We believe the recent spike in Covid-19 cases is stoking concerns of another nationwide lockdown. While such concerns are fair, it is not our base-case scenario. Regardless of the measures, we think a targeted assistance approach will likely be favoured by the authorities to aid borrowers, as compared to the earlier broad-brush loan moratorium. Fundamentally, we think revenue-led headwinds have eased given that the bulk of the modification losses and OPR cuts have been absorbed in 1HCY20. This leaves asset quality as the key challenge ahead. As mentioned previously, the automatic loan moratorium, targeted loan assistance and various SME lending programmes provide band-aids that mask the true impact of the economic downturn on asset quality while buying banks time to build up loan loss reserves. Potentially, investors may have to wait until 2H2021 before a better picture emerges as to the adequacy of these reserves. Given the delay, this may also keep a lid on dividends pay-outs. Banks with solid asset quality offer better earnings predictability, which, in turn, underpins dividend payments (assuming banks stay conservative with pay-outs). Hence, we continue to prefer banks with solid asset quality (HLBK, PBK) and capital (RHB). NEUTRAL sector call maintained.

Banking sector continues to lag FBMKLCI. The banking sector (based on the eight main banking stocks and share prices up to 25 Sep) posted a negative return of 5.5% in 3Q20, lagging the FBMKLCI’s flat return for the quarter. Nevertheless, the gap in performance narrowed as compared to 2QCY20, where the FBMKLCI rose 11% for the quarter vs +2% for the sector. 3QCY20 price performance for the sector was negatively impacted by CIMB (MP; TP: RM3.45) (3Q20: -14%, due to weaker-than-expected 2QFY20 results) while big cap peers Maybank (MP; TP: RM7.85) (-6%) and PBK (OP; TP: RM18.00) (-6%) also posted negative returns partly due to, we believe, the absence of interim dividends. HLBK (OP; TP: RM17.00), on the other hand, posted a return of +5% for the quarter. Notably, HLBK was the only bank out of the eight that declared dividends during the 2QCY20 reporting quarter, which we believe aided its share price performance. On a YTD basis, the sector is still down 23% vs FBM KLCI: -5%. Banking stocks that outperformed the sector YTD were HLBK, MAYBANK, ABMB (MP; TP: RM2.20), RHB (OP; TP: RM5.75) and PBK while key underperformers were CIMB and AMMB (OP; TP: RM3.60).

All eyes on the targeted loan assistance programme take-up rate post 30 Sep. Banks had generally shared in Aug that c. 10-15% of loans could require some assistance post 30 Sep, with CIMB having guided the highest proportion of 20-30%. Up to mid-Sep, we understand from the banks that the take-up rates have been lower than earlier expectations, i.e. at single-digit percentage of loans. That said, the banks did caution the possibility of a late spike in applications towards the end of the automatic loan moratorium period. These loans are not expected to be staged just yet and hence, asset quality should stay relatively intact for now. We do, however, expect the banks to continue booking in pre-emptive provisions and build up loan loss reserves.

Signs of green shoots? Firstly, some banks had mentioned during the Aug briefings that loan demand had picked up. While this, by itself, was not surprising given the low base during the EMCO period, the positive surprise was that the momentum was sufficient to prompt banks such as PBK to raise its FY20 loan growth guidance. Apart from pick-up in big ticket consumer loans (auto and mortgages), healthy pipelines for the SME relief funding were also cited as key drivers. Secondly, BNM had kept the OPR unchanged at 1.75% in its recent Sep MPC meeting. If BNM is indeed done with its OPR cuts, this would be positive for banks as it would ease NIM pressures but perhaps, more importantly, may suggest that BNM thinks the economic recovery is on track. Thirdly, consensus earnings forecasts may be bottoming out. The key earnings downgrade by consensus during the 2QCY20 reporting quarter was for CIMB’s 2020E PATMI (-22% revision) but 2021E PATMI was relatively unchanged (-2% change). We also note some upgrades have started to surface. For instance, HLBK’s FY21E PATMI was revised up by 6% while Affin’s (MP; TP: RM1.45) 2020F/2021E PATMI was raised by 10%/1% respectively.

Forecasts. We forecast 2020 sector net profit to fall by 26% YoY followed by a recovery of +18% YoY in 2021. Our estimates suggest that the banks will need to look beyond 2021 before net profit can recover to 2019 levels. In our models, we have assumed banks such as Maybank and CIMB resuming with their DRP programme to preserve capital. Hence, our 2020E sector EPS stands with a sharper contraction of 29% followed by a 16% YoY recovery in 2021. NIM compression (2020E: -17bps; 2021F: +9bps) and credit cost (2020E: 71bps; 2021E: 58bps) are the key drivers of net profit trend ahead.

Maintain NEUTRAL sector call. We think asset quality will likely to be the key swing factor to earnings in the coming quarters and thus, keep with our preference for banks with solid asset quality such as HLBK and PBK. Their asset quality track records suggest that the pre-emptive loan provisions required should be lower relative to peers while the smaller exposure to the corporate space would shield them from chunky loan impairments. Thus, we see these banks offering investors better earnings predictability and “safer” dividend yields (assuming banks continue to be conservative with dividend pay-outs). We also like RHB for its capital strength. While this may not translate to higher dividend pay-outs vs peers in the near term, RHB should be able to resume with its capital management plans relatively quick once the pandemic is past (vs peers that may need time to rebuild their capital positions). AMMB is our laggard pick.

Banks’ share prices generally down in 3Q, underperforming broader FBMKLCI

The banking sector (based on the eight main banking stocks and prices up to 25 Sep) posted a negative return of 5.5% in 3QCY20, lagging the FBMKLCI’s flat return for the quarter. Nevertheless, the gap in performance narrowed as compared to 2QCY20, where the FBMKLCI rose 11% for the quarter vs +2% for the sector. 3QCY20 price performance for the sector was negatively impacted by CIMB (3Q20: -14%, due to weaker-than-expected 2QFY20 results) while big cap peers Maybank (-6%) and PBK (-6%) also posted negative returns due to, we believe, the absence of interim dividends. HLBK, on the other hand, posted a return of +5% for the quarter. Notably, HLBK was the only bank out of the eight that declared dividends during the 2QCY20 reporting quarter, which we believe aided its share price performance. On a YTD basis, the sector is still down 23% vs FBM KLCI decline of 5%. Banking stocks that outperformed the sector YTD were HLBK, MAYBANK, ABMB, RHB and PBK while key underperformers were CIMB and AMMB.

Source: Kenanga Research - 6 Oct 2020