We expect the pickup in GDP next year to benefit the banks via stronger business loan growth, improved capital market activities and help keep asset  quality  in  check.  The  measures  to  cool  the  property  market  and rein in household debt should turn out to be a longer-term positive for asset  quality,  in  our  view.  We  upgrade  our  sector  call  to  Overweight from Neutral as the negatives appear largely priced in.

Sector  call  upgraded.  We  are  upgrading  our  recommendation  on  the banking  sector  to  OVERWEIGHT  from  Neutral  as  sector  valuations appear  inexpensive,  relative  to  both  the  market  and  historical  trends. Hence, in our view, the sector’s risk-reward profile is tilting to the positive as the negatives appear largely priced in, and banking stocks are poised for a rerating once the current macro headwinds start to ease.

GDP  pickup  to  support  lending…  The  pickup  in  GDP  next  year (2014F:  5.4%  vs  2013E:  4.7%)  is  expected  to  bode  well  for  business lending  activities.  We  expect  business  loans  to  pick  up  pace  in  2014, underpinned by the progress of long-gestation projects under the various economic programmes. As projects flow through the value chain, this will benefit  mid-sized  businesses  and  SMEs.  Already,  we  are  seeing  some potential  green  shoots  emerging  with  respect  to  business  lending,  with business loan disbursements gradually on the rise.

 …  and  capital  market  activities.  The  fundraising  for  the  various projects  and  the  stronger  economic  growth  envisaged  for  2014,  in  our view, should also be positive for capital market activities and non-interest income going forward.

Measures  to  rein  in  household  debt  and  cool  property  market  a longer  term  positive.  The  property  tightening  measures  announced  in Budget  2014  and  Bank Negara’s measures  to  rein  in  housing  debt  will likely dampen household lending going forward. However,  this would be cushioned  by  the pipelines of  loans  the banks  have  built  up,  as  well  as our  expectations  of  stronger  business  lending.  Also,  we  believe  these measures target specific groups, ie low income households and property speculators, and should put asset quality on a firmer footing as we move into a period of higher inflation and interest rates.

NIM  compression  should  ease.  The  degree  of  net  interest  margin (NIM) compression should slow ahead as lending yields have stabilised. A 25bps hike in OPR (expected late-3Q14) would also be mildly positive for NIMs.

Investment  case.  We  like  Maybank  (MAY  MK,  BUY,  FV:  MYR11.40) and  CIMB  (CIMB  MK,  BUY,  FV:  MYR9.50)  as  excellent  proxies  to  the ETP  and  key  beneficiaries  as  capital  market  activities  improve.  We see HLB (HLBK MK, BUY, FV: MYR16.60)’s growth accelerating now that its post-merger restructuring activities are largely completed.

Negatives are largely priced in but market is still ignoring the improved prospects ahead

Turning more positive on sector

We upgraded our sector call to OVERWEIGHT from Neutral in our Malaysia Strategy 2014  report,  “Positive Local Backdrop But QE Taper Fears Linger”  (12  Dec  2013). We hold the view that the sector’s risk-reward profile has tilted to the positive. Current valuations suggest  that the market is pricing in most of the negatives but has yet to recognise the pickup in global and domestic economic growth going forward.

Business loans growth is expected to pick up in 2014 as the implementation of projects under the various economic programmes accelerates GDP pickup to support lending and capital market activities

Business loans growth has been muted this year (Oct ’13: 7.4% y-o-y vs household loans growth of 11.9% y-o-y). We believe this was partly due to businesses taking a wait-and-see  stance  in  the  run-up  to  various  major  events  this  year  (eg  General Election,  Budget  2014)  as  well  as  expectations  of  potential  QE  tapering. Nevertheless,  we  expect  business  lending  activities  to  pick  up  pace  in  2014, underpinned  by  the  progress  of  long  gestation  projects  under  the  various  economic programmes such as the Economic Transformation Programme (ETP). The ETP will be  entering  its  fourth  year  of  implementation  next  year  and  will  only  likely  reach  its peak  in  the  fifth  or  sixth  year  of  implementation.  That  said,  we  expect  to  see  an acceleration of projects being implemented, one of them being the MRT project. The project was about 12-18% completed as at early 4Q13, but with a mid-2015 deadline for the completion of civil works, project activities are expected to peak next year. We also understand that project works have begun to flow through the value chain, which will  benefit  mid-sized  businesses  as  well  as  SMEs.  Already,  we  are  seeing  some potential  green  shoots  sprouting  with  respect  to  business  lending  ahead,  with business loan disbursements gradually on the rise (see Figure 2).

This would also help cushion the potential slowdown in household lending arising from the various measures to address household indebtedness… ... although this could be a longer-term positive to help keep asset quality intact. Meanwhile,  lending  to  the  household  segment  has  been  growing  steadily  and  will continue to be bolstered by the country’s young demographic structure, high savings, rising consumerism, favourable labour market conditions and the current low interest rate  environment.  However,  while  the  property  tightening  measures  announced  in Budget  2014  and  Bank  Negara Malaysia (BNM)’s measures  to  rein  in  housing  debt will  likely  dampen household  lending going  forward,  this  would be cushioned  by  the pipelines  of  loans  the  banks  have  built  up,  as  well  as  our  expectations  of  stronger business lending. Furthermore, we believe these measures target specific groups, ie low  income  households  and  property  speculators,  and  should  help put asset  quality on better footing as we move into a period of higher inflation and interest rates. YTD (Jan-Oct ’13) system loans  grew  10.1%  (annualised),  close  to  our  10-11%  growth estimate for 2013. We project 2014 system loan growth will be sustained at a similar pace.

