Our Neutral view on the sector remains with system and industry loans growth for CY2017 expected to be in line as expected. We don’t see any catalysts or game changers ahead in 2H17 with industry earnings likely to be driven by easing of credit costs and NIM. Thus, our valuation for the stocks in our banking universe remains unchanged. After playing catch-up in 2Q17, a couple of the banking stocks’ valuations are looking undemanding due to the recent steep fall in share prices. We maintain our MARKET PERFORM call for most of the banking stocks with the exception of AFFIN (TP: RM2.90) and RHBBANK (TP: 5.60) where we upgrade to OUTPERFORM as valuations are looking attractive again with the recent softening in share prices.

Stellar 1H17 for banking stocks. As of 23 June 2017, the KL Finance Index (KLFIN) outperformed the FBMKLCI index by 870bps and advanced by +7.1%, pushed by heavyweights CIMB (+48.1%), MAYBANK (+17.1%) as loans growth exceeded expectations boosted by positive news on the economic front. Overall results in the last two quarters (4Q16 and 1Q17) were in line with our estimates with no major game changer. Loans were soft in the industry with earnings boosted by easing of NIMs and softening credit costs. Both the FBMKLCI and KLFIN’s stronger performances are were due to positive economic news on the local and external front. The higher-than-expected positive expectations saw the revival of interest in banking stocks as banks’ valuations were deemed as undemanding; thus, banking stocks were seen playing catch-up.

Recap - 1QCY17 results. There were no surprises in 1QCY17 with all the 9 stocks in our banking universe performing within our estimates. We maintain our FY17 estimates for most banking stocks with the exception of AFFIN, which was revised marginally by +0.8% on the assumption of better NIM ahead. For AFG, (with its recently concluded FY17 results) its FY18E earnings were shaved by 5% due to our concerns on its ability to maintain sustainable loans growth.

1QCY17 saw earnings drag QoQ but surging YoY. QoQ earnings were a drag, falling by 5% QoQ but rebounded by +14% YoY. On a QoQ viewpoint, the impediment in earnings was pulled by subdued top-line growth. QoQ earnings were dragged by AFFIN (-29%), MAYBANK (-28%) and PBBANK (-16%). Fall in top-line revenue dragged both AFFIN and MAYBANK, but higher impairment allowances coupled with marginal top-line dragged PBBANK’s earnings for the quarter. As for CIMB and RHBBANK, earnings surged by 38% and 92%, respectively, for the quarter due to lower impairment allowances. On a YoY basis, earnings continued to record double-digit growth driven by strong performances from CIMB (+45%), followed by AMBANK (+20%) and MAYBANK (+19%). CIMB’s performance was driven by strong top-line supported by strong loans at +12%. Both AMBANK and MAYBANK strong earnings were primarily galvanized by strong credit recovery (AMBANK) and lower impairment allowances (MAYBANK).

Moderate loans ahead maintained. Our view of moderate system loans growth ahead still stands with system loans expected to grow between 5.5% and 6.0% for 2017. To note, as of end-May 2017, annualised system loans growth advanced +2.9% YoY for 2017, implying loans growth will still be a challenge ahead but sustainable to reach our 2017 target. We believe growth will be supported by the resilient household as inflation is expected to be moderate with cost-push inflation expected to be contained in 2H17. We view the slump in business loan applications due tight business approvals as a temporary blip which is likely to reverse and pick up pace in 2H17 as economic prospects improve for 2018, coupled with easing of approvals as asset quality looks to be favourable. We still see limited catalyst to drive earnings growth for the industry materially beyond our current expectation of a mid-to-high single-digit growth.

Maintained view of moderating industry loan growth ahead. We view that the industry aggregate loans growth to be in moderation, at ~+6.0% for 2017 (vs. 2016: +6.2%) driven by the household segment boosted by better approval rates. Furthermore, banks will focus on selective assets giving better returns ahead/better secured loans.

NIM continued to compress albeit at a slower pace. In 1Q17, NIM was well contained on a quarterly basis. Despite lower funding costs (as deposits were re-priced due to lagged adjustment in FD rates attributed to the cut in OPR in July 2016), the presence of competitive pricing of loans mitigated the prospect of better NIM for both QoQ and YoY basis. Our view of compressing NIMs for 2017 (albeit slower) does not change for 2017 on the basis of: (i) competitive pricing of loans, and (ii) banks searching for longer maturity of deposits. We opined that NIM compression will be mild as banks will be able to adjust their lending rates as demand accelerates.

