ALLIANCEDBS Research notes that the banking sector’s return on equity (ROE) has seen a gradual downtrend over the past five years due to volatile earnings and capital build-up.
“Currently, the sector is trading at a multi-year low of 1.1x CY20F BV but also at a stagnant ROE of c.10%. In the near term, there are few avenues for re-rating – the sector would need to shed 9% of capital or generate north of 10% in earnings growth just to increase ROE by 100bps,” says the research house.
It has revised its CY20-21F sector earnings by 3-4% after incorporating a 25bps rate cut in 1QCY20 as well as more moderate loans growth assumptions. It adds that revenue traction will be a challenging endeavour due to a still weak credit environment and on-going margin pressure.
Infrastructure sector revival could see more loans being given out. Separately, treasury income, which had been instrumental to top-line growth thus far in CY19, is likely to slow down given the already depressed bond yields.
The sector recorded increasing gross impaired loans (GIL) ratio over 9MCY19, mainly originating from the corporate end. It has also observed some gradual uptick in retail GILs in recent months arising from mortgages and personal loans.
Moving forward, Alliance DBS is of the opinion that there is greater risk to the banks’ corporate books if economic conditions deteriorate due to a build-up in leverage as well as lower debt protection metrics over the past five years.
Its top picks are Hong Leong Bank and RHB. The research house prefers HLB for its lower risk footprint and RHB, which offers near-term upside potential.
AllianceDBS says RHB is still attractive despite a 10% stock appreciation for potential dividend upside, affordable valuations still and capacity for growth under its FIT22 strategy.
The Malaysian banking sector is currently trading at 1.1x CY20F forward BV, past -1SD of the 23-year mean. The last time it hovered at these levels was in CY16, though a hair above the troughs of the Global Financial Crisis (GFC) at 1.0x. Both the current environment and that of CY16 coincided with periods of falling profitability as measured by ROE.
The plunge in sector valuation during the GFC was largely sentiment-driven, as the banks were fairly insulated from the carnage roiling advanced economies. The CY08 banking sector earnings fell by around 10%, only because of major goodwill impairments made at Maybank for its stake in Bank Internasional Indonesia (BII). Excluding these impairments, the sector earnings growth would have been -1% and ROEs were still a fairly healthy 14%.
Meanwhile, the current CY20F earnings growth is projected to be around 3% (excluding major one-off gains) but at a vastly lower 10% ROE.
Banking sector ROE has fallen precipitously since CY11 from 17% to our expectation of 10% in CY19F; the sector had been operating within the 10-11% range for the past three years.
Given the high correlation between P/BV and this metric, P/BV levels had also fallen in tandem from more than 2x forward BV to 1.1x, making the sector the cheapest it has been since CY16.
The market has also seemingly priced in the effects of an Overnight Policy Rate cut in CY20 though there seem to be some downside risk for specific banks.
For the forseeable future, AllianceDBS envisages banking sector ROE to remain at current levels. While there have been efforts to optimise the banks’ capital efficiency, it thinks regulatory forces will prevent them from releasing a meaningful amount of capital.
According to BNM figures, banking sector loans growth has remained weak up till November 2019 at 3.7% yoy. YTD, the sector had only expanded by 3.4% on an annualised basis, dragged by non-household sector loans (+1.8%). Household loans were still going strong at 4.6%, originating from mortgages (7.2%).
