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This article first appeared in The Edge Financial Daily on December 9, 2019

Banking sector
Maintain neutral:
Excluding Affin Bank Bhd and Alliance Bank Malaysia Bhd which missed estimates, the six other banks under our coverage reported numbers that were in line; the disappointment at Affin was due to falling loan growth, lower joint venture and associate income, and a higher effective tax rate, while Alliance booked in surprisingly high bad loan provision.

Quarter-on-quarter (q-o-q), third quarter of 2019 (3Q19) sector net profit was flat even though total income grew 6% as net credit cost shot up 24 basis points (bps) and loan loss provision doubled. At the top, non-interest income (NOII) rose 6% given good trading results (falling yield climate) and the net interest margin (NIM) nudged up 3bps on the back of downward deposit repricing.

As for operating expenditure (opex), banks are still managing costs tightly (ex-CIMB Group Holdings Bhd which incurred a one-off high transformational expense). Generally, these were the trends seen but some like Affin and AMMB Holdings Bhd saw profound earnings dragged down by higher bad loan allowances. Besides, Alliance did not have to content with impairment on financial assets, while RHB Bank Bhd’s top line contracted.

Year-on-year (y-o-y) similarly, the spike in provision for bad loans (+72%) erased total income growth (+9%) and caused sector net profit to be flattish. Again, NOII shined with a 21% growth but was capped by the 7bps contraction in NIM.

Glaring outliers were Affin, Alliance and AMMB as three of them booked in substantially higher impaired loan provision, while Public Bank Bhd was hit by negative Jaws (opex accelerated a five percentage points faster versus revenue).

Loan growth tapered to 4.1% y-o-y (2Q19: +5.1%) while deposits slowed to 5.6% y-o-y (2Q19: +7%). Based on these two categories, the top three fastest growing banks were BIMB Holdings Bhd, CIMB, and Alliance (+5% to 11%).

As for asset quality, the gross impaired loan ratio continued to weaken (5bps q-o-q to 2.06%), primarily due to bad business loans. Save for Affin and BIMB (new bad loan formation shrank), all the other banks under our coverage encountered similar problems.

We expect 4Q19 to see some sequential earnings growth from further NIM recovery (through more downward deposit repricing and statutory reserve requirement cuts) along with better investment gains being realised.

However, the first half of 2020 (1H20) is seen to be challenging due to tepid credit demand and mild asset quality deterioration amid the softer present-day macro climate as well as weak consumer and business sentiment. Also, our economists expect Bank Negara Malaysia to have an easing bias with a 25bps overnight policy rate cut by end-1H20.

Following the cut in earnings for Affin and Alliance this reporting season, we are now forecasting a three-year aggregate net profit compound annual growth rate of 2.3% (from financial year 2019 [FY19] to FY21) for the sector versus our previous estimate of 2.4%.

We retain “neutral”. Although the growth outlook for banks is modest, we draw comfort from the sector’s inexpensive valuations as it is trading near -2 standard deviations (SD) to its five-year average price-to-book value.  Those that favour exposure to this sector have to be selective. We like banks that give above-average dividend yields (Maybank; target price [TP]: RM9.50), still eking out healthy growth (RHB; TP: RM6.45/BIMB; TP: RM5), and saw their valuations got bashed down to below -2SD and through level (Alliance; TP: RM3.30). — Hong Leong Investment Bank Research, Dec 6

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