While we maintain our cautious view on the banking sector due to moderate domestic economy, we raised our valuations on the banking stocks in our universe on the premises of revived interest in the banking sector, healthy/positive interest rate margins and a potential hike in the domestic interest rates due to external conditions. We based our new valuations on the banks 5-year average P/BV but with variance of between -0.5 to -1.0 SD to reflect challenging conditions. We maintain our MARKET PERFORM calls on AFG (TP: RM4.17), AMBANK (TP: RM4.93), BIMB (TP: RM4.54), CIMB (TP: RM5.55), MAYBANK (TP: RM9.17), PBBANK (TP: RM21.17), RHBBANK (TP: RM5.65). AFFIN (TP: RM2.85) is maintained as UNDERPERFORM. We pick HLBANK (TP: RM14.75) as our top pick which we raised to OUTPERFORM due to its undemanding valuation.

So far, excellent for banking stocks. As of 10 March 2017, the KL Finance Index (KLFIN) outperformed the FBMKLCI index by 250bps and advanced by +7.1%, pushed by heavyweights CIMB (+19.1%), AMBANK (+13.0%) and RHBANK (+9.6%), boosted by their recent quarterly results, which showed improved earnings due to operational efficiency. The FBMKLCI and KLFIN’s stronger performances are alluded to an expected strong US economic performance with rising interest rates and stronger fiscal policy. The higher-than-expected positive expectations saw the revival of interest in banking stocks as banks valuations are being deemed as undemanding; thus, banking stocks are playing catch-up.

Recap - 4QCY16 results mostly in line. 6 of the stocks in our banking universe were in line with our estimates with AFFIN and MAYBANK above our estimates with AMBANK below. Our underestimation of AMBANK was due to its better-than-expected credit recovery and loans. AFFIN and MAYBANK exceeded our expectations as AFFIN experienced higher-than-expected NonInterest Income while MAYBANK saw lower impairments and better operational efficiency. All in, our FY17 estimates have been revised for our banking stocks coverage except for PBBANK (where our estimates are consistent with management’s guidance. We toned down; (i) AMBANK (-5%) due to higher Cost to Income Ratio (CIR); (ii) BIMB (-3.2%) on higher credit costs but weaker financing growth and NIMs compressions; and (iii) RHBBANK (-1%) on concerns on higher credit costs and NIMs compression. For the rest, we revised our estimates upwards; (i) AFFIN (+21%) on better loans and higher NIMs, (ii) AFG (1%) on higher NIMs, (iii) CIMB (+2%) on lower CIR, (iv) HLBANK (+2%) on widening NIMs and lower credit costs; (v) MAYBANK (+4%) on higher loans and lower credit costs.

4QCY16 boosted by strong performances from AFFIN, MAYBANK and PBBANK. Sequentially, earnings continued to improve in the 4Q both on a QoQ and YoY basis at 9.5% and 17.6%, respectively. The strong almost double-digit QoQ growth was essentially boosted by strong performance of AFFIN (23% QoQ), MAYBANK (32% QoQ) and PBBANK (20% QoQ). Broad healthy growth with widening NIMs bolstered MAYBANK QoQ earnings while PBBANK was aided by widening NIMs and credit recovery. AFFIN’s strong earnings were essentially better due to Non-Interest Income (NOII) gains and a lower tax rate. The rest saw declining earnings QoQ due to weak top-line growth and higher impairments) with the exception of HLBANK, which registered a slight traction at +1% QoQ (strong top-line and widening NIMs).

No change in our view of moderating growth ahead. No change in our view of moderating loan growth ahead as rising costs and cautious stance on the challenging economy are curtailing the advancement in loan growth. To note, as of end-Jan17, annualised system loans growth advanced 5.1% YoY vs. our full-year target of 5.0-5.5% for 2017, implying loans growth will still be a challenge ahead. System approval rate has not been encouraging with Jan 2017 approval rate down by 8bps to 42.5% from the month before. Furthermore, the still elevated industry loan-to-deposit ratio (LDR) of 93.1% will exacerbate the cautious lending by banks. Excess liquidity is still trending downwards and although demand for loans growth is expected to be moderate for 2017, we expect NIMs compression to continue due to the tightening liquidity and competition for longer tenure deposits. With the economy to be slightly better for 2017 growing at between 4.5% and 5.0%, 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 moderate between +5.5 to 6.0% for 2017 (vs. 2016: +6.2%) dampened by: (i) net interest margin compression, (ii) subdued capital market activities, and (iii) elevated credit costs. Overall we see limited opportunities to drive earnings growth for the industry materially beyond our current expectation of a mid-to-high single-digit growth.

