YTD, KLFIN outperformed the FBMKLCI by 1.7ppts. Essentially, the lagging market was primarily due to: (i) an uninspiring 1Q15 reporting season, (ii) growing fear of potential political instability, (iii) uncertainty from GST implementation, and (iv) impending sovereign rating review. That said, the banking sector still lacks re-rating catalysts; structural and cyclical headwinds such as: (i) muted loans growth, (ii) tight liquidity environment, (iii) narrowing NIM, (iv) weak capital market activities, as well as (v) rising credit costs continue to plague the industry. All in, we maintain our NEUTRAL stance on the sector. MAYBANK (TP: RM9.74) remains the lone OUTPERFORM in our universe, while AFFIN (TP: RM2.74) is an UNDERPERFORM and the others are MARKET PERFORMs.

Most banking stocks got bashed down in 2Q15. The old market adage “sell in May and go away” held true. Both the KL Finance index (KLFIN) and FBMKLCI got bashed down during the 1-mth period (start of May: +2-3%; end of May: -1%). We believe the former’s decline was systemic in nature. Essentially, the market sell-off was mainly due to: (i) an uninspiring 1Q15 reporting season, (ii) growing fear of potential political instability, (iii) uncertainty from GST implementation, and (iv) impending sovereign rating review. The three performers in the banking sector were: PBBANK, MAYBANK, and BIMB, while the rest saw negative price returns.

 1Q15 results review. Jan-Mar 2015 results were largely in-line. 7 out of the 9 stocks met expectations (AFG, AMBANK, BIMB, HLBANK, MAYBANK, PBBANK, RHBCAP) while 2 came in below (AFFIN, CIMB). The subpar performance registered by both AFFIN and CIMB was due to higher-than-expected provision for bad loans. Notable QoQ observations were: (i) flat earnings growth, (ii) liquidity position remained tight, (iii) net interest margin (NIM) narrowed, (iv) capital market environment was still weak, (v) operating expenses stay elevated, and (vi) credit cost rose despite (vii) improving asset quality. These trends are largely expected to persist throughout the year.

 Expectations for FY15/FY16: (i) aggregate loans growth is expected to weaken to 8.6%/8.0% (vs. FY14: +11.7%), (ii) sector NIM to contract by 7.4bpts/3.6bpts (vs. FY14: -18.1bpts), (iii) non-interest income growth to pick up some paced (4.8%/4.5% vs. FY14: -2.3%), (iv) credit charge for the sector to increase by 8.6bpts/-1.6bpts (vs. FY14: +0.2bpts), (v) cost-to-income ratio (CIR) to fall by 101.5bpts/1.7bpts (vs. FY14: +15.7bpts), and (vi) earnings growth for the sector to remain muted at 5.3%/6.0% (vs. FY14: +0.4%).

Asset quality is seen to be stable. For the past six years, the asset quality of banks has been improving. The big question now is whether it will continue to gain traction. In this report, we took a closer look on the matter and study the implications from asset quality deterioration (see pg. 7 to 10). All in all, we reckon that further progress would be a tall order to achieve and at best, it should remain stable moving forward. We believe borrowers are capable of honouring their existing loan obligations. Firstly, in the household segment, the value of financial assets owned by debtors is double the value of their liabilities. Furthermore, they are able to service twice the amount they owe via income earned. Similarly, in the business sector, credit risk is well contained given sound overall debt servicing capacity and liquidity position where: (i) balance sheet is unstretched with debt-to-equity ratio standing at ~40% while (ii) interest coverage ratio is still robust in excess of 6x. These suggest that loan repayment is not an issue. Hence, we opine that asset quality would not fall off the cliff. Will it continue to improve? We do not think so but at best, it should remain resilient for the rest of the year.

Maintain NEUTRAL on the sector. Outlook for the sector remains unchanged. Structural and cyclical headwinds such as: (i) muted loans growth, (ii) tight liquidity environment, (iii) narrowing NIM, (iv) weak capital market activities, as well as (v) rising credit costs continue to plague the banking industry. Thus, we maintain our NEUTRAL recommendation on the sector while advocating caution and adopt a selective stock picking strategy; MAYBANK (TP: RM9.74) remains the lone OUTPERFORM in our universe. Essentially, we like its: (i) superior yield offerings of ~6% and (ii) extensive regional exposure in ASEAN-5. The other stocks under our coverage are MARKET PERFORMs, save for AFFIN (TP: RM2.74) which is an UNDERPERFORM.

Source: Kenanga Research - 3 Jul 2015