KLFIN entered 2H19 relatively calm but eventually tumbled, closing -7%. Seeing tepid credit demand, mild asset quality deterioration, and OPR being potentially cut, we expect 1H20 to be challenging. That said, 2020 sector profit is projected to bounce back partially to +3.5%. Overall, the modest growth outlook combined with rising asset quality and interest rate risks, prevented us to be more bullish on the sector; this is despite attractive valuations, which now trades near -2SD to both its 5-year and 10-year mean P/B. We retain NEUTRAL and advise long term investors to be selective; preferred pick is Maybank (TP: RM9.05). Other BUY calls are RHB (TP: RM6.20), BIMB (TP: RM4.80) and Alliance (TP: RM3.15).

Poor 2H19 performance. Despite entering the mid-year mark relatively calm, KLFIN closed 2H19 with a 7% decline. This came on the back of: (i) investors fearing another round of OPR cut, (ii) asset quality concerns, (iii) muted financial showing, and (iv) broad negative impact as the US got embroiled in multiple trade skirmishes. The only bank that generated positive return was RHB (share price rose 6% in 2H19), thanks to good earnings momentum, fundamentals, and higher dividend payouts.

Modest growth outlook. Although the first 3 quarters of 2019 have been difficult, we expect 4Q19 to see some earnings improvement from: (i) further NIM recovery and (ii) better trading gains. However, 1H20 is seen to be challenging on tepid credit demand and mild asset quality deterioration (amid softer present-day macro climate as well as weak general sentiment). Also, our economist expects a 25bp OPR cut by end-1H20. That said, 2020 sector profit is still projected to bounce back partially to +3.5% (from a low base effect in 2019) but remains below the historical 5-year and 10-year CAGR of 4.4% and 10.3% respectively.

Downside risk to 2020-21 profit forecasts? With GIL ratio edging up from its lows in recent months, there is cause for pessimism. Also, the sector ‘Stage 3’ allowances -to impaired loans ratio is only at 36% (pre-MFRS9: 21%) while ‘Stage 1 & 2’ provisions to-total gross loans ratio is not higher vs pre-MFRS9’s regime at 73bp; every 1bp rise in NCC could cut sector profit by 0.5%. Assuming if the sector ‘Stage 3’ provisions-to impaired loans ratio in 2020 was raised to 50%, NCC would jump to 42bp (+14bp) and drag down bottom-line by 7%. Instead, if NCC swells to GFC level in 2020 (+32bp), the profit impact is -16%. Similarly, the potential OPR cut in 1H20 is a net negative for banks. On a full year basis, we estimated that every 25bp reduction in OPR would see sector NIM slipping by 3-4bp and our profit forecast reducing by 2-3%.

More price pain to come? Based on time-series (sector P/B close to -2SD) and P/B ROE regression analysis (situated near the best-fitting line), we find that valuations of Malaysian banks are fair but there is rising asset quality risk (hence, short-term price downside cannot be ruled out). In order to reflect this, we raise our COE assumption by 25bp for all the banks under coverage; recall, interest rate risk has been taken into account in our TP computation (see our 3-Jul-19 report: ‘Patience is a virtue’). Despite cutting our TPs, stock ratings were unchanged.

Maintain NEUTRAL. The modest growth outlook coupled with rising asset quality and interest rate risks prevented us to be more bullish on banks; this is despite attractive valuations, trading near -2SD to both its 5-year and 10-year mean P/B. However, for long-term investors who favour sector exposure, we advise to adopt a selective stock picking strategy. Our preferred pick is Maybank (TP: RM9.05) given its above-average dividend yield of 6-7% and low foreign shareholding (19%) vs larger domestic peers (30-35%). Other BUYs are RHB (TP: RM6.20) and BIMB (RM4.80), where both are still eking out robust growth of 3.9% and 7.3% respectively vs sector’s 3.5%, while Alliance (TP: RM3.15) saw its valuations got bashed to below -2SD and trough level.

Source: Hong Leong Investment Bank Research - 7 Jan 2020