Feb  2014  system  data  showed  the  typical  seasonal  trends  (eg  softer loan  growth  m-o-m)  on  festivities  and  a  shorter  working  month.  That said, we were surprised by the resiliency in business loan applications and approvals, both improved m-o-m and helped support our view of a pickup in business lending activities this year. Maintain OVERWEIGHT.

Business  loan  applications  and  approvals  still  healthy.  Despite  a shorter  working  month,  system  loan  applications  were  surprisingly robust, up 5.9% m-o-m (+8.5% y-o-y) to MYR57bn. The m-o-m rise was driven  by  business  loan  demand  (+25.9%  m-o-m;  +8.5%  y-o-y)  while household  loan  applications  declined  7.6%  m-o-m  (+8.6%  y-o-y),  which was largely broad-based. System loan approvals fell 4.5% m-o-m but up 9.5% y-o-y. The drop was mainly due to lower household loan approvals (-13.3%  m-o-m;  +8.3%  y-o-y).  Business  loan  approvals,  however,  grew 13.5% m-o-m and 11.4% y-o-y.  

System loans growth  eased. Not surprisingly,  Feb 2014 system loans growth eased to +0.2% m-o-m (+10.7% y-o-y) vs Jan 2014’s +1% m-o-m (+11%  y-o-y).  Loan  disbursements  to  businesses  moderated  to MYR51.3bn  from  MYR67.5bn  in  Jan  2014  –  significantly  above  the MYR43.9bn  recorded  in  Feb  2013  –  on  stronger  loan  disbursements  to the  manufacturing,  wholesale  and  retail  trade  and  real  estate  sectors. Household  loan  disbursements  eased  17%  m-o-m  to  MYR22.3bn  (Feb 2013:  MYR21.7bn).  Thus,  Feb  2014  business  and  household  loans growth  stood  at  9.3%  y-o-y  (Jan  2014:  +9.9%  y-o-y)  and  +11.8%  y-o-y (Jan  2014:  +11.9%  y-o-y)  respectively.  We  retain  our  10-11%  system loan growth expectation.

Absolute gross impaired loans saw a slight uptick, up 0.5% m-o-m (+1%  y-o-y). We are not overly concerned at this stage as we think the rise was largely seasonal due to the festive season. As at end-Feb 2014, gross and net impaired loan ratios were unchanged m-o-m at 1.8% and 1.3% respectively, while system loan loss coverage remained healthy at 104.5%, broadly stable m-o-m.

System deposits rose 7% y-o-y but was flat m-o-m. However, system loan-to-deposit  ratio  was  broadly  stable  m-o-m  at  85.5%  as  at  end-Feb 2014.

Lending  rate  dipped  but  deposit  rates  stable.  The  average  lending rate  (ALR)  for  banks  dipped  to  4.44%  from  4.53%  in  Jan  2014.  In  the past, we noted that the ALR can be volatile when monthly comparisons are made. For now, we keep our assumption of a mid-single digit decline for sector net interest margins (NIMs) in 2014.

Investment  case.  We  remain  OVERWEIGHT  on  the  sector  with Maybank, Hong Leong Bank and CIMB as our BUYs.

Sector Outlook

Sector appears inexpensive, relative to its historical trading range and the FBM KLCI

Valuations inexpensive

The  sector  got  off  to  a  slow  start  this  year,  down  1.8%  YTD  (based  on  the  banks under  our  coverage),  compared  with  a  0.3%  decline  in  the  FBM  KLCI.  This  was notwithstanding  a  decent  4QCY13  reporting  quarter  that  saw  the  banks  reporting earnings  that  were  either  above  or  within  expectations.  Generally,  sector  earnings have been resilient and our outlook has not changed. With net profits broadly intact, sector  valuations  appear  attractive.  Relative  to  its  historical  trading  range,  we  note that the sector P/BV is currently below its long-term 10-year average, while the sector P/E is around 1SD below the average.

Compared to the FBM KLCI, the banks are currently trading at a 2014F P/E of 12.2x, at  a  23% discount to the index’s 15.9x  P/E.  This  is  despite  the  sector  offering  EPS growth that is roughly similar to the FBM KLCI. In terms of P/BV, the sector’s 2014F 1.7x is lower than the index’s 2.1x, despite a stronger-than-expected ROE of 14.7% (FBM  KLCI:  13.5%).  Thus,  we  think  the  sector  valuations  are  attractive  and  we expect the valuation gap to close, especially as the macroeconomic headwinds start to ease. Our 2014F dividend yield of 4% is also more attractive than the FBM KLCI’s 3.2%, which should help provide support to share prices when markets are volatile, in our view.

