We keep our NEUTRAL call on the sector. As expected, 4Q14 sector net profit  was  dampened  by  NIM  pressure  and  chunky  loan  impairment allowances made by CIMB. The jump in overheads was also a negative surprise although non-interest income was better than expected, while asset quality was generally stable. Looking ahead, the banks see 2015 as another challenging year amid softer GDP and capital markets.

4Q14  results  roundup.  Four  out  of  the  seven  banking  stocks  that  we cover  reported  results  that  were  in  line  with  both  our  and  consensus expectations, but Maybank and Affin beat estimates while CIMB’s results were  below  expectations.  Overall,  4Q14  sector  net  profit  slipped  7% QoQ  and  YoY  to  MYR5.2bn,  mainly  due  to  higher  loan  impairment allowances  (+50%  QoQ,  +55%  YoY)  as  well  as  other  impairment charges,  both  mainly  due  to  CIMB.  For  the  full-year  2014,  sector  net profit inched down 1% YoY to MYR21.6bn, with pre-impairment profit flat while loan impairment allowances were up by 5% YoY.

Key  takeaways: 

i)  Loan  growth  picks  up  pace  thanks  to  SME segment.  Loan  growth  ended  2014  on  a  strong  note,  ie  +4%  QoQ (+11%  YoY)  –  with  several  banks  reporting  robust  lending  activities  to the SME segment. The numbers suggest that banks’ efforts to focus on SMEs may be starting to bear fruit. The banks remained optimistic that this segment will be a key loan growth driver ahead, as household loan growth  is  expected  to  continue  to  moderate  due  to  the  various  macro prudential  measures  introduced,  while  the  current  uncertain  economic environment would impact corporate lending activities.

ii)  Asset  quality  –  is  raising  coverage  via  regulatory  reserves  the way  forward?  Sector  asset  quality  was  slightly  better  QoQ  and excluding  CIMB’s  chunky  provisioning,  it  would  have  enjoyed  a  net writeback  in  loan  impairment  allowances  in  4QCY14.  Thus,  loan  loss coverage (LLC) levels for most banks were relatively stable QoQ and, in some cases, lower. Increasingly, more banks are setting aside regulatory reserves to meet BNM’s requirement.  We  would  not  be  surprised  if banks opt to build up coverage via the regulatory reserves ahead so as to avoid impacting profits.

iii)  Dividend  payouts  ratios  go  up.  Despite  the  challenging  macro environment,  slower  earnings  growth  and  need  to  preserve  capital  last year,  some  banks  raised  their  dividend  payout  ratios.  Possible  reasons for  this  could  include  managing  ROEs,  better  capital  levels,  and  giving shareholders  decent  returns.  We  see  tools  such  as  the  dividend reinvestment  plan  as  transitory,  ie  until  capital  reaches  a  comfortable level, upon which banks would then revert to all-cash dividends. In that event, we do not see some of the high payout ratios being sustained.

Investment case. We remain NEUTRAL on the sector, with Public Bank (PBK MK, BUY, TP: MYR21.00) as our sole BUY recommendation.

4QCY14 Results Roundup

4QCY14 results – Higher loan allowances dampen sector net profit

Banking results a mixed bag, but better relative to expectations than 3Q14. The recent 4Q14 reporting quarter saw four out of the seven banking stocks that we cover report  results  that  were  in  line  with  our  and  consensus  estimates.  Affin  Holdings’ (Affin) (AHB MK, NEUTRAL, TP: MYR3.30) and Malayan Banking’s (Maybank) (MAY MK,  NEUTRAL,  TP:  MYR10.00)  results  came  in  above  our  and  consensus expectations,  aided  by  lower-than-expected  credit  costs.  Maybank  also  enjoyed  a strong pick-up in non-interest income during the quarter. Meanwhile, as forewarned earlier by management, CIMB’s (CIMB MK, SELL, TP: MYR5.20) 2014 results missed  estimates  due  to  a  spike  in  loan  impairment  allowances  (Indonesia  coal portfolio and a domestic legacy corporate loan) and goodwill impairment charges.  In  the  previous  3Q14  reporting  quarter,  four  out  of  the  six  banking  stocks  that  we covered reported results that were in line with our estimates.  Affin’s results came in below  expectations  due  to  higher-than-expected  overheads  and  credit  cost  while Maybank’s earnings missed estimates due to weaker-than-expected  non-interest income.  Relative  to  consensus  expectations,  Affin,  Maybank  and  CIMB  reported numbers that were below estimates.

