Period  2Q13/1H13

Actual vs. Expectations  The reported 1H13 net profit of RM767.5m accounted for 41.3% and 39.3% of the consensus forecast of RM1,858.3 and our estimate of RMRM1,951.0m.

 Apart from higher operating expenses, the lowerthan-expected result was due to higher loan loss impairment in CIB & Business Banking.

 As a result, the annualised ROE came up to only 9.9%, below the management target of >13%.

Dividends  Similarly to 1H12, RHBCAP declared single-tier interim DPS of 6.0 sen.

Key Results Highlights   6M13 vs. 6M12  Total income grew 20.6% YoY driven by strong growth in non-interest (+43.2%) and Islamic banking (+24.2%) incomes. The jump in noninterest income was due to the acquisition of OSKIB while higher Islamic Banking income was mainly due to higher net funding income on the back of 22% financing growth YoY.

 As for net interest income, it grew 9.8% YoY driven by 12.8% YoY growth in gross loan, which was inline with management’s target of 12%. The growth was driven by household (purchase of securities +40.2% YoY, purchase of landed properties +13.4% & personal use +20.1%) and corporate loans (for working capital +19.3%).

 Customer deposit, on the other hand, grew 15.4%, also higher than management target of 10%. As a result, loan-to-deposit ratio (“LDR”) remains supportive for growth at 84.4% (vs. 86.0% in 1H12).

 Operating expenses jumped 39.6% YoY. We understand that the increase is mainly due to full-period impact of enlarged investment bank cost base and sales related headcount increase. Besides, higher sales commission and incentive compensation linked to wealth management businesses were also contributory factors. The cost-to-income ratio (“CIR”) increased from 45.3% in 1H12 to 52.4% in 1H13.

 Loan loss impairment also surged >200% YoY due to classification of one large corporate account of RM409m (to impaired loans). Hence, annualised credit charge ratio spiked from 15bps in 1H12 to 52bps. However, gross impaired loan ratio remains relatively unchanged at 3.2%. Nonetheless, its loan loss coverage ratio remains relatively low at 60.2% (vs. 69.4% in 1H12) as compared to industry average of 101%.

 The Group has adopted BNM Basel III capital adequacy requirements which came into effect on 1 January 2013. The Tier 1 and Total Capital ratios stood at 12.6% and 14.8% as of end-June13 (vs. 12.5% and 16.1% as of end-June12). We understand that total capital ratio was lower mainly due to application of transitional arrangement with the 10% phased-out of sub-debts and Hybrid Tier-1 and increase in business volume.

 All told, the annualised ROE at 9.9% was below the management target of >13%.

2Q13 vs. 1Q13  Net profit grew 14.9% QoQ due to decent growth in total income (+5.1%) and lower loan loss impairment (-6.7% QoQ).

 Loan grew 3.3% QoQ while NIM remained stable at 2.33%, hence net interest income grew 3.1% QoQ.

 Non-interest income grew 7.9% QoQ due mainly to higher fee income and MTM gains on derivatives.

 Despite a 4.1% growth in operating expenses, CIR has improved slightly to 52.2% in 2Q13 vs. 52.7% in 1Q13.

 Higher impairment write-backs reduced loan loss impairment by 6.7% QoQ with an improved annualised credit charge ratio of 0.50% (vs. 0.55% in 1Q13).

 Effective taxation also was lower at 24.3% in 2Q13 vs. 26.4% in 1Q13.

Outlook  While the Group saw revenue synergies of RM69m realised post-completion, which is ahead of the original Year 1 target of RM56m, derived from Investment Banking and Asset Management, the Group has yet to see the anticipated cost synergy (especially funding cost). However, the management is still hopeful to see higher synergies from the acquisition of OSKIB.

 As the 1H13’s financial performance has fallen short of targets, the management has revised down its ROE target to 12% from 13% previously.

Change to Forecasts  Due to higher-than-expected loan loss impairment, we have revised down (5.4%) our FY13 net profit estimate from RM1,951.0m to RM1,845.6m (+3.4%).

 However, the anticipated merger synergies could be delayed to FY14 and based on the fact that loan loss impairment could be normalised in FY14, we have revised up (3.4%) our FY14 net profit estimate to RM2,138.0 from RM2,068.4m.

 Based on our latest earnings and DPS (FY13: 23 sen, FY14: 27 sen) estimates, we anticipate RHBCAP’s ROE to register at 11.7% and 12.5% in FY13 and Fy14, respectively.

Valuation  We have decided to lower our Target Price (“TP”) to RM8.75 (from RM9.20 previously).

 This is because we believe the stock’s valuations will be under pressure, owing to 2 consecutive quarters of disappointing results, while awaiting a pick up in earnings momentum.

 Our new targeted price multiples are based on the 1.2x and 10.2x FY14 PBV and PER, respectively.

 These valuations represent the trough valuation of RHBCAP for the last 3 years.

Rating   Upgrade to OUTPERFORM

 Despite our earnings and TP revisions, we have upgraded our stock call to OUTPERFORM as it offers 17% upside from here after the recent sharp price corrections.

Risks  Tighter lending rules and further margin squeeze in general.

 Tougher operating environment especially in investment banking and treasury market.

 Further deterioration in asset quality especially the RHBCAP’s loan loss coverage ratio which is below industry average.

Source: Kenanga