August loans growth continued to moderate YOY but on annualized basis momentum continued to pick up. Leading indicators showed improvement as the effect of the July OPR cut began to filter in. Our forecast of 5-6% loans growth is unchanged, thus we maintain a NEUTRAL call on the sector. Seven of the banking stocks in our universe are maintained at MARKET PERFORM with the exception of AFFIN being UNDERPERFORM and both MAYBANK and RHBBANK are upgraded to OUTPERFORM as the recent steep fall in their share price has set their share prices looking attractive again.

Year-on-year loans growth continued to moderate but momentum picking up on an annualized basis. System loans growth moderated further for Aug 2016 at (+4.2% YoY vs. July 2016: +5.1% YoY) with both household and business segments slower from the previous month. The former moderated at +6.7% YoY (July 16: +6.8% YoY) while the latter was slower at +1.9% YoY (July 16: +3.6% YoY). Moderation in growth was caused by higher loan repayments (Ytd-16: +2.5% YoY) which outpaced the decline in loan disbursements (Ytd-16: -3.6% YoY). When annualised, industry loans advanced 3.7% YoY (vs. July 16: +3.1% YoY), the fourth consecutive month of pick-up. However, with annualized loans picking up, we expect loans for 2016 will reach our expectations of 5-6%.

Leading indicators showed improvement as approval rate picking up. Leading indicators showed a change in momentum for August as the downturn in loan applications weakened by only 1.6% YoY (vs. July 16: -18.0% YoY) led by demand for business loan falling slower at -11.2% YoY (vs. July 16: -21.8% YoY) while demand for household loan reversed momentum to grow at 10.0% YoY (vs. July 16: -13.7%). The rebound in demand for household loans was driven by: (i) rise in credit demand in passenger cars (+6.3% YoY vs. July 16: -23.8% YoY), (ii) higher demand for property financing, which rose 12.7% YoY (July 16: -11.8% YoY), and (iii) further demand in credit cards at 31.9% YoY (vs July 16: +20.7% YoY). Demand for business loans fell led by: (i) fall in demand for working capital (-30.5% vs July 16: -22.3%), and (ii) fall in construction (-20.4% vs Jul 16: -7.1%) but mitigated by rebound in demand for purchase of non-residential property (+8.8% vs Jul 16: -11.1%). Compounding the moderate fall in demand was the slight improvement in approvals by 0.2% vs. July 16 fall of 19.4% as the approval rate for business loan fell by 0.2% YoY vs. July’s 16 fall of 18.1% YoY with household loan approvals rebounded slightly to 0.5% vs. July’s fall of 20.8%. The improvement in household approvals was led by rise in approvals for purchase of passenger cars, personal use and credit cards at +1.3%, +6.0% and +14.6% (vs July 16: -25.1%, -20.0% and - 5.4%) respectively. Residential property approvals fell moderately at 3.0% (vs July 16: 21.5%). Overall system loan approval rate (MoM) fell slightly by 70bps in August to 42.4% % but improved by 10bps to 41.8% YTD. The cut in OPR in July had probably improved the approval rate.

Asset quality deterioration slowed YoY. On a YoY basis, asset quality deterioration slowed, as system net impaired loans ratio was up by only 4bps to 1.27% YoY (vs Jul 16: +7bps YoY) with weakening pace of net impaired loans vs. slower loans growth at +8.0% YoY vs. +4.2% YoY (Jul 16: +11.23% vs +5.1%). The business segment led the way as its impaired loans grew slower at +11.0% YoY (vs. July 16: +12.7% YoY) and household segment moderated to +2.8% YoY (vs July 16: +4.0% YoY). The business segment saw slower deterioration underpinned by slower impairments in working capital and purchase of non-residential property at +9.8% YoY and +16.9% YoY (July 16: +19.2% YoY and +19.9% YoY) respectively but offset by higher impairments in construction at +30.7% (Jul 16: +5.5%). The moderate rise in impairments in the household segment was dragged by a slow rise in impairments in purchase of residential property at +2.8% (July 16: +3.2% YoY) and further fall in impairments in purchase of passenger cars at 14.8% (July 16: -11.9%). On a MoM basis, net impaired loans ratio deteriorated by 3bps to 1.30%. Meanwhile, loan loss coverage deteriorated YoY to 89.6% (+0.9ppts MoM and -8.0ppts YoY) as impaired loans grew at +8.0% YoY while provisioning fell by 0.8%.

Excess liquidity continued to narrow MoM, but interest spread wider. System deposits growth moderated in August (+0.8% YoY vs. July 2016: +1.0% YoY) albeit slower compared to system loans growth (+4.2% YoY vs. July 2016: +5.1% YoY). Hence, the industry loan-deposit-ratio rose marginally by 28bps MoM to 89.0%. Likewise, with slower deposits, excess liquidity to total deposit base fell 30bps to 11.0% MoM. The percentage of current account and savings account (CASA) improved slightly by 10bps to 25.7% MoM, as savings deposits improved +4.7% (Jul 16: +3.8%) while demand deposits fell further (-1.3% vs July 16: -0.1%). The interest spread between average lending rate (ALR) and 3-month fixed deposit rate (FDR) was wider by 5bps to 1.59% where the former was down by 6bps to 4.46% and the latter down by 11bps to 2.87%. As liquidity is still constricting, we expect a narrowing in interest spread going forward with another upcycle in deposit taking activities.

NEUTRAL stance maintained. With loans growth for 2016 are expected to be within our expectations of 5-6%, we maintain our NEUTRAL call for the sector. Structural and cyclical headwinds such as: ii) moderate loans growth, (iii) constricting liquidity environment, (iv) narrowing NIM, (v) weak capital market activities, and (v) higher credit costs, are expected to plague the banking industry well into 2017.

We have a MARKET PERFORM call for most of the banking stocks in our universe except for AFFIN, which we maintained our UNDERPERFORM rating. We upgrade our call for both MAYBANK and RHBBANK to OUTPERFORM, as the recent fall in their share prices have set valuations looking attractive.

Source: Kenanga Research - 4 Oct 2016