In terms of dividends, Maybank surprised with a higher-than-expected final net DPS of 33 sen, which brought its 2014 net payout ratio to 78.5% vs our 70% assumption. CIMB’s dividends were lower than expected, reflecting the weak 4Q numbers but its payout  ratio  was  kept  unchanged  at  40%.  Dividends  from  Public  Bank  and  Hong Leong Bank (HL Bank) (HLBK MK, NEUTRAL, TP: MYR15.90) were as expected.  Aggregate 4Q14 net profit fell 7% QoQ and YoY, with impairments both for loans and other assets being the main culprit. 4Q14 trends of headline items are as set out below (see Figure 1):

i)  Net  interest  income  (flat  QoQ,  +3%  YoY).  Loan  growth  ended  2014  on  a strong note, ie at 4.3% QoQ/11.3% YoY vs 3Q14’s 2.6% QoQ/10.3% YoY – with several  banks  reporting  robust  lending  activities  to  the  small  and  medium enterprise  (SME)  segment  (Figure  5).  The  strong  loan  growth,  however,  was crimped  by  net  interest  margin  (NIM)  pressure  (4Q14  NIM:  -9bps  QoQ/-17bps YoY vs 3Q14’s 2bps QoQ/-8bps YoY). Average funding cost for the sector rose by  19bps  QoQ  (+25bps  YoY)  due  to  a  combination  of  the  repricing  of  fixed deposits following the  overnight policy rate (OPR) hike in Jul 2014 and deposit competition  to  fund  the  pick-up  in  loan  growth  as  well  as  to  meet  regulatory requirements.  

ii)  Non-interest  income  (+14%  QoQ,  +2%  YoY).  As  expected,  fixed  income trading  activities  were  impacted  by  the  spike  in  bond  yields  in  December, resulting  in  realised  gains  from  the  sale  of  investments  slipping  43%  QoQ  or 38%  YoY.  This,  however,  was  more  than  offset  by  stronger  fee  income  (+8% QoQ  and  YoY),  and  better  other  non-interest  income  (+327%  QoQ/+6%  YoY). There  was  a  significant  improvement  in  contributions  from  the  insurance business for Maybank, while CIMB recognised gains totaling MYR127m from the disposal of building and its insurance broking business.  

iii)  Overheads (+8% QoQ, +7% YoY). The sequential rise in overheads was partly caused  by  staff  costs  (higher  variable  staff  compensation),  as  well  as investments  in  projects.  Thus,  4Q14  cost-to-income  ratio  (CIR)  deteriorated  to 50.2% from 48.0% in 3Q14 and 4Q13.

iv)  Loan  impairment  allowances  (+50%  QoQ,  +55%  YoY).  The  spike  was principally driven by CIMB’s kitchen-sinking exercise relating to its coal portfolio in Indonesia, as well as one domestic legacy corporate account. 

Key highlights from results
Below are the highlights from banks’ recent reporting quarter: i.  Loan growth – Banks’ focus on SME segment showing signs of pay-off?  4Q14 loan growth picked up pace, with several banks reporting robust lending activities  to  the  SME  segment.  For  a  while  now,  the  banks  have  been highlighting their intent to focus on the SME segment, and the growth reported in 4Q14 suggests that their efforts may be starting to bear fruit. From Figure 6, we note that growth in lending to the SME segment appears to have been a driver to the overall QoQ pickup in  loans growth. During the results briefings, the banks once again remained optimistic that the SME segment will be a key loan growth driver.  This  is  especially  given  that  household  loan  growth  is  expected  to continue to moderate due to the various macro prudential measures introduced, while  the  current  uncertain macro  environment  would impact  corporate  lending activities.

