This article first appeared in The Edge Financial Daily, on March 16, 2016.

Banking sector
Maintain overweight: Banks’ total net profit slipped 0.1% year-on-year (y-o-y) to RM5.33 billion in the fourth quarter of 2015 (4Q15). Although 4Q15 net earnings were below our expectations, this was the best performance following 2% to 6% y-o-y net profit declines in the past five quarters. The improvement in 4Q15 mainly came from a pickup in net interest income growth, as well as smaller increases in overheads and loan loss provisioning.

The drop in banks’ 2015 net profit was seen as a foregone conclusion by the market, given the upward reversal in credit costs and hike in cost of funds during the year. Malaysian banks’ net profit (excluding CIMB Group Holdings Bhd) fell 2.5% in 2015, primarily dented by a 177.4% y-o-y surge in loan-loss provisioning. However, net and non-interest incomes rose by stronger momentum of 6% to 7% in 2015 versus 2.3% and 0.2% respectively in 2014.

We expect banks to resume positive earnings growth in 2016 and project a net profit increase of 7.2%. In our view, earnings growth will come from a narrower increase in loan-loss provisioning and overheads. Two banks will also start to realise cost savings from their mutual separation schemes (MSS) implemented in 2015. Net interest margin contraction in 2016 is likely to be narrower than in 2015, given a smaller increase in banks’ cost of funds.

In spite of the macro headwinds putting pressure on banks’ asset quality, the industry has successfully kept its gross impaired loan (GIL) ratio at 1.6% in September to December 2015; 1.6% is an all-time low since the monthly data was first made available in 1998. For 2016, we expect a moderate increase in the GIL ratio to 1.8%.

We remain “overweight” on Malaysian banks, as we envisage better earnings growth in 2016. Other potential rerating catalysts for the sector include: i) attractive valuations, as most banks now trade below their historical five-year average price-earnings ratio and price-to-book valuation; ii) an enticing dividend yield of 4.2% in 2016; and iii) an expected slowdown in, if not an end to, the equity fundraising spree. RHB Capital Bhd remains our top pick.

We estimate that loan loss provisioning will still increase in 2016, but by a smaller 31.7% y-o-y (versus the 177.4% y-o-y jump in 2015). We also project that the increase in overheads will be narrower at 3.6% in 2016, compared with 6.3% in 2015, thanks to cost-saving benefits from the MSS implemented by RHB Capital and Hong Leong Bank Bhd last year. Top-line growth is expected to be softer in 2016, with both net and non-interest incomes slowing from 6% to 7% in 2015 to 4% to 5% in 2016 respectively. — CIMB Investment Bank, March 14