Figure 1: Banks' net profit and yoy % growth. RM m 30,000 20,000 15,000 10,000 10% OUTLOOK... 6 VALUATION AND RECOMMENDATION...

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1 Financial Services Banks MALAYSIA BANKS SECTOR NOTE Notes from the Field Winson NG Gia Yann, CFA T (60) E winson.ng@cimb.com Another tough year in 2015 After a tough year in 2014, the operating environment does not look any easier for Malaysian banks in Apart from sliding lending yields, banks will have to contend with (1) GST s negative impact on business/consumer sentiments, (2) keen competition for deposits, (3) slowing residential mortgages, and (4) guidelines for Islamic deposits. Figure 1: Banks' net profit and yoy % growth RM m 30,000 % 5 Show Style "View Doc Map" 25, ,000 3 Contents 15,000 2 RECAP OF ,000 1 OUTLOOK... 6 VALUATION AND RECOMMENDATION ,000 BANK S STRATEGIES FOR APPENDIX: SHARE PRICE PERFORMANCE OF BANKS IN Net profit yoy growth SOURCES: CIMB, COMPANY REPORTS Highlighted Companies Malayan Banking Maybank is our top pick due to its regional network, which will help to support its longer-term growth, especially in Indonesia and the Philippines. Public Bank Public s strong fundamentals are fully reflected in its rich valuation (P/E of 13.6x and P/BV of 2.7x) against single-digit EPS growth and dividend yield of only 3.3%. Hong Leong Bank Weak topline growth is the major reason for our negative view Hong Leong Bank. This results mainly from its below-industry loan growth and margin contraction. All the above underpin our cautious stance on the earnings outlook for banks. We retain our Underweight on the sector, keeping Maybank as our top pick. Underperforming the market in 2014 The KL Financial Index (KLFIN) fell by 7.4% in 2014, underperforming the KLCI by 1.8%. This primarily reflects the negative outlook for banks. The sector s financial performance was disappointing, with 9M14 net profit up a mere 2.8% yoy. Projecting 1 net profit growth in 2015 We are forecasting 10.4% net profit growth in 2015, supported by an expansion of 8.6% in net interest income and 10.5% in non-interest income. There could be downside risk to our forecast arising from wider-than-expected margin erosion and unexpectedly weak non-interest income growth. New threats in 2015 In 2015, banks will have to grapple with new earnings threats (1) a potential slowdown in the growth of residential mortgages, (2) implementation of GST which will dent business/consumer sentiments, and (3) compliance with the new guidelines for Islamic deposits, which will further tighten banks liquidity. Suppressed loan growth We see limited prospects for an improvement in loan growth in 2015 given the anticipated slowdown in the growth of residential mortgages. As such, we are forecasting stable loan momentum of 9-1 in 2015, on par with the level in IMPORTANT DISCLOSURES, INCLUDING ANY REQUIRED RESEARCH CERTIFICATIONS, ARE PROVIDED AT THE END OF THIS REPORT. Designed by Eight, Powered by EFA

2 KEY CHARTS Performance of banks vs. KLCI in 2014 The KL Financial (KLFIN) index fell by 7.4% in 2014, underperforming the KLCI by 1.8%. This primarily reflects the negative outlook for banks, plagued by margin compression and a drop in non-interest income. For these reasons, Malaysian banks net profit rose by a mere 2.8% in 9M14. 15% 1 5% Jan 14 Apr 14 Jul 14 Oct 14-5% -1-15% Absolute Relative Quarterly net interest margin Banks net interest margin (NIM) inched up by 1bp qoq to 2.01% in 3Q14, lifted by the rate hike in Jul 14. But on yoy basis, NIM was down 11bp in 3Q14. We believe that margins will still be under pressure in 2015, caused by (1) a continuous downward re-pricing of banks mortgage book resulting from rate competition in the past few years, and (2) intensified competition for deposits. % 2.5% 2.4% 2.3% 2.2% 2.1% % 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 Industry loan base and yoy growth The industry s loan growth softened from 10.6% yoy in Dec 13 to 9.3% yoy in Nov 14, mainly due to the moderation in consumer loan momentum from 12% to 10.2% yoy in Nov 14. Business loan growth also eased from 8.9% yoy to 8.2% yoy over the same period. We are projecting stable loan growth of 9-1 in 2015, on par with the level in 2014, based on similar rates for both consumer and business loan expansion. RM m % 1,400,000 14% 1,300,000 13% 12% 1,200,000 11% 1,100, ,000,000 9% 900,000 8% 7% 800,000 6% 700,000 5% 600,000 4% Nov-12 May-13 Nov-13 May-14 Nov-14 Loans yoy growth Impaired loan ratios and loan loss coverage In the 11-month period ending Nov 14, the industry s gross impaired loans dipped by 1.1% to RM22.6bn, against a 7.7% expansion of the loan base. As such, the gross impaired loan ratio dropped from 1.9% in Dec 13 to 1.7% in Nov 14. Total provisioning (including collective and individual assessment allowances) rose by 2.6% over the same period to RM23.3bn in Nov 14. This helped banks to keep their net impaired loan ratio at 1.3% in Dec 13 and Nov 14 and increased their loan loss coverage from 99.5% in Dec 13 to 103.3% in Nov 14. % Aug-11 Feb-12 Aug-12 Feb-13 Aug-13 Feb-14 Aug-14 Loan loss coverage (LHS) net impaired loan ratio (RHS) 3% 2% 1% SOURCE: CIMB, COMPANY REPORTS, BANK NEGARA MALAYSIA, BLOOMBERG 2

