We anticipate loan growth of 6.4% in 2025, with consumer loans remaining a key driver, bolstered by a resilient labour market, supportive policies, and steady consumer demand. Business and SME loans are also expected to gain momentum, driven by robust manufacturing, technology, and construction activity. With that, we forecast healthy net interest income (NII) growth of 5.3% and 5.1% YoY in CY25 and CY26, respectively, driven by healthier loan growth and stable net interest margins (NIM). Income from Islamic Banking Operations is projected to rise by 6.3% and 6.7% YoY over the same period.

Sector-wide NIM is expected to improve by 1-5 bps, supported by easing funding cost pressures and expectations that Bank Negara Malaysia (BNM) will maintain the Overnight Policy Rate (OPR) at 3%. However, some downside risks to NIM remain, such as rising competition in asset yields within certain sectors. In our view, BNM's proposal to abolish the Rule of 78 could potentially reduce NIM for banks.

Meanwhile, the non-interest income (non-NII) is expected to expand by 9.1% in CY25 and 9.8% in CY26, bolstered by continued market volatility, rising demand for loans, Bancassurance, and Wealth Management products, and a steady pickup in capital market activities. Banks with established Investment Banking outfits are well-positioned to capitalise on this upward trajectory.

The banking sector's asset quality has remained strong, with total impaired loans declining to RM30.9bn in October 2024 and consumer and business impaired loans showing stability. The outlook for provisions is expected to continue improving, with a lower gross credit assumption in CY25 and CY26. Banks under our coverage still have accumulated management overlays totalling around RM7.6bn. The Malaysian banking system also remains well-capitalised and supported by ample liquidity. The sector's Common Equity Tier 1 and Total Capital Ratio stand at 14.4% and 18.0%.

Potential downside risks to earnings include operating expenses, which are expected to rise by 7% in CY25 and CY26, attributed to higher personnel, establishment, and marketing costs. The need for IT investments is increasing due to cyber threats and data privacy concerns as the adoption of e-payments and digital infrastructure is also accelerating. While we expect banks to manage personnel costs by improving staff efficiency, there may be a need to re-evaluate branch network size and distribution. Despite rising costs, we forecast the banking sector's cost-to-income ratio to remain stable at around 45.9% in CY25 due to positive JAWs.

In all, the banking sector remains an attractive investment opportunity, with an attractive FY25 P/B valuation of 1.06x and an industry ROE of 10.2%. However, several banks are trading above the 1- standard deviation (SD) of their 10-year PBV cycle, suggesting that valuations are becoming stretched. Despite this, there is potential for upside due to improving investor confidence, favourable economic indicators, and a stable domestic political environment. Sector earnings are also projected to grow by 6.0% to RM37.6bn, driven by a 6.3% increase in loan growth and stabilising margins following 2024's NIM compression. We maintain an OVERWEIGHT stance on the sector. Our top BUY picks are Public Bank, CIMB and Maybank. We also have BUY recommendations on AMMB, Hong Leong Bank, RHB Bank, and Alliance Bank. Given the recent decline in the share price and the expanded risk-reward potential, we take this opportunity to raise Affin Bank from hold to BUY.

Source: TA Research - 26 Dec 2024