Healthy NIMs. NIMs surprisingly reversed its downward trend in 4QCY16, rebounding by 11bps QoQ and decelerating by 5bps QoQ. The rebound was attributed to the focus on better priced loans and lower funding costs. Incidentally, CASA growth was significant on both QoQ and YoY basis at +5% and 8%, respectively, pushing CASA ratio above 30% for the first time since 2QCY14. Despite the rebound, we expect NIMs to be under pressure as excess liquidity has been trending down with competition for longer maturity funds. Nevertheless, we don’t expect compression to be as severe as in CY2016.

CY17 earnings lowered slightly. As our tone for the banking industry is still moderate, we revised down our FY17 estimates slightly. Earnings estimates for FY17E are revised downwards for AMBANK and BIMB taking into account elevated credit costs, lower NIMs and higher CIRs. PBBANK and RHBANK are maintained slightly as guidance from managements are well within our estimates. For the rest, earnings are revised upwards as we expect lower credit costs, widening NIMs and improved loans to prevail. We expect the banking sector’s CY17 earnings to be slightly lower at 4.5% YoY (from +7.2% YoY previously). Compounding the drag in CY17 earnings are: (i) slower industry loans at +5.5-6.0% (from +6.5-7.0% previously), (ii) NIMs compression by 5bps (previously 1bps), but (iii) unchanged industry’s credit costs at 35bps.

CY18 earnings conservative, impacted by MFRS9. Mindful of the full impact of MFRS9 in 2018, our CY18E earnings are slightly lower despite the economic environment expected to improve. We expect: (i) industry’s loans at ~ +6.0%, (ii) slightly lower compression for NIM, i.e. 2bps, and (iii) credit costs spiking higher to 47bps as the industry implements the MFRS9 measures.

Revival of interest in banking stocks? Banking stocks might see revival of interest ahead with several positive factors likely to come on stream ahead. Among them; (i) further US interest rate hike, (ii) improving US and global economic environment, (iii) domestic interest rates rising due to hike in US interest rates coupled with rising domestic inflation, and (iv) volatile capital movement in anticipation of US interest rate hike. The domestic banking stocks are already seeing healthy/positive interest rates margin compared to Europe adding to the flavour of the domestic banking stocks. We see AFG, BIMB and CIMB and among the better beneficiaries of a hike in OPR as their variable rate loans are > 83% (above the industry average of 78%) with AFG’s long term funding is the highest 22% (vs industry’s 19%).

Valuations revised to reflect the potential of better ROE ahead. Our valuations for the banking stocks in our universe are revised higher to reflect the potential of improving ROE ahead due to an interest rate hike and healthier NIMs. We based our new valuations on the banks 5-year average P/BV but with variance of between -0.5 to -1.0 SD to reflect (i) our concerns on higher credit costs going forward and (ii) low variable rate loans. With the revised TP, we see some undemanding valuations.

Challenging conditions prevailing…maintain NEUTRAL. We maintained our NEUTRAL view although 2018 might see a better economic environment with improved ROEs but the spectre of MFRS9 will see net earnings eroded. Hence, our conservative stance is maintained. We maintain our MARKET PERFORM calls for most of the banking stocks in our coverage with the exception of AFFIN, and HLBANK. For AFFIN, TP is raised but UNDERPERFORM call maintained as we feel its loans growth target will be challenging. We upgraded HLBANK to OUTPERFORM due to its undemanding valuation. This pick will act as a proxy to the revival of foreign interest in banking sector. Besides, its relatively strong asset quality and adequate coverage should see minimum risk of higher credit cost going forward.

Source: Kenanga Research - 30 Mar 2017