The  recent  3Q14  reporting  period  saw  earnings  momentum  pick  up thanks to NIM expansion following July’s OPR hike, better non-interest income  contribution,  positive  jaws  and  stable  credit  cost.  We  stay NEUTRAL, as the improvement was not as strong as expected, judging from  the  number  of  results  that  missed  estimates  as  well  as  some banks guiding down further 2014 ROE targets.

3QCY14  results  –  better,  but  still  some  misses.  Four  out  of  the  six banking stocks that we cover reported results that were in line with both our  and  consensus  expectations,  but  Malayan  Banking  (Maybank)  and Affin both missed estimates. CIMB’s results were also below consensus expectations. Overall, 3Q14 underlying sector net profit rose 6% QoQ (-3% YoY) to MYR5.6bn. This was driven by: i) stronger net interest (+3% QoQ, +5% YoY) and non-interest (+9% QoQ, -8% YoY) income growth, ii)  positive  jaws,  and  iii)  stable  credit  cost  of  c.18bps.  That  said,  the improvement was, generally, still short of expectations.

Net  interest  margin  (NIM)  pressure  alleviated,  for  now.  Sector  NIM expanded by 2bps QoQ to 2.39% (-8bps YoY) with the overnight policy rate  (OPR)  hike  providing  a  temporary  relief  to  the  NIM  pressure. Notably,  NIM  performance  for  domestic-driven  banks  outperformed those that are more geographically diversified while retail-focused banks enjoyed stronger NIM expansion relative to peers with a more diversified loan base. We believe this  was due to mortgages  – where  loan pricing tends  to  be  based  on  base  lending  rate  (BLR)  –  making  up  a  larger proportion  of  the  loan  book.  We  expect  NIMs  to  come  under  pressure again in the quarters ahead due to the ongoing repricing of deposits.

Corporate lending  activities  picked  up  pace.  This  was  thanks to the domestic  corporate  segment  and  regional  corporate  banking,  which helped  lift  sequential  loan  growth  for  Maybank,  CIMB  and  Affin.  Going forward,  concerns  over  asset  quality,  eg  Indonesia  and  vulnerable segments, may temper loan growth. 

Divergence  between  asset  quality  and  credit  cost.  Absolute  gross impaired loans for the sector saw an uptick of 5% QoQ (flat YoY) due to Maybank  (domestic  corporate)  and  CIMB  (Indonesia  operations). However,  sector  credit  cost  was  broadly  stable  and  still  low  at  18bps, aided partly by stable/higher recoveries. That said, with coverage levels falling and recoveries expected to taper off, we continue to hold the view that credit cost should rise ahead towards more normalised levels.

Targets lowered further. Maybank lowered its 2014 ROE target to  13-14%  from  14%  while  CIMB  said its  13.5-14%  ROE  target  for  2014  will not  be  met.  AMMB  tweaked  down  its  ROE  target  to  14%  from  14.2-14.5%.  Post  the  reporting  quarter,  we  estimate  consensus  trimmed sector net profit projections for FY14-15 by 3% per annum.

Investment  case. We remain  NEUTRAL  on the  sector,  with  AMMB  as our sole BUY recommendation.

3Q14 Results Roundup

3Q14 results – better but not good enough

Banking  results  still  not  beating  estimates...  The  recent  3Q14  reporting  quarter saw four  out of the  six banking stocks that we cover report results that were in line with our estimates. Affin’s (AHB MK, NEUTRAL, TP: MYR3.30) results came in below expectations due to higher-than-expected overheads and credit cost while Maybank’s (MAY  MK,  NEUTRAL,  TP:  MYR10.20)  earnings  missed  estimates  on  weaker-than-expected  non-interest  income.  Relative  to  consensus  expectations,  Affin,  Maybank and CIMB (CIMB MK, NR) reported numbers that were below estimates.