3 Figure 2: Sector Comparison Company Bloomberg Price Target Price Market Cap Core P/E (x) 3-year EPS P/BV (x) Recurring ROE (%) P/PPOPS (x) Dividend Yield (%) Recom. Ticker (local curr) (local curr) (US$ m) CY2014 CY2015 CAGR (%) CY2014 CY2015 CY2014 CY2015 CY2016 CY2014 CY2015 CY2014 CY2015 DBS Group DBS SP Add , % % % % OCBC OCBC SP Add , % % 12.4% 12.3% % 3.4% United Overseas Bank UOB SP Hold , % % 12.4% 12.5% % 3.9% Singapore average % % 11.9% 12.1% % 3.5% Agricultural Bank of China 1288 HK Add , % % 21.1% 21.1% % 7.4% Bank of China 3988 HK Add , % % 18.2% % Bank of Communications 3328 HK Add , % % 12.4% 13.5% % China CITIC Bank 998 HK Hold , % % 17.5% 16.8% % 5.4% China Construction Bank 939 HK Add , % % 20.7% 20.6% % 7.5% China Merchants Bank 3968 HK Reduce , % % 19.1% % China Minsheng Bank 1988 HK Reduce , % % 18.2% 18.1% % 1.8% ICBC 1398 HK Add , % % 19.8% 19.2% % 6.8% Hong Kong average % % 19.2% 19.2% % 6.4% Bank Central Asia BBCA IJ Hold 13,000 13,950 25, % % 22.3% 21.8% % Bank Danamon BDMN IJ Reduce 4,660 3,675 3, % % % % 2. Bank Mandiri BMRI IJ Add 10,750 11,750 19, % % 18.2% % 2.4% Bank Negara Indonesia BBNI IJ Add 6,150 6,800 9, % % 18.7% 18.3% % 2.7% Bank Panin PNBN IJ Hold 1,030 1,220 1, % % 12.4% 12.9% Bank Rakyat Indonesia BBRI IJ Add 11,825 13,000 23, % % 23.6% % 2.4% Bank Tabungan Negara BBTN IJ Add 1,170 1, % % 9.8% 10.8% % 2.5% Bank Tabungan Pensiunan BTPN IJ Add 3,985 4,625 1, % % 17.7% 17.4% Indonesia average % % 19.2% 19.1% % 1.9% Affin Holdings AHB MK Reduce , % % % % 5.1% Alliance Financial Group AFG MK Hold , % % % % 5.7% AMMB Holdings AMM MK Hold , % % 12.8% 13.1% % BIMB Holdings BIMB MK Hold , % % 11.9% 11.9% % 4.2% Hong Leong Bank HLBK MK Reduce , % 15.4% 14.9% % 3.1% Malayan Banking Bhd MAY MK Add , % 13.2% % 6.4% Public Bank Bhd PBK MK Reduce , % % 18.8% 19.9% % 3.3% Malaysia average % % 14.1% 14.2% % 4.5% Bangkok Bank BBL TB Hold , % % 11.5% 11.8% % Bank of Ayudhya BAY TB Reduce , % % 11.8% 12.1% % 1.5% Kasikornbank KBANK TB Add , % % 18.9% 18.1% % 1.9% Krung Thai Bank KTB TB Add , % % 15.8% 16.1% % 4.8% Thanachart Capital TCAP TB Hold , % % 10.4% 10.7% % 4. Tisco Financial Group TISCO TB Hold , % % 15.6% % 4.6% TMB Bank TMB TB Reduce , % % 13.2% 14.3% % 2.5% Thailand average % % 14.3% 14.4% % 2.9% Average (all) % % 18.4% 18.5% % SOURCES: CIMB, COMPANY REPORTS Calculations are performed using EFA Monthly Interpolated Annualisation and Aggregation algorithms to December year ends 3

