System loans saw flat growth in Apr17 after a strong month in Mar17 (+0.56% mom). On a yoy basis outstanding loans was up 6.1% yoy, with the stronger growth from the business loans (+7.5% yoy) while household loans grew by +5.1% yoy. The Apr17 statistics continue to reinforce our view of an improving earnings trend for the banking sector on a yoy basis, sustained by steady average lending rates and a higher CASA ratio, which underpins a better NIM. Notably, we see that an improving global economic outlook and stronger commodity prices could be in favour of a rebound in the banking sector’s 2017 earnings. We maintain our OVERWEIGHT stance with our top sector pick being Public Bank, CIMB and Maybank.

Disbursements Reversed in Apr17 After a Strong Month in Mar17

Subsequent to a strong March 2017 where we saw high disbursements especially for business loans, April 2017 witnessed a sharper pullback in loan disbursements (-21.7% mom), approvals (-24.4% mom) and applications (-15.6% mom) for both the household and business. In our view, the monthly fluctuation should normalize and we may see a more discernible growth trend in the coming months. On a yoy basis, the outstanding system loans were up 6.1% yoy (in-line with our 2017 target of 6.0%), with the household segment rising by 5.1% yoy and business (+7.5% yoy). Key sectors driving loan growth are the retail and trades, construction, real-estate and transportation. Domestic liquidity remains ample for credit growth as year-to-date system deposit was up 1.3%, driven by improved cash balances at government institutions (+6.3% ytd) and businesses (+0.16% mom). Domestic asset quality remains sound with a gross impaired loan ratio of 1.66% (Apr17), though there was an uptick of 4 bps mom while impaired loan cover declined marginally to 88.9% in Apr17 (from 89.1% Mar17).

NIM Expected to Remain Steady Going Into 2Q17

The domestic banking system’s average lending rate has remained steady from Mar17 to Apr, hovering at 4.6% in Mar17 and 4.59% in Apr17. We believe this is due to an improved loan mix and higher loan pricing, most likely in the business-loan segment rather than consumer loans. In order to counter NIM compression, which had been weighing down on the sector badly from 2014-16, most industry players have resorted to higher riskadjusted returns loans, repricing initiatives and improving funding-mix. Meanwhile, CASA ratio remained steady at 26.7% in Apr17 vs. 26.6-27% in Jan-Mar17 and 25.2% in Apr16, should also underpin lower cost of funding for the banks. Hence, this reinforces our view that NIM may start seeing some positive improvements in 2017E. Banks continue to operate with a high liquidity-coverage ratio (LCR) of 127% in Feb17 (Dec16: 125%) while the overall loan-to-fund ratio stood at 82.8% in Apr17 (flat vs. Mar17).

Underlying Economic Trends in Favour of a Rebound in the Sector

We note an improving global economic outlook and stronger commodity prices are in favour of a rebound in banking sector earnings in 2017:

i) Improving economic indicators – Our 1Q16 GDP growth grew at a strong 5.6% (vs. 1Q16: 4.1% and 4Q16: 4.5%). More encouragingly, we note that economic indicators such as Nikkei Malaysia Purchasing Manager Index, the export and import trade data have all shown an improving trend in recent months – hence, implying stronger economic growth ahead and rising business sentiment, which bodes well for business loans growth. Higher net export proceeds repatriated back to the country would also boost system deposit growth and liquidity.

ii) Robust labour market – While unemployment rate stood at 3.3%, labour force participation rate remain high and number of workforce is still growing in tandem with population growth. A robust labour market would be supportive of increased consumer spending and demand for both big and small-ticket items.

iii) Stronger commodity prices – Based on our chart in Fig 9, commodity prices are gradually turning around since 4Q16 as the industry supplydemand dynamics continue to improve. Recovery in commodity prices would help to justify a higher carrying value and writebacks in value of a related loan account of which previously has been written-down and recognized as an impairment charge.

Maintain Sector OVERWEIGHT

We maintain our sector OVERWEIGHT call. We foresee a sector earnings growth of +10.9% yoy in 2017E, while subsequently growing by a modest 3.6% yoy in 2018E and 3.9% yoy in 2019E (EPS growth: +8.9% 2017E, +1.5% 2018E, +1.9% 2019E). Favourable domestic demographic trends (driving consumption and housing needs), ample infrastructure projects in the pipeline and accommodative monetary policy are supportive reasons for the growth. The sector’s overall valuation in 2017E still appears attractive at a 1.3x P/BV multiple (on a forward basis) against the 10-year average of 1.6x, 5-year average of 1.5x and a 3-year average of 1.34x. Key risks: new NPL formation, NIM compression, higher funding costs, weaker loan growth, much higher provisions on FRS 9 adoption.

Top Picks – Public Bank, CIMB Group, Maybank

For sector exposure, we continue to like Public Bank (PBK MK, BUY, RM20.06; TP: RM23.25, based on a 2017E P/BV of 2.42x) given the group’s more stringent credit underwriting standards and established franchise in the domestic retail financing markets.

For CIMB Group (CIMB MK, RM6.40, BUY, TP at RM7.00 based on a 1.3x P/BV target) we expect 2017 earnings to continue improving from 2016 (+25% yoy), projected at a growth rate of 31% yoy, after a trough period in 2014-15. In our view, heightened provisions seen in 2014-16 may subside in 2017 while stronger loan growth (projected at 6.9% yoy) and steady NIM at 2.66% will be another key earnings driver.

For Maybank (MAY MK, RM9.44, BUY, TP of RM10.50 based on a 1.5x P/BV target), we foresee a better year underpinned by robust fund-based income generation, while NIM is expected to remain steady. Asset quality is also expected to improve as global headwinds ease, while its Indonesian unit is also showing signs of turnaround.

Source: Affin Hwang Research - 1 Jun 2017