The recent 2QCY14 reporting period was  unexciting.  Loan growth  was soft while non-interest income was still subdued due to muted marketsrelated  income.  On  the  flipside,  costs  were  tightly  controlled  while credit costs remained benign.  Expectations of  a pickup in lending and capital market activities ahead, coupled with July’s OPR hike, should be positive for 2H earnings, but these appear priced in. Stay NEUTRAL.

2QCY14 results  still  unexciting.  The recent 2QCY14 reporting quarter saw five out on the seven banking stocks that we cover  reporting  results that were in line with both our and consensus  estimates. CIMB’s results were  below  expectations  due  to  weaker-than-expected  non-interest income while Affin missed estimates due to higher -than-expected costs.Overall, 2QCY14’s  underlying  sector  net profit eased 3%  q-o-q (flat y-oy) to MYR5.2bn. This was a reflection of weak operating income (flat q-oq/-2% y-o-y),  with both net interest income (soft loan growth, net interest margin  (NIM)  compression)  and  non-interest  income  (muted  treasury and markets-related income) staying subdued. 

Key  takeaways:  i)  NIM  pressure  had  switched  to  funding  cost.Sector  NIM  fell  4bps  q-o-q  (-9bps  y-o-y)  but  unlike  previous  quarters, 2Q’s NIM compression stemmed from rising funding cost (+5bps q-o-q and y-o-y) whereas average asset yields rose 2bps q-o-q (-5bps y-o-y). We gather that some banks had raised deposit rates in anticipation of a hike in the overnight policy rate (OPR) in July. Competitive pressure may have also put upward pressure on deposit rates. 

ii) Overheads  –  keeping a tight rein.  The banks’ ability to keep  a tight control on costs was a positive surprise. This was important, especially given the softness in operating income. Underlying overheads rose just 2% q-o-q and  were  down 1% y-o-y.  Going forward, we would expect a pickup in variable spending should income levels trend higher but on the whole, improved operating efficiency is generally one of the key levers cited by banks to drive earnings ahead.

iii) Targets  coming  down.  Maybank  (MAY  MK,  BUY,  FV: MYR11.00)lowered its 2014 ROE target to 14% from 15% while CIMB  (CIMB MK, NEUTRAL,  FV: MYR7.55)  flagged out that its 13.5-14% ROE target for 2014 was at risk. AMMB (AMM MK, BUY, FV: MYR8.00) toned down its loan growth guidance but kept its ROE target.   While the revisions appear reasonable given the June-quarter results, we believe the lower targets were already expected as most of the results met expectations.

Investment case.  While  the  1H14 numbers lacked spark, 2H earnings should  improve  on  the  back  of  a  pickup  in  lending  and  capital  market activities, coupled with July’s OPR hike . That said, we think these factors have already been priced in. Thus,  we remain  NEUTRAL on the sector. Maybank,  BIMB  (BIMB  MK,  BUY,  FV:MYR5.05)  and  AMMB  are  our BUYs.

2QCY14 Results Roundup

2QCY14 results – Largely in line but unexciting
Results largely in line  ...  The recent  2QCY14 reporting quarter saw  five out of the seven banking stocks that  we cover report results that were in line with  both our and consensus  estimates.  CIMB’s  results  were  below  our  and  consensus  expectations due to weaker-than-expected non-interest income while Affin (AHB MK, NEUTRAL, FV: MYR3.50) missed estimates due to higher-than-expected costs. In the previous  1QCY14  reporting quarter,  six  out of the seven banking stocks that we cover reported  results that were in line with our  estimates,  with CIMB’s results at the lower end of our estimate as, apart from a soft start for non -interest income, its effective tax rate was also higher than expected. Relative to consensus expectations, the seven banking stocks we cover came in broadly within estimates.In  terms  of  dividends,  four  banks  under  our  coverage  declared  dividends.  CIMB’s, Maybank’s  and  Public  Bank’s  (PBK  MK,  NEUTRAL,  FV:  MYR19.85)  interim dividends  were  in  line  with  expectations  but  Hong  Leong  Bank’s  (HL  Bank)  (HLBK MK, NEUTRAL, FV: MYR15.10) final DPS of 26 sen was slightly ahead of our 24 sen expectations. 
… but unexciting.  Aggregate 2QCY14 net profit inched up 1% q-o-q (+4% y-o-y), aided  by  AMMB’s  MYR390m  gain  from  the  partial  divestment  of  stakes  in  its insurance  units.  Excluding  this  as  well  as  lumpy  cost  items ,  AMMB  booked  in  net gain  of  MYR208m,  2QCY14  underlying  net  profit  eased  3%  q-o-q  (flat  y-o-y)  to MYR5.2bn  (1QCY14:  -3%  q-o-q;  +1%  y-o-y).  This  was  a  reflection  of  weak  core operating  income  (flat  q-o-q/-2%  y-o-y),  with  both  net  interest  and  non-interest income  staying  subdued.  2QCY14  also  saw  HwangDBS  Investment  Bank contributing  to  Affin’s  earnings  but  its  impact  was  not  significant,  after  including associated interest costs for the bridge  financing and integration costs.  Overall, the key trends in 2Q were largely similar to that in the previous quarter. Loan growth was still soft with the corporate segment impacted by repayments, while underlying noninterest  income  was  subdued  as  markets-related  income  was  muted  (weaker volumes  and  low  volatility).  To  cushion  the  lack  of  growth  in  topline,  costs  were tightly-controlled.  Most  banks  also  reported  credit  cost  that  was  lower  than assumptions.