In the previous 2Q14 reporting quarter, five out of the seven banking stocks that we cover  reported  results  that  were  in  line  with  both  our  and  consensus  estimates. CIMB’s  results  were  below  our  and  consensus  expectations  on  weaker-than-expected  non-interest  income  while  Affin  missed  estimates  due  to  higher-than-expected costs. In terms of dividends, Affin surprised with a higher-than-expected interim DPS of 15 sen,  which  translates  to  a  net  payout  ratio  of  about  50%  vs  our  36%  assumption. Dividends from Alliance Financial Group (AFG) (AFG MK, NEUTRAL, TP: MYR4.90) and AMMB (AMM MK, BUY, TP: MYR7.45) were broadly as expected.  …despite an improved quarter.  Aggregate  3Q14 reported net profit inched up  2% QoQ  (-3%  YoY).  However,  recall  that  2Q14  reported  net  profit  was  boosted  by  a MYR208m  net  gain  that  AMMB  booked  in  relation  to  the  gain  from  the  partial divestment of stakes in its insurance units together with lumpy cost items. Stripping this out, sequential underlying net profit growth would have been a decent 6% QoQ.

This was on the back of:  

i)  Stronger net interest income (+3% QoQ, +5% YoY)  as loan growth  saw a mild uptick (+2.6% QoQ,  +10.3%  YoY)  vs  2Q14 (+1.8% QoQ,  +10%  YoY)  – led  by domestic corporate and overseas. Meanwhile, sector  NIM enjoyed a  temporary reprieve thanks to July’s 25bps OPR hike: 3Q14 NIM (+2bps QoQ, -8bps YoY) vs 2Q14 NIM (-4bps QoQ, -9bps YoY) 

ii)  Better  underlying  non-interest  income  contribution  (+9%  QoQ),  led  by  fee  and forex income. YoY, non-interest income was down 8% due to lower forex income mainly from Maybank iii)  Overheads were generally under control, leading to positive jaws. 3Q14 cost-to-income ratio (CIR) declined to 48% from 48.8% in 2Q14 (3Q13: 47.2%) 

iv)  Relatively low and stable credit cost sequentially of 18bps (2Q14: 17bps, 3Q13: 26bps). Thus far this year, most banks have reported credit cost that was lower than  guidance. We  note  that  absolute  gross  impaired  loans  for  the  sector  had risen  5%  YTD,  although  the  rise  was  predominantly  driven  by  Maybank (domestic corporate segment and Indonesia) and CIMB (Indonesia operations).  Overall, despite the stronger earnings momentum, the improvement was still short of expectations. Maybank lowered its 2014 ROE target to 13-14% from 14% while CIMB said its 13.5-14% ROE target for 2014 will not be met. AMMB tweaked down its ROE target to 14% from 14.2-14.5%.

Forecasts 
Except for Public Bank (PBK MK, NEUTRAL, TP: MYR20.60) and Hong Leong Bank (HL Bank) (HLBK MK, NEUTRAL, TP: MYR15.90), our FY14-15 net profit projections for the other banks were lowered by 3-9% during the reporting period. 
 
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 
Despite the pickup in sector earnings, the improvement was, generally, not as strong as expected. This can be judged by the number of results that missed estimates as well as some banks guiding down further 2014F ROE targets. Earnings in the coming quarters  may  not  be  too  exciting,  as  we  expect  income  growth  to  come  under pressure  again  due  to the  ongoing repricing  of fixed  deposits  while  the  recovery  in capital  markets  appears  elusive.  Rising  credit  cost  could  put  further  pressure  on bottomline growth. In mitigation, the sector currently trades at 2014 P/E and P/BV of 13x and 1.6x respectively, ie around 1SD below average levels. This suggests that the  lacklustre  outlook  ahead  may  have  already  been  priced  in.  Thus,  we  remain NEUTRAL on the sector.  

AMMB  is  our  sole  BUY  for  the  sector.  In  our  view,  valuations  appear  inexpensive while potential M&A news flow may provide a fillip to share price performance. Apart from the  above,  AMMB’s ROA is the highest among the domestic banks under our coverage.  This  would  be  further  supported  by  the  full  synergistic  benefits  from  the Kurnia and MBF Cards acquisitions, which should start to be felt from FY16F.

