Loan growth momentum slowed in Feb 2017 after a bright start in Jan 2017. Leading indicators were mixed with loans application surging ahead but approvals rate was still tight in tandem with slower loans deposits. On a positive note, CASA continued to improve despite deposits momentum slowing. No change in our view of moderate loans growth but NIMs compression is likely to continue as excess liquidity is tight. We maintain our NEUTRAL call for the sector. Most of the banking stocks in our universe are maintained at MARKET PERFORM with the exception of AFFIN (TP: RM2.85) at UNDERPERFORM and HLBANK (RM14.75) at OUTPERFORM.

Surprisingly earlier tapering of loans. The February industry loan growth was slower, by 30bps to 5.3% YoY (Jan 17: +5.6% YoY) at RM1,527.3m. On a MoM basis, it was flat (Jan 17: +0.4% MoM ) the fourth straight month of deceleration. As it had been since Dec 15, the loans were driven by household loans at +6.0% (Jan 17: +6.0% YoY) with the business loans slower at +4.8% YoY (Jan 17: +5.2% YoY). The tapering can be attributed to slower loans disbursement at +3.3% YoY (Jan 17: +3.4% YoY) vs loans repayments at +7.1% YoY (Jan 17: -0.7% YoY). On an annualized basis, loans growth was at +2.3% YoY, vs Jan 17 annualized growth of +5.1% YoY.

Mortgages still the driving force in loans. Growth in the household loan was again attributed to loan for residential property at +9.0% YoY (Jan 17: +9.1% YoY). Hire purchase continued its downward trend at -0.9% YoY (Jan 17: -0.9% YoY). Growth in the business segment was driven by non-residential property at +5.7% YoY (Jan 17: +6.1% YoY) and working capital maintained its growth at 6.1% YoY despite slower by 20bps from January.

Leading indicators showed strengthening due to lower base effect but approval rate for households falling. Despite the slower loan momentum, loan applications showed the opposite, rebounding at double digit to +21.2% YoY (Jan 17: -8.4% YoY), resulting from a lower base effect. On a MoM basis, loan applications continued its upward trend at +2.8% YoY (Jan 17: +2.1% YoY). Both business and household loan applications rebounded with the former rebounding to +13.6% YoY (Jan: -13.6% YoY) while the latter rebounded at +24.2% YoY (Jan 17: -2.8% YoY). The strong business applications were pushed by higher applications for working capital (Feb 17: +9.2% YoY vs Jan 2017: -15.0% YoY) and purchase of non-residential property (Feb 17: +5.8% YoY vs Jan 2017: -10.5%). The higher demand for household loans was propelled by higher demand for passenger cars (Feb 17: +24.3% YoY vs Jan 2017: -2.1% YoY) and demand for residential property (Feb 17: +34.5% YoY vs. Jan 17: +3.4% YoY).

Loans approved rebounded to +17.4% YoY (vs Jan 17: -5.1% YoY) again due to a lower base effect. The rebound was driven by business loans rebounding at +18.5% (Jan 17: -15.3% Y0Y) while household loans surged ahead at +16.1% YoY (Jan 17: +6.7% YoY). The approvals in the business segment was led by higher approval in purchase of securities (+141.3% YoY vs Jan 17: -8.7%) and other purposes (Feb 17: 75.1% vs Jan 17: -75.2% YoY). Higher approvals for purchase of residential property (+27.3% vs Jan 17: +12.5% YoY) drove the approvals for the household segment. No change in the system approval rate which was flat at 42.6%. While approvals for business loan seem to be lax, up by 4.2ppts MoM to 45.8% household approvals seems to be tightening, falling by 400bps from Jan 17to 39.3%.

Deposits slower at +2.2% YoY and liquidity continued to fall. Deposit in Feb 2017 was at RM1,702.4b, falling by 40bps from Jan 2017. CASA demand was strong at +5.8% YoY (Jan 17: +5.8% YoY) but overall deposits was slower dragged by the decline in fixed deposit, foreign exchange and other deposits. CASA ratio deposits increased by 40bps to 27.1%. Falling deposits dragged down the loan-to-deposit ratio rose by 31bps to 89.46% in Feb 2017. System excess liquidity to total deposit base rose slightly by 30bps to 10.5% MoM but system excess liquidity fell by 18.4% YoY to RM180.0b.

Asset quality stabilized but LLC regressed YoY. On a YoY basis, asset quality seemed stable as system net impaired loans fell by 1 bps to 1.24%. Growth in impaired loans seems to continue to decelerate since October 16 slowing at +4.6% YoY (vs Jan 17: +5.4%). While the household segment slowed at +4.0% YoY (Jan 17: +6.4% YoY), the business segment accelerated by 20bps to +5.0% YoY. Meanwhile, loan loss coverage is still below the 100% mark (-73bps MoM and -203bps YoY) at 90.8% as impaired loans growth outpaced provisioning at +4.6% YoY vs +2.3% YoY.

Increase in interest spread. The 3-month deposit rate remained intact at 2.92% and the average lending rate for Feb 2017 was up by 7bps to 4.61% (the fourth straight month of increase). Interest spread was higher by 6bps to 1.68% in Feb 2017 from the previous month. With CASA improving and average lending rates trending upwards, we still believe that NIMs compression will continue albeit lower as excess liquidity is still narrowing and stiff price-based competition for deposits continues to plague the market.

Outlook maintained. Given our view that the banks will be cautious/selective on asset quality with approval rates still tight, the momentum of the system loan growth will be moderate for 2017. Stiff price-based competition might trend upwards in 2017 as competition for deposits intensified for excess and longer-term funding. However, better pricing on assets and higher CASA

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. We have MARKET PERFORM calls for most of the banking stocks in our universe except for AFFIN (TP: 2.85) and HLBANK (TP: 14.75). For AFFIN, UNDERPERFORM call maintained as we feel its loans growth target will be challenging. HLBANK is an

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 - 3 Apr 2017