KUALA LUMPUR (July 2): Hong Leong Investment Bank Bhd (HLIB) has turned cautious on the country’s financial services sector, following the surprise outcome of the 14th general election (GE14) that had led to the installation of the Pakatan Harapan government, and dethroned the Barisan Nasional government after a 60-year rule.

Warning investors to beware of headwind signals and heightened risks, HLIB has downgraded the country’s banking industry scene to "Neutral" from Overweight, on uncertain economic policies to be adopted by the Pakatan Harapan government, as well as the reviews of certain mega infrastructure projects, which could dent the banks’ earnings, and put the asset quality at risk.

Justifying the move to downgrade the banking sector, HLIB said the recent surprise outcome of GE14 has heightened risk to the overall financial services industry's prospects in the near- to mid-term.

“We are turning cautious on the sector, given our concerns on near- to mid-term prospects,” HLIB analyst Khairul Azizi Kairudin said in a banking sector note to its clients today.

In addition to the banking sector's rating downgrade, HLIB has also downgraded its rating on the country’s two largest banks — CIMB Group Holdings Bhd and Malayan Banking Bhd — to Hold, from Buy, and slashed the target price by between 6% and 19%. 

HLIB said its downgrade of CIMB and Maybank were on the back of various factors, which included continuing volatilities in the financial market that could impact the non-interest income (NOII),  while the review of several mega infrastructure projects by the Pakatan Harapan government could impede the banks' loans growth.

At the same time, HLIB has also slashed the country’s loans growth forecast by 0.5 percentage points to between 4.5% and 5% this year, from its previous assumption of 5% to 5.5%, as the Pakatan Harapan government reviews the feasibility of embarking on billion ringgit mega infrastructure projects.

“Prior to GE14, we maintained our loan growth assumption of 5% to 5.5% for the banking sector, despite loan growth at less than 5% for the first four months of 2018, as we were hopeful that economic activities would pick up after GE14, supported by more mega project rollouts.

“However, the unprecedented GE14 results have heightened risks on loan growth, as certain projects were being reviewed and this will likely put pressure on system loan growth, at least in the near term,” Khairul added.

HLIB’s move to downgrade the country’s banking scene was trailing behind Bank Negara Malaysia’s recent release of the country’s banking statistics for May.

Amid a slight uptick in the overall loans growth, BNM data revealed overall loan applications fell by 9.2% in May 2018, from 20% in April, while loan approvals grew by 0.6% during that period, a steep reduction from 21.6% previously.

On NOII, HLIB said the current volatile environment in the financial services sector is a bane for the banks' income derived from non-interest transactions, such as fees and service charges.

“While volatile market generally lends support to trading activities, we believe higher income arising from more active trading activities will be more than negated,” Khairul Azizi said, as he outlined three factors that could impact the NOII.

The three factors are lower mark-to-market (MTM) gains or higher MTM losses arising from bond and equity market sell off, weaker fundraising activities and lower participation from the retail trading segment.

On net interest margin (NIM), a barometer of the bank’s profitability, HLIB said there is a limited upside as the expansion seen in the first quarter of 2018 (1Q18), which widened by two basis points, is unsustainable and is expected to gradually normalise as a result of longer term deposits and the absence of further interest rate hike for the remaining part of the year.

“Beyond 2018, the incoming NSFR (net stable funding ratio) regulations in 2019 will add more uncertainties to NIM, as banks will be collecting longer dated deposits, which usually carry higher funding cost to comply with the regulations,” Khairul Aziz added.

To comply with the NSFR, a rule designed by the banking regulator to strengthen banking liquidity, HLIB believes banks could launch another round of deposit competition at a milder pace, which may in turn put pressure on funding cost and subsequently limit the NIM upside.

The NSFR, which requires banks to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities, will be rolled-out by Bank Negara Malaysia, starting January 2019.

On whether the outcome of the GE14 could pose a risk to the banking sector’s asset quality, HLIB said: “For now we believe asset quality for household segment is well contained especially in the mortgage loan.”

“Corporate segment may pose a downside surprise in asset quality in view of current environment, especially for construction and manufacturing related loans,” HLIB added.

In May, BNM data showed that the banking industry’s gross impaired loan ratio or commonly referred to as the non-performing loans, inched up to 1.6% at end-May, from 1.58% at end-April, while the loan loss coverage fell from 95% to 94.4% over the same period.

Despite its downgrade of CIMB and Maybank, HLIB said there is still a pocket of opportunities within the banking sector. It upgraded Public Bank Bhd to Buy from Hold, and raised the 12-month target price to RM26 from RM22 previously.

Amid a rich price-to-book valuation of around 2.5 times, which is among the highest in the banking industry, HLIB said Public Bank will be largest beneficiary from consumer sentiment recovery, given its high retail loan composition of 64%.