September loans growth continued to moderate YoY. Leading indicators showed weakening signs ahead but approval rate continued its upward momentum. No change in our views of subdued loans ahead, 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 (TP: RM2.04) being rated as an UNDERPERFORM but calls on both MAYBANK (TP: RM8.46) and RHBBANK (TP: RM5.33), on the other hand, maintained as OUTPERFORM.

Year-on-year loans growth continued to moderate but picking up on an annualized basis. System loans growth was flattish for Sep 2016 at 4.2% YoY with both household and business showing contrasting fortunes from the previous month. The former moderated at +6.6% YoY (August 16: +6.7% YoY) while the latter buck the trend at +2.0% YoY (August 16: +1.9% YoY). Moderation in growth was caused by higher loan repayments (Ytd-16: +1.4% YoY) which outpaced the decline in loan disbursements (Ytd-16: -4.0% YoY). When annualised, industry loans advanced 3.6% YoY (vs. August 16: +2.8% YoY), slower than our expectations of a 2016 loans growth of 5-6%.

Leading indicators in September showed weakening loans ahead but approval rate improving MoM. Leading indicators showed continued deceleration for September as the downturn in loan applications weakened further by 8.7% YoY (vs. August 16: -1.6% YoY) led by demand for business loan declining further at 14.4% YoY (vs. August 16: -11.2% YoY) while demand for household loan reversed momentum to fall at 2.1% YoY (vs. August 16: +10.0% YoY). The slower demand for household loans was driven by: (i) declining credit demand in passenger cars (-8.9% YoY vs. August 16: +6.3% YoY), (ii) slower demand for property financing, which rose moderately at 2.2% YoY (August 16: +12.7% YoY), and (iii) further decline in demand for personal loans at 18.7% YoY (vs August 16: -6.3% YoY). Demand for business loans fell led by: (i) fall in demand for nonresidential property (-17.4% vs August 16: +8.8%), (ii) moderate fall in construction (-11.5% vs August 16: -20.4%) but mitigated by rebound in demand for working capital (+1.7% vs Jul 16: -30.5%). Compounding the fall in demand was declining approvals by 8.2% vs. August 16 improvement of +0.2% as the approval rate for business loan fell further by 10.1% YoY vs. August 16 fall of 0.2% YoY with household loan approvals weakened to 6.2% vs. August 16 pickup 0.5%. The deterioration in household approvals was led by falling approvals for purchase of passenger cars and residential property at -6.3%, and -9.9% (vs August 16: -3.0%, and +1.3%) respectively. However overall system loan approval rate (MoM) continued to tick upwards, improving by 90bps in September to 43.3% % and 20bps to 42.0% YTD.

Asset quality deterioration slowed YoY. On a YoY basis, asset quality deterioration slowed, as system net impaired loans ratio was up by only 3bps to 1.26% YoY (vs August 16: +4bps YoY) with weakening pace of net impaired loans vs. slower loans growth at +6.7% YoY vs. +4.2% YoY (August 16: +8.0% vs +4.2%). The business segment led the way as its impaired loans grew slower at +7.5% YoY (vs. August 16: +11.0% YoY) but the household segment ticked upwards to +3.7% YoY (vs August 16: +2.8% YoY). The business segment saw slower deterioration underpinned by slower impairments across the board. The slight uptick in impairments in the household segment was dragged by slight increase in impairments for purchase of residential property at +2.9% YoY (August 16: +2.8% YoY) and personal use by 20bps to 31.7% but offset by slowing impairments in purchase of passenger cars at -12.4% (August 16: -14.8%). On a MoM basis, net impaired loans ratio deteriorated by 1bps to 1.26%. Meanwhile, loan loss coverage deteriorated YoY to 89.4% (-20bps MoM and -8.7ppts YoY) as impaired loans grew at +6.1% YoY while provisioning fell by 3.3%.

Excess liquidity improved slightly MoM, and interest spread wider. As with loans system deposits growth was flattish in September at +0.8% YoY albeit slower compared to system loans growth (+4.2% YoY). Hence, the industry loan-deposit-ratio fell marginally by 39bps MoM to 88.6%. With loans and deposits flattish, excess liquidity to total deposit base improved slightly by 40bps to 11.4% MoM. The percentage of current account and savings account (CASA) fell slightly by 10bps to 25.6% MoM, as savings deposits improved +5.2% (August 16: +4.7%) while demand deposits fell further at 2.8% (vs. August 16: -1.3%). The interest spread between average lending rate (ALR) and 3-month fixed deposit rate (FDR) was wider by 4bps to 1.63% as the former was up by 9bps to 4.54% and the latter rising by only 5bps to 2.92%.

NEUTRAL stance maintained. Loans growth for 2016 is expected to be within our expectation of 5% and subdued for 2017 with no clear catalyst ahead in the immediate/medium term. Thus, no change in our NEUTRAL stance for the sector. Further structural and cyclical headwinds such as: (i) constricting liquidity environment, (ii) narrowing NIM, (iii) weak capital market activities, and (iv) elevated credit costs, are expected to plague the banking industry well into 2017. We have MARKET PERFORM calls for most of the banking stocks in our universe except for AFFIN which we maintained an

UNDERPERFORM rating while both MAYBANK and RHBBANK are rated OUTPERFORM. Besides, the recent falls in share prices have made them looking attractive.

Source: Kenanga Research - 1 Nov 2016