Period  2Q14/1H14

Actual vs. Expectations 2Q14 net profit of RM556.5m brought 1H14 net profit to RM1.0b.

 This met expectations; accounting for 47% and 50% of our full-year estimate and street numbers, respectively.

Dividends  No dividend was declared since our last results note (2Q13: 6.0 sen), as the group is seeking clarification on its capital requirements.

 However, a continued absence of dividend declaration in the next 3 months may warrant a revision downwards to our estimate of 27 sen (payout c.31.5%).

Key Results Highlights YoY, 1H14 net profit advanced 31.2% due in part to: (i) a decent increase in net interest income (NII) to

RM1.6b (+4.3%) on loan book expansion, and (ii) an excellent growth in Islamic banking income (+20.5%). Non-interest income (NOII), on the other hand, slipped 1.2%. The result was a 4.1% increment in total income to RM2.9b.

 Growth at the net profit level surged as: (i) loan impairment allowance fell to RM71.6m (-76.1%), and (ii) write-backs leapt to RM120.3m (1H13: 17.3m). Potential growth was capped, however, by a higher cost-to-income (CI) ratio of 54.4% (+1.9ppts).

 Gross loan-to-deposit (LD) ratio was up 2.6ppts to 88.6% (industry: 81.4%), as strong gross loans growth of 13% (industry: +9.3%) outpaced that of deposits’ 9.7% (industry: +6.5%). Main drivers of loans growth were the purchase of securities (+32%), purchase of residential properties (+21.1%), and working capital (+13.2%).

 Asset quality improved with gross impaired loans (GIL) ratio dropping to 2.45% (-70bps). Hence, annualised credit cost ratio was lower at 11.1bps (-27.8bps) and loan impairment coverage (LIC) ratio was better at 66.7% (+6.5ppts) (industry: 104.4%).

 Meanwhile, annualised return on equity (ROE) gained 1.7ppts to 11.5% in response to the commendable 1H14 net profit growth.

 QoQ, 2Q14 net profit also gained (+23.5%) despite a retracement in total income to RM1.4b (-1.6%). Growth in NII was a meagre 1.1% as NIM dipped 4bps to 2.29%, while NOII declined 12.8%. Islamic banking income, on the other hand, performed well (+20.8%) but only accounted for 12.7% of total income.

 Main contributors to 2Q14 net profit growth were: (i) a relatively large RM108.4m write-back in impairment losses on other assets (1Q14: RM11.9), and (ii) a lower effective tax rate of 24.3% (-4.5ppts). Nevertheless, a deterioration in CI ratio to 55.2% (-1.4ppts) limited potential growth.

Outlook  2014 targets are maintained, with ROE (>12% target vs. 11.5% in 1H14), loans growth (12% target vs. 13% at 1H14),

CASA growth (>15% target vs. 14.6% at 1H14) and GIL ratio (<2.5% target vs 2.45% at 1H14) on-track to meet targets.

 Nevertheless, CI ratio may fall short of its <50% target (1H14: 54.4%) given the group’s recent manpower expansion (+14% YoY). Our FY14 estimate implies a more conservative 52.6% CI ratio.

 International contribution could also miss its >12% target (1H14: 3.4%) and will likely register a mid-single digit growth.

 Meanwhile, NIM should continue trending downwards (after reprising of deposits) on stiffer competition for deposits ahead of a possible second overnight policy rate hike.

Change to Forecasts No change in our earnings estimates of RM2138.0m-RM2374.7m for FY14-FY15.

Rating Upgrade to OUTPERFORM from MARKET PERFORM on a higher target price (TP) due to a possible merger and acquisition (M&A).

Valuation  While we believe recent upswing in share prices could have reflected its immediate term potential, we do not rule out further run in share prices due to the rising investment sentiment on M&A play.

 As such, we increase our TP from RM8.75 to RM10.00. We arrive at our TP based on a blended FY15 PER of 11x and FY15 PBV of 1.3x. These price multiples are within its historical range for the past 2 years (PER: 10.7x-11.0x & PBV: 1.2x-1.3x).

Risks  A second increase in the overnight policy rate in 2014.

 Tighter lending rules and further margin squeeze.

 Tougher operating environment in treasury and capital markets.

 A stickier-than-expected CI ratio.

 The relatively low LIC ratio against industry average could be a threat to our credit cost assumption.

 Lower-than-expected merger synergies.

Source: Kenanga