The banking system saw a decrease of 6.1% mom in loan disbursement in Sept17 (vs. a +9.7% mom expansion in Aug17). Meanwhile, the ytd-Sept17 banking system loan growth is still at a subdued 2.6% given a mom growth of +0.2% (with an annualized growth rate of 3.5%) vs. our full year revised forecast of 5%. On a positive note, sectors such as wholesale/retail trade, services, realestate, construction and transportation could see stronger demand for financing, and hence, we do not discount the possibility of a potential ramp up in loan disbursements in the 4th quarter. Maintain OVERWEIGHT. Sector top picks: Public Bank, Maybank and AmBank.

Banking System Loan Growth (+2.6% Ytd)

The banking system’s loans growth, which remained subdued at +2.6% ytd, is attributable to a few key factors:

i) the shift in funding to the corporate bonds market (24% of system financing), which was reflected by a much stronger growth of +11.2% ytd Sept17 vis-à-vis the banking system’s business loan growth of +1.8% ytd. Arising from the recent large scale infrastructure and construction projects, it is not a surprise for the shift in funding to the debt market due to the size (larger) and tenure (longer);

ii) moderation in the household segment’s loan growth, with a ytd growth of 3.2% (annualized growth at 4.3%) vs. >10% yoy growth prior to Dec14; and

iii) loan replenishment remains sluggish. Ytd, loan disbursements is just slightly ahead of loan repayment (aided by the household sector, while business loans disbursement was behind repayment).

Despite that, the banking system loans continued to hold up at 5.2% yoy in September, with household loans growth at 5.0% and business loans growth at 5.4% yoy. Key sectors driving loan growth were households, retail and trade, construction, real-estate and transportation. We have revised down our sector loan growth target from 6% to 5% for 2017, subsequent to our revision on CIMB Group’s 2017 loan growth target. On a positive note, we do not discount the possibility of loan growth being ramped up in the fourth quarter, which we had seen in the previous years. Holding all else constant, despite the subdued loan growth ytd, banks had continued to see robust expansion in the 1H17 fund-based income (+9.3% yoy) as a result of the lower overall funding cost and repricing of loans. This was also reflected in the 1H17 NIM, which was up +7bps yoy to 2.32%.

Banking System Liquidity Remains Healthy and Ample

The banking system’s liquidity remains comfortable, as implied by the system’s Liquidity Coverage Ratio (LCR, Fig 29) of 136% (Sept17) while the loan-to-fund ratio remains ample at 83.1% (Fig 28). To recap, banks have been diversifying its funding sources to better-manage currency and maturity mismatches, though deposits still remains the main source.

3Q17 NIM May Contract 1-2bps Qoq, as FD Rates Picked Up

We expect the banking sector’s 3Q17 NIM to see some marginal contraction of 1-2bps (from 2.33% in 2Q17) as fixed deposit rates remained at 3.1% in July-Sept17 (vs. 3.08-3.1% in Apr-Jun17) while the average lending rate (ALR) was relatively unchanged at 4.61-4.62% (July-Sept17) against 2Q17. Meanwhile, CASA ratio also held up well in July-Sept17 at 26.7-26.9% (vs. 26.7-27.1% in Apr-Jun17) as it continued growing by 0.2% mom and at a more robust rate of 8.8% yoy. With the combination of these factors, we believe that the banking sector’s NIM will continue to outperform that of last year, whereby 3Q16 NIM stood at 2.25%. Since 3Q16, most banks have been able to stem the decline in NIM which averaged at 2.26% in 2016. The sector’s 1H17 NIM averaged at 2.32% (+7bps yoy).

Commercial Property and Working Capital Loans Stress

Non-residential property and loans for working capital activities are the few segments which are showing some stress in terms of asset quality as at Sept17 (Fig 31-34). As at Sept17, the gross impaired loan ratio had remained stable on a mom basis at 1.67% while the outstanding gross impaired loans have increased by 6.3% ytd.

Underlying Economic Trends Favour a Rebound in the Sector

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

i) Improving economic indicators – Malaysia’s 2Q17 GDP grew at a strong 5.8% (vs. 1Q17: 5.6% and 4Q16: 4.5%). On the other hand, we note that economic indicators such as the Nikkei Malaysia Purchasing Manager Index had shown a reversal since June17 (at 46.9%), currently at 49.9% as at Sept17. The overall import and export growth rates are also at levels higher than 2016.

ii) Robust labour market – While the unemployment rate stood at 3.5% (July17), the labour-force participation rate remains high and the 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) Relatively stronger commodity prices – Commodity prices have been gradually turning around since 4Q16 (Fig 9) as the industry’s supply-demand dynamics continue to improve. A recovery in commodity prices would help to justify a higher carrying value and writebacks in value to the related-loan account, which previously had been written-down and recognized as an impairment charge.

Maintain Sector OVERWEIGHT

We maintain our sector OVERWEIGHT call. We foresee sector-earnings growth of 9.0% yoy in 2017E, followed by a more modest 5.6% yoy in 2018E and 3.5% yoy in 2019E (EPS growth: +7.0% in 2017E, +4.8% in 2018E, +1.4% in 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 in earnings. The sector’s overall valuation in 2017E still appears attractive at a 1.31x P/BV multiple (on a forward basis) against the past-10-year average of 1.6x and the past-5-year average of 1.5x. Key risks: new NPL formation, NIM compression, higher funding costs, weaker loan growth, much higher provisions on FRS 9 adoption.

Top Picks – AMMB, Public Bank, Maybank

We believe the sell down of AMMB (AMM MK, BUY, RM4.28; TP RM5.20 based on 0.9x CY18 P/BV) is unjustified (currently trading at 0.8x P/BV vs. the sector at 1.31x), subsequent to the aborted merger plan with RHB Bank. While there are concerns on AMMB's contingent liabilities, management reassured that these are due in part to the ordinary course of business activities. Management remains focused on achieving a much improved operating and profitability level by year 2020 based on its Top 4 Aspirations programme. A potential uplift of some impaired corporate loans (to the tune of RM1bn) could be a boost to FY18E’s earnings. Near-term targets : i) a gross impaired loan (GIL) ratio below 1.88%; ii) a positive JAWs, with a CIR of ≤55% in FY18/19E; iii) a FY18/19E ROE target of 10%; iv) being a Top 4 bank in wholesale, SME and retail-banking.

We continue to like Public Bank (PBK MK, BUY, RM20.46; TP: RM24.00, based on a 2018E P/BV of 2.3x) given the group’s more stringent credit underwriting standards and established franchise in the domestic retail financing markets.

For Maybank (MAY MK, RM9.25, BUY, TP: 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 expected to improve as global headwinds ease, while its Indonesian unit is also showing signs of a turnaround.

Source: Affin Hwang Research - 1 Nov 2017