Staying Resilient In The Face Of Economic Slowdown
The KLFIN index has experienced selling pressure of late due to the spillover effects of global economic growth concerns. However, we opine that Malaysian banks’ earnings resilience will continue to prevail given the healthy provision buffers built in and still commendable domestic macroeconomic growth. Sector valuations have declined to an attractive 1SD below the historical mean. Maintain OVERWEIGHT while switching our top pick to Public Bank from HLBank.
• Sentiment dragged down by fear of slowing macroeconomic growth. The banking sector’s share price performance has remained rather lukewarm of late, with the KL Finance index declining 5.0% (FBMKLCI: -6.2%) in Sep 22 despite Bank Negara Malaysia’s (BNM) recent 3rd Overnight Policy Rate (OPR) rate hike for the year. Fears of a potential global economic recession had clearly dampened the sector’s sentiment of late. That said, the banking sector remains one of the more defensive sectors, outperforming the FBMKLCI by 13% ytd 22.
• Simulating adverse scenario 1 & 2. In addressing the investors’ concerns over the impact of slowing GDP growth forecast (UOB forecast: 2022: 6.5% vs 2023: 4.8%) and a potential extension of the prosperity tax, we have simulated the potential impact of two adverse scenarios on our sector 2023 earnings assumptions.
• Adverse scenario 1 (AS1) assumes: a) 20-30% increase in net credit cost assumptions (despite banks having built up comfortable pre-emptive provision buffers), b) 5% contraction in non-interest income vs our current low-to-mid single-digit growth, and c) flattish NIM trend vs our current 2bp expansion. Meanwhile, adverse scenario 2 (AS2) encompasses all the assumptions of AS1 coupled with potential extension of the prosperity tax.
• Sector still expected to deliver earnings growth in AS1 and flattish in AS2. Despite a potential 10% and 18% downward earnings revision to our current 2023 earnings assumption under AS1 and AS2 respectively, we are still expecting the sector to deliver a commendable 7.6% yoy earnings growth for 2023 (current base case: +19% yoy) and a manageable 2% yoy contraction under AS2 (extension of prosperity tax). Public Bank and HLBank are expected to face a relatively more modest 5% and 8% potential earnings downgrade respectively vs peers’ average of 11% under AS1.
• Maintain OVERWEIGHT. We remain positive on the sector. This is premised on: a) sector valuation of -1.0SD nearing average crisis trough of -1.5SD, b) earnings resilience sustained by potential positive NIM surprise as we remain at the early-to-mid stages of the OPR hike cycle, c) comfortable pre-emptive provisions which provide some buffer against any deterioration in asset quality on inflationary pressures, and iv) attractive 2022/23 dividend yields of 4.8%/5.4%.
• Top picks. We take the opportunity to upgrade Public Bank to a BUY following its recent share price retracement. Consequently, we switch our top defensive stock pick to Public Bank from HLBank given the former’s relatively more attractive risk-to-reward proposition. For higher beta names, we like Alliance Bank given its attractive valuations and it being the prime beneficiary of an interest rate hike cycle.