Considering things are not entirely rosy for Malaysian banks, we reckon stock picking will be more critical than broad sector selection. Our preferred choice is biased toward banking stocks that trade at attractive valuations. We believe it is a sign the market has already priced in any potential earnings disappointment and hypothetically, should outperform the sector. Our 1H19 investment thesis focuses on value play opportunities to limit downside risks. Maintain NEUTRAL view on the sector as valuations are reasonable. Top pick is RHB (TP: RM6.60) for its attractive risk-reward profile, trading at -1SD for both its 5-year mean P/B and P/E, coupled with the potential for dividend surprise.

Not many levers left to pull to drive strong industry loans growth. For 2019, loans growth is expected to come in between 4.5%-5.0%, a tad lower to the level seen in 2018 with an annualized acceleration of 5.5% (2017: 4.1%). This is premised on a loans-to-GDP growth multiplier of c.1x, in line with the new run-rate seen between 2016-18 but below the 10-year average of 1.6x; HLIB’s 2019 GDP forecast is 4.6%.

• For the household lending segment, it should resume its soft growth patch of 4.5%- 5.0% (2017-18: 5.1%-5.5%) as we see: i) unwinding of strong consumer sentiment post-GE14, ii) sombre residential property market, and iii) slower demand for cars.
• Similarly, corporate loans is likely to remain lethargic with growth of only 4.5%- 5.0% (2017-18: 2.8%-5.4%) given: i) passing of bountiful government investments, ii) no policy boost from Budget 2019, and iii) uncertainties on the external front.

Benign prospect for credit quality. Barring any unforeseen circumstances in 2019, we expect credit quality to stay relatively benevolent, driven by a higher proportion of new loans and low new impaired loans formation. Besides, provisioning trend should be stable, only seeing mild uptick in credit cost to 28bp (from 27bp in 2018). This comes on the back of rising impaired loans coverage, stronger credit culture, and improved risk management after MFRS9 kicked in from the start of 2018.

No NIM bounce expected. We see compression in 2019’s net interest margins (NIM) but not at an alarming rate of 2bp, following an estimated decline of 4bp for 2018. This is formed based on: i) towering system loan-to-deposit ratio (LDR), which should continue to spur fixed deposits competition to some extent, and ii) asset yield is poised to be under pressure, again on rivalry along with greater emphasis on higher quality loans origination.

Robust capital position. Even after we take into account all the necessary capital requirements by both BNM and the Basel Committee, we find Malaysian banks are well capitalized with an average common equity tier 1 (CET1) ratio of 13.0%. Heading into 2019, we opine the need to conserve capital has eased and this allows room for higher dividend distribution - RHB is a clear standout with CET1 of 14.8%.

Transfer of coverage; maintain NEUTRAL stance. Things are not entirely upbeat for Malaysian banks but valuations are reasonable, hovering not too far away (at 1.24x) to its 5-year mean P/B of 1.32x; the 2-year earnings CAGR for the sector is 4.2% (from 2018-20), in line with the 4.5% historical 5-year level. With the transfer of coverage to our new banking analyst, we chose to maintain our NEUTRAL stance on the sector. RHB  stays as our top banking pick for its attractive risk-reward profile and potential for dividend surprise. Another BUY would be BIMB , while the rest like Maybank , Public Bank , CIMB , AMMB , Alliance , Affin , are HOLDs.

Source: Hong Leong Investment Bank Research - 9 Jan 2019