This article first appeared in The Edge Malaysia Weekly, on February 1 - 7, 2016.

As the financial reporting season draws closer, industry chatter has it that most banking groups have missed their key performance indicators (KPIs) and internal targets for the financial year ended Dec 31, 2015 (FY2015), no thanks to the headwinds that are getting stronger.

Given the anticipated tough operating environment this year, banks are expected to lower their targets moving forward.

“The banking landscape started to turn challenging last year, and although the banks were quick to embark on fine-tuning their business strategies for the year, the turbulence got too bumpy, too fast. As a result, a number of us were not able to hit the targets we had set for the year,” says a senior bank executive. 

“It is a given that we will need to set lower KPIs for this year given the tougher operating landscape today. We can control our cost but we are not able to control revenue and it is the top line that is unpredictable.”

Banks declined to comment on the matter when contacted by The Edge, saying that it is a “blackout period” now. Public listed banking groups are due to release their earnings for the financial quarter ended Dec 31, 2015 by end-February.

Meanwhile, a banking analyst says bank managements have been meeting with analysts and their guidance has been “somber”.

“A number of them have hinted that they will miss their targets and it is understood that the targets for 2016 will be lower than last year’s,” says a banking analyst with a local research house. “Some were frank enough to share that they don’t know what to guide for this year.”

For the nine months ended Sept 30, 2015, earnings at most local banking groups shrank.

Last year, the largest banking group — Malayan Banking Bhd (Maybank) — revised its FY2015 targets twice. On both revisions, Maybank lowered a number of its KPI targets citing a challenging economic outlook.

In February last year, Maybank lowered its headline KPI for both its group loan and group deposit growth to between 9% and 10% for FY2015, on expected economic headwinds. Six months later, the banking group revised downwards its group loan growth forecast to 8% to 9% while projected return on equity (ROE) was cut to 12% to 13%. Forecast group deposit growth, however, was revised upwards to 10% to 11% from 9% to 10%

Maybank had originally set a ROE target of 13% to 14% for FY2015.

Affin Holdings Bhd registered a much lower ROE for the nine months ended Sept 30, 2015 of 3.4% compared with its target of 8% for the year. Gross impaired loan ratio was 2.21% compared with a target of 1.64%.

For the financial year ended Dec 31, 2014, Affin surpassed its gross impaired loans KPI of 1.84% and achieved 91% of its ROE target of 9.2%. For FY2014, Affin’s gross impaired loans and ROE stood at 1.82% and 8.4% respectively.

With no improvement in sight for the banking landscape in the near term, banking analysts advise investors to stay defensive.

“Everything in the banking industry right now is flat and uncertain. It is difficult to see things pick up or a catalyst for the sector. Investors should stay defensive,” says one of them. 

“Valuations are attractive now but there is no catalyst for a rerating. That is the problem. So look at defensive stocks like Public Bank Bhd and Hong Leong Bank Bhd. Public Bank may be expensive compared with the other banking stocks that have dropped so much, but it is trading at 2.9 times price to book — that is the lowest in five years. Hong Leong Bank, meanwhile, is trading at 1.2 times price to book, which is attractive.”

Nomura Research, in a Jan 15 report, says it is “neutral” on Malaysian banks despite their strong balance sheets and attractive valuations because it is concerned about their weak top line growth due to slower loan growth and narrower net interest margin (NIM).

“We think earnings in 2016F will be constrained by a combination of lower loan growth, NIM compression and high provisioning. We think NIM will likely continue to be under pressure as the banks chase deposits in order to defend their positions under the liquidity coverage ratio requirements. 

“We think this is a multi-year theme. We expect the slowdown in GDP growth to lead to lower loan growth of 6% to 7% in the near term. The lower loan growth and narrower NIM should result in only mid- to single-digit earnings growth in 2016F, which we think is unlikely to excite the market,” it notes.

“Our top pick is Maybank as we believe its formidable current account, savings account deposit franchise, together with a diversified asset base, augurs well in the current challenging environment. 

“Our least preferred is CIMB Group Holdings Bhd as we believe its low capital ratio could curtail dividend payouts while its Indonesian exposure could keep its provisioning high for some time,” says Nomura Research.

Affin Hwang Research, meanwhile, has an “overweight” rating on the banking sector.

“There are still concerns in terms of NIM pressure, weakening loan growth, lacklustre capital market activities and concerns over asset quality (corporate loans in particular) but valuation is cheap, which we believe has at least adequately reflected the current challenges.

“For sector exposure, we favour the defensive Public Bank, given its more stringent credit underwriting standards and established franchises in the domestic retail financing markets, and CIMB as a potential turnaround play,” it says in a Jan 22 report.

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