SME  lending  may  not  be  sufficient  to  offset  the  slower  household  and corporate lending activities. While we are generally optimistic as to the growth prospect of SME lending ahead, we do note that the SME segment (as disclosed in the quarterly results, which are based on BNM’s definition) tends to form a smaller portion of the loan book relative to loans to households and corporations.

Thus,  one  potential  reason  for  the  strong  growth  numbers  may  be  due  to  the base effect. Also, given that SME loans form a smaller portion of the loan book for most banks, the stronger growth from this segment may not be sufficient to lift overall  loan  growth  if  household  and  corporate  lending  end  up  being  much slower than expected.

Looking ahead to 2015, the big banks have generally guided for loan growth of 9-10%, a moderation from the +11.3% YoY in 2014.

i.  Funding  cost  pressures  kicked  in.  As  expected,  4Q14  NIM  came  under pressure from rising funding cost (+19bps QoQ vs +9bps QoQ for average asset yield).  Comparing the  sector  average  asset yield  in  4Q14  with  that  of  2Q14, ie prior  to  the  OPR  hike,  we  note  that  the  average  yield  had  gone  up  by  19bps. Over this same period, average funding cost rose by 25bps.

Confluence of factors drove up 4QCY14 funding cost. We believe the rise in 4Q14  funding  cost  was  due  to  a  combination  of  repricing  of  fixed  deposits following Jul 2014’s OPR hike and deposit competition to fund the pick-up in loan growth as well as to meet regulatory requirements. Also, we believe the deposit competition in 4Q14 was exacerbated by seasonality (year-end window dressing for banks closing off the  financial year) as well as tightness in system liquidity. Maybank had commented that the tightness in the deposit market was not just confined domestically but regionally as well. Hence, we believe the combination of  the  above  factors  together  with  the  need  to  manage  margins  led  to  some banks  ending  2014  with  a  loan-to-deposit  ratio  (LDR)  of  >90%,  ie  above  the typically-cited LDR comfort zone of 85-90%. From a sectorial perspective, LDR as at end-2014 was relatively unchanged QoQ at 89%, but up from 87% a year ago.

8-10bps NIM contraction expected for 2015. For this year, some of the banks have guided for NIM compression of 8-10bps, with margins largely coming under pressure  from  funding  costs.  The  softer  loan  growth  expected  for  2015  could help ease some pressure on deposit-gathering activities – but we believe some banks may take the opportunity to build up liquidity and lower their LDRs, which would also put downward pressure on NIMs. As we highlighted previously, there were some differences in opinion among the banks as to how long funding cost pressures would last. Some banks were of the view that funding cost pressures should  ease  in  2H15  once  the  regulatory  requirements  on  liquidity  coverage ratios take  effect,  while  other  peers  opined  that funding  costs  would likely  stay elevated for the year.

ii.  Non-interest income – Not as bad as earlier feared thanks to other income. Non-interest  income  was  a  positive  surprise  this  quarter.  Although  the  drop  in contributions from treasury (ie  fixed income) was expected, this was more than compensated for by stronger fee income, and  better  other  non-interest income. We suspect the improvement in fee income was partly helped by lending-related fees,  on  the  back  of  the  stronger  loan  growth  during  the  quarter.  RHB’s corporate  advisory  fees  also  grew  by  4.5x  QoQ  to  MYR108m.  As  for  other income, as mentioned above, there was a significant improvement in contribution from the insurance business for Maybank, while CIMB recognised gains totaling MYR127m from the disposal of building and its insurance broking business.

iv.  Asset quality – Raising coverage via regulatory reserves the way forward? Absolute gross impaired loans declined 2% QoQ to MYR22.7bn (+3% YoY) with most  banks  reporting  lower  absolute  figures  sequentially.  The  exception  was AMMB, whose absolute gross impaired loans ticked up 7% QoQ (-4% YoY) due to a corporate loan relating to property development. In terms of impaired loan formation  rate,  this  also  improved  during  the  quarter  to  82bps  vs  126bps  in 3Q14. In the previous quarter, asset quality was impacted by a chunky impaired loan  reported  by  Maybank.  Overall,  due to CIMB’s kitchen-sinking  exercise, sector  annualised  credit  cost  rose  to  27bps  vs  18bps  in  3Q14  (4Q13:  14bps). Excluding CIMB’s chunky provisioning, the sector would have enjoyed a net writeback in loan impairment allowances for the quarter.  This would have been due  to  low  loan  impairment  allowances  (ex-CIMB’s provisioning) and healthy inflow of recoveries (+23% QoQ/+21% YoY) during the quarter.  

