No change to our NEUTRAL call for the sector as on-going challenges prevail. The year ended with most banking stocks outperforming both the FBMKLCI and the KLFIN. On a YOY basis earnings, earnings rebounded as lower opex and loan loss provisions aided earnings growth. However, we see moderating loans growth ahead with earnings enhanced by lower loans provisions with downside pressure on NIMs likely to subside. Lacking concrete earnings catalyst, we maintain NEUTRAL on the sector with the exception of AFFIN and CIMB. For CIMB, we maintained our TP but upgrade it to OUTPERFORM as the stock is looking attractive due to the weakness in its share price and at 0.9x PBV it is trading near to its 10-year low. AFFIN is maintained as UNDERPERFORM as we feel its loan growth is still challenging in the light of the volatile environment.

Not a bad year for selected banking stocks. For 2016, the KL Finance Index (KLFIN) outperformed the FBMKLCI index by 460 bps and advanced by 1.6%, pushed by heavyweights BIMB, PBBANK and RHBBANK. The FBMKLCI and KLFIN weaker performances were alluded to the spectre of rising US interest rates, weak Ringgit and commodity prices, 1MDB saga and MSCI’s reduced weighting of the banking stocks. Most the banking stocks bucked the trend, led by BIMB (strong financing growth), PBBANK (strong asset quality) while the outperformance of AFG and RHBANK were more specifically related to the entrance of new shareholders (AFG) and changes in corporate structure (RHBBANK taking over the listing of RHBCAP).

QoQ and YOY results rebounded. 3QCY16 results saw improvements across the board with all stocks in our banking universe meeting expectations. The only exception was AFFIN, which outperformed due to lower-than-expected loan loss provisions. Notably after three quarters of negative growth, the industry saw a rebound at +15.9% QoQ with all except BIMB, HLBANK and PBBANK recording positive growth for the quarter. BIMB, HLBANK and PBBANK saw contracting earnings for the quarter due to contracting income from investment of shareholders’ funds (BIMB), credit charge vs. a credit recovery in the 2nd quarter (HLBANK) and higher impairments (PBBANK). The rest saw improvement in earnings due to lower credit costs or in the case of AMBANK, higher credit recovery. On a YoY basis, earnings rebounded by 6%, boosted by stellar performances from RHBBANK (+120% YoY) and AFFIN (+36% YoY) partly due to lower opex (RHB) and loan loss provisions (AFFIN). The rest with the exception of AFG, AMBANK and MAYBANK saw growth of between 3% (PBBANK) and 17% (BIMB) on account of lower tax rate (PBBANK) and strong topline growth (improved financing and NIMs) for BIMB.

Moderating loans growth ahead. However, we seen no change in our view of moderating loan growth ahead as rising costs and cautionary stance on the challenging economy are curtailing the advancement in loan growth. To note, as at Nov 2016, annualised system loans growth advanced 4.7% YoY (Oct 2016: +4.0% YoY) vs. our full-year target of 5.0% for 2016, implying loans growth will still be a challenge ahead. System approval rate has not been encouraging with YTD (Nov 2016) approval rate flattish at 42.7%. Furthermore, the still elevated industry loan-to-deposit ratio (LDR) of 92.1% makes bank lending slightly more difficult/cautious than usual. Although excess liquidity is trending downwards, we expect marginal competition for deposits as demand for loans growth is expected to be subdued for 2017, thus NIMs to be flattish ahead. We expect the economy to be slightly better for 2017 at growing at between 4.5% and 5.0%, thus our base case estimate for the system loan growth for 2017 is in the range of 5.0-5.5%. For banks under our coverage, aggregate loans growth is expected to improve slightly to +6.5% for 2017 (vs. 2016E: +6.0%) dampened by: (i) flattish net interest margin, (ii) weak capital market activities, and (iii) flattish credit costs, as there are limited opportunities to drive earnings growth for the industry materially beyond our current expectation of a mid-to-high single-digit growth.

New growth drivers? To counter lower earnings from loans, we noticed that the banks’ strategy in 3QCY16 was to build earnings from: (i) Non-interest income (NOII), (ii) Islamic banking income, and (iii) lower impairment for allowances. We saw this trend manifesting in: (i) Enhanced NOII in AFFIN (+15% QoQ), MAYBANK (+13% QoQ) and RHBBANK (+7% QoQ) attributed to gains in disposal/financial revaluation of financial investments/assets while capital market activities remained weak, (ii) Improved Islamic Banking income in AFG (+17% QoQ), HLBANK and PBBANK (both at +7%), and (iii) falling allowances in impairments in BIMB (-23%), CIMB (-11%), MAYBANK (-72%) and RHBBANK (-55%). While credit costs have been challenging in 2016, we expect the industry average to trend lower for 2017, falling by 4bps to 0.35%. Stabilizing in commodity prices is also expected to prevail in 2017, thus lowering credit costs for some banks. Maybank and RHBANK are expected to benefit from this stabilization with the added advantage of some reclassification of loans from nonperforming to performing

Downward pressure on NIM to subside. We expect less volatility in NIM for 2017. Although NIM declined by 18% YoY, the momentum in NIM falling has decelerated since 1Q16 (-8.8% QoQ) to -2.7% (3Q16). This is probably due to: (i) better product pricing by the banks, and (ii) deposits taking activities winding down due to high LDR in the industry (3Q16: 92.1%) and subdued demand for loans resulting in less demand for deposits. With loans demand ahead seen moderating, we opined that deposit taking activities in 2017 will be less intense, thus pricing competition for deposits will likely to be marginal. Thus, we expect downward industry NIM to subside if not lower by 1bps to 2.18%

Asset quality to stabilize. We do not expect asset quality to deteriorate adversely as seen in Q2 and Q3 of 2016 mostly attributed to prudent provisioning of loans (by MAYBANK and RHBBANK to the O&G sector). With the oil prices expected above the USD50 mark, reclassification of performing loans exposed to the O&G is on the cards, thus asset quality is expected to improve in 2017. Note that in the period between 2012-2013 when GDP was hovering between 5% and 6%, loans growth was in the double-digits and GIL was above 2% but GIL has tapered since then in tandem with subdued loans growth. YTD 2016, system GIL has been hovering at between 1.61% and 1.68% with Nov’s GIL dropping by 2bps to 1.63%. Hence, we are in the opinion that asset quality deterioration will not be adverse and GIL will probably hover between 1.7% and 1.8% for 2017.

Lacking concrete earnings driver…maintain NEUTRAL. We made no change to our NEUTRAL stancein the absence of concrete catalyst and no clear game changer going forward. Our view on structural and cyclical headwinds such as; (i) moderate economy; (ii) muted loans growth and (iii) moderate NIMs, remains, hence earnings growth will still be challenging. Hence, there is no change to our cautious stance. With most 3QCY16 results coming in line, we maintained our MARKET PERFORM call for most of the banking stocks in our coverage with the exception of AFFIN and CIMB. For CIMB, we maintained our TP but upgrade it to OUTPERFORM as the stock is looking attractive due to the weakness in its share price and at 0.9x PBV, it is trading near its 10-year low. For AFFIN, maintain our UNDERPERFORM call maintained as we feel its loan growth is still challenging in the light of the volatile environment.

Source: Kenanga Research - 5 Jan 2017