The recent GE14 surprise outcome has heightened concerns on banking mid term prospects. The uncertain economic policies and reviews of certain mega projects have put banks’ earnings and asset quality at risk. The delay in mega projects will pose a risk to banks’ loan growth target for 2018. In addition, current volatile environment is a bane for the banks NOII. Asset quality is well contained now, however we may see a gradual weakness if this situation persist. Post earnings forecast revisions and valuation parameter upda te, we downgrade our rating on CIMB and Maybank to HOLD (from Buy previously), and upgrade our ratings on AMMB and PBB to BUY (from Hold previously). Ratings for Affin, Alliance, BIMB, and RHB remain unchanged. We downgrade our sector rating to NEUTRAL (from Overweight previously). For exposure, our top pick is now PBB (BUY; TP: RM26.00).

Heightened uncertainties post GE14. The recent GE14 surprise outcome has heightened risk to the sector’s near to mid-term prospects. In our view, heightened uncertainties on economic policies and reviews of certain mega projects (which will likely lead to delays and/or cancellations of these projects) will likely pose higher earnings and asset quality risks, as well as weaker investment sentiment to the banking sector.

Loan growth at risk. Prior to GE14, we maintained our loan growth assumption of 5- 5.5% for the banking sector despite loan growth at less than 5% for the first 4 months of 2018, as we were hopeful that economic activities would pick up after GE14, supported by more mega projects rollouts. However, the unprecedented GE14 results have heightened risks on loan growth, as certain projects were being reviewed and this will likely put pressure on system loan growth (at least in the near term).

Challenges to NOII. While volatile market generally lends support to trading activities (see Figure 3 and 4 for trading activities equity and bond market trading activities trend), we believe higher income arising from more active trading activities will be more than negated by (i) lower MTM gains (or higher MTM losses arising from bond and equity market sell off, (ii) weaker fund raising activities as we believe corporates will hold back from new issuances given current market uncertainties, and (iii) lower retail participation given current weak equity market sentiment.

Downside to asset quality. For now we believe asset quality for household segment is well contained especially in the mortgage loan. Corporate segment may pose a downside surprise in asset quality in view of current environment especially for construction and manufacturing related loans.

Limited NIM upside. A 25 bps OPR hike (since July 2014) has resulted in banking institutions’ NIMs expanded by 2bps YoY in 1Q18. However, we believe the NIM expansion in 1Q18 is unsustainable and expect NIM to gradually normalise, as repricing of longer term deposits takes place and the absence of further rate hike for the rest of 2018. Beyond 2018, the incoming NSFR regulations in 2019 will add more uncertainties to NIM, as banks will be collecting longer dated deposits, which usually carry higher funding cost to comply with the regulations. To comply this, we believe banks will launch another round of deposit competition (although it will likely be milder compared to the previous round of deposit competition), which may in turn put pressure on funding cost and this will limit NIM upside.

Sector loan growth assumption cut to reflect heightened uncertainties. We cut our system loan growth assumption by 0.5%-pt to 4.5-5% (from 5-5.5% previously) for 2018.

Source: Hong Leong Investment Bank Research - 2 Jul 2018