4 Another tough year in 2015 RECAP OF 2014 Banks underperformed the market in was not a good year for Malaysia s equity market as the KLCI shed pts or 5.7% over the course of the year. As shown in the following table, banks lagged behind the market as the KL Financial Index (KLFIN) fell by 7.4%, underperform the KLCI by 1.8%. It was also the second-worst performing sector in 2014, the worst behind the plantation sector, which saw an 11.8% contraction in the KL Plantation Index. Figure 3: Performance of key indices for Bursa Malaysia in Dec Dec-14 % Change FBMFL Index % KLTEC Index % KLTIN Index % FBMHS Index KLCON Index % KLIND Index % FBMMES Index % KLPRP Index % FBMS Index % FBMSC Index % KLSER Index % FBMKLCI Index % KLCSU Index % FBMEMAS Index % FBM100 Index % KLFIN Index % FBM70 Index % KLPLN Index % SOURCES: CIMB, BLOOMBERG KLFIN s underperformance was in line with our cautious view on banks earnings prospects. Banks financial performance was also disappointing in 2014, with a weak rise of 2.8% yoy in 9M14 net profit and a 2.2% yoy drop in 3Q14. In 2014, banks earnings were hurt by a (1) slowdown in loan growth, (2) low-to mid-single-digit expansion in net interest income, and (3) a drop in non-interest income. We downgraded our recommendation on Malaysian banks from neutral to Underweight on 29 Jul 14. From 29 Jul to 31 Dec, the KLFIN fell by 9.5%, underperforming the KLCI by 3.5%. Lower share prices for banks in 2014 As shown in the following chart, the share prices of all banking stocks declined in 2014, with the drop ranging from 1% to 27%. Interestingly, the three best-performing banking stocks, i.e. Alliance (-1% in share price in 2014), Public Bank (-3%) and Hong Leong Bank (-3%), focus primarily on the consumer banking segment in Malaysia. This was in line with the industry developments in 2014 as the consumer banking operations of most banks turned in a better performance than other units including investment banking. Relative to the KLCI, Alliance outperformed by 5% while Public Bank and Hong Leong Bank outperformed by 3%. 4

5 Maybank s share price underperformed the market In 2014, we rated Maybank an Add but its stock price fell by 8%, underperforming the KLCI by 2%. Sentiment on the stock was dented by its weak financial performance due to the plunge in contributions from its subsidiary in Indonesia, Bank Internasional Indonesia (BII), lower earnings from its investment banking/insurance units and a slump in foreign exchange gains. We anticipate a recovery in BII s earnings given the expected gradual improvement in the operating environment in Indonesia and stabilisation of its investment banking income in This should help its share price to perform this year. A plunge in Affin s share price Affin s share price plummeted by 26% in 2014, partly due to an EPS-dilutive rights issue to finance its acquisition of HwangDBS Investment Bank. In addition, its financial performance was feeble, with 5-3 yoy declines in 1Q-3Q14 net profit, partly because of an upturn in credit costs. We had a Reduce rating on Affin throughout Figure 4: Absolute share price performance in % -3% -3% -4% Alliance Public HL Bank RHBCap -6% KLCI -7% -8% KLFIN Maybank -9% AMMB -1 BIMB -27% -26% Affin CIMB -3-25% -2-15% -1-5% SOURCES: BLOOMBERG 5

6 Figure 5: Share price performance in 2015 relative to KLCI Alliance 5% Public HL Bank RHBCap 2% 3% 3% -2% KLFIN -5% -2% -3% Maybank AMMB BIMB -23% -22% Affin CIMB -25% -2-15% -1-5% 5% 1 SOURCES: BLOOMBERG OUTLOOK Old drags The operating environment in 2014 proved to be challenging, pushing down banks core net profit growth to a mere 2.8% yoy in 9M14 (vs. 5.1% in 2013). In 2014, banks earnings were primarily dampened by:- slower loan growth continuous margin contraction a plunge in contributions from Indonesia due to higher provisioning and margin contraction amid an adverse operating environment weaker investment banking income, not only from Malaysia but also in the region. Affected by the above, banks net interest income rose by only 4.1% yoy in 9M14 (vs. loan growth of circa 9%) while non-interest income even fell by 5.7% yoy. The saving grace was the 8.6% yoy drop in loan loss provisioning. However, we expect loan loss provisioning to turn upwards in and new threats Although investment banking income and contributions from Indonesia are expected to stabilise in 2015, margin compression will continue to constrict topline growth. On top of this, banks will have to grapple with new threats in 2015: a slowdown in the momentum for residential mortgages residential mortgages were the key driver of the industry s loan growth in the past 2-3 years, contributing 35-47% to the industry s incremental loans in In Oct 12, the government introduced several cooling measures for the property market, which dampened property transactions. 6

