Period  3Q14 / 9M14

Actual vs. Expectations 3Q14 net profit of RM192.4m brought 9M14 net profit to RM622.0m.

 This ran ahead of expectations, accounting for 92% and 89% of our estimate and street numbers, respectively, as allowance for loan impairment was significantly lower than in 3Q13.

Dividends  No dividend was declared since our last results note (last year: 5 sen).

Key Results Highlights YoY, 9M14 net profit advanced 34.1% due in part to an outstanding 60.0% growth in net interest income (NII) to RM188.0m. The other income segments did not fare as well with Islamic banking income (-1.1%) and non-interest income (NOII) (-19.3%) both recording declines. The result was a slight 4.4% increment in total income to RM1.1b.

 Growth at the net profit level accelerated on: (i) a decline in allowance for loan impairment to RM26.1m (-85.9%), and (ii) a lower effective tax rate of 26.4% (-5.4ppts). A higher cost-to-income (CI) ratio of 20.3% (+3.0ppts), however, capped potential growth.

 Gross loan-to-deposit (LD) ratio was up 2.3ppts to 113.7% with gross loans slipping by a smaller 0.3% compared to deposits’ -2.3%.

 Asset quality remains a concern but improved with gross impaired loans (GIL) ratio dropping to 7.4% (-1.0ppts). In line with this, annualised credit cost ratio was also lower at 0.32% (-1.1ppts). Meanwhile, loan loss coverage (LLC) ratio dropped to 66.3% (-26.7ppts).

 Annualised return on equity (ROE) came in 10.0ppts lower at 20.0%, given an enlarged share base.

 QoQ, 3Q14 net profit fell 17.4% partly on a decrease in NII (-25.4%) and NOII (-31.2%). On the upside, income from Islamic banking operations advanced by a strong 13.3%. As such, total income reported a small growth to RM368.4m (+1.1%).

 Nevertheless, 3Q14 net profit retraced given: (i) a higher CI ratio of 20.3% (+1.5ppts), and (ii) the incurrence of allowance for loan impairment of RM26.1m vs. a writeback in the previous quarter.

Outlook  The group is in a transitional phase as its core retail segment in personal loans (72.1% of total loans) and mortgages (15.4% of total loans) have been hit by a slew of tightening measures.

 Expect diversification into corporate business lending, which seems to be showing promising growth (1H14 disbursements: +15% YoY). As at end-Sept 2014, corporate loans stood at RM3.6b (10.9% of total loans).

 Asset quality is still a concern with GIL ratio remaining high end-Sept 2014. Management, however, appears committed to enhancing its asset quality especially in the personal financing segment. Hence, the GIL ratio may improve.

 Operations-aside, the Group is currently a party to the potential CIMB-RHBCAP-MBSB merger which could result in the creation of a mega Islamic bank. Given the progress so far, the merger appears forthcoming.

Change to Forecasts  Taking into account, inter alia, the writeback in 2Q14, the lower than expected allowance for loan impairment in 3Q14 and a lower effective tax rate, we revise upwards our FY14E and FY15E earnings by 13% and 5%, respectively.

Rating ACCEPT OFFER

Valuation  The proposed merger between CIMB-RHBCAP-MBSB has yielded a proposed offer price of RM2.82/share for MBSB. In light of this, we revise upwards our target price (TP) to RM2.82 (up from RM2.65).

 The TP implies a superior FY15 price-to-book (PB) value of 1.6x given our expectations of a declining trend in ROE.

 At current market price, total potential upside is a compelling 12.4%.

 Hence, we advocate investors to ACCEPT OFFER.

Risks  Potential tighter regulations by the central bank.

 Higher credit cost arising from weaker asset quality.

 Higher credit risk as the Group has started to grow its loan book via industrial hire purchase and property-related projects.

Source: Kenanga