We  maintain  our  NEUTRAL  stance  on  the  sector.  December’s  system loan growth  eased to  +8.7%  YoY  (Nov: +9.3% YoY)  with business and household  loans  expanding  by  7.5%  YoY  and  9.7%  YoY  respectively.Otherwise, system asset quality  improved  (absolute impaired loans 2% lower  YoY)  while  deposit  growth  gathered  pace  MoM,  resulting  in system LDR declining 40bps MoM to 86.2%.

System  loans  expanded  8.7%  YoY.  MoM  loan  growth  was  slightly stronger at 1% compared with +0.8% MoM in November  due to stronger disbursements  in  both  business  (December:  MYR70bn  vs  November: MYR63bn)  and  household  (December:  MYR27bn  vs  November: MYR24bn)  loans.  That  said,  due  to  the  base  effect,  YoY  system  loan growth moderated to 8.7% from November’s +9.3% YoY and missed our 9-10% estimate. Business loan growth ended the year on a softer note  -+7.5%  (2013:  +8.3%  YoY)  while  household  loan  growth  moderated  to +9.7% YoY from 2013’s 12.4% YoY. We  keep  our system loan growth projection of 8-9% in 2015, in view of slowing household loan growth.

Asset quality improved. As of end-2014, system asset quality generally registered improvement with absolute  system  impaired loans down 2% vs  end-2013 and lower by 2%/4% MoM/QoQ respectively. The decline came  mainly  from  the  drop  in  impaired  loans  for  working  capital purposes. Thus, system gross and net impaired loan ratios  declined to 1.66%  and  1.23%  respectively,  compared  with  end-Sep  2014’s  1.78% and  1.31%  respectively.  System  loan  loss  coverage  rose  to  106%  at end-2014 vs 102% at end-Sep 2014 and 100% at end-2013.

December  loan  leading indicators lower MoM,  with applications down 9%  MoM  (+16%  YoY)  while  approvals  fell  4%  MoM  (+2%  YoY).  The MoM decline in both system applications and approvals were mainly due to the business segment with business loan applications and approvals down  16%  and  7%  MoM  respectively.  YoY,  however,  business  loanapplications  were  up  35%  while  loan  approvals  rose  12%.  As  for  the household segment, loan leading indicators were generally stable MoM while  household  loan  applications  rose  3%  YoY,  although  household loan approvals were down 4% YoY.

System  deposits  growth  outpaced  loan  growth,  up  1.8%  MoM(+7.5% YoY). Thus, system loan-to-deposit ratio declined by 40bps MoM to 86.2% (end-2013: 84.6%).

Average  lending  rate  broadly  stable  MoM,  at  4.67%  (+2bps  MoM, +11bps  YoY).  That  said,  we  generally  expect  net  interest  margin  to remain under pressure in 2015 largely caused by rising funding cost.

Investment  case.  We  remain  NEUTRAL  on  the  sector  with  AMMB (AMM MK, BUY, TP: MYR7.45) our sole BUY.

December banking statistics – softer loan growth but asset quality held up
System loans  expanded 8.7%  YoY.  MoM loan growth was slightly stronger at 1% compared  with  +0.8%  MoM  in  November  due  to  stronger  disbursements  in  both business  (December:  MYR70bn  vs  November:  MYR63bn)  and  household (December:  MYR27bn  vs  November:  MYR24bn)  loans.  That  said,  due  to  the  base effect, YoY system loan growth moderated to 8.7% from November’s +9.3% YoY and missed our 9-10% estimate. Business loan growth  ended the year on a softer note  -+7.5% (2013: +8.3% YoY) with growth driven by the electricity, gas and water supply (+33%  YoY);  construction  (+15%  YoY),  real  estate  (+21%  YoY)  and  transport, storage  and  communication  (+14%  YoY)  sectors.  Household  loan  growth  also moderated to +9.7% YoY from 2013’s 12.4% YoY. Household lending activities were driven by residential mortgages (+13% YoY) and loans for the purchase of securities (+11% YoY) but auto loans growth eased to 1% YoY from 6% YoY in 2013.  We are keeping  our  system  loa  growth  projection  of  8-9%  in  2015,  in  view  of  slowing household loan growth.