The low loan impairment allowance for the quarter meant that loan loss coverage (LLC)  levels  for  most  banks  were  relatively  stable  QoQ  and,  in  some  cases, lower. However, increasingly, more banks are setting aside regulatory reserves to meet BNM’s requirement that banks need to hold collective impairment allowance  and  regulatory  reserves  of  no  less  than  1.2%  of  total  loans  (net  of individual  impairment  allowance)  by  31  Dec  2015.  Taking  into  account  the regulatory reserves,  we  note  that  total  coverage  levels  for banks  such  as  Affin and Maybank are at or slightly above the 100% mark, as compared to LLC levels
of  76%  and  96%  respectively  as  at  end-2014.  We  would  not  be  surprised  if banks  opt  to  build  up  coverage  via  the  regulatory  reserves  ahead.  This  is  to avoid impacting profits as the build-up of regulatory reserves merely involves a transfer within shareholders equity. Also, while this transfer would impact CET-1 levels, banks today are better capitalised

v.  Dividend  payout  ratios  rise.  One  interesting  observation  from  2014  was  that despite  the  challenging  macro  environment,  slower  earnings  growth  and  the need to preserve capital, some banks lifted their dividend payout ratios. Alliance Financial  Group  (AFG)  (AFG  MK,  NEUTRAL,  TP:  MYR4.90)  started  the  ball rolling  in  May  2014  by  paying  out  a  special  dividend  (its  FY14  (Mar)  dividend payout ratio was 81%) as well as raising its dividend payout policy to up to 60% from up to 50%. Notably, other banks that have raised payout ratios with respect to  the  2014  financial  year  include  Affin,  Maybank  and  Public  Bank.  The exception was RHB, which opted to be more conservative in terms of dividends paid out to conserve capital.

A few possible reasons for increased payout ratios, but a better outlook is unlikely to be among them. The increase in payout ratios may raise questions as  to  the  possible  signals  that the  banks may be  trying  to  convey  to investors. Typically,  increased  payout  ratios  tend  to  be  associated  with  an  improved outlook ahead, although in this case, we do not think this is so – as the banks were generally of the view that 2015 would be another challenging year. Other possible  reasons  for  the  increased  payout  could  include:  i)  improved  capital levels.  As  noted  from  Figure  17,  banks’ CET-1 levels  have  risen  over  the  past year due to a combination of equity raising activities as well as ongoing capital conservation  programmes,  such  as  dividend  reinvestment  plans,  ii)  managing  ROEs.  The  need  to  boost  capital levels  amid  weak  profitability  levels  last  year have  dragged  down  ROEs.  Increasing  payouts  may  help  strike  a  balance  for some banks (eg. AFG), and iii) providing shareholders with decent returns. 2014 was  generally  a  poor  year  for  the  share  prices  of  banking  stocks,  with  all  the banks under our coverage posting negative returns (ranging between -1% and -27%). Dividend yields would help cushion the poor share price performance.

vi.  Challenging outlook ahead. The banks’ outlook for the year ahead was rather unanimous  –  challenging  and  tough  given  slower  GDP  growth,  soft  capital markets and commodity prices. In mitigation, the banks still appeared optimistic that asset quality would be able to hold steady this year.  
 
Forecasts
We  updated  our  2015-2016  net  profit  projections  during  the  reporting  period  for banks that reported full-year results. The impact, however, was not too significant.
 
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 portfolios.
 
Valuations and recommendations
Maintain  NEUTRAL on  the  sector. Given  the  challenging macro  environment,  our key  sector  picks  are  skewed  towards  a more  defensive  stance.  We  like  banks that offer  strong  and  predictable  book  value  growth  to  continue  creating  shareholders value.  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.  In our  view,  Public  Bank  meets  the  criteria  above  and  is  our  sole  BUY  stock  for  the sector.

Source: RHB