At glance, 4Q18 reporting period was respectable with sector earnings up 5% QoQ. However, closer scrutiny showed that it was backed mainly by falling loan loss provision. Overall, the quarter ended with perfect hits, whereby all 8 banks under our coverage, posted largely in line results. That said, the street could be too optimistic on sector earnings growth in 2019-20, making it a downside risk. Regardless, our NEUTRAL stance on the sector remains intact as valuation is fair. Focus continues to be on value play opportunities and banking stocks with little risk of earnings downgrade by the street. RHB (TP: RM6.60) and BIMB (TP: RM5.00) are our selective bets to the sector.

4Q18 results round-up. All 8 banks under our coverage posted financial results that were largely in line but then we flag out the trio of Affin, AMMB, and Maybank, who have reported numbers which came at the upper-end of our estimates; they booked in lower-than-expected net credit charges along with lumpy recoveries.

QoQ. 4Q18 sector net profit grew 5% despite negative Jaws (tepid income rise of 3% vs opex increase of 7%), thanks to the drop in bad loan allowances (-55%). This was apparent across the board, especially Maybank, which saw a drastic 81% decline in loan loss provisions, while Affin and AMMB experienced net write-backs. Besides, we observed easing NIM pressure but in general, non-interest income remained weak (NOII, -5%) due to challenging capital market climate; this excludes Maybank’s good NOII showing (+30%), attributed to its insurance business.

YoY. Similar to QoQ, sector earnings grew 7%; this was lifted by the fall in impaired loans allowances (-54%). Again, we saw the presence of negative Jaws, considering that total revenue contracted 1% while opex ticked up 2%. The drag in total income came from poor NOII performance (-14%).

Other key trends. Loans and deposits continued to expand but with a surprisingly faster clip of 5-7% YoY vs 3Q18’s 4-5%. The top 3 fastest growing banks, based on these two categories, were Affin, BIMB, and CIMB (6-13%). Besides, gross impaired loans (GIL) ratio improved to 1.87% vs 3Q18’s 1.93%. However, Affin bucked the trend, seeing a 48bp sequential rise, owing to the deterioration at both its construction and non-residential loans portfolio.

Outlook. Despite a decent finish to 2018, we reckon consensus could be too bullish on earnings growth over the next 2 years. The annual earnings run rate projected by the street for 2019-20 is RM25-26b, implying a CAGR of 5.5% (but we are already 1- 3% more conservative vs them); this is higher than the 5-year historical level of 4.4% and we believe it will be difficult to achieve considering the softer present-day macro climate, which should trickle down to the banking sector. Thus, we see downside risk to sector earnings.

Forecast. Erring on the conservative side, we are forecasting 2-year earnings CAGR of 4.1% for the sector vs our previous estimate of 3.7%; this includes the upward profit revision made on Affin, AMMB, Maybank, and RHB during the 4Q18 reporting season.

Maintain NEUTRAL. Without strong growth catalysts and tracking near to the 5-year historical growth pace, we find that current sector valuation is fair, since it is also trading close to its corresponding time series mean P/B of 1.31x. Under such context, we reckon stock picking will be more critical than broad sector selection and focus is on value play opportunities and banking stocks with little risk of earnings downgrade by the street. RHB (TP: RM6.60) and BIMB (TP: RM5.00) meet all these conditions, making them both BUY calls.

Source: Hong Leong Investment Bank Research - 7 Mar 2019