KLFIN is poised to end 2H22 with a positive return (so far +4%). In 1H23, we see decent operational outlook and FY23 sector profit is projected to expand 14.5% (FY22: +4.6%) due to the absence of prosperity tax (without this, it is forecasted to rise at a slower pace of 4-5%). Now, there are brewing risks of steeper cost of funds, smaller NOII and loans growth. That said, the sector’s risk-reward profile is balanced, in our view, given dissipating tailwinds are soothed by inexpensive valuations. Maintain NEUTRAL; the two BUY calls we have are RHB and BIMB.

Range-bound market. KLFIN zig-zagged throughout 2H22 but is poised to finish with a positive return (so far +4%). Generally, it was a trading-oriented market and interest on banking stocks were fairly mixed. On a relative basis, Alliance (+21%) was the best performer given good persistent quarterly results while BIMB (-4%) was the weakest, owing to stubbornly weak financial showing.

Slower growth in FY23. We see subdued QoQ performance in 4Q22 due to (i) NIM pressure, (ii) higher opex, and (iii) additional pre-emptive provisions top-up. However, these are expected to improve slightly in 1H23. Overall, the absence of prosperity tax in FY23 would largely aid in bottom-line increase, where it is projected to grow 14.5% vs 4.6% in FY22 while sector ROE is seen expanding to 9.5% (+90bp). Ex-prosperity tax base effect, sector profit is forecasted to rise at a slower pace of 4-5% in FY23.

Weaker NIM ahead? Although we are still in an interest rate upcycle, we believe NIM will peak in 1Q23 and then begin to descend on more upward FD repricing and CASA reversal. We note sector CASA ratio remains elevated at 31% against pre-pandemic level of 26%. Every 1% CASA ratio reversal would drag sector NIM by 2bp and profit by 1%, assuming an FD-CASA spread differential of 200bp. If a full CASA reversion scenario plays out, it will neutralize gains from 75bp OPR hike. Recall, our economics team has a base case assumption of only 2x OPR hikes in 2023 (25bp each round).

Subdued NOII. We believe 10-year MGS yield will turn choppy again, since we have not reached the terminal OPR/Fed fund rate and exit from the interest rate upcycle. Even if we are wrong, where the 10-year MGS yield drifts lower (which benefit banks), we reckon MTM gains would be rather limited this time and has little room to surprise on the upside given that banks have raised their mix of financial assets measured at AC (35% in 3Q22 vs 24% in 4Q19). Moreover, a larger portion of their investments measured at FVOCI and FVTPL have been hedged (23% in 3Q22 vs 16% in 4Q19) to protect against rising yield environment but will work against them if it is falling.

No fresh positive catalysts to drive prices higher. Although for the past 1-2 years we flagged the banking sector could climb to as high as +1SD above its 5-year mean P/B, we reckon the odds of this happening now is much slim than before. Currently, it is still trading at inexpensive valuations (near to -0.5SD and -1.0SD to both its 5-year and 10-year mean P/B at 1.04x), but there are no new positive catalysts to drive share prices higher. Also, we see pedestrian price showing in 1H23 as the market did not rerate the sector up meaningfully even with all the tailwinds that occurred this year.

Maintain NEUTRAL. All considered, we opine that the banking sector has a balanced risk-reward profile. We expect KLFIN to trade largely sideways in 1H23 since appetite for the sector has diminished on waning outlook. That said, consolation comes in the form of undemanding sector valuations and decent dividend yield of 5%, which would provide downside support to share prices. Now, we only have two BUY ratings under our coverage, namely RHB (TP: RM6.60) and BIMB (TP: RM3.00). The former is liked for its elevated CET1 ratio and attractive price-point while the latter is favoured for its laggard share price showing and bright structural long-term growth prospects.

Source: Hong Leong Investment Bank Research - 19 Dec 2022