Outperforming the market, YTD. As of 21 September 2017, the KL Finance Index (KLFIN) had outperformed the FBMKLCI index by 860bps and advanced by 16.5%. YTD, all the banking stocks in our universe made gains with CIMB (+41%), MAYBANK (+20%) and HLBANK (+18%) outpacing the FBMKLCI and KLFIN. Overall results for 1HCY17 were in line with our estimates with moderate loans growth and boosted by improving NIMS and softening credit costs. Both the FBMKLCI and KLFIN’s stronger performances were due to positive economic news on the local and external fronts which pushed heavyweights CIMB and MAYBANK as they are the proxy for any positive upturn. The sharp rise in HLBANK was due to its undemanding valuations and being a laggard compared to the rest.

Recap - 2QCY17 results. There were no major surprises in 2QCY17 with all the 9 banking stocks in our banking universe performing in-line with our estimates. While YoY earnings growth was spectacular (+18%), QoQ earnings was a drag (-2%) as higher unexpected impairments coupled with marginal loans growth dragged earnings for the quarter. AFFIN, AFG and PBBANK saw earnings growth QoQ attributed to better fee-based income and lower impairments for the quarter (PBBANK). On a YoY basis, CIMB (+35% YoY) and MAYBANK (+30% YoY) saw stellar earnings on account of lower impairments (MAYBANK) and strong top-line revenue (CIMB). Flat Loans QoQ, after a marginal rise in 1Q (+0.4% QoQ). All with the exception of AFG, CIMB and MAYBANK saw a semblance of healthy growth for the quarter. AMBANK and BIMB saw good growth at 2.0% QoQ each driven by residential properties and SME (AMBANK) while for BIMB, it was from purchase of residential properties and personal financing. YoY loans were faster (+6%) albeit easing with BIMB and CIMB leading the charge at 11% YoY and 8% YoY, respectively. YoY, BIMB’s financing growth was driven by residential properties & personal financing while for CIMB, it was from residential properties and working capital. On a positive note, NIMs seemed to be improving both QoQ and YoY on account of lower funding costs and re-pricing of assets. CIMB led the way in YoY improvement (+25bps) on account of better liability management from its overseas markets (notably from Indonesia). Overall improving CASA supported the downside pressure from funding costs with most banks seeing improvement in CASA. Despite CASA trending down, repricing in asset prices supported AFFIN’s QoQ (+6bps) improvement in NIMs. Uptick in GIL QoQ due to R&R. Gross Impaired Loans (GIL) ratio was up by 5bps QoQ mostly pushed by AFG and MAYBANK with upticks of 12bps and 13 bps, respectively. However, on a net basis, impaired loans were better at 0.7% and 1.8%, respectively, as most of the upticks were caused by loans that were Rescheduled and Restructured (R&R) and expected to be performing by end of 2017. MAYBANK’s uptick in GIL was mostly from Singapore (+61bps QoQ) while for Malaysia and Indonesia, they were much more favourable, dropping by 1bps and 13bps, respectively. As with the uptick in GIL, credit costs also hiked QoQ by 10bps but as expected on YoY basis credit costs were lower falling by 2bps. All with the exception of PBBANK and RHBBANK saw upticks in credit costs led by AFFIN (+27bps), CIMB (+25bps) and MAYBANK (+23bps). With AFFIN, uptick was due to a couple of corporate accounts (from mortgages) while for CIMB and MAYBANK, upticks were mostly from households due to the festive season at the end of 2Q.

Maintaining conservatism ahead. Our conservative stance on the sector is due to the prevailing challenging condition in the immediate horizon. We slashed slightly our CY17E earnings by 60ps to 3.5% YoY mainly on account of softer loans. Supporting earnings will be; (i) loans growth of 5.5% (downward revision of 50bps due to a) revision of PBANKs loans expectation from 6- 7% to 4-5% and HLBANK’s full-year loans growth of <4% from initial expectation of 5-6%); (ii) no change in NIMs at 2.2%; (iii) no change in our credit costs assumptions at 0.36%, and (iv) growth in fee based income slashed by 120bps to -0.5% YoY (mainly from revised downwards revision of MAYBANK’s fee based income by 4ppts to -10% YoY and HLBANK’s full FY17 feebased income, which was 5% lower from our estimation but mitigated by upward revision of AFFIN’s fee-based income growth by 9ppts to +16% YoY).

