Our NEUTRAL view remains unchanged. We continue to see trends of: (i) moderation in loans growth and (ii) structural NIM compression to put pressure on banks’ top-line growth. While we have yet to see any significant jump in credit cost, we are still concerned over the potential normalisation in credit cost, especially if domestic interest rates start to increase. While we reckon that any hikes in domestic interest should be positive to banking stocks in the near-term, higher interest rate would inevitably post some negative impacts in the long-run (i.e. higher credit cost, slower loans growth & higher cost of funding). To position for the potential rate hike, we select AFG (OP, TP: RM5.25) as our Top Pick due to its high proportion of variable rate loans and higher-than-industry percentage of CASA. We also keep our OUTPERFORM (OP) rating on BIMB (TP: RM4.55) and MAYBANK (TP:

RM11.20) and PBBANK (TP: RM21.90). We are NEUTRAL on AFFIN (TP: RM4.00), AMMB (TP: RM7.80), CIMB (TP: RM8.00), HLBANK (TP: RM15.20) and RHBCAP (TP: RM8.75). Vis-à-vis banking stocks, we notice that non-bank financial, such as insurers and money lenders offer better earnings visibility. Hence, our OP calls on MBSB (TP: RM2.65), LPI (TP: RM18.75) and BURSA (TP: RM8.10). We pick AEOCR (OP, TP: RM17.80) as our mid-cap TOP BUY for its undemanding valuation and sound fundamentals. We are not overly concerned over the deterioration in asset quality and rising credit cost as AEOCR’s NIM which is much higher than banks should be able to cushion such concerns.

1QCY14 results were pretty much within expectations as we had factored in the underlying trends of: (i) moderation in loans growth, (ii) structural NIM compression, and (iii) rising credit cost. During the quarter, AFFIN and CIMB reported weaker-than-expected results as: (i) AFFIN saw weaker top-line growth and higher operating expenses while (ii) CIMB’s 1Q14 net profit declined 23.1% as 1Q13 earnings had included exceptional net gains of RM265m (gains from sale of CIMB Aviva of RM515m less restructuring charges of RM200m and a tax impact of RM50m). Nonetheless, if these gains were excluded, the Group would see a 4.4% YoY increase in earnings.

Operating environment remains challenging. Again, our concern over the sustainability of their earnings growth remains as we strongly believe that normalisation in credit cost is well on the cards. For instance, we notice some banks’ profits boosted by lower credit cost (i.e. MBSB & RHBCAP) and writebacks in investment assets (i.e. MAYBANK). Without these, their results would have been lower. During the results season, we also notice that some banks (i.e. AFFIN, CIMB & RHBCAP) failed to meet their respective ROE targets.

As for top-line, most of the banks continued to diversify their lending directions to non-household or non-retail segment. We believe this is a necessary strategy to cushion the continuous contraction in NIM due to keener competition apart from searching for growth avenues. The Average Lending rate (ALR) declined 25bps YoY (or 5bps MoM) to 4.47 as of end-May14 as per BNM’s latest monthly statistics.

As of end-May14, the industry outstanding loans grew 9.7% YoY (vs. 10.0% in Apr14 & 9.3% in May13), which is inline with our expectations. Recall that our regression study suggests that the industry loan growth is likely to register between 10% and 12% with a 2014 real GDP growth assumption of 5.0%-5.5%. Until now, household loans remain as the major growth driver with a YoY growth of 10.7% and accounted for 54.1% of the total loan. Despite tighter administrative measures on residential property financing (accounted for 53.2% of household loan or 28.8% of total loan), this sub-segment still grew 13.6% YoY (consistently for the last 3 months). This is a pleasant surprise to us, but it is inline with the recovery in Approval Rate (AR=Loans Approved/Loans

Applied). The 3-month average AR registered at 52.0% as opposed to 49.7% in the corresponding period of last year. On the contrary, the next largest household loan (accounted for 12.2% of total and 22.5% of household loans), namely passenger car loans, only grew moderately by 5.7% YoY. We were not surprised over such lacklustre growth as bankers may be concerned over the growth prospect and asset quality of auto loans in the long-run, as car prices are expected to decline gradually in the next five years (say 20%-30%) under the objective of the National Auto Policy (NAP).

As at end-May14, while Net Impaired Loans Ratio remained near the historical low of 1.27% (vs. 1.26 at end-April 2014 & 1.36% in end-May 2014) and declined 1.2% YoY, the loan to purchase of passenger cars ratio surged 18.4% YoY (vs. 21.6% YoY in Apr14 & -0.6% in May13). The higher growth in impaired loan has reinforced our earlier mentioned view. Loan Loss Reserve/Coverage (LLC) was flat at c.105% as compared to the previous month but it was an increase from 99.2% in May13.

On the deposit front, while total (customer) deposits only grew 5.9% YoY, the Loan-to-Deposit Ratio (LDR) remains flat at approximately 81.7%. CASA as a percentage to Total Deposits has declined marginally to 26.0% from 26.4% in end-May14 but increased from 25.5% in May13. CET1, Tier 1 and Total Capital ratios were also flat at 12.1%, 12.8% and 14.5%, respectively, but representing improvement from 11.9%, 12.8% and 14.1% as of May13.

As for heightened talks of hike in interest rate, we reckon that any hikes in domestic interest should be positive to banking stocks in the near term due to: (i) faster re-pricing of loan as opposed to deposits and (ii) concern over rising credit cost could be overplayed should the rate hike is merely 25-50bps as our economist reckons that the country’s neutral rate is approximately 3.50% (vs. the current OPR of 3.00%). In general, banking groups that have: (i) higher contribution from Net interest income to total income, (ii) higher variable loans mix, (iii) higher domestic loans, (iv) longer time weighted fixed deposits, and (v) higher percentage of CASA to total deposits should benefit from such move.

To position for the potential rate hike, we select AFG as our Top Pick due to its high proportion of variable rate loans and higherthan-industry percentage of CASA. However, in the long-run, this advantage could be muted as higher rate could potentially: (i) dampen credit demand, hence lower loans growth, (ii) be eroded by higher cost of funding and (iii) results in higher credit cost should affordability of borrowers deteriorate. We do not discount the later scenario as higher interest rate would inevitably post negative impact given the high household debt to GDP.

Other latest development. The Monetary Authority of Singapore (MAS) has just introduced a new liquidity coverage ratio (LCR) requirement for banks operating in Singapore. Under LCR, minimum levels of liquid capital are required to be held by banks as part of global regulatory efforts to inoculate banks against sudden financial stress. Under the new MAS requirements, Singaporean banks will have to maintain 100% local-currency LCR from January 2015. An all-currency LCR will also be implemented – starting at 60% in 2015 and rising in annual 10% steps to 100% by 2019. Foreign banks that operate in Singapore will also fall under the new framework, with LCR requirements of 100% and 50% for Singapore dollar and foreign-currency liabilities, respectively, beginning in January 2016. We understand that this tougher liquidity requirement (including foreign banks in Singapore) could spur banks to compete more aggressively for deposits, which could translate into narrower NIM and higher marketing expense. However, we do not expect this rule to impact Malaysian banks that have operations in Singapore significantly judging from the relatively low earnings contribution. For instance, Maybank Singapore only contributed 13% of the Group’s PBT in 1Q14.

Source: Kenanga