We maintain our OVERWEIGHT call on the sector. Valuations continue to appear depressed as softer macros (weak currency, downside bias to GDP expectations, unstable foreign markets) keep investors sidelined. In lieu of this, we input a higher cost of equity demanded by investors to stay vested, leading to narrower applied valuations and lower TPs by 4%-11%. Still, we believe the presented upside is justified with the resilience offered within the banks. These opportunities are supported by a stabilising credit cycle (flat OPR expectations for CY23), well-contained inflation (May 2023 CPI: 2.8%) and sufficiently sheltered assets. Although industry loans growth is expected to be slower (CY23 at 4.0%-4.5% from CY22’s 5.7%), we reckon that it would be broad based and not isolated to specific segments. Meanwhile, 2HCY23 could be the period where writebacks of management overlays are more materially felt and may brighten dividend prospects. For 3QCY23, we propose tactical opportunities to capitalise on market weakness. CIMB (OP; TP: RM6.00) offers the most upside amongst the large cap in surprise dividends should banks write back on their provisions aggressively in CY23. It is also projected to deliver sustained earnings growth in the near term. PBBANK (OP; TP: RM4.40), being heavily sold down by foreign investors could be well positioned to rise should there be clarity in its shareholding structure while still overly leading in asset quality. AMBANK (OP; TP: RM4.80) which we had recently featured, is in a better shape for potential consolidation which we reckon could be a strong rerating catalyst for the group.

Higher price to hold. Domestic markets seem to anticipate more challenges to come, with our local domestic currency exhibiting perpetual weakness. Meanwhile, factors that were expected to boost overall economic activity (i.e. China’s reopening) failed to translate to meaningful immediate improvements. Not helping either are mixed signals sent by foreign markets with the US Fed’s “hawkish pause” to interest rates in attempts to tighten inflationary pressures there. All that said, there may be a lower appetite for investors to remain with long-term positions, which typically point towards banking stocks. To reflect this, we opt to adjust our Gordon Growth Model valuations to generate a higher cost of equity between our banking stocks, mainly recalibrating our beta assumptions given the growing disparity between them and headline indices. Overall, this resulted in an adjustment to our TPs by between 4%-11%. However, our calls remain unchanged as despite the lower TPs, there could still be opportunities presented in the banking sectors in the near-term which should be wholly considered.

(refer to the overleaf for changes to our sector TPs)

Fundamentals mostly intact, with headwinds well-guided. Although there could be some pressure with regards to interest margins from deposits competition, other aspects from the banking sector are expected to remain resilient. Continued loans growth should still move in tandem with economic activities. Although the outlook for investment markets could appear mixed, stable interest rates should prevent excessive fair value losses to a bank’s portfolio, particularly in debt securities. Meanwhile, credit cost guidance lean towards stable-to-improving reporting, notwithstanding possible write-backs as mentioned. More materially, the lapse of prosperity tax imposed in CY22 provides a notable support to bottomline readings.

(refer to the overleaf for our scenario analysis on plausible earnings and dividend gains)

Maintain OVERWEIGHT on the banking sector. Despite our reduction in TPs, we continue to have confidence in the banking space for its resilient earnings and with average dividend yield of 6% providing an attractive shelter for longer-term investors. While we had previously promoted safety in rationalising our top picks, we believe certain stocks have now been oversold and present tactical opportunities for investors. We highlight (i) CIMB as we believe investors may pay closer attention towards writeback prospects closer to the end of the year, and CIMB’s sizeable overlay relative to earnings present some handsome translation to earnings and special dividends. On the other hand, the group is also expected to report double-digit earnings growth in the coming years, where some peers could only see more modest performance. We also like (ii) PBBANK as the large outflux of foreign investors on the stock may be unwarranted, seemingly only justified by weakening MYR undermining foreign portfolio holdings. The group also appears arrested by uncertainties in its future shareholding structure, but we believe any clarity from here only offers upside prospects as overall operations are expected to be fundamentally untouched given its systematic importance to the local financial ecosystem. Being the safest bank in terms of asset quality readings, present levels offer cheap opportunities for entry. Lastly, we also consider (iii) AMBANK as we believe its current fundamentals are highly supportive of healthier discussions for M&As, which has in the past been frequently considered. The group is also one of the leaders in terms of SME profile, which is touted as a high-growth segment that could accelerate market share growth for the group.

