With the worsening Covid-19 situation, we now expect 2020 sector profit to fall 7.4%; this comes on the back of weak loans growth, more OPR cuts, softer NOII, and rising NCC. However, near-term headwinds are being balanced out by the sector’s inexpensive valuations (P/B is now below -2SD and GFC’s level). Retain NEUTRAL and we like banks that were acutely bashed down; preferred picks are CIMB (TP: RM4.70) and Alliance (TP: RM2.50). Other BUY calls are RHB (TP: RM5.40) and BIMB (TP: RM3.70).

Banks were not spared from this virus-spooked market; the selldown was fuelled by fear. Key concerns are: (i) slower loans growth, (ii) further OPR cuts, and (iii) weaker asset quality. Also, the 10-year MGS yield has crept upwards due to falling oil prices. In this report, we review our earnings estimates and target prices (TPs).

Loans growth & NIM. Following the spread of Covid-19 along with its effect on global and local economic activity, our economics team has cut 2020 GDP forecast to 2.3% from 4.1%; this is below the MoF’s range of 3.2-4.2%. In turn, we also lowered our 2020/21 sector loans growth projection to 3.5%/3.4% from 4.3%/4.2%. Besides, we expect BNM to cut OPR by another 50bps to 2.0% this year (as early as 1H20; total reduction: -100bps); we now see 2020 sector NIM slippage of 10bp instead of 6bp.

Net credit cost (NCC). Although in our previous report (titled ‘Impact of Covid-19 & oil crash’ published on 12 Mar-20), we argued that NCC is unlikely to spike drastically, there are growing anxieties over current headwinds to hit as hard as the GFC. To err on the conservative side, we raise our 2020/21 sector NCC assumption to 31/33bps from 27/28bps. Back during the GFC, the average NCC level was 60bps but this was accompanied by high system GIL ratio of >7% vs <2% presently; we estimate every 1bp increase in NCC could reduce sector earnings by 0.5%.

Non-interest income (NOII). Considering Malaysia is still fairly reliant on petroleum related revenue, the drop in oil prices have led to ringgit weakness and MGS selloff. Hence, the 10-year MGS yield is now at 3.6% but the YTD average has carried on to slide to 3.1% vs 3.4% in 4Q19. That said, this is expected to normalize up in 2Q-4Q20 as oil prices are to remain soft on supply-demand imbalance. In view of lower trading related income, we cut our 2020 sector NOII growth forecasts to -1.2% from +3.1%.

Valuation. We revisit the equity price of banking sector during the GFC and find that peak P/B of 2.30x took 21 months to decline to trough of 1.14x (from Jul-07 to Mar- 09); this marked a P/B de-rating of 1.16x while at the same time, ROE fell to 12.0% from 17.4% (-5.4ppts). Looking at the recent peak P/B of 1.40x (Apr-18), it has shrunk to 0.83x (Mar-20) over the past 24 months (-0.57x). Also, ROE is projected to drop to 8.2% from 10.2% (-2.0ppts). Even though the selldown has been less severe vs the GFC, we believe downside is limited, seeing the sector is trading below -2SD level to both its 5-year and 10-year mean P/B.

Forecasts & stock ratings. With the above revisions, we now expect sector earnings growth of -7.4% for 2020 (from -0.1%) and +1.7% for 2021 (from +2.8%). As such, we also cut the TPs for banks under our coverage but ratings were unchanged.

Retain NEUTRAL as near-term headwinds are being balanced out by the sector’s inexpensive valuations. We like banking stocks that were acutely bashed down and especially those with P/B below 1.00x, GFC’s trough, and -2SD; two of our BUY calls meeting this criteria are CIMB (TP: RM4.70) and Alliance (TP: RM2.50), making them our preferred picks. Other BUYs are RHB (TP: RM5.40) and BIMB (TP: RM3.70).

Source: Hong Leong Investment Bank Research - 30 Mar 2020