CY18E earnings revised slightly. For CY18, our earnings are revised higher to +4.0% (from +3.1% initially) as we expect: (i) pick-up industry loans (of between +6.0 to +6.5%) on stronger economic conditions, (ii) no change in NIMs at 2.2%; (iii) better fee-based income (revision of 70bps to 6.6%), and (iv) no change in our credit costs estimation at 43bps. The higher credit costs due to the full impact on MFRS9 which will be felt on those banks with financial year beginning Jan 2018, with AMBANK, ABMB and HLBANK from their FY19 onwards. We do not expect significant impact on BIMB with its high loans loss coverage of 160%.

Impact of MFRS9 affecting our FY18E valuations.

Our FY18E valuations have accounted for the impact on MFRS9 for banks which financial year begins on 1 Jan. As highlighted before, AMBANK, AMBM and HLBANK will bear the brunt of MFRS9 in 2019 as their financial year begins in 1 April (ABMB and AMBANK) and 1 July (HLBANK).

In our FY18E loan loss provision estimates, we raised provisioning by >30% from the previous year forecast estimates. This is in line with industry’s experts estimates of upwards revision of >30% that banks will have to raise in compliance with MFRS9. This upwards revision is also in line with what the National Australian Bank (NAB) complied with when they implemented IFRS9 on 1 Oct 2014, raising their loan-loss provisions by at least ~30% in its FY15 Financial Statements. This is further supported by a local bank’s assertion that their loan-loss provisions will have to be revised upwards (as guided by BNM) by 20-30% based from their April 2016 Balance Sheet.

In hindsight, it is expected that the banks will cover their expected increase in loan loss provisions via the use of their regulatory reserves and/or retained earnings, which will erode their CET1 ratio. Another local bank highlighted recently that their CET1 ratio will likely to be eroded by 50bps on 1 Jan 2018. From their 2QFY17 results, the bank had a CET1 ratio 11.9% well above the regulatory requirement of 7.0% and was well capitalised. From the recent 2QCY17 results, all the banks were well capitalised with CET1 ratio above 13% with the exception of CIMB and PBBANK (12.2%). The absence of large capital raising exercise in 2017 indicated that the banks are comfortable that their reserves are adequate to cover the shortfall in provisioning by 1 Jan 2018.

With loans loss provisioning rising, it is safely assumed that credit costs will rise, with expected credit costs to be measured using the credit models required under MFRS 9, which has not specific connection or relevance to loan loss coverage. So how much will these elevated credit costs be under MFRS9? So far, most banks have not been able to give a guidance on their credit costs for FY18 and most likely they will reveal them next year at their 4QCY17 results briefing in Feb 2018. Taking a conservative view, we raise our allowances for impairments in proportion to the elevated rise loan loss provisioning, thereby giving our elevated credit costs for the industry for FY18.

Re-rating of the sector likely the end of 1QCY18. Our sector valuations are conservative based on a forward FY18E taking into account of the impact of MFRS9. Hence, our FY18E earnings have already factored in the impact of elevated credit costs based on elevated loan loss provisions as guided by the industry. As banks will only give a guided impact on their credit costs for FY18 by early CY18, our rerating for the sector will likely be by end of 1QCY18 as we roll over our valuations to FY19E.

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 for the sector. Although 2018 might see a better economic environment with improved ROEs, the spectre of MFRS9 will see net earnings erosion. Hence, there is no change in our conservative stance.

Maintain NEUTRAL. With all things remaining equal and as expected going forward, our valuations for the banking stocks in our universe remain unchanged. Although 2018 might see a better economic environment with improved ROEs, the spectre of MFRS9 will see net earnings erosion. Hence, there is no change in our conservative stance. Our MARKET PERFORM call for most of the banking stocks in our coverage remains with the exception of AFFIN, ABMB, AMBANK, RHBBANK and CIMB, which are at OUTPERFORM as at current share prices, we see attractive proposition with potential total returns of more than 10% each. However, the NEUTRAL call maintained as we see no change in the prevailing conditions ahead (and market cap weighted total returns for the sector is still <10%). There is no concrete catalyst and game changer on the horizon and structural and cyclical headwinds are still prevailing such as; (i) moderating economy, (ii) subdued loans growth, with (iii) mild downward pressure on NIM and (iv) elevated credit costs in 2018.

Source: Kenanga Research - 5 Oct 2017