A dull 2Q20 as sector profit displayed negative growth (-8% QoQ and -21% YoY due to higher impaired loan allowances from additional MEV adjustments and management ECL overlays). Overall, it was a mixed bag quarter, with 3 earnings beat, 3 in line, and 2 misses. Despite the negative growth outlook for banks (2- year CAGR of -6.8%), it is balanced out by deflated valuations (P/B close to -2SD & lower than GFC’s level). Retain NEUTRAL and the only banking stock that we like now is RHB (TP: RM5.80), mainly for its strong CET 1 ratio, relatively large untapped FVOCI reserves, and undemanding valuations.

2Q20 results round-up. This reporting season was a mixed bag as 3 out of 8 banks under our coverage trumped estimates (Affin & AMMB saw better-than-expected NOII while BIMB surprised with lower cost of funds), 3 in line (Alliance, Public, RHB), and 2 below (CIMB & Maybank booked higher-than-expected loan loss provision).

QoQ. 2Q20 sector net profit decreased 8%, no thanks to higher bad loan allowances (+47%); this was especially apparent at Maybank and CIMB. Otherwise, pre-provision profit was up 2% given strict cost containment measures (opex fell 6% vs total income decline of 2%). Although non-interest income (NOII) printed 2% growth, it was erased by a 12bp sequential compression in net interest margin (NIM). These were recurring themes throughout the entire reporting period but AMMB and RHB were standouts as both chalked in above average investment income showing. Also, the former dialled back on heavy macro provision charges while the latter benefitted from stronger forex gains and insurance income.

YoY. Similarly, the 4-fold jump in provision for impaired loans caused sector earnings to fall 21%. Positive Jaws was again visible as total income expanded 4% while opex dropped 3%; this was lifted by better treasury income and tight cost control. That said, Alliance was one of the outliers bucking negative profit growth trend due to absence of lumpy impairment on financial investments. Also, BIMB was another bank to do so but on the back of lower loan loss provisioning.

Other key trends. Loans growth was firm at 2.4% YoY (1Q20: +2.6%) while deposits gained traction to 4.4% YoY (1Q20: +1.5%). Based on these two categories, the top 3 fastest growing banks were BIMB, RHB, and CIMB (+4-12%). For asset quality, gross impaired loans (GIL) ratio improved 7bp QoQ, thanks to the effect of loan moratorium.

Outlook. With potentially another OPR reduction (-25bp) in 2H20, we believe this will continue to exert pressure on NIM. Also, loans growth is anticipated to remain tepid as Covid-19 related headwinds drag performance. Separately, we see GIL ratio to stay at low levels for the rest of the year, considering troubled borrowers will receive targeted assistance from banks; however, this may hide actual damage and cause lag in non performing loan (NPL) formation if the situation does not improve rapidly or an advent of Covid-19 second wave paralyses the country again.

Forecast. Following the downward profit revision on CIMB, Maybank, and Public this reporting season, we are now forecasting 2-year aggregate earnings CAGR of -6.8% (FY19-21) for the sector vs our previous estimate of -5.8%.

Maintain NEUTRAL. We believe it is too early to claim that pain points from Covid-19 crisis are behind us. The sector may have to contend with risk of delayed deterioration in asset quality and advent of a second wave infection. However, these are balanced out by deflated valuations. For exposure, the only bank we like now is RHB (BUY, TP: RM5.80) given its appealing risk-reward profile, backed by undemanding valuations, strong 16.6% CET1 ratio (sector: 14.4%), and fairly large untapped FVOCI reserves. Separately, we have SELL rating on Public (TP: RM14.80) for rich valuations.

Source: Hong Leong Investment Bank Research - 7 Sept 2020