Asset  quality  improved.  As  of  end-2014,  system  asset  quality  registered improvement with absolute  system  impaired loans down 2% vs  end-2013 and lower by  2%/4%  MoM/QoQ  respectively.  The  decline  came  mainly  from  the  drop  in impaired loans  for  working capital purposes.  Thus, system gross  and net impaired loan  ratios  declined  to  1.66%  and  1.23%  respectively,  as  compared  with  end-Sep 2014 of 1.78% and 1.31% respectively. System individual and collective allowances were  relatively  stable  QoQ,  and  hence,  loan  loss  coverage  rose  to  106%  at  end-2014, as compared with 102% at end-Sep 2014 and 100% at end-2013.December  loan  leading  indicators  lower  MoM,  with  applications  down  9%  MoM (+16%  YoY)  while  approvals  fell  4%  MoM  (+2%  YoY).  The  MoM  decline  in  both system  applications  and  approvals  were  mainly  due  to  the  business  segment  with business loan applications and approvals down 16% and 7% MoM respectively. YoY, however,  business  loan  applications  were  up  35%,  driven  by  the  manufacturing (+79%  YoY),  real  estate  (+136%  YoY),  finance,  insurance  and  business  activities (+50%  YoY)  and  other  (+208%  YoY)  sectors.  Meanwhile, business  loan  approvals rose  12%,  led  by  the  electricity,  gas  and  water  supply  (+241%  YoY),  wholesale  & retail  trade,  restaurants  and  hotels  (+59%  YoY),  construction  (+27%  YoY)  and finance,  insurance  and  business  activities  (+65%  YoY).  As  for  the  household segment,  loan  leading  indicators  were  generally  stable  MoM  while  household  loan applications rose 3% YoY but household loan approvals were down 4% YoY.

System  deposits  growth  outpaced  loan  growth,  up  1.8%  MoM  (+7.5%  YoY).From our  recent round of meetings and conversations with the banks,  we gathered that deposit competition had picked up pace towards end -2014 and hence, the strong deposit  growth  in  December  was  not  too  surprising.  Thus,  system  loan-to-deposit ratio declined by 40bps MoM to 86.2% (end-2013: 84.6%). Average lending rate  broadly stable MoM,  at 4.67%  (+2bps MoM, +11bps YoY).We generally expect spreads to continue narrowing in 2015, largely  as funding cost rises  further.  Firstly,  the  ongoing  re-pricing  of  fixed  deposits  from  July’s  ovenight policy rate (OPR) hike will likely spill over into 1H15. Secondly, liquidity has tightened as  deposit  growth  has  generally  lagged  loan  growth.  Thirdly,  new  regulatory requirements  on  liquidity  would  see  banks  focus  on  stable  as  well  as  longer -term funding, which could again exert upward pressure on funding cost.

Capital.  System CET-1/Tier-1/total capital ratios stood  at 12.6%/13.3%/15.2% as at 31 Dec 2014.

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

Earnings forecasts
No changes to our earnings forecasts.

Valuations and recommendations
We  expect  another  challenging  year  ahead  for  the  banks  amid  a  softer  macro backdrop, tighter liquidity and potential concerns over asset quality. Nevertheless, we are NEUTRAL on the sector amid an expected earnings rebound this year as well as valuations that appear fair. Given the challenging macro environment, our key sector picks are skewed towards a more defensive stance. Generally, we like stocks that offer:  i) low valuations, and ii) strong and predictable book value growth to continue creating  shareholders  value.  For  ii),  this  would  entail  a  combination  of  superior returns,  sound  earnings  predictability  (eg  less  reliant  on  markets -related  income) and/or solid asset quality.  Also, banks with relatively lower market risk should aid in insulating book value against adverse interest rate/bond yield and foreign exchange rate movements.

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.Among our NEUTRAL calls, our preferred pick is Public Bank. We like the  group for its good earnings predictability, sound asset quality and cost  Sefficiency. Moreover, its  book  value  has  remained  relatively  resilient  during  times  of  adverse  bond  yield and forex movements, thus preserving book value growth.

Source: RHB