Net interest income growth improved 
Sector  net  interest  income  growth  improved.  It  rose  3%  QoQ  and  5%  YoY  as compared to 2Q14’s +1% QoQ and  +4% YoY due to a combination of  better  loans growth momentum and an uptick in NIM.

Loan  growth  –  corporate  segment  picked  up,  finally.  Aggregate  loan  growth momentum saw an uptick to 2.6% QoQ and 10.3% YoY vs 2Q14’s +1.8% QoQ and +10%  YoY  while  annualised  growth  stood  at  9%.  Two  observations  that  stood  out from the recent results are:  

i)  In  contrast  to  the  previous  reporting  quarter,  banks  that  are  skewed  towards orporate/wholesale  lending  enjoyed  stronger  growth  momentum  this  quarter (see  Figure  11).  This  was  led  by  the  domestic  corporate  segment  (Affin  and Maybank) as well as regional corporate banking (Maybank and CIMB). AFG also reported robust loan growth,  driven by the  small and medium enterprise (SME) (+7% QoQ, +11% YoY) and corporate (+4% QoQ, +21% YoY) segments ii)  Asset  quality  concern  is  tempering  growth.  Asset  quality  issues  in  Indonesia have  seen  Maybank  and  CIMB  tone  down  growth  expectations  for  their operations  there.  Domestically,  AMMB’s  loan  base  has  shrunk  QoQ  as  it reduces the proportion of new business from the vulnerable segment as well as tighter credit policies adopted for the auto and non-residential segments. 

Deposit  growth  momentum  slowed,  loan-to-deposit  (LDR)  rose  further. Aggregate  deposit  growth  decelerated  in  3Q  (+1%  QoQ,  +6%  YoY)  vs  2Q  (+2% QoQ, +7% YoY). With loan growth outpacing deposit growth sequentially, sector LDR jumped 150bps QoQ to 89.3% (end-3Q13: 86%). 

NIM pressure enjoyed a temporary reprieve. Sector NIM expanded by 2bps QoQ to  2.39%  (-8bps  YoY)  with  the  OPR  hike  providing  a  temporary  relief  to  the  NIM pressure (2Q14 NIM: -4bps QoQ, -9bps YoY). Average asset yield rose sequentially by  an  estimated  8bps  QoQ  (-1bps  YoY)  while  average  funding  cost  was  up  7bps QoQ (11bps YoY). The sequential NIM expansion would have been even stronger if not for the NIM performance of the big banks. Maybank’s NIM was flat QoQ (-13bps YoY)  with average  asset  yield  (up  a mere  3bps QoQ)  was offset  by  higher funding cost while CIMB’s NIM was estimated to be down 5bps QoQ and YoY.  Four observations:  

i)  NIM performance for banks whose income were derived largely from domestic operations outperformed banks that are more geographically diversified  

ii)  Retail-focused  banks  (Public  Bank,  AFG,  HL  Bank)  appear  to  have  enjoyed stronger margin expansion as compared to peers that have a more diversified loan base. We believe this is due to mortgages (where loan pricing tends to be  based  on  BLR) making  up  a  larger  proportion  of  the  loan  book  for these banks 

iii)  Affin’s NIM expansion was predominantly driven by lower funding cost rather than  higher  asset  yields,  as the  bridge  loan taken  out to finance  the  Hwang Investment  Bank  (IB)  acquisition  was  repaid  following  completion  of  its MYR1.2bn rights issue 

iv)  AMMB enjoyed a 13bps QoQ NIM expansion, although YoY, NIM was down 6bps.  Given  that  variable  rate  loans  only  comprise  57%  of  total  loans,  ie lowest  proportion  among  peers,  we  believe  the  robust  NIM expansion  would have been a positive surprise to the market. We note that the rise in NIM was driven by higher asset yields and believe this reflects the efforts management mentioned previously to position the balance sheet ahead of a rate hike.

