Although Jan 2017 loans were slightly higher YoY, leading indicators are still weak ahead with our view that the banks will be selective on asset quality with tight approval rates. The momentum of the system loan growth will likely be subdued for 2017. We maintain a neutral call for the sector. Most of the banking stocks in our universe are maintained at MARKET PERFORM with the exception of AFFIN (TP: RM2.55), AFG (RM3.79) and BIMB (RM4.15) at UNDERPERFORM.

Positive start. 2017 banking industry loan growth started promisingly, advancing by 30bps to 5.6% (Dec 16: +5.3% YoY) at RM1,527.9m or +0.4% MoM vs Dec 16: +0.9% MoM) driven by household loans at +6.0% YoY (December 16: +6.1% YoY). Business loans saw improvements with Dec 2016 and Jan 2017 growths at 4.5% YoY and 5.2% YoY. We are not surprised with this positive surge as it’s the usual trend for stronger loans in the earlier part of the year before tapering off. The strong growth was also due to loans disbursed (+3.4% YoY) outpacing loans repayments (-0.7% YoY). On an annualized basis, growth was at +5.1% YoY within our expectations of 5-5.5% growth for 2017.

Growth in the household loan was mainly attributable to loan for residential property at 9.1% YoY (Dec 16: +9.2% YoY). Hire purchase continued its downward trend at -0.9% YoY (Dec 2016: -1.0% YoY). Growth in the business segment was driven by non-residential property at +6.1% YoY (Dec 2016: +6.1) working capital continued to surge ahead at 6.3%% from December 2016’s +5.3% YoY.

Leading indicators shows weaknesses ahead especially from the business side. Despite the positive loan growth, loan applications were weak, declining further at 8.4% YoY (Dec 16: -4.6% YoY. Both business and household loan applications dipped with the former declining further by 13.6% YoY (Dec 16: -10.2% YoY) while the latter fell slower at -2.8% YoY (Dec 2016: -5.7% YoY). The weak business applications were dragged by falling applications for working capital (Jan 2017: -15.0% YoY vs Dec 2016: -16.2% YoY) and purchase of non-residential property (Jan 2017: -10.5% vs Dec 2016: -11.4% YoY). The weak demand for household loans was dragged by falling demand for passenger cars (Jan 2017: -2.1% YoY vs Dec 2016: -1.1% YoY) and personal use (Jan 2017: -28.9% YoY vs Dec 2016: -29.0% YoY). Demand for residential property rebounded to +3.4% YoY (vs. Dec 2016: -2.7% YoY). On a positive note loan rejection decelerated with loans approved falling slower at 5.1% YoY (vs Dec 16: -12.8% YoY) with business continued to decline at 15.3% YoY but loans approved for household rebounded to +6.7% YoY. The decline in the business segment was led by falling approval in purchase of non-residential property (-8.9% YoY vs Dec 16: +26.6%) and other purposed (Jan 17: -75.2% YoY vs Dec 16: -45.1% YoY). Higher approvals for purchase of residential property (+12.5% YoY vs Dec 2016: +13.5% YoY) drove the approvals for the household segment. Not surprisingly overall approval rate in the system fell 9.5ppts to 42.5% with business loan falling by 16.2bps from Dec 2016 but household up by 50bps from Dec 16 to 43.3%

Deposit growth improved to +2.6% YoY but liquidity continues to fall. Deposit in Jan 2017 was at RM1,702.4b, rising by 110bps from Dec 2016. The increase was because of the improved demand for CASA at +5.8% YoY (vs Dec 16: +5.0% YoY) mitigated by the decline in fixed deposit, foreign exchange and other deposits. CASA ratio deposits increased by 20bps to 26.7%. The loan-to-deposit ratio rose marginally by 3bps to 89.77% in Jan 2017. System excess liquidity to total deposit base shrunk slightly by 10bps to 10.2% MoM with system excess liquidity falling by 17.5% YoY to RM174.2b.

Asset quality stabilized but LLC regressed YoY. On a YoY basis, asset quality stabilized as system net impaired loans ratio was flattish at 1.20% Growth in impaired loans seems to be decelerating with business segment slowing at +4.8% YoY (Dec 16: +5.7% YoY) while the household segment slower by 10bps to +6.4% YoY. Meanwhile, loan loss coverage is still below the 100% mark (+1.3ppts MoM and -4.1ppts YoY) but 130bps higher from Dec 16 to 91.5% as impaired loans grew at 5.4% YoY while provisioning was slower at 0.9% YoY.

Increase in interest spread. The 3-month deposit rate remained intact at 2.92% and the average lending rate for Jan 2017 was up by 6bps to 4.54%. Interest spread was higher by 5bps to 1.62% in Jan 2017 from the previous month. We believe this is a temporary blip as excess liquidity is still narrowing and stiff price-based competition continues to plague the market

Outlook maintained. Given our view that the banks will be cautious/selective on asset quality with approval rate still tight, the momentum of the system loan growth will hence likely be subdued for 2017. Stiff price-based competition might trending upwards in 2017 as competition for deposits intensifying for excess and longer-term funding. However, better pricing on assets might minimise NIMs compression. Our base case estimate for the system loan growth for 2017 is in the range of 5.0-5.5%. Together with the ongoing headwinds such as: (i) compressing net interest margin, and (ii) elevated credit costs expected to be seen in 2017, there are limited opportunities to drive earnings growth for the industry materially beyond our current expectation of a mid-to-high single-digit growth.

Source: Kenanga Research - 2 Mar 2017