7 However, growth in residential mortgages remained resilient at % yoy between Jan 14 and Oct 14 though it softened to 13.2% yoy in Nov 14. This was supported by the strong pipeline of property loans built up from robust property sales in the preceding 2-3 years. However, we think that the pipeline is depleting and a slowdown in the growth of residential mortgages is imminent. intensified deposit competition, leading to higher cost of funds and further pressure on banks margins implementation of GST in Apr 15, which will affect business and consumer sentiments and exert pressure on the growth of banks loans and fee income. upturn in credit costs banks credit charge-off rate has been low in the past four quarters (4Q13 to 3Q14), at 16-19bp, aided by strong recoveries/write-backs by a few banks. This was below the more sustainable level of about 30bp in the longer term. Hence, the normalisation of the charge-off rate points to an expected upturn in credit costs. compliance with the new guidelines for Islamic deposits The Islamic Financial Services Act 2013 (IFSA) has introduced two major classifications of products for the acceptance of money from customers by the Islamic banking institutions (1) Islamic deposits, and (2) investment accounts. Islamic banks have to fully comply with the new ruling by 30 Jun 15. Under the new guidelines, some of the funds in Islamic deposit accounts will be shifted to investment accounts, further tightening banking system liquidity. As such, Islamic banks will have to offer better rates to entice depositors to keep their money in the deposit accounts. This will be detrimental to banks margins. In our view, the negative impact from this will outweigh the additional fee income that banks will earn from managing these investment accounts. All the above underpin our cautious stance on banks earnings prospects in Projecting 10.4% net profit growth in 2015 We are projecting healthy net profit growth of 10.4% in 2015, vs. 6.8% in This is expected to be supported by an expansion of (1) 8.6% in net interest income, and (2) 10.5% in non-interest income. Cost-wise, we expect the overheads and loan loss provisioning to increase by 8-9%. Nonetheless, we see downside risks for our projected net earnings growth in 2015 (1) wider-than-expected margin contraction resulting from keen deposit competition, and (2) weaker-than-expected growth in non-interest income, impacted by GST implementation. This could scale back the growth of net and non-interest income to 7-8% in Net interest income In the absence of rate hikes, the contraction in banks net interest margin is expected to be wider for their Malaysian operations in 2015 than in However, this is expected to be partly offset by the expected stabilisation of the margins of Maybank s BII. Dragged down by the weaker margins in Indonesia last year, Maybank s net interest margin even fell by 26bp in 9M14. Furthermore, we expect the housing loan rates to remain stable after the change in the loan pricing framework where starting from 2 Jan 15, the lending rate is pegged to the base rate rather than the base lending rate. Nonetheless, there is downside risk to banks net interest margin (and our projected growth in net interest income) from protracted stiff competition for deposits, which would lift banks cost of funds. 7

8 Figure 6: Banks' net interest income and yoy growth RM m 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5, % 14% 13% 12% 11% 1 9% 8% 7% 6% 5% 4% Net interest income yoy growth SOURCES: CIMB, COMPANY REPORTS Non-interest income 2014 was a disappointing year for banks non-interest income which slipped by 5.7% yoy in 9M14. This was primarily impacted by a decline in income from the investment banking and insurance units. Also, Maybank s 9M14 foreign exchange gains plunged as 9M13 had been lifted by extraordinary gains from its position in US$. In 2015, income from insurance and foreign exchange gains (for Maybank) will stabilise while investment banking income could get a lift from two potential mega listings Malakoff and 1MDB. Conversely, the implementation of GST in Apr 15 is expected to dent business sentiment, leading to slower growth in income from business loans, including income from trade finance, remittances etc. Figure 7: Banks' non-interest income and yoy growth RM m 20,000 % 25% 2 15,000 15% 10, % 5,000-5% Non-interest income yoy growth SOURCES: CIMB, COMPANY REPORTS Loan loss provisioning We continue to expect an upward reversal in banks credit cost cycle though the pace has been slower than expected in 2Q-3Q14. We believe that banks credit charge-off rate will normalise to a more sustainable level of 20-30bp in the longer term, compared to only 18-19bp in 9M14. Overall, we are projecting an 8.8% rise in loan loss provisioning for banks in

9 Figure 8: Banks' loan loss provisioning and yoy growth RM m 5,000 % 8 4,000 3, , , Loan loss provisioning yoy growth SOURCES: CIMB, COMPANY REPORTS Loan growth We see limited chance for banks to improve their loan growth in 2015, given the expected slowdown in residential mortgages from 13-14% in We are projecting stable loan momentum of 9-1 in 2015, on par with the level in This is based on an expected expansion of 9-1 for consumer loans and business loans. However, loan growth may weaken (probably to 8-9%) in 2015 if the business loan growth fails to recover to above the 9% level to offset the weakening pace for consumer loan growth. 9