Mixed  outlook  for  loans  growth.  Going  forward,  banks  that  rely  more  on  the corporate segment appear optimistic that the utilisation of credit facilities will pick up for  domestic  as  well  as  overseas  (ex-Indonesia)  operations.  Business  loan  growth momentum  improved  further  in  October’s  banking  statistics,  which  would  lend support  to  the  aforementioned  expectations.  On  the  other  hand,  we  note  that household loan growth momentum has been decelerating recently, down to +10.5% YoY in October from +11% YoY in August.

Notwithstanding the above, we think net interest income growth will be more subdued ahead as margins come under pressure once again. According to the banks, lending yields  have  largely been  repriced  during 3Q14  but the  repricing  of  fixed  deposits  is still ongoing and will put margins under pressure ahead. Apart from that, we believe a pickup in loans growth will also need to be accompanied by stronger deposit growth. This is because some banks are operating close to  – or at –  their comfortable LDR levels. Competition for deposits may also put further upward pressure on funding cost ahead.

Non-interest income – some improvement, but not by much Some  improvement  in  3Q14  but  more  optimism  for  2015.  Sector  non-interest income chalked up a 9% QoQ growth (underlying basis), with most banks reporting a rise thanks  to  stronger  fees,  investment  and  forex  income. HL  Bank,  however,  saw non-interest income decline 16% QoQ due to forex losses while Maybank reported a 3%  sequential  drop  in  non-interest  income  on  marked-to-market  losses  and  lower forex  income.  YoY,  sector  non-interest  income  was  down  8%,  but  this  was  mainly due to lower forex income from Maybank (-81% YoY) as the group enjoyed chunky gains  last  year  from  the  appreciation  of  the  USD  vs  MYR  on  its  USD  net  asset position. Overall, non-interest  income  contribution improved  to  28.2%  in  3Q14 from 27.2% in 2Q14, but was still significantly lower than the 31% contribution in 3Q13. Looking ahead to 2015, larger IBs like Maybank, CIMB and AMMB appear optimistic that  capital  market  activities  will  be  better  in  2015,  citing  healthy  IB  pipelines (especially for debt capital markets).  Overall,  the underlying operating income for the sector rose 5% QoQ and 1% YoY. 3Q14  was  the  first  quarter  thus  far  this  year  where  operating  income  managed  to report YoY growth.

Overheads – still keeping a tight rein over costs Costs generally under control. Banks continue to keep a tight control on costs with the  rise  in overheads  capped  at just  3% QoQ  and  YoY.  Together  with  the  stronger operating income, the sector’s CIR declined  to  48%  from  48.9%  in  2Q14  (3Q13: 47.2%).  Going  forward,  we  would  expect  a  pickup  in  variable  spendings  (eg personnel  cost  and marketing  expenses)  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. 

Loan impairment allowances: still low despite uptick in impaired loans Big  banks  impact  sector  asset  quality.  Absolute  gross  impaired  loans  for  the sector  saw  an  uptick  of  5%  QoQ  (flat  YoY)  on  the  back  of  higher  impaired  loan formation  of  126bps  (2Q14:  88bps,  3Q13:  82bps)  for  the  quarter.  The  sequential increase  in  absolute  impaired  loans  for  the  sector  was  mainly  driven  by  higher impaired  loans  reported  by  Maybank  (domestic  corporate  involved  in  shipbuilding) and CIMB (Indonesia operations). However, despite the deterioration in asset quality, sector annualised credit cost was broadly stable and still low at 18bps (2Q14: 17bps, 3Q13: 19bps) as credit cost for most banks continued to trend below guidance (low individual  allowances  and  stable/higher  recoveries).  In CIMB’s case, we note that despite  the  jump  in  credit  charge  for  the  quarter,  its  9M  credit  cost  of  33bps (annualised) was still below the 35-40bps guidance. For Maybank, 3Q14 credit cost was low, as higher recoveries helped cushion the rise in individual allowances.  Notwithstanding  the  above,  we  believe  a  combination  of  falling  loan  loss  coverage levels  and  with  recoveries  expected  to  taper  off  means  that  credit  cost  should  rise ahead and trend towards more normalised levels.

Source: RHB