While we are comfortable with the sector’s FY13 & FY14 PERs valuation of c. 14.3x & 13.3x, as compared to FBMKLCI’s 19.4x & 17.3, respectively, we still maintain our NEUTRAL call in the Banking & Non-Bank Financial sector given that we are concern over (i) potential moderating in loans growth, especially with the recent implemented tighter lending guidelines to mortgages, (ii)continuing decline in NIM and (iii) potential weaker in non-interest income due to higher uncertainties in the capital market. Hence, earnings growth prospect seems challenging. We are maintaining our MARKET PERFORM calls on AFFIN (TP: RM4.60), AMBANK (TP: RM8.10), BIMB (TP: RM4.74), CIMB (TP: RM8.10), HLBANK (TP: RM15.20) & PBBANK (TP: RM18.20). Meanwhile, our OUTPERFORM ratings are on AFG (TP: RM5.62), MAYBANK (TP: RM10.40) & RHBCAP (TP: RM8.75). We pick RHBCAP as our TOP PICK for the quarter due to its undemanding valuation as per our PBV-ROE regression study. While the value of CIMB has emerged based on this study, it was not nominated as one of the top picks due to our MP-call.

3QCY13 results have shown trends / observations that within our expectations. Recall that in the previous quarter, we have seen signs of weakness emerging among banks. While most of the banks under our coverage were able to meet consensus expectations and that of ours, some banks’ profitabilities were boosted by below norm credit charge ratio. For instance, AFFIN’s profitability was sustained by writebacks of loan impairment in the past 3 quarters despite registered a flattish total income growth of only 1% YoY. The same observation also found in AFG, HLBANK and AMBANK. However, the trend of historically low credit cost may not be sustainable. Already we saw PBBANK and MBSB (OP, TP: RM3.05) booked in higher credit cost during the quarter.

Moderating In One of The Major Growth Engine. The industry loans growth is expected to growth between 10%-12% throughout 2014 as per our regression study with a 2014 real GDP growth assumption of 5.0%-5.5%. As at end-Nov13, housing loans accounted for c.28% of total loan and grew 13.3% YoY against the total loans growth of 9.9%. However, the risk of moderating in loans growth exists. The Approval Rate (=Loans Approved/Loans Applied) has dipped to 45.0% in end-Nov13 (with a multi-year low of 41.3% in October 2013) from 49.5% a year ago. Statistically speaking, should the Approval Rate moderate by 1 percentage point (“pp”), it will drag the total loans growth to decline by 0.33pp. It is believed that the underlying downtrend in Approval Rate to continue given a well-defined (R2=67.5%) regression line. The regression line projects mortgages to register growth rates of 12.9% and 12.1% for end-13 and end-14, respectively. This could imply total loans to grow at 11.8% and 11.2% for the similar period of time as total loans will grow by 0.64% for every 1% growth in mortgage.

Developing new growth drivers. To counter the potential slowdown in the major loans driver such as mortgages, we also notice that banks have gradually switched their lending directions to other segments such as corporate loans and share margin financing. It is widely expected that potential credit demand could come from ETP projects. However, we have yet to see substantial drawdown of these loans. Most bankers agree that they may start seeing drawdown of loans probably in 1H14. While this might offer good growth going forward, we need to emphasis that these loans are normally short-term in nature and having higher credit risk profile as most of the projects are under Private Finance initiative (“PFI”) / Public Private Partnership (“PPP”) arrangements. In the meantime, banks also try to build their non-interest income positions, especially for those banks that have lesser contributions from non-interest income.

Margin Compression – A New Norm? Thus far, we have seen interest spread between the average lending rate (ALR) of banks and their 3-month Fixed Deposit Rates declining since late-2006 (from the high of 3.48%). As at end-Nov13, the interest spread narrowed by another 15 basic points (“bps”) to 1.59%. This seems to be a new emerged trend for the banking sector. While we reckon this underlying trend is inevitable due to competitions and pricing of loans, such historical low interest margin/spread may not be sufficient to price in potential deterioration in asset quality.

While we see no immediate risk of deteriorating in assets, (i) the flattening net impaired loan ratio of ≈1.4% as at end-Nov13 and (ii) the declining loan loss coverage (of 97.1% as at end-Nov13 from its peak of 102.4% in end-Oct12) could be early signs for the emergence of trend of higher credit cost, which will erode banks’ bottomlines. Thus far, we have only priced in 25.0bps and 26.5bps, on average, in credit costs for banks under our coverage for their FY14F and FY15F estimates as opposed to 25.6bps and 21.5bps in FY12A and FY13A/E.

Should there is a hike in interest rate, say in 2H14, we believe this could be mixed for banks. This is because while banks are able to increase their top-lines due to wider interest spread, in the short-run, they may get hit from hire credit cost due to lower affordability (especially in a cost-push inflation scenario). Besides, higher interest rate may also slow down credit demand. On treasury front, the movement of interest rate may also affect banks’ non-interest incomes due to mark-to-market positions for fixed income and forex instruments.

The prospect of non-bank money lenders such as MBSB and AEOCR (Under Reviewed) may be affected by higher living cost hence lower disposable income. While the credit demand remains strong as these loans are considered as micro financing, especially when times are tougher, the main issue to be focused on is the collection of loan repayments. In this sense, MBSB has an upper hand, as it is able to deduct salaries from its borrowers (who are mainly government servants) hence having lower NPL issues. Nonetheless, its venture into corporate loans and property-related loans may exposure to higher credit and market risks henceforth.

Source: Kenanga