Earnings recovery entrenched. We believe there is another leg to the recent rally and the banks are among our preferred exposures for a reflation trade. We expect the sector to muster a 10-25% YoY EPS recovery in 2021-22E. The decline in credit cost, in general, is the key driver for EPS reversion in the next two years, but a working base case now is for core banking activity to resume alongside a further re-opening of the economy. 

Better macro to support lending. We estimate system-wide loan growth to rebound to 7.4% YoY in 2021E and accelerate further to 10.1% YoY in 2022E as demand recovers and current supply of credit remains at robust levels. As optimism abounds after positive progress in vaccine development abroad, Philippines is looking at a best case scenario of end-2Q21 vaccination rollout. As it is, mobility trends have improved and additional fiscal stimulus could catalyse a 6.5-7.5% GDP growth next year.

Monetary policy balancing act. BSP has shown a willingness to support any shortfall in potential economic recovery so far this year. We think there is room for a rate cut and another 200 bp RRR cut in 2021E. But potential scaling down of QE may raise concerns over MTM risk for banks on a rising bond yield environment. 

Reflation trade favors cyclicals. We believe there is still a 16-24% upside for select banks heading into 2021 despite the recent recovery of share prices following optimism towards the rollout of vaccinations next year. We pick banks with potential loan growth recovery, strong CASA franchise and positive NIM sensitivity, ample loan loss reserves, limited MTM risks, robust capital buffers, and relatively attractive valuations vis-à-vis earnings expectations. Based on the aforementioned criteria, which we used to score the banks under our coverage, our top picks in the space are BPI, SECB, and BDO. We downgrade PNB/MBT to NEUTRAL and UBP to UNDERPERFORM (from Neutral).