline for investment banking deals to increase fee income from this area, and (iv) new growth avenue from the derivative and foreign exchange businesses. However, for a play on Indonesia, Maybank is our pick. ? CIMB Research

This article appeared in The Edge Financial Daily, August 13, 2010.