Stable sector net profit growth (c.8% vs 2013’s 9%), despite a lack of episodic income

Takeaways from 4QCY13 results help reinforce our 2014 view

The  recent  4QCY13  reporting  quarter  has  helped  reaffirm  our  2014  outlook  for  the sector.  Some  key  takeaways  include  stable  NIMs,  no  systemic  asset  quality  issues and common expectations among the banks, ie domestic loan growth this year will be driven by business lending activities from both small and medium enterprises (SMEs) and  corporate.  On  the  whole,  despite  the  lack  of  episodic  income  that  some  banks enjoyed last year, we still expect sector earnings to grow 8% y-o-y in 2014 (2013: 9% y-o-y). This will be driven by 7% y-o-y operating income growth (2013: 8% y-o-y) and operating leverage as banks continue to keep a tight rein on costs. Our 2014 sector net  profit  growth  factors  in  higher  credit  costs  of  25bps  vs  2013’s  21bps,  as recoveries continue to taper off.

Business loans growth is expected to pick up in 2014, as the implementation of projects under the various economic programmes accelerates.

We  expect  business  lending  activities  to  pick  up  pace  in  2014,  underpinned  by  the progress of long gestating projects under various economic programmes such as the Economic Transformation Programme (ETP). The ETP will be entering its fourth year of implementation in 2014, and will only likely reach its peak in the fifth or sixth year. That  said,  we  expect  to  see  accelerated  implementation  of  projects,  one  of  them being  the  Klang  Valley  MRT  project.  We  also  understand  that  project  works  have begun to flow through the value chain and 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  picking  up  pace  in  recent months.

This will also help cushion the potential slowdown in household lending arising from 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  a  current  low  interest rate environment. However, while the property-tightening measures announced in the 2014 Budget and Bank Negara’s measures to rein in housing debt will likely dampen household lending going forward, this will be cushioned by the pipelines of loans that 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  a  better footing  as  we  move  into  a  period  of  higher  inflation  and  interest  rates.  We  project 2014 system loan growth of 10-11%, vs 2013’s +10.6% y-o-y. The  pickup  in  GDP  (2014E:  5.4%;  2013:  4.7%)  should  also  be  positive  for  capital market  activities  and  non-interest  income.  This  will  be  supported  by  fund-raising activities  for  the  various  projects.  Guidance  from  the  banks  thus  far  points  to  a healthy  debt  capital  market  pipeline.  Volatile  forex  rates  may  also  benefit  banks,  in terms of stronger customer flows and wider spreads.

Interest rate hike may be a boon

013 sector NIMs dropped 14bps, but we expect the rate of compression to slow to mid-single digits in 2014

Interest rate hike may be a boon

While  we  expect  NIMs  to  remain  under  pressure,  the  rate  of  compression  should slow as lending yields have stabilised, while rising bond yields from  the US Federal Reserves’ quantitative easing (QE) tapering may lead to better gapping opportunities. More  recently,  we  understand  that  the  banks  had  raised  interest  rates  on  hire purchase loans  by  up  to  50bps.  The  increase,  according  to the  banks  we  spoke  to,was partly due to the risk-based pricing framework. Possibly, the rise was also partly due to the rise in impaired loans for motor vehicles, as reported by the press.  In terms of expectations on the overnight policy rate (OPR), we see the central bank raising  the  OPR  by  25bps  in  late  3Q14  to  3.25%.  Generally,  banks  tend  to  benefit from interest rates hikes, as interest rate-sensitive assets are re-priced quicker than liabilities, providing a temporary lift to NIMs. The hike in OPR and recent increase in hire purchase lending rates would help support our mid-single digit NIM compression forecast for 2014.

Risks

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

Forecasts

No changes to our earnings forecasts.

Valuations and recommendations

We  view  the  resiliency  in  business  loan  applications  and  approvals  positively  as  it helps reaffirm our view that business lending is on an upcycle. We continue to prefer banks that offer stronger leverage to the corporate segment (excellent proxies to the ETP  and  key  beneficiaries  as  capital  markets  improve).  We  also  like  Hong  Leong Bank  as  we  expect  growth  to  accelerate  now  that  its  post-merger  restructuring activities are largely done. Overweight stance on the sector maintained.

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Source: RHB