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This article first appeared in The Edge Financial Daily on February 4, 2020

Banking sector
Retain market weight:
Loan growth remained weak at below our expectation of 4% for 2019. With the sector’s sentiment likely to be capped by the ongoing Wuhan virus, we retain our “market weight” call on the sector. On a brighter note, asset quality is holding up stronger than expected, which could lead to lower provisions. Hong Leong Bank Bhd remains our top sector pick for its above-industry loan growth and resilient asset quality.

The sector’s loan growth in 2019 ended on a weak note at 3.8%, implying a muted 0.83 times loan-to-gross domestic product (GDP) growth (based on our expectation of a 4.6% GDP growth). Business loans remained a key drag on overall loan growth, up 2.7% year-on-year (y-o-y) in 2019 (2018: 5.6%). Household loan growth also moderated to 4.7% from 5.6% in 2018 as auto and credit card loan growth deteriorated. Mortgage loans declined the least, growing 7.3% (2018: 7.6%) but this was partially attributed to the homeownership scheme which ended in December 2019. The front-loading of mortgage purchases during the homeownership scheme in 2019 could result in further weakness in mortgage loan growth in 2020 which in turn could partially offset our expectation of a stronger business loan recovery in the second half of 2020 (2H20) on the back of the roll-outs of some mega infrastructure projects. As such, we have pencilled in only a modest recovery in loan growth to 4.5% for 2020 from 3.8% in 2019.

In assessing the potential impact of the ongoing Wuhan virus on the banking sector, we looked back at the impact of the severe acute respiratory syndrome (SARS) on the sector, and note that the impact on pre-provision operating profit and earnings was marginal, if any, as GDP growth expanded at a faster 5.4% in 2003 (the SARS period) versus 4.4% in 2002. As such, the sector recorded a relatively healthy 7.4% y-o-y growth in pre-provision operating profit and a much stronger 27% y-o-y net profit growth on the back of lower provisions.

However, we made two key observations: i) loan-to-GDP growth moderated slightly to 0.9 times in 2003 versus one times in 2002; and ii) despite the sector’s return on equity rising to 11.5% in 2003 from 10.7% in 2002, the outbreak clearly impacted the sentiment on the sector, with the sector’s price-to-book value (P/BV) declining 13% from November 2002 (when the first suspected SARS case occurred) to April 2003 (when an approved vaccine was discovered) and starting to stage a strong recovery (+32%) from early June 2003 (one month before the World Health Organization announced that the SARS virus was contained) to end-2003. Drawing parallels, we believe the sector’s performance is likely to remain muted in 1H20 but may not decline to the extent it did during the SARS period as the current valuation (1.1 times forecasted 2020 P/BV) is near its 10-year historical trough. Year to date, the sector has declined 4% on the back of a cut in the overnight policy rate and the Wuhan virus outbreak.

The sector’s gross impaired loan (GIL) ratio declined from 1.6% in November 2019 to 1.51% in December, driven by the business loan GIL ratio (November: 2.34%; December: 2.17%). The improvement was across most business sectors (except construction), potentially driven by the reclassification of rescheduled and restructured loans back to performing and write-offs. This could lead to a slight improvement in credit cost in the fourth quarter of 2019. If the sector’s net credit cost remains relatively well contained in 2020 (at 2019’s level), this could lead to a stronger sector earnings growth of 4.2% in 2020 versus our current estimate of 2.7%. We have currently pencilled in a 28-basis-point (bp) net credit cost for 2020 (2019: 24bps).

We like CIMB Group Holdings Bhd and BIMB Holdings Bhd for their attractive valuations (-2 standard deviation below their 10-year historical mean P/BV) and above-industry earnings growth. — UOB Kay Hian, Feb 3

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