10 Figure 9: Breakdown of loans and yoy growth (Mar 14-Nov 14) RM'm Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Total loans 1,246, ,252, ,261, ,272, ,272, ,281, ,298, ,309, ,320,194.8 Purchase of securities 72, , , , , , , , ,630.4 Auto 163, , , , , , , , ,649.4 ~ passenger cars 153, , , , , , , , ,151.3 Residential 356, , , , , , , , ,761.9 Non-residential 159, , , , , , , , ,226.2 Purchase of fixed asset 9, , , , , , , , ,578.5 Personal use 58, , , , , , , , ,312.3 Credit card 33, , , , , , , , ,269.7 Consumer durables Construction 35, , , , , , , , ,654.8 Working capital 289, , , , , , , , ,191.0 Other purposes 68, , , , , , , , ,318.0 By sector Total loans 1,246, ,252, ,261, ,272, ,272, ,281, ,298, ,309, ,320,194.8 Agriculture 32, , , , , , , , ,097.0 Mining 8, , , , , , , , ,531.7 Manufacturing 96, , , , , , , , ,793.4 Utility 14, , , , , , , , ,680.9 General commerce 91, , , , , , , , ,545.1 Construction 51, , , , , , , , ,443.8 Real estate 73, , , , , , , , ,705.2 Transport 29, , , , , , , , ,520.8 Finance 85, , , , , , , , ,691.4 Education, health and others 39, , , , , , , , ,671.2 Household 708, , , , , , , , ,669.5 Others 16, , , , , , , , ,844.8 YoY growth (%) Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Total loans 10.2% % 9.3% 8.6% 8.6% % Purchase of securities 19.4% 17.5% 16.8% 16.8% 13.4% 16.7% 15.5% 15.2% 13.6% Auto 4.5% 4.1% 4.1% 3.7% 3.2% 2.4% % 1.3% ~ passenger cars 4.6% 4.3% 4.6% 4.2% 3.7% % 2.2% 2. Residential 13.8% 13.8% 13.9% 13.9% 13.8% 13.9% 13.9% 13.7% 13.2% Non-residential 15.8% 15.4% 15.6% 14.9% 15.1% % 14.9% 15.1% Purchase of fixed asset % 13.8% % 10.6% 13.9% 14.6% 13. Personal use 4.7% 4.3% 3.8% 4.1% 3.4% 3.2% 3.5% 3.9% 4.7% Credit card 4.9% 4.5% 5.3% 4.9% 1.6% 2.4% 2.1% 2.4% 2.6% Consumer durables 230.6% % 294.1% 309.3% 269.9% 250.5% 222.8% 201.5% Construction 14.7% 12.7% 13.3% 15.4% % 16.6% 14.8% 16.6% Working capital % 6.8% 6.7% 6.7% 7.5% % Other purposes -0.2% 0.5% -0.7% -4.3% -8.4% -9.9% -8.3% -10.9% -4.7% By sector Total loans 10.2% % 9.3% 8.6% 8.6% % Agriculture 5.1% 3.7% 1.9% 0.3% % 0.3% -0.3% -2.4% Mining 19.4% 15.3% 14.6% 8.6% 2.7% 1.3% 6.8% 13.5% 9.2% Manufacturing 1.3% 2.9% 1.6% % 2.2% 4.1% 5.4% 4.8% Utility 46.7% % 33.1% 32.8% % 31.5% 30.3% General commerce 6.4% 6.3% 7.4% 6.4% 6.9% 7.2% 7.3% 7.5% 8. Construction 12.5% 11.9% 11.7% 11.2% 10.1% 10.8% 12.8% 13.7% 14.6% Real estate 16.7% 16.1% % 15.4% 15.4% 15.5% % Transport 6.9% 11.6% 9.7% % 14.5% 14.1% 14.2% 18.3% Finance 15.2% 9.1% 7.7% % 6.5% 9.7% 8.3% Education, health and others -10.2% -11.5% -11.3% -14.2% -20.1% -20.1% -18.9% -18.9% -13.6% Household 11.6% 11.6% 11.6% 11.5% 11.1% % 10.5% 10.2% Others 16.8% 28.6% % 12.6% 1.8% 19.3% -0.9% 2.9% SOURCES: BANK NEGARA MALAYSIA 10

