PETALING JAYA: Despite the subdued first quarter (1Q) financial numbers and downside risks to the local banking sector’s outlook for the second half of the financial year (2H25), RHB Research has retained its “neutral” stance on the sector after banks retained their 2025 guidance and return on equity (ROE) targets.

The research house, in a sector report, stated that banks’ operating income in 2H25 faced challenges from US tariffs but was cushioned by realising trading profits and overlay reversals.

“Banks guided for limited first-order impact from US tariffs, pointing to minimal exposures to loans that may be at risk.

“The banks are still trying to quantify second-order effects, but segments that may be at risk include unsecured lending for retail, and non-retail loans to small and medium enterprises.

“That said, while some banks took the opportunity from stable asset quality to book in pre-emptive loan provisions and overlays, the management teams were generally comfortable with the outlook on asset quality,” RHB Research summarised from the various 1Q25 results briefings attended.

The impact from the uncertainties ahead could be felt on operating income due to factors such as change in loan growth, policy rate cuts as well as lower loan and markets related non-interest income.

RHB Research added that in 1Q25, some banks reported key financial metrics that were trailing 2025 guidance, notably around loan growth and ROE, but credit cost was better than guided.

The banking sector’s 1Q25 operating income grew 2% year-on-year (y-o-y) with net interest income rising 3% y-o-y as the 4.5% loan growth enjoyed by the sector was partly offset by an estimated three basis points (bps) y-o-y squeeze in net interest margin (NIM) due to asset yield pressure, it stated.

Non-interest income was flat y-o-y in 1Q25 due to a high base in 1Q24 for both fee, as well as trading and markets income.

The research house added that the sector’s operating expenditure was up 3% y-o-y in 1Q25 leading the cost to income ratio to tick up to 46.2%.

The sector’s earnings in the period increased by 3% y-o-y albeit with compensating factors at the loan impairment and associate lines.

Sector gross impaired loans in the period declined by 7% y-o-y while loan loss coverage fell to 105% due to overlay reversals.

RHB Research added the majority of the banks under its coverage are expecting one cut in the overnight policy rate (OPR) in 2H25, and while this would put some pressure on NIM, they pointed to mitigating factors such as the recent reduction to the statutory reserve requirement, current account savings account growth and tapping the debt market, where rates can be cheaper as compared to wholesale deposits.

“Some banks have also started to make preemptive moves in anticipation of a lower OPR, such as reducing its fixed deposit tenor mix towards the shorter tenor, while CIMB Bank said it had lowered its deposit campaign rates by 10 bps to 20 bps in May,” the research house said.

From a stock selection perspective, RHB Research’s top picks for the local banking sector are Malayan Banking Bhd (Maybank), Hong Leong Bank Bhd (HLB) and CIMB Group Holdings Bhd.

“We prefer the larger banks. Aside from better liquidity and slightly higher yields, smaller banks may post 2025 net profit declines of 2% to 5% y-o-y, on credit cost normalising versus 2% to 4% net profit growth for big-cap peers,” it reasoned.

RHB Research has a target price of RM8.40 per share for CIMB, RM10.90 for Maybank and RM24.30 on HLB.