The sector got off to a rousing start but quickly lost steam in 1H19. For the next 6 months, it is expected to remain challenging. Overall, there are no signs of picking up and we see moderation in 2019 sector earnings growth to 2.6% from 7.0% in 2018. Also, with the Fed sounding even more dovish in recent weeks, BNM may follow suit and cut OPR again (not our base case). Despite these, we draw comfort from the sector’s strong asset quality and capital position. We retain NEUTRAL and advise long-term investors to be selective; preferred pick is Maybank (TP: RM10.30). Other BUY calls are RHB (TP: RM6.45) and Alliance (TP: RM4.20). Besides, we cut BIMB to HOLD (TP: RM5.00) in this report.

Started off great but quickly lost steam. A rousing start for Malaysian banks, whereby KLFIN clocked gains of 3% in the first two months of 2019 but it was quickly erased in the following 3-4 months; 1H19 was down 4%. The anaemic performance was largely caused by: (i) OPR cut, (ii) potential removal from FTSE WGBI, and (iii) broad negative impact from escalating US-China trade angst. However, there were positive outliers like BIMB and RHB which saw their share prices rise by 28% and 8% in 1H19 respectively; the former saw strong showing at its Takaful operations while the latter was lifted by good fundamentals and higher dividend payouts.

Sluggish with no signs of picking up. Banks were off to a humble start (whereby 1Q19 sector pre-provision profit was down 2% YoY due to negative Jaws from tepid revenue growth) and we expect 2Q19 to be challenging as domestic OPR was cut by 25bp in early May-19, putting strain on short-term NIM. Furthermore, we see tapering loans growth and lacklustre NOII, considering the softer present-day macro climate. Hence, we expect moderation in 2019 sector earnings growth to 2.6% from 7.0% in 2018. Also, sector ROE is seen to drop to 10.0% (-20bp), no thanks to the faster uptick in net credit cost (NCC) of 24bp in 2019 (vs 2018: 17bp).

Potential downside risk to 2019 earnings forecast. With the Fed sounding even more dovish in recent weeks, BNM may follow suit and cut OPR again (not our base case). On a full year basis, we estimate that every 25bp reduction in OPR would see sector NIM slipping 3-4bp and our profit forecast falling by 2-3%; from our sensitivity analysis, Alliance and BIMB would lose most if interest rate falls while Affin and AMMB are least affected. However, our economist thinks otherwise and anticipates OPR will be kept unchanged for the rest of 2019 but caveated that a worsening global environment may induce BNM to cut the OPR to support the domestic economy.

Fair price points but discounts may be on the horizon. Based on time-series and P/B-ROE regression analysis, we find that valuations of Malaysian banks are fair but short-term price downside portends on higher interest rate risk. In order to reflect this, we raise our COE assumption by 25bp for all banks under coverage. Also, it is to add further margin of safety in our interest rate risk treatment. Besides, we rolled over our valuation base year to end-2020 since we have already reached the halfway mark of 2019. Following the revisions in our TPs, we downgrade BIMB to HOLD (from BUY; TP: RM5.00). As for the other banking stocks, our ratings remain unchanged.

Maintain NEUTRAL. The market has not priced in another OPR cut, which therefore, make banking stocks susceptible to fresh sell-downs. Thus, this presents a short-term underperformance risk. Despite this and a modest growth outlook, we draw comfort from the sector’s strong asset quality and capital position. Hence, we advise long-term investors who strongly favour sector exposure to be selective. Our preferred pick is Maybank (TP: RM10.30) for its above-average dividend yield and low foreign share holding level vs larger domestic peers. Other BUY ratings are RHB (TP: RM6.45) and Alliance (TP: RM4.20).

Source: Hong Leong Investment Bank Research - 3 Jul 2019