11 Stable asset quality Despite the higher inflation, we do not see any material risk of an upturn in banks impaired loan ratios in 2015 because of (1) the strong balance sheets of the corporates, reflected by the low gearing ratio for the big-cap stocks under our coverage, (2) continuous improvement in banks loan approval and monitoring systems, and (3) Bank Negara s proactive move to tighten consumer lending which will limit the gearing of the lower-income group. On this score, we expect banks gross impaired loan ratio to be stable at circa 1.8% in 2015 (vs. 1.7% in Nov 14). VALUATION AND RECOMMENDATION Remain Underweight on Malaysian banks We reiterate our Underweight stance on Malaysian banks in view of the negative earnings outlook in The potential de-rating catalysts are (1) the continuous compression of net interest margins, (2) an expected slowdown in the growth of residential mortgages, (3) weaker business/consumer sentiments upon implementation of GST in Apr 15, (4) an anticipated upturn in credit costs, and (5) the compliance of the new rulings for Islamic deposits, which will further tighten banks liquidity. Three stocks on Reduce We have Reduce calls on three banks: Public Bank in our view, Public Bank is overvalued, at a CY15 P/E of 13.6x vs the sector average of 11.2x. The pricey valuation is not justified given our projection of single-digit EPS growth in FY15-16 and a below-sector dividend yield of 3.3%. Other potential de-rating catalysts are (1) continuous margin contraction, which will constrict its topline growth, (2) the weak expansion of its business in Hong Kong due to intense industry competition, (3) succession uncertainties as Tan Sri Teh Hong Piow, the founder and controlling shareholder of the group, is already in his 80s, and (4) a drop in ROE following its rights issue last year. Affin Holdings We are cautious about the earnings prospects for Affin Holdings, as reflected in our projected EPS drop of 28.8% for FY14. Though EPS is expected to recover in FY15, growth is projected to be only 2.9%. Potential earnings risks include an upturn in credit costs, below-industry loan growth and weak margins. Furthermore, the acquisition of HwangDBS Investment Bank is expected to dilute its EPS by an estimated 15-16%. Hong Leong Bank While Hong Leong Bank is known for its prudent management, our major concern for the group is its slow topline expansion. Its loan growth of 6-8% has been below the industry s pace in the past 10 quarters (2½ years). Although management is gunning for 9-1 loan growth which is closer to the industry s rate, the key challenge in achieving this is the expected industry-wide moderation in residential mortgages, which make up the biggest portion of its loan base. Another potential drag on earnings growth is the expected upward reversal in the credit cost cycle as its credit charge-off rate was low (below 10bp) in the past six quarters (even a net write-back in 1QFY6/14 and 1QFY6/15) compared to a more sustainable level of 20-30bp, in our view. Maybank is our top pick Mayank is still an Add and our top pick among Malaysian banks for its size and well-diversified business portfolio. Its geographical diversification, with exposure to underpenetrated markets like Indonesia and the Philippines, is a boon. In Indonesia, BII is poised to benefit from the expected improvement in the operating environment in 2015 following Jokowi s victory in the presidential election. Other potential catalysts would come from (1) its continuous drive to 11

12 regionalise its operations, which would help the group to achieve better operating efficiencies and cross-selling among countries in the longer term, and (2) the gain in market share for its investment banking business in the region. BANK s STRATEGIES FOR 2015 Greater focus on margins... For the lending business, we believe that banks will put more emphasis on sustaining (or improving) their margins instead of pushing for loan growth. The incremental benefits from growing loans have been depleting with the slide in net interest margins and the rise in credit costs. Banks aims to sustain their margins could be achieved via (1) greater price discipline for overall lending practices, and (2) increased exposure to the loan segments that carry higher margins than the residential mortgage segment, which was the battleground for rate competition in the past few years. and SME loans For the above reason, a few banks, including AMMB and Affin, have partly shifted their focus to SME loans. This would help their margins in the short term but we see this as a temporary solution. In fact, the moves could be negative for the sector as a whole as it would increase competition in the SME segment, exerting pressure on the yields for SME loans in the longer term. Strategies for individual banks in 2015 The strategies of the individual banks in 2015 are: Maybank its top priority in 2015 will continue to be strengthening its regional business portfolio, primarily for its operations in Malaysia, Singapore, Indonesia and the Philippines. Greater attention will be given to BII to defend its asset quality and margins. Once the operating environment starts to improve later this year, probably from 2Q15 onwards, the focus is expected to shift partly to growth of its loans and fee income. The ongoing thrust is expected to be the continuous regionalisation of its operations to (1) promote cross-selling among its operations in various countries, (2) achieve cost savings by centralising some of the common functions like regional treasury, compliance, human resource, IT, etc. and (3) share information and expertise, which would lead to the transfer of business models and products from one country to another if they prove to be successful. Public Bank Public will be unwavering in its focus on its area of strength retail banking. For the lending business, the key objective would be balancing loan growth and margin preservation while keeping a close eye on asset quality. We think that the group will be eyeing loan growth of 10-11% in 2015, primarily from the property and SME segments, while auto loans would be growing at the projected industry s pace of 7-8%. One of the key challenges for Public in 2015 could be the increased competition in the SME market as most banks are shifting their focus to this segment in view of its superior margins relative to residential mortgages. However, given its strong relationships with its customers, we believe that Public will be able to maintain its market share in this segment though it may have to offer better rates to retain some of its customers. For fee income, it will continue to push for growth in the bancassurance and wealth management businesses. Hong Leong Bank (HLB) We believe that HLB will focus on rejuvenating its loan and fee income growth as it has been successful in keeping its costs (overheads and loan loss provisioning) low. Management is targeting loan growth of 1 but achieved only 6-8% yoy in the past 10 quarters. Faster loan growth could come from SME and auto loans and smaller contractions in credit card receivables and personal loans. But the challenge is the possible industry-wide slowdown in the growth of 12