Meanwhile,  lending  to  the  household  segment  has  been  growing  steadily  and  will continue to be bolstered by the country’s young demographic structure, high savings, rising consumerism, favourable labour market conditions and the current low interest rate  environment.  However,  while  the  property  tightening  measures  announced  in Budget  2014  and  Bank  Negara Malaysia (BNM)’s measures  to  rein  in  housing  debt will  likely  dampen household  lending going  forward,  this  would be cushioned  by  the pipelines  of  loans  the  banks  have  built  up,  as  well  as  our  expectations  of  stronger business lending. Furthermore, we believe these measures target specific groups, ie low  income  households  and  property  speculators,  and  should  help put asset  quality on better footing as we move into a period of higher inflation and interest rates. YTD (Jan-Oct ’13) system loans  grew  10.1%  (annualised),  close  to  our  10-11%  growth estimate for 2013. We project 2014 system loan growth will be sustained at a similar pace.

9M13 sector NIM down 12bps vs 2012, but we expect the rate of compression to slow to mid-single digit in 2014. A potential 25bps hike in OPR in late-3Q14 would be mildly positive to NIMs

Interest rate hike may be a boon

We expect NIMs to remain under pressure, but the rate of compression should slow as lending yields have stabilised while rising bond yields from QE tapering may lead to  better  gapping  opportunities.  We  see  the  possibility  of  BNM  raising  the  OPR  by 25bps  in  late  3Q14  to  3.25%.  Banks  tend  to  benefit  from  interest  rates  hikes  as interest  rate-sensitive  assets  are  repriced  quicker  than  liabilities,  providing  a temporary lift to NIMs. We have yet to factor a rate hike in our earnings forecasts.

Asset quality expected to remain benign

From banks’ feedback  during  the  recent  3QCY13  reporting  quarter,  asset  quality generally  remains  benign.  We  believe  the  current  low  unemployment  rate  will  be supportive  of  household  asset  quality  while  for  the  business  segment,  the improvement in GDP and pickup in exports (2013E: +0.2% vs. 2014F: +4.5%) should bode  well  for  the  segment.  That  said,  we  believe  investors  will  continue  to  keep  a close  watch  on  developments  in  Indonesia  and,  on  the  domestic  front,  selected sectors  such as the steel industry. We project  sector  credit cost  to  remain relatively stable for next year (2014F: 27bps vs 2013E: 26bps).

Sector appears inexpensive, especially relative to the FBM KLCI

Valuations inexpensive

The  sector  is  currently  trading  at  a  2014F  P/E  of  12.1x  –  at  a  25%  discount  to  the FBM KLCI’s P/E of 16.2x. This is despite the sector offering stronger EPS growth of 8.5% for 2014 vs +7% for the FBM KLCI. In terms of P/BV, the sector’s 2014F P/BV of  1.7x  is lower than the FBM KLCI’s 2.2x  P/BV  despite  its better expected  ROE  of 14.7% (FBM KLCI: 13.4%). Thus, we think sector valuations are attractive and expect the valuation gap to close, especially as macro headwinds start to ease. Our 2014F net dividend  yield  of  3.7%  is also more attractive than the FBM KLCI’s 3.0%,  which would help provide support to share prices when markets are volatile, in our view.

Risks

The  risks  include:  i)  slower-than-expected  loan  growth;  ii)  weaker-than-expected NIMs; iii) deterioration in asset quality; and iv) changes in market conditions that may adversely affect investment portfolios.

Forecasts

We project sector (based on banks under our coverage) net profit growth of 10% y-o-y  in  2014F  (2013E:  +8%  y-o-y)  on  the  back  of:  i)  stable  operating  income  growth (2014F:  +9%  y-o-y  vs  2013E:  +8%  y-o-y,  ex-CIMB’s gain from disposal of CIMB Aviva); ii) positive jaws as overheads are expected to rise by a slower 5-6% y-o-y vis-à-vis  operating  income  growth;  and  iii)  stable  sector  credit  cost  of  27bps  (2013E: 26bps).  Sector  EPS  growth,  however,  is  projected  to  accelerate  to  +8%  y-o-y  in 2014F  from  +4.5%  y-o-y  in  2013E.  The  slower  EPS  growth  in  2013E  partly  reflects the full impact of Maybank’s private placement exercise in 2012.

Recommendations

We  see  both  Maybank  and  CIMB  as  excellent  proxies  to  the  ETP  and  key beneficiaries  as  capital  markets  improve.  However,  Indonesia’s challenging macro conditions  remain  a  bigger  dampener  for  CIMB  than  Maybank  as  contribution  from Indonesia  made  up  31%  of  9M13  pre-tax  profit  for  CIMB  vs  7%  for  Maybank. However, we continue to view any share price weakness in CIMB as an opportunity to  buy.  As  for  HLB,  we  expect  growth  to  accelerate  now  that  its  post-merger restructuring is largely completed.

Source: RHB