The recent 1QCY20 reporting quarter produced a mixed bag. Notably, credit cost has started to rise leading to the drop in overall aggregate CNP, but this was cushioned by strong treasury gains. Furthermore, despite asset quality being much better currently vs. during the previous Global Financial Crisis (GFC), guidance from some banks suggest that a GFC-level credit cost is no longer a long-tail risk. We keep our NEUTRAL sector call. While banks’ share price performances suggest that investors are already looking beyond the upcoming results, we believe the path to recovery for banks remains uncertain and volatile. RHB is our sector top pick.

The recent 1QCY20 reporting quarter was a mixed bag. Based on the six banking groups that released results, HLBK, PBANK and RHB all reported results that were in line with estimates, ex-modification loss impact. Maybank and CIMB were deemed to perform below expectations after taking into account significantly higher credit cost that these banks were guiding for 2020 while Affin results were above expectations, due to outsized treasury gains. Note that the above are ex-modification losses, which we have partly incorporated into our forecasts.

Sector (based on the banks that have reported results) 1QCY20 CNP slumped 12% YoY (-19% QoQ) with majority of the reporting banks posting weaker QoQ and YoY results. Maybank reported strong YoY growth due to better NoII while Affin managed to keep CNP flat sequentially, mainly due to its treasury gains. Key takeaways from the briefings are as below:

1. Credit cost guidance points to much wider dispersion vs. GFC. PBANK’s “rule-of-thumb” was for credit cost to be 2-2.5x higher than recent numbers. Also, the banks expect credit cost to stay elevated in 2021. Two notable points from the guidance are: (i) guidance by some banks (e.g. CIMB and Maybank) points to a revisit to and in some cases, higher than, their credit cost during the GFC. This was surprising given that asset quality today has improved significantly compared to GFC days, and (ii) dispersion in charge-off guidance appears much wider compared to the actual dispersion during the GFC;

2. NIM squeeze higher than expected, at c.15bps (vs <10bps previously). May OPR cut added further pressure to the earlier guidance and this guidance excludes Day One modification loss impact as well as the impact from further rate cuts;

3. Day One Modification losses - Only Maybank (RM1b) and Affin (RM200m) quantified the expected Day One losses. Affin further highlighted that after taking into account the decrease in SRR, where the proceeds are reinvested into interest yielding instruments, the net impact to NII would be a more manageable RM70m;

4. Sustainability of absolute DPS a question mark. Most banks felt confident that payout ratios can be maintained. This would be supported by current, strong capital levels, as well as the reactivation of DRP programmes. Nevertheless, even if payouts are maintained, we expect absolute DPS to be reduced as banks are projected to report lower earnings ahead (e.g. CIMB FY20E DPS of 13.5 sen vs 2019: 26 sen). Only RHB guided to maintain its absolute DPS of 31.0 sen (payout of 57% vs 2019: 50%) given its peer high capital ratios.

Maintain NEUTRAL sector call. The main earnings downgrade relates to CIMB (FY20E: -23%; FY21E: - 15%). In our view, banks’ earnings ahead remain uncertain and volatile, as a combination of factors such as Day One modification losses and rising credit cost kicks in. The path to recovery too is unlikely to be clear cut. In mitigation, the reopening of the economy and significant cuts to policy rate has helped clear some overhang for the sector. Please see our separate sector report – “Banking PEs – How Much More Can They Expand?”, where we updated our TP and stock ratings following a roll forward in valuations to CY21 and reduced our equity risk premium by 25bps. RHB remains our top pick. Our other OUTPERFORMS are ABMB, AMMB, BIMB and HLBK. Near-term upside risk to our sector call is a liquidity fuelled rally, rotational plays into value/cyclicals as well as better than expected macro data. Near-term downside risk is the emergence of a Covid-19 second wave

Source: Kenanga Research - 9 Jun 2020