Capital Market activities still weak for most of the banks with NOII performances supported by gains in disposal of assets. On a QoQ basis, Non-Interest Income (NOII) dipped 5% QoQ but rebounded >3% YoY. QoQ decline was mitigated by a strong surge from AMBANK (driven by reinforced fee & commission income and gain on disposal of property, equipment plus profit sale of goods & services), BIMB (driven by Takaful Business) and RHBBANK (driven by fund management income). YoY, NOII gains were driven by gains from AFFIN (mostly from gains in disposal of assets) and CIMB (gains in investment & trading income). YTD, we fail to see any vibrancy in the equity and debt capital markets. YTD net funds raised in the public and

private sector were depressing, falling by 73.1% and 68.4%, (2016: -16.2% and 44.0%), respectively. Vibrancy in the ASEAN-5 seems to be mixed and muted as well. Number of IPO deals seems to be trending down (YTD: -34.5%) but bond issuance is up (YTD: +26.3%) vs 2016 with IPO deals and bond issuance of +36.5% YoY and 0.13% YoY, respectively. We view that NOII will be subdued ahead marginally growing by 1% as weak capital market activities and the absence of volatile currency curbed the prospect of forex gains. Going forward, we would not be surprised if the trend disposal/revaluation of financial assets continues throughout 2017.

Downside risks on asset quality expected to be minimal. Overall industry’s asset quality deteriorated slightly both QoQ and YoY but at a slower pace, rising 3.2bps QoQ and 18bps YoY. On a QoQ basis, deterioration in asset quality can be seen in AFFIN, AMBANK and MAYBANK while on a YoY basis, MAYBANK and RHBBANK led the deterioration. MAYBANK’s uptick in GIL was across the board in Malaysia, Singapore and Indonesia, primarily from mortgages and working capital while for RHBANK, the uptick was mainly from Singapore with upticks mostly from working capital. AFFIN and AMBANK’s uptick are mostly from mortgages. Recall that deterioration in asset quality in 2016 was mainly from volatile commodity prices with the major banks taking prudent move to reclassify some of their O&G loans as impaired, which pushed GIL higher. While we expect industry’s asset quality to be stable in 2017 at ~1.9%, we do not discount further impairments in 2H17 on softening oil prices.

Credit costs still high albeit lower. Although GIL deteriorated, credit costs were down, falling both on a QoQ and YoY basis at 11bps QoQ and 9bps YoY respectively. Improvement on a QoQ basis was driven by CIMB and RHBBANK whilst on a YoY basis, it was driven by BIMB and MAYBANK. We opined that allowances for impairments will still be challenging especially from household loans affected by higher cost of living and industry credit costs for 2017 will still be at elevated levels (~ 36bps) but below its 2016 level of 42bps.

Moderate growth ahead. No change in our view of challenging conditions ahead. We expect the industry’s CY17E earnings undoubtedly to improve by +4.1% (CY16: +3.1%) on the back of lower impairment allowances and better NOII (via disposal gain/revaluation of financial assets) as we view loan growth to be moderate.

CY18E earnings expected to be better. For CY18, our earnings are revised higher to +3.1% (from -0.4% previously) as we expect: (i) better industry loans (of between +6.0 to +6.5%) on stronger economic conditions; (ii) minimal compression from industry’s NIM (revised upwards by 1bps to 2.11%) and (iii) credit costs to be revised lower by 4bps to 0.43%, as full impact on MFRS9 on AMBANK, AFG and HLBANK will only be felt from their FY19 onwards and we do not expect significant impact on BIMB with its high loan loss coverage of 175%.

Unchanged stance. With all things remaining equal and as expected going forward, our valuations for the banking stocks in our universe remain unchanged and we reiterate our NEUTRAL call. Although 2018 might see a better economic environment with improved ROEs the spectre of MFRS9 will see net earnings eroded. Hence, there is no change in our conservative stance.

Undemanding valuations for some. While we maintained our MARKET PERFORM call for most of the banking stocks in our universe, the recent bashing down in some of the banking stocks points to some attractive propositions in the banking sector. We revised our call for both AFFIN and RHBBANK as we find potential >10% upside in total returns from the recent sell-down. We also favour AMBANK based on its potential acquisition price of 1.0x P/B valuing it at RM5.32. The stock is currently trading at 0.94x P/B giving it an attractive valuation ahead of >10% in total return.

Source: Kenanga Research - 6 Jul 2017