Uninspiring reads were across 1Q20 reporting period as sector profit declined 18% QoQ and 11% YoY; the culprit was bad loan provision as banks proactively raised this in view of a weakening credit climate. Overall, it was a disappointing quarter, with 3 profit misses and 3 in line. Despite the negative growth outlook for banks (2-year CAGR of -5.7%), ample liquidity in the market forced us to cut equity risk premium and raised TPs. However, Public and Affin were lowered to SELL while Alliance to HOLD. Retain NEUTRAL and the only bank we like now is RHB (TP: RM5.80), mainly for its strong CET 1 ratio.

1Q20 results round-up. Excluding AMMB and Alliance (postponed results to June), it was a poor quarter as 3 out of the 6 banks under our coverage, missed expectations (Maybank, CIMB, RHB); the trio posted higher-than-expected bad loans provision.

QoQ. 1Q20 sector net profit was down 18%, no thanks to higher loan loss allowances, which doubled (save for CIMB, many banks proactively raised this in anticipation of a weakening credit climate). If not for this, pre-provision profit saw an improvement of 2% given positive Jaws from strict cost control (opex fell 3% vs total income decrease of 1%). At the top, net interest margin (NIM) slipped 8bp due to the 50bp OPR cut in 1Q20, while non-interest income (NOII) growth was muted on the back of tepid fee revenue, weak trading and forex performance. Generally, these were the trends seen but the likes of Affin saw bottom-line ticked up as gains of its FVOCI debt papers were fully realized and BIMB rose on better takaful income contribution. Whereas, the steep earnings drop at CIMB was caused by a fraudulent O&G account in Singapore.

YoY. Similarly, sector earnings contracted 11% as a result of the doubling in provision for bad loans. Positive Jaws was again present but instead led by total income growth, which outpaced opex by 3ppt; this was hoisted by the better insurance underwriting income at Maybank and contributed to its net profit expansion as well. Besides, BIMB also bucked the trend but through lower effective tax rate. CIMB was another anomaly and the plunged in earnings is same as the reason explained above.

Other key trends. Loans growth tapered to 2.4% YoY (4Q19: +3.5%) while deposits slowed to 1.1% YoY (4Q19: +3.5%). Based on these two categories, the top 3 fastest growing banks were BIMB, CIMB, and RHB (+3-9%). For asset quality, GIL ratio was up 8bp sequentially given broad weakness at both business and household sectors.

Outlook. NIM pressure is seen to persist into following quarters given May-20’s 50bp OPR cut and possibly another 25bp reduction in 2H20. Also, with the confluence of events from Covid-19 crisis and imminent recession, loans growth is expected to taper further. Besides, asset quality is poised to remain weak but it should not spiral out of control (at least till end Sep-20); this is because Malaysian borrowers were granted 6- mth loans deferment while any restructuring & rescheduling (R&R) of loans affected by Covid-19 will not be tagged as impaired.

Forecast. Following the profit cut on CIMB, Maybank, Public, and RHB this reporting season, we are now expecting 2-year aggregate earnings CAGR of -5.7% (FY19-21) for the sector vs our previous estimate of -3.0%.

Valuation & stock ratings. We believe recent sector rally was due to ample liquidity (which we underestimated) given the 6-mth loan moratorium, series of OPR cut, and low FD rates. In turn, this led to decade high retail participation and more generous valuations were accorded to stocks than usual, despite challenging outlook. To reflect this in our financial model, we reduce our COE assumption by 50bp for all the banks under coverage (in effect, pricing them at 5-year P/B of -1.5 to -2.0 SD). As such, TPs were raised but we downgraded Public and Affin to SELL while Alliance to HOLD.

Source: Hong Leong Investment Bank Research - 9 Jun 2020