We maintain our NEUTRAL call on the sector as prevailing economic challenges undermine the industry’s performance moving forward. Furthermore, the sector still lacks of near-term catalyst as the economic and political uncertainties continue to weigh heavily on the sector; 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. All in, we maintain our NEUTRAL stance on the sector. MAYBANK (TP: RM9.74) and RHBCAP are the OUTPERFORM in our universe, while AFFIN (TP: RM2.40) is an UNDERPERFORM and the others are MARKET PERFORMs.

Banking stocks continued to be bashed down in 3Q15. Both the KL Finance index (KLFIN) and FBMKLCI continued to be bashed down in 3Q15. Essentially, the market sell-off was mainly due to: (i) an uninspiring 2Q15 reporting season, (ii) fear of higher impaired loans, (iii) on-going fear of potential political instability, (iv) uncertainty from the challenging economy and (v) downgrade of the country's sovereign rating.

2QCY15 results were mostly in of line. 5 out of the 9 stocks met expectations. Sector earnings was relatively flat QoQ and YoY, marginally lower by 0.1% and 0.9% YoY, respectively (1Q15: -0.9% QoQ and -3.4% YoY). The uninspiring numbers were attributed to: (i) weak income growth, (ii) rising opex, and (iii) higher credit cost, all of which were expected.

Liquidity position is tightening. For the 2Q, loans and deposits growth improved QoQ and YoY. The improved loan growth saw aggregate loan-deposit-ratio (LDR) improving by 127 bpts QoQ indicating liquidity position is getting tighter. To note, current account and savings account (CASA), as a percentage of total deposits was still flattish at 30%, hence, net interest margin (NIM) compression was unavoidable.

NIM up but downward pressure is still evident. NIM compression surprisingly eased in 2Q (+3.2bpst QoQ, -9.4 bpts YoY (1Q: -7.1 bpts QoQ, -14.3 bpts YoY). This is due to a stronger average lending yield for the quarter. However, given that LDR is on the uptrend, (with deposit growth lagging loan growth) competition for deposits will likely increase, pressuring NIM downward.

No boost from capital market activities, still weak overall. 2Q15 aggregate non-interest income (NII) fell 5.6% QoQ and 0.2 YoY (1Q: -4.1%, +13.9% YoY). Aggregate NII is on a downward trend as weak capital market activities dragged earnings.

The industry’s cost-to-income ratio (CIR) was still at elevated levels, above the 50%-mark for the third-straight quarter despite banks implementing various initiatives to control costs. Root of the matter, opex surged 0.5% QoQ and 10.1% YoY (1Q: -0.2% QoQ and -12.5% YoY) but income contracted by 0.3% QoQ, and increased 3.9% YoY (1Q: -0.8% QoQ and +7.0% YoY).

Asset quality deteriorated further, except for AFG, BIMB, HLBANK and PBBANK. Their gross impaired loans (GIL) ratio decreased by 2-5bpts QoQ vs. the industry’s GIL which increased by 4bpts QoQ. We expect this to stay stable for the remainder of the year as banks continue to seek out new creditworthy customers. Industry’s credit cost retracted. Aggregate credit charge ratio decreased by 3.1bpts QoQ and 9.9bpts YoY (1Q: +4.0 bpts QoQ, +12.4bpts YoY) as most banks saw their loans loss provision dipping. However, we believe this to be a temporary blip and credit costs will turn upwards again given the prevailing economic conditions. Improved capital position. Across the board we saw improved common equity tier 1 (CET1) ratio of between 20-118bpts QoQ. Only AFFIN bucked the trend, attributable to lower capital and risk weighted assets from the previous quarter.

System loans accelerated but muted loan growth ahead. Loans growth has been on the uptrend since May 15, but leading indicators showed muted loan growth ahead with approvals and disbursements on the downtrend since Jul 15. 

Source: Kenanga Research - 7 Oct 2015