13 residential mortgages. For fee income generation, it will continue to build on its strengths in the treasury and SME loan segments while wealth management could be the next avenue for growth. AMMB Holdings Its tight liquidity, with its loan-to-deposit ratio almost touching 10 in Sep 14, does not bode well for AMMB amid increased competition for deposits. AMMB will have to rely on external liquidity to fund its lending business and this will increase its overall cost of funds if it were to push for loan growth. As such, we think that AMMB will focus more on enhancing the overall margins of its loan book instead of pushing for loan growth. The above can be partly achieved by a shift in its focus from retail loans to SME loans, which fetch better margins. In the past 1-2 years, it has invested a lot of resources in its small business banking (SBB) operations. To push for expansion of this business, it (1) offers tailored solutions and products for its clients, (2) has 70 dedicated small business specialists covering all AmBank branches nationwide, (3) utilises a customer-centric sales process, supported by SBB BizReview, a comprehensive profiling and needs assessment tool, and (4) has a dedicated contact centre team called SBB Customer Assist for SBB customers. Affin Holdings We think that the group will still take a conservative stance for its lending business, to balance loan growth and preserve its margins. In fact, it has been conservative since 2013, as reflected by the slowdown in its loan growth from 12-18% in to 7-1 in the past two years. Last year, it completed the acquisition of HwangDBS Investment Bank (HDIB), which turned Affin Investment Bank into one of the biggest investment banking players in the market. Once it completes the integration with HDIB later this year, it will push for growth of its investment banking business, in the areas of corporate advisory, broking and asset management. With HDIB, Affin has one of the largest market shares in retail broking. Alliance Financial Group We do not expect any drastic changes in Alliance s strategic direction under its new group CEO who took the helm on 1 Jan 15. The group will continue to build on its strengths in retail banking, especially in the niche market for smaller SMEs. Its thrust to grow fee income will be achieved by expansion of its treasury, wealth management and asset management businesses. BIMB Holdings We believe that BIMB will continue to fast track its loan growth, Although the loan momentum is projected to moderate from 18.7% in 2014, it is expected to remain strong at 16.2% in 2015, which should be unrivalled by other banks. For fee income, there have been signs of weakening in 2014 and it will, therefore, put more attention into growing its lending-related and Takaful income by launching more products and pushing for more cross-selling among the various business units. By Jun 15, BIMB will have to comply with Bank Negara s guidelines for Islamic deposits, under which Islamic banks will have to offer depositors the choice of putting their money in deposits or investment accounts. BIMB will have to launch various types of investment account products and may have to offer better deposit rates to entice depositors to keep their money in the deposit accounts. 13

14 APPENDIX: Share price performance of banks in 2014 Figure 10: Maybank - share price performance in 2014 (yoy % change) 15% 1 5% Jan 14 Apr 14 Jul 14 Oct 14-5% -1-15% -2 Absolute Relative SOURCES: BLOOMBERG Figure 11: CIMB Group Holdings - share price performance in 2014 (yoy % change) 5% Jan 14 Apr 14 Jul 14 Oct 14-5% -1-15% -2-25% -3-35% Absolute Relative SOURCES: BLOOMBERG Figure 12: Public Bank - share price performance in 2013 (yoy % change) 3 25% 2 15% 1 5% Jan 14 Apr 14 Jul 14 Oct 14-5% Absolute Relative SOURCES: BLOOMBERG 14

