The 4Q15 results season, while mixed, reinforces our view that sector ROE has yet to bottom out with most banks guiding for lower ROEs ahead. We continue to see a challenging environment ahead for banks with: i) asset growth likely constrained by tighter liquidity and soft macroeconomicconditions, ii) NIMs still under pressure, iii) capital markets yet to recover meaningfully, and iv) higher credit costs ahead – all of which should keep bottomline growth muted, in our view. We keep our NEUTRAL sector call.

4Q15 a mixed quarter for the banks. Three out of the seven banking stocks that we cover reported results that were in line with our estimates. Affin and Hong Leong Bank (HL Bank) both missed our and consensus estimates with the main variances being weaker-than-expected associate contribution (Affin and HL Bank) and lower-than-expected net interest margin (NIM) (HL Bank). CIMB’s results were in line with our expectations but missed consensus estimates. Public Bank’s results exceeded our and consensus forecasts on the back of lower-than-expected credit cost.

Key takeaways: i) ROE targets missed/lowered. For non-FYE Dec banks, Alliance Financial Group (AFG) said that its earlier ROE target would likely be missed, while AMMB and HL Bank lowered their ROE targets for FY16 by 100-150bps. For banks that reported 4Q results, expectations are for further ROE dilution ahead with 2016 ROE targets set at 100-200bps lower relative to 2015 targets.

ii) Credit costs set to rise ahead. 2015 credit costs for the larger banks, ie Maybank and CIMB, were both higher than our estimates due to the deterioration in asset quality for their overseas operations. For banks that are predominantly domestic-based, asset quality was relatively more benign. That said, we note from the guidance provided that expectations are for credit costs to rise ahead, in line with our expectations. Banks’ oil & gas exposure varied with retail-focused banks at <1%, while corporate-focused banks cited a 3-5% range. At this stage, the banks appeared comfortable with their exposure.

iii) Surprise improvement in capital ratios. Both Maybank and CIMB reported a surprising 100-130bps sequential improvement in their common equity tier-1(CET-1) ratios. Reasons provided for the improvement include risk-weighted assets (RWA) management, asset disposals as well as favourable market trends (eg forex).

Bottomline growth remains challenging. We project underlying sector net profit to rise 4% YoY in 2016 (2015: flat YoY), led by stronger operating income. That said, banks earnings had generally disappointed in the past two years.Banks’ earnings are more sensitive to credit costs and NIMs, and we think downside risks to earnings would likely stem from these two factors. Key upside risks include benign asset quality, an upturn in capital market activities, and better-than-expected NIMs.Investment case. We remain NEUTRAL on the sector, with Public Bank as our top sector pick.

4Q15 results dampened by higher tax rate Three of the seven banking stocks that we cover reported results that met our and consensus estimates. Affin (AHB MK, SELL, TP: MYR1.80) and HL Bank (HLBK MK, SELL, TP: MYR11.00) both reported results that missed our and consensus estimates due to weaker-than-expected contribution from their respective associates (insurance associate for Affin while HL Bank was dragged by its China operations). HL Bank was also weighed by lower-than-expected NIM. CIMB’s (CIMB MK, NEUTRAL, TP: MYR4.50) results were in line with our expectations but missed consensus estimates. Public Bank (PBK MK, NEUTRAL, TP: MYR19.40) reported a strong set of numbers that was ahead of our and consensus estimates thanks to lower-than-expected credit cost.

Sector 4Q15 net profit was flat QoQ and YoY, mainly due to a higher effective tax rate during the quarter. At the pre-tax level, profit rose 3% QoQ and YoY with the QoQ increase aided by lower loan impairment allowances while YoY, net interest income rose 9% driven by balance sheet expansion. Stripping out staff separation costs, 4Q15 pre-tax profit was down 1% QoQ (seasonally higher opex) but up 6% YoY. 4Q15 trends of headline items are set out as below:

i) Net interest income: flat QoQ, +9% YoY. Loan growth ended 2015 on a weaker note – flat QoQ/+10% YoY vs 3Q15: +5% QoQ/+15% YoY – a reflection of weaker macroeconomic conditions, less favourable forex fluctuations and a deliberate slowdown of asset expansion due to tighter liquidity conditions and to preserve asset quality. Meanwhile, NIM was down an estimated 3bps QoQ (+2bps YoY) with the sequential drop due to higher funding cost (+10bps QoQ/-1bps YoY) from the seasonal competitive pressure on deposits in 4Q, together with issuances of capital qualifying debt securities. ii) Non-interest income: +5% QoQ, +2% YoY. The QoQ growth was driven by stronger fee income but YoY, fee income fell 5%, reflecting weak capital market activities as well as loan-related fee income for some banks. YoY, the modest rise was from better trading income. iii) Overheads: +2% QoQ, +7% YoY. Excluding costs relating to mutual separation schemes, underlying overheads rose 6% QoQ and 5% YoY. The QoQ trend reflectedseasonal patterns while the YoY rise was partly due to adjustments for collective agreements. Underlying cost-to-income ratio (CIR) stood at 49% in 4Q15, vs 3Q15’s47.3% (4Q14: 49.8%). iv) Loan impairment allowances: -14% QoQ, +58% YoY. The significant YoY rise wasdue to higher provisioning made by Maybank and RHB during the quarter coupled with the swing from a net writeback in 4Q14 to a net charge in 4Q15 for banks such as HL Bank and Affin. Key highlights from results Below are highlights from banks’ recent reporting quarter: i) ROE expected to trend lower For banks that reported 4Q results, we note that 2016 ROE targets and guidance are about 100-200bps lower, when compared to respective targets for 2015. For the nonFYE Dec banks, management of these banks either guided that the FY16 ROE target will be missed or revised down targets. We set out in Figures 4-5 below a comparison of the numbers. Possibly, rising credit cost ahead could suppress ROEs

ii) Credit costs on the rise.2015 credit costs for the larger banks, ie Maybank and CIMB, were both higher than our estimates due to the deterioration in asset quality for their overseas operations. For banks that are predominantly domestic-based, asset quality was relatively more benign. That said, we note from the guidance provided that expectations are for credit costs to rise ahead, in line with our forecast.

iii) Domestic asset quality still holding up well, for now. Banks’ oil & gas exposure varied with retail-focused banks at <1%, while corporatefocused banks cited a 3-5% range. At this stage, the banks appeared comfortable with their exposure. In terms of soft spots, opinions varied ranging from low-income individuals to property developers but so far, the banks do not expect the issue to be systemic. iv) Surprising improvement from capital management initiatives. Both Maybank and CIMB reported a surprising 100-130bps sequential improvement in their CET-1 ratios. Reasons provided for the improvement include RWA management, asset disposals as well as favourable market trends (eg forex). As at end-Dec 2015, AMMB appeared light on the capital front but we believe there is scope for capital management initiatives. We believe the ratio of the group’s RWA-to-total assets is in excess of 70%, vs above 60% for CIMB and 53% for Maybank.

Source: RHB Research - 4 Mar 2016