CIMB Research has upgraded its call on the local banking sector to neutral from

underweight, as major concerns such as losses from toxic assets, margin squeeze due to the overnight policy rate cut and capital raising are fading.

“The drop in valuations, in our view, has factored in the cautious earnings outlook. We expect an earnings recovery for banks in 2010. Public Bank Bhd remains our top pick,” the research house said.

It said the sector’s price-to-book value (P/BV) had fallen to 1.4 times from 1.9 times a year ago, and the drop had factored in the more cautious earnings outlook for 2009.

“We expect an earnings recovery for banks in 2010 on the back of better economic numbers. In the longer term, most banks will benefit from their ongoing transformation programmes and regional expansion,” it said.

It also upgraded Alliance Financial Group Bhd and Malayan Banking Bhd, to outperform from neutral, and to neutral from underperform, respectively, as it expected both stocks to attract more buying interest given the improvement in market sentiment.

“From the recent run-up of the stock market, it appears that investors are looking beyond the dismal 2009 to next year when a recovery of the economy is expected to kick in.

Having the largest weighting in the market, the banking sector is seeing a return of interest, in keeping with the improvement in market sentiment,” CIMB Research said.

Meanwhile, it expected to see a revival of banks’ earnings growth in 2010, on the back of a recovery in economic growth, adding it projected net earnings growth of 17.4% in CY10, versus a projected 6.5% decline in CY09, as non-interest income was expected to increase by 12.7%.

“We are also narrowing the discounts to their DDM (dividend discount model) value by five to 15 percentage points, leading to 3%-28% upgrades of our target prices.

The narrower discount reflects the still-healthy loan growth and asset quality in early 2009, which suggests that banks could outperform our and market expectations,” CIMB Research said.

It added potential positive developments in the banking industry included a recovery in investment banking (IB) income, as better stock market performance would revitalise deal flow and trading activities, thus enhancing IB income, and less pressure on interest margins, with rate competition subsiding in 2009 as banks turned cautious on their lending businesses in the fear of rising NPLs.

On valuations and recommendations of banking stocks in its universes, CIMB Research said with the largest weightage in the market, banking stocks should benefit from the improved market sentiment, leading to selective buying activity.

It added with loan growth and NPL ratio remaining healthy in February 2009, this could be a sign that banks could perform its and market expectations.

Of its upgraded stocks, Alliance and Maybank, CIMB Research said Alliance could benefit if foreign investors started to accumulate Malaysian stocks, as it was investors’ pick of the smaller-cap banking stocks.
“In terms of financial performance, the prudent and agile management, aided by the continuing improvement in their risk management systems, will mitigate the jump in NPLs. Swift loan growth will be revived in CY10 when the economic situation improves.”

On Maybank, the research house said being one of the biggest stocks by market cap, it could benefit from increased buying interest in the market.

“We believe that the potential impairment losses from its investment in overseas banks have been priced in as the stock price has plunged by 38.9% over the past year.

“However, we expect a strong recovery in FY10 with a projected net earnings growth of 36.5%, assuming that most of the credit costs are provided for in FY09” it said.

Meanwhile, it said it placed its bets on Public Bank for its resilience to the sector downturn, proven track record and prudent management.

“The group is still gunning for aggressive targets of 14%-15% loan growth and net NPL ratio of less than 1% in 2009. Although we view the targets as challenging and project more modest loan growth of 12% and net NPL ratio of 2.6%, Public Bank will still outperform its peers in these aspects.”