- We upgrade our rating on Alliance Financial Group Bhd (AFG) to BUY from HOLD, with a lower fair value of RM4.30/share (from RM5.00/share previously). This is based on a revised ROE of 11.8% (from 12.8%) for FY16F, leading to a lower fair P/BV of 1.4x (previously 1.6x).

- AFG’s 1QFY16 net earnings, if annualised, trailed our forecast by 17.4%, and consensus estimates’ RM565.9mil by 13.8%. The shortfall compared to our forecast is due mainly to the non-interest income line.

- However, NIM surprisingly improved by 1bps QoQ to 2.16% in 1QFY16, from a normalised level of 2.15% in 4QFY15. This is in contrast to the expectations of ongoing QoQ compression in NIM, in line with that of the banking industry. This is also ahead of the company’s targeted NIM compression of about 10bps YoY for FY16F to mainly account for on-going deposit pressure.

- The NIM improvement was due mainly to concerted repricing effort for both its asset and liabilities portfolios. This indicates strong execution of its new strategy to boost profitability and asset efficiency as measured by risk-adjusted returns, in our view.

- AFG’s share price has softened, in line with other banking stocks, which we believe is reflective of concerns over the industry’s credit cost trends. Generally, the larger players in the industry have hinted at a higher normalised credit cost of 40bps next year, rising from a normalised level of 30bps this year. We have conservatively changed our credit cost assumption to 40bps (from 19bps previously) for AFG, which is in line with the industry’s.

- Going by historical trend, AFG’s credit costs peaked at 62bps in FY09, during the external economic slowdown. Barring further major negative feedback loop in macroeconomic trends, we believe the company expects its credit costs to likely normalise at 30bps, assuming that industry credit costs normalise and rise to 40bps in FY16F. The company had earlier targeted a normalised credit costs range of 20bps to 25bps for FY16F. Thus, we believe our 40bps forecast is reasonable, assuming no major negative feedback loop impacts the bank’s earnings ahead.

- At the current share price level, we believe the riskreward trade-off for AFG looks attractive, as AFG is currently trading at an attractive valuation of only 1.2x. We are therefore upgrading our rating to BUY.

Source: AmeSecurities Research - 19 Aug 2015