Following the recent sell-off, we are turning bullish on banks again; in our view, the market has broadly baked in negative headwinds into forward expectations, which thus, reduce the odds of downside surprises and tip the sector’s risk-to reward profile to be more favourable. Also, we believe the prominence of FY23 NIM slippage may be smaller than initially feared and asset quality risk remains tame. Besides, we do not foresee Malaysian banks suffering from the same fate as SVB. All in all, we advocate to employ a more trading-oriented strategy as we believe the market will stay choppy. As such, we tactically upgrade the sector to OVERWEIGHT and raise Public to BUY. Other BUY ratings include: RHB, AMMB, Alliance, and BIMB.

More favourable risk-reward profile. The performance of KLFIN index has been dull since our sector downgrade in early Dec-22 (-6%). This was caused by concerns and poor sentiment over: (i) lesser overnight policy rate (OPR) hikes in 2023 and higher cost of funds, leading to net interest margin (NIM) slippage, (ii) weaker loans growth, (iii) subdued treasury income performance, along with (iv) insufficient loan loss cover in the event of sharp asset quality deterioration. Now seeing that banks’ share prices have pulled back, we are tactically turning bullish on the sector again. In our view, the market has more or less baked in headwinds into forward expectations, which hence, reduce the odds of downside surprises and tip the sector’s risk-to-reward profile to be more favourable.

Less prominent NIM slippage? Although the banking sector has to contend with less OPR hikes this year (our base case assumption is only a single time, 25bp increase), we are beginning to notice easing competition for fixed deposits (FD), thanks partially also to slower loans growth outlook. In turn, we reckon NIM compression would not be as prominent as initially feared; large domestic banks like Maybank, CIMB, and Public have guided FY23 NIM slippage of >5-10bp. That said, Bank Negara Malaysia (BNM) may potentially raise the statutory reserve requirement (SRR) ratio, where it currently stands at 2.0% vs pre-pandemic level of 3.5%. Based on our calculations, every 50bp SRR increase and assuming a 4% interest yield forgone would shave banks’ earnings by only 1%.

Tame asset quality risk. Like before, we are not overly worried with gross impaired loans (GIL) ratio inching up as we believe banks are better equipped vs prior slumps; the large pre-emptive allowances built up in FY20-22 to fight Covid-19 pandemic woes and latency in credit loss from OPR hikes, act as robust buffer to pillow for any short term asset quality weakness. Besides, FY23-24 NCC assumption (23-27bp) pencilled in by both us and consensus are fairly elevated (above the normalized run -rate [18bp] but below FY20-21’s level [58-67bp]); including pre-emptive provisions (FY22: 47bp), it becomes on par to global financial crisis (GFC) highs (74bp). Also, we are relieved by the sector’s lofty loan loss coverage (LLC, 97%) and steep collateral value against gross loans (77%).

SVB moment in Malaysia? In our view, troubles at Silicon Valley Bank (SVB) were highly idiosyncratic in nature and we do not foresee Malaysian banks suffering from the same fate. Basically, SVB’s meltdown was instigated by: (i) overreliance on less sticky, fast cash burning venture capital-backed start-ups wholesale deposits, (ii) force selling on its bond investments to raise cash, along with (iii) poor crisis communication plan. Back home, we observed local banks have much larger concentration in stickier retail deposits as % of total deposits at 40% vs SVB’s <10%. Also, they have liquidity coverage ratio (LCR) and Net Stable Funding ratio (NSFR) of >100% as necessitated by BNM, unlike SVB who was not obligated to report these figures as it was exempted from stricter US Federal Reserve (Fed) regulations due to its smaller size.

Divergence in P/B-ROE trajectory. Following the recent sell-off, the banking sector is currently trading close to -1.0SD to both its 5-year and 10-year mean P/B at 0.86x, making valuations more attractive than before. Besides, the pullback has reset market expectations for 2023 by considering headwinds in the horizon. Net-net, banks are still expected to chalk in FY23 earnings growth of 12.6% given the absence of prosperity tax while sector ROE is seen rising to 9.6% (+75bp). In turn, this contributes to higher dividends payout as well (the sector is now offering commendable yields of 5-6%). Ex prosperity tax base effect, sector profit is forecasted to grow at a slower pace of 2.9% in FY23. Overall, we are seeing a divergence between the trajectory of P/B and ROE (see Figure 7), where the former is heading south while the latter is trending up; both of these should instead be moving in unison, given their historical correlation of 87%.

Tactical upgrade to OVERWEIGHT. We see opportunity to buy banks on weakness in wake of the recent market slump, given irrational fear-driven selling – fundamentally speaking, nothing has drastically changed or deteriorated. That said, we turn bullish on banks again but we believe the market will remain choppy since investors have not shaken off their jittery mood. Hence, we advocate to employ a more trading-oriented strategy. We expect appetite for banks to come back, spurred on by: (i) inexpensive valuations, (ii) appealing yield, and (iii) undervalued Ringgit, luring foreign investors back to Malaysian market. As such, we raise our recommendation on Public to BUY with an unchanged TP of RM4.80, bringing the total BUY calls under our coverage to 5 instead of 4 previously: (i) RHB (TP: RM6.60), (ii) AMMB (TP: RM4.35), (iii) Alliance (TP: RM4.15), and (iv) BIMB (TP: RM3.00). The rating upgrade of Public is premised on recent price lull and its strong asset quality.

Source: Hong Leong Investment Bank Research - 20 Mar 2023