Writebacks an approaching eventuality. With the diminishment of Covid-19 related concerns, banks are due to rationalise their management overlays which could also encapsulate other economic concerns. Progressively, we have seen some banks gradually writing back the said provisions but gather most banks have reserved their remaining balances for the sake of prudence. While this conversation has persisted since 1HCY22, we reckon that 2HCY23 could be when the write-backs are more meaningfully reflected, presuming a successful six months observation period from May 2023’s 25 bps OPR hike.

We observe the above scenario should a complete writeback of overlays were to occur, where understandably, the large-cap banks possess higher overall overlays owing to their larger book size. That said, the spill-over to earnings for these banks are modest (13%-31%) as compared to the smaller cap banks given more stringent asset quality management and undertakings. With regards to potential earnings surprises from the write-backs, we find that CIMB could provide the best special dividend spread amongst the large cap banks. AFFIN (OP; TP: RM2.10) on the other hand has the largest upside given its heavy provisioning practices amidst its burgeoning loans books. AFFIN has also demonstrated the largest loans book growth (+15%) which could warrant more careful provisioning.

From leaders to laggards. Following the poorer perception from banking fallout in March 2023, we note that local banking stocks have failed to initiate any recovery momentum. This is in spite of a commendable 1QCY23 earnings delivery, where we only saw one reporting disappointment namely BIMB (OP; TP: RM2.00) from under-projected operating costs. YTD-June 2023, only MAYBANK (OP; TP: RM9.25) managed to outperform the FBMKLCI and Bursa Financial Index, closing slightly below (-1%) its year’s opening. BIMB was the largest underperformer, lagging 36% behind its opening price. We reckon that the depressed prices could likely have bottomed out as macros are indicating stabilisation, though investors may request for better certainty from 2QCY23 reporting season in the event banks decide to input higher provisions which may signal wider asset quality concerns.

Slower CY23 industry loans growth expected, keeping at 4.0%-4.5% (CY22: 5.7%). April 2023 system loans growth came in 4.5% YoY with a hint of softening in the latter half of the year. That said, growth appears to be equally carried by both household and business accounts. While we previously anticipated a slowing down of household loans, it was mainly supported by the shift of housing loans from secondary market transactions to primary market ones. With OPR likely to cap at 3.00% throughout the year, lenders may be required to offer more competitive rates to prospective borrowers which may in turn be more eager to scout the market for the most attractive offerings. On the flipside, the comparatively higher cash flows pressure may also lead to existing business borrowers to rationalise their cashflows before seeking more debt for expansionary purposes.

Sharp NIMs decline may gradually recover. 1QCY23 saw a significant decline in NIMs owing to the premature upwards repricing of termed deposit products in anticipation of the Jan 2023 OPR hike which did not materialise. No thanks to the more aggressive locked-in rates, the banks were faced with a higher funding cost during the period. That said, we gather that the banks are progressively easing their deposit rates to more sustainable levels which should support NIMs going forward. The 25 bps OPR hike in May 2023 should also help, albeit probably not sufficient to revert NIMs to CY22 levels as the banks may now be required to compete in the financing front. Corporate guidances unanimously present a downside bias, up to double-digit compressions.

GIL levels still fair. Sector gross impaired loans (GIL) are relatively stable with minor increments owing to the previously troubled repayment assistance accounts falling into delinquency again from inflationary pains. We believe that such accounts may only be restaged up to 2QCY23, given that most increments to interest rates would have already been reflected with cashflow pressures gradually being felt. We also opine that 2QCY23 may see a higher recording of GIL as repayments may be set aside in favour of higher seasonal commitments during the period. CIMB stands out in GIL reporting no thanks to its wide regional exposure (i.e. Indonesia and Thailand) which distorts group-wide readings. HLBANK (OP; TP: RM22.65) and PBBANK remain the industry gold standard with GIL readings of 0.5% and 0.4%, respectively, thanks to strict credit risk measures and selective retail-focused portfolios.

Source: Kenanga Research - 14 Jul 2023