System loans and deposits expansion continued to dive down to 3.9% and 4.9% YoY respectively. Also, leading indicators remained lacklustre, asset quality has weakened, and interest spread narrowed. Despite these negative developments and the growth outlook for banks is modest, we draw comfort from the sector’s inexpensive valuations as it trading at -1.5SD to its 5-year mean P/B. We retain NEUTRAL and advocate selective stock picking rather than blanket exposure to the sector. Our preferred pick is Maybank (TP: RM9.50). Other BUYs are RHB (TP: RM6.45), Alliance (TP: RM3.70), and BIMB (TP: RM5.00).

Loans growth still slowing. Jul-19’s system loans growth tapered to 3.9% YoY (vs Jun-19: +4.2%), large extend due to business (Biz) lending that decelerated sharply to 2.5%. That said, the household (HH) segment slowed as well but not at such a sore pace (+4.7% YoY). In Biz, weakness stemmed from softer working capital (+1.6%) and non-residential property purchases (+2.5%). As for HH, the contraction in auto financing (-0.8%) was the main drag. Again, overall loans expansion missed our +4.5- 5.0% expectation for the full year. With limited positive catalysts to spur stronger borrowing demand, we tone down our 2019 loans growth estimate to +4.0-4.5% (from 4.5-5.0%).

Little to brag on leading indicators. Loan application remains muted despite turning positive again (+0.5% vs Jun-19: -11.3%) as better credit demand from Biz (+13.5%) but was offset by HH (-7.5%). That said, loan approvals followed-suit but at a larger magnitude (+11.2% vs Jun-19: -3.0%) on the back of accommodative lending for both Biz (+19.3%) and HH (+5.5%) segments.

Deposits growth lost steam too. Likewise, system deposits growth softened to 4.9% (vs Jun-19: +5.1%) primarily due to a slowdown in fixed deposits (+6.6% vs Jun-19: +7.7%); we believe banks are managing lower this expensive product category to prevent overexposure ahead of another potential OPR cut. In Jul-19, loan-to-deposit ratio (LDR) stood at 88% (highest seen was 89%, back in Feb-18). The general feedback from our discussion with banks, deposit taking competition has eased.

Asset quality weakened as gross impaired loans (GIL) ratio has been on the rise for several months now (Jul-19: 1.60% vs Jun-19: 1.57%). This came mainly from Biz (+5bp QoQ), no thanks to the manufacturing and construction segments. Besides, personal financing in HH (+2bp QoQ) fuelled the overall increase. That said, sector’s GIL ratio was still at a low healthy level and broadly, we find that borrowers have the financial buffers to withstand severe shocks (see our 28 Mar-19 report, titled ‘On a steady ship’).

Narrowing interest spread. The average lending rate fell 7bp vs a flattish 3-month board fixed deposit. In turn, the spread contracted 7bp to 1.92%. However, over the course of next few months, gradual recovery should take place as banks retire their expensive retail fixed deposits, (accumulated from prior rivalry). After normalizing, we believe sustaining net interest margins (NIM) would remain as an uphill challenge, seeing that the slower loans growth environment should encourage banks to engage in price-based competition to chip share away from one another.

Retain NEUTRAL. Although the growth outlook for banks is modest, we draw comfort from the sector’s inexpensive valuations as it trading at -1.5SD to its 5-year mean P/B. Those that favour exposure to this sector have to be selective. We like banks that give above average dividend yields (Maybank; TP: RM9.50), still eking out healthy growth (RHB; TP: RM6.45 & BIMB; TP: RM5.00), and valuations got bashed down to -2SD and trough P/B valuations (Alliance; TP: RM3.70).

Source: Hong Leong Investment Bank Research - 3 Sept 2019