October loans growth continued to be moderately higher YoY. However, deceleration is in the cards with leading indicators showing 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. Eight of the banking stocks in our universe are maintained at MARKET PERFORM with the exception of AMMB (TP: RM4.63) being rated as OUTPERFORM due to its cheap valuations and AFFIN (TP: RM2.20) maintained at UNDERPERFORM.

Annualised loans still below expectations. The July OPR cut seems to be bearing fruit with system loans growth improved for Oct 2016 at 4.5% YoY but both household and business showing contrasting fortunes. The former continued to moderate at +6.4% (Sep 16: +6.6%) for the third straight month while the latter bucked the trend at +2.7% (Sep 16: +2.0%) accelerating for the third straight month. When annualised, industry loans advanced 4.0% YoY (vs. Sep 16: +3.8% YoY), slower than our expectations of a 2016 loans growth of 5%.

Fall in applications suggests resumption in the deceleration of loans growth. Leading indicators showed continued deceleration for October as the downturn in loan applications weakened further by 14.5% YoY (vs. Sep 16: -8.7% YoY) led by demand for business loan declining further at 22.2% YoY (vs. Sep 16: -14.4% YoY) while demand for household loan continued its falling momentum at 4.9% YoY (vs. Sep 16: -2.1% YoY). The falling demand in household loans was driven by: (i) further decline in credit demand in passenger cars (- 11.8% YoY vs. Sep 16: -8.9% YoY), and (ii) decline in demand for personal loans at 19.3% YoY (vs Sep 16: -18.7% YoY). Demand for business loans fell, led by: (i) fall in demand for working capital (-19.8% vs. Sep 16: +1.7%), (ii) fall in construction (- 23.7% vs. Sep 16: -11.5%). On a positive note, decline in approvals rate was slower in October at -4.0% YoY (vs Sep 16: -8.2%) as the approval rate for business loan rebounded 1.7% YoY vs. Sep 16 fall of 10.1% YoY with household loan approvals weakening further, declining 10.5% (vs. Sep 16: -6.2%). The deterioration in household approvals was led by falling approvals for purchase of residential property and passenger cars at -9.6% and -18.5% (vs Sep 16: -6.3%, and -9.9%), respectively. However, overall system loan approval rate (MoM) continued to tick upwards, improving by 6ppts in September to 49.0% and 70bps to 42.7% YTD.

Asset quality maintained. On the upside, asset quality continues to stabilize, with gross impaired loans ratio (GIL) flattish at 1.65%. Meanwhile, loan loss coverage deteriorated YoY to 83.8% (-6ppts MoM and -14ppts YoY) as impaired loans grew at +7.9% YoY while provisioning fell by 7.9%.

System LDR inched higher, excess liquidity shrinking. System deposits continued to grow at a slower pace against loans (+1.9% YoY vs +4.5% YoY). As a result, the industry’s loan-to-deposit ratio (LDR) inched higher by 26bps to 88.8% (Sep 16: 88.5%) while system excess liquidity to total deposit base shrunk slightly by 20bps to 11.2% MoM with system’s excess liquidity falling by 15.2% YoY to RM187.7b. Meanwhile, there was no change in the percentage of CASA to total deposits (25.7% vs 25.6%).

Interest spread narrowed as ALR fell. As anticipated, the interest spread between average lending rate (ALR) and 3-month fixed deposit rate (FDR) narrowed by 9bps to 1.54% as the former was down by 11bps to 4.46% and the latter was flat at 2.92%.

NEUTRAL stance maintained. Loans growth for 2016 is expected to be within under 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) muted loans growth (ii) weak capital market activities, (iii) elevated credit costs on the back of a potential up-cycle in non-performing loans are likely to plague the banking industry well into 2017. We have MARKET PERFORM calls for most of the banking stocks in our universe except for AMMB (TP: 4.63) which we raised to an OUTPERFORM rating as the recent fall in share price have made the stock looking attractive and we maintained our UNDERPERFORM call on AFFIN (TP: RM2.20).

Source: Kenanga Research - 1 Dec 2016