From  Figure  4  below,  it  would  appear  that  retail-focused  banks  (Public  Bank,  HL Bank)  outperformed  peers  that  are  skewed  towards  corporate  lending  and  capital markets income in terms of profitability. This would seem reasonable as lending to households  has  remained  resilient  (according  to  Bank  Negara  Malaysia  (BNM)statistics)  while  non-interest  income  should  be  less  volatile.  However,  for  these banks,  we  note  that  the  bottomline  improvement  was  also  aided  by  lower  loan impairment allowances (Public Bank) and low effective tax rate due to tax writebacks (HL Bank). At the pre-impairment operating profit level, growth momentum was more subdued. 

Forecasts

Key earnings revisions made during the reporting season were with respect to Affin’s and CIMB’s projections.  We lower our FY14F/15F net profit projections  for Affin  by 8.0%/6.5%  respectively,  mainly  after  raising  our  operating  expense  estimates. We also lower our FY14F/15F net profit forecasts for CIMB by 5%/6% respectively due to its weaker-than-expected non-interest income  YTD. 

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. 

Valuations and recommendations While  1H14  numbers  lacked  spark,  2H  earnings  should  improve  on  the  back  of  a pickup  in lending and  capital market  activities,  coupled  with  July’s OPR  hike.  That said, we think these factors have already been priced in. Thus, we remain NEUTRAL on the sector. For a big cap exposure, our pick is Maybank, which  offers investors a well-balanced exposure to both the retail and corporate segments, and is also a major beneficiary when capital markets pick up again.  In our view, dividend yields are attractive while 
valuations are also decent, especially staked against large-cap peer Public Bank. Among  the  mid-sized  banks,  we  like  AMMB  for  its  focus  on  profitable  and  viable segments,  healthy  current  account  savings  account  (CASA)  growth  and  efforts  to grow  recurring  non-interest  income.  AMMB’s  return  on  asset  (ROA)  is  the  highest among the domestic banks under our coverage.  Finally, the full synergistic benefits from the recent Kurnia and MBF Cards acquisitions should start to be felt  in FY16F.Our small-cap pick among the banks is BIMB, which we see as a proxy to the growth in Islamic finance.

Net interest income growth under pressure 

Sector net interest income growth was a struggle  (+0.6% q-o-q; +4% y-o-y) due to a combination of soft loan growth and continued pressure on  NIMs.

Loan growth still soft. Aggregate loan growth momentum eased to 1.8% q-o-q/10% y-o-y  (vs  1QCY14’s 2.2% q-o-q/11.3% y-o-y) while annualised growth stood at 8.2%. Three observations that stood out from the recent results are: i)  Consistent  with  the  banking  statistics,  wholesale  lending  was  still  soft  due  to repayments. This impacted loans growth of banks that are m ore reliant on this segment,  eg  AMMB  and  CIMB.  As  for  Maybank,  domestic  corporate  loans growth  was  weak,  but  this  was  cushioned  by  a more  diversified  loan  base,  ie domestic consumer and overseas operations (see below); ii)  Banks that are skewed towards retail banking fared  better, eg Public Bank, AFG (AFG MK, NEUTRAL, FV: MYR4.95) and HL Bank; and iii)  Indonesia’s  contribution  is  slowing,  but  there  are  pockets  of  opportunities elsewhere.  Both  Maybank’s  and  CIMB’s  Indonesian  units  reported  annualised loans  growth  of  9-10%,  in  IDR  terms.  Maybank’s  loans  growth,  however,  was shielded by a  relatively more diverse contribution from its international markets. Notably, its Singapore loan book rose 14.6% while loans from other international markets  surged  27%,  mainly  from  its  Greater  China  operations  (figures annualised).

NIM still under pressure, but now from funding cost.  Meanwhile, sector NIM fell 9bps  y-o-y  and  4bps  q-o-q.  While  the  NIM  compression  would  not  have  been  too surprising, what appeared  to have been different this quarter was  the source of the compression. Unlike previous quarters, 2Q’s NIM compression  was driven by  rising funding cost (+5bps y-o-y and q-o-q) whereas average asset yields rose 2bps q-o-q (-5bps  y-o-y).  Possibly,  the  rise  in funding  cost stemmed from  a  combination  of: i) banks offering higher deposit rates ahead of the OPR increase to lock in their funding costs. In the near term, this nudges up funding costs but this would be made up when the  central  bank raises rates and lending yields are repriced up; and ii)  competitive pressures. As for asset yields, lending yields have been rather stable for the past few quarters now and we note that the compression in average asset yield in  2QCY14 was significantly lower than the 19bps y-o-y decline in 2013.

Source: RHB