15 Figure 13: RHB Capital - share price performance in 2014 (yoy % change) /1/14 1/4/14 1/7/14 1/10/ Absolute Relative SOURCES: BLOOMBERG Figure 14: Hong Leong Bank - share price performance in 2014 (yoy % change) 15% 1 5% Jan 14 Apr 14 Jul 14 Oct 14-5% -1-15% Absolute Relative SOURCES: BLOOMBERG Figure 15: AMMB Holdings - share price performance in 2014 (yoy % change) 2 15% 1 5% Dec 13 Mar 14 Jun 14 Sep 14 Dec 14-5% -1-15% -2 Absolute Relative SOURCES: BLOOMBERG 15

16 Figure 16: Affin - share price performance in 2014 (yoy % change) Dec 13 Mar 14 Jun 14 Sep 14 Dec Absolute Relative SOURCES: BLOOMBERG Figure 17: Alliance - share price performance in 2014 (yoy % change) 2 15% 1 5% Dec 13 Mar 14 Jun 14 Sep 14 Dec 14-5% -1-15% -2-25% Absolute Relative SOURCES: BLOOMBERG Figure 18: BIMB - share price performance in 2014 (yoy % change) Dec 13 Mar 14 Jun 14 Sep 14 Dec Absolute Relative SOURCES: BLOOMBERG 16

17 Figure 19: Key Financial Information & Ratios Banks F 2014F 2015F 2016F Banks F 2014F 2015F 2016F Net profit (RM'm) BV/share (RM) Maybank 5, , , , ,914.7 Maybank CIMB 4, ,540.4 CIMB PBB 3, , , , ,375.2 PBB AMMB 1, , , , ,889.4 AMMB HLB 1, , , , ,544.9 HLB Affin Affin Allliance Allliance BIMB BIMB Total 15, , , , ,226.7 EPS (sen) Price/BV (x) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average EPS growth (%) DPS (sen) Maybank (3.6) Maybank CIMB CIMB PBB PBB AMMB AMMB HLB 40.0 (2.0) HLB Affin (37.1) Affin Allliance Allliance BIMB (8.7) 7.7 BIMB Average PER (x) Div Yield (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average SOURCES: CIMB, COMPANY REPORTS 17

18 Figure 20: Key Income Statement Information & Ratios Banks Banks ROE (%) Net interest margin (%) Maybank Maybank CIMB CIMB 2.62 PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average ROA (%) Growth in revenue (%) Maybank Maybank CIMB CIMB (14.1) 37.8 PBB PBB AMMB AMMB 10.7 (12.7) HLB HLB (2.0) Affin Affin (0.3) Allliance Allliance BIMB BIMB (30.5) Average Average Yield on earning assets (%) Non-interest income ratio (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average Average cost of fund (%) Cost-to-income ratio (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average SOURCES: CIMB, COMPANY REPORTS 18

19 Figure 21: Key Balance Sheet Information & Ratios Banks Banks Loan growth (%) Net NPL ratio (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance (9.4) 8.9 Allliance BIMB BIMB Average Average Deposit growth (%) Loan loss coverage (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average Loan-to-deposit ratio (%) Earnings assets / total assets (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average RWCAR (%) Total loans / total assets (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Average Average SOURCES: CIMB, COMPANY REPORTS 19

20 Figure 22: Key Information & Ratios - Loans & Deposits Banks Banks Gross loans (RM'bn) Residential mortgages / total loans (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Total , , ,196.7 Average Gross NPLs / impaired loans (RM'bn) HP loans / total loans (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Total Average Performing loans (RM'm) Consumption credit / total loans (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Total , , ,180.8 Average Total deposits (RM'bn) Consumer loans / total loans (%) Maybank Maybank CIMB CIMB PBB PBB AMMB AMMB HLB HLB Affin Affin Allliance Allliance BIMB BIMB Total 1, , , , ,336.8 Average SOURCES: CIMB, COMPANY REPORTS 20

21 Figure 23: Comparison of banks' Dupont ratios Affin Alliance AMMB HL Bank Maybank PBB BIMB CIMB FY12 ROE (%) Tax & MI retention (x) Overheads coverage (x) Cost efficiency (x) Dependence on non-int inc (x) Margin (%) Equity multiplier (x) FY13 ROE (%) Tax & MI retention (x) Overheads coverage (x) Cost efficiency (x) Dependence on non-int inc (x) Margin (%) Equity multiplier (x) FY14 ROE (%) Tax & MI retention (x) Overheads coverage (x) Cost efficiency (x) Dependence on non-int inc (x) Margin (%) Equity multiplier (x) FY15 ROE (%) Tax & MI retention (x) Overheads coverage (x) Cost efficiency (x) Dependence on non-int inc (x) Margin (%) Equity multiplier (x) FY16 ROE (%) Tax & MI retention (x) Overheads coverage (x) Cost efficiency (x) Dependence on non-int inc (x) Margin (%) Equity multiplier (x) SOURCES: CIMB, COMPANY REPORTS 21

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