This article first appeared in The Edge Financial Daily on September 12, 2017 - September 18, 2017

Banking sector
Maintain market weight: Second quarter 2017 (2Q17) earnings were largely in line. As expected, sector earnings growth moderated as provisions normalised upwards, while net interest margin (NIM) eased quarter-on-quarter (q-o-q). The market could turn more defensive with a greater focus on laggard banks with solid provision buffers — Public Bank Bhd (buy), Hong Leong Bank Bhd (buy) and BIMB Holdings Bhd (buy) — as the market turns its focus to the impact of Malaysian Financial Reporting Standards 9 (MFRS9) on the sector’s 2018 provision trends. We reiterate our sell recommendation on RHB Bank Bhd.

The percentage of banks delivering positive earnings surprise declined from 44% in 1Q17 to 11% in 2Q17. Only Affin Holdings Bhd surprised on the upside, while two disappointed — Malayan Banking Bhd (Maybank) and BIMB.

Maybank and RHB Bank Bhd registered strongest earnings growth on low-base effect. Lumpy bond impairments related to oil and gas (O&G) in 2Q16 for Maybank and RHB Bank helped to fuel a relatively strong 19% year-on-year (y-o-y) low-base effect, which drove 2Q17 sector earnings growth.

Excluding the lumpy Swiber bond impairments, 2Q17 earnings reflect a milder 8% y-o-y growth (vs 1Q17’s 12.3% y-o-y growth). Maybank and RHB Bank witnessed the strongest 2Q17 earnings growth at 43% and 43.1% respectively, driven by the low-base effect of their 2Q16 earnings base arising from the abovementioned Swiber bond impairments.

Excluding the lumpy effects of the bond impairments, CIMB Group Holdings Bhd registered the strongest earnings growth at 26.3% y-o-y followed by Maybank at 18.6% y-o-y, driven largely by strong NIM expansion from lower funding cost and lower provisoins.

This is, however, well reflected in our 30% and 15% financial year 2017 (FY17) earnings growth assumption for CIMB and Maybank respectively. RHB Bank’s 2Q17 earnings growth, excluding the low-base effect of lumpy bond impairments, was a modest 3.2% y-o-y.

Excluding Maybank and CIMB, 2Q17 earnings growth for the other banks averaged 2.5% y-o-y as upward normalisation in credit cost, modest fee income and loan growth of 4.5% and 4.8% stifled overall earnings growth. In fact, q-o-q loan growth moderated to 0.1% in 2Q17 from 0.3% in 1Q17.

As expected, provisions are normalising upwards with sector net credit cost rising from 31 basis points (bps) in 1Q17 to 41bps in 2Q17. This is in tandem with the 14.9% y-o-y and 2.4% q-o-q increase in gross impaired loans balance, which resulted in a 16 bps y-o-y increase in gross impaired loan ratio to 2.05%.

As 2Q17 earnings trends were largely within our expectations, we have kept our FY17/18 sector earnings forecast largely unchanged at 12.7% and 6.6% growth respectively.

In the recent 2Q17 results, loan growth and non-interest income remained weak with positive y-o-y NIM being one of the very few growth drivers. Even then, we note that NIMs for most banks are starting to reverse downwards on a q-o-q basis. Loan life coverage ratio continues to decline for most banks while provision trend is normalising upwards, especially with the upcoming implementation of MFRS9.

On a positive note, the healthy common equity tier 1 ratios for most banks (averaging 11%) will ensure that they are able to absorb the capital impact of higher Day 1 MFRS9-fuelled provision in the balance sheet without having to top up capital buffers via additional equity capital. — UOB Kay Hian, Sept 11