Period  3Q14/9M14

Actual vs. Expectations CIMB’s 9M14 core earnings of RM2,907m (-8% YoY) missed expectations, representing only 67%-68% of our and consensus’ full-year forecasts.

 The underperformance was mainly due to weak contribution from its Islamic banking operations, tepid non-interest income and higher loan loss provision

Dividends  As expected, no dividends were declared.

Key Results Highlights

9M14 vs. 9M13, YoY

 The weak showing came on the back of: (i) sluggish growth from its Islamic banking unit (-5%), (ii) lower non-interest income as capital market activities remained lethargic (-11%), along with (iii) higher loan loss provision for its coal & coal-related loan portfolio in Indonesia (+71%).

 Pressure on net interest margin (NIM) was well contained at 2.83%, thanks to better price management in Thailand and Singapore.

 Loans grew at a faster pace vs. deposits at 9% vs. 1%, lifting loan-to-deposit ratio (LDR) by 8ppts to 95%. So far, loans growth is below our and management expectations of 13%-14%.

 The slower-than-expected loans growth is primarily due to: (i) lumpy repayment from Malaysia corporate customers (-16%) and (ii) weak consumer loan take-up (+2%) in Indonesia, especially from the mortgage (-2%) and auto segments (-3%).

 Similarly, deposit-taking activities were tepid in Malaysia (+5%) and Indonesia (+2%). Following suit, overall current account & savings account (CASA) grew only by a mere 2%. It now makes up 35% of total deposit base (+50bpts).

 Effective cost discipline resulted in a fall in cost-toincome ratio (CIR) to 58% (-3ppts). However, if we were to exclude the one-off restructuring expense for RBS amounting to RM200m last year, CIR would have only declined by 1ppts.

 Ebbing asset quality. Although gross impaired loans and gross loan loss provision dipped by 11bpts and 36bpts respectively, overall credit charge ratio rose 12bpts on deteriorating asset quality in Indonesia and Thailand. Worryingly, loan loss coverage (LLC) is at an all-time low of 74% (-8ppts).

 Annualised ROE dropped 2ppts to 12%, coming below our and management expectations of 13%-14%.

 CET1, Tier 1 and total capital ratios improved 1%-2% to 9%, 11% and 14%, respectively.

3Q14 vs. 2Q14, QoQ

 Quarterly earnings contracted 6% given higher loan loss provision as explained above (+134%). On a positive note, non-interest income improved 13% from better treasury market and investment performance.

 NIM fell marginally (-5bpts).

 LDR spiked up to 95% as loans grew 4% while deposits declined 2%.

 CIR scaled back 1ppts to 8% given strict cost controls and higher income base.

 Similarly, asset quality indicators were discouraging. Gross impaired loan and credit charge ratio ticked up 16bpts and 32bpts, while LLC declined 5ppts.

Outlook  Domestically in Malaysia, loans growth is expected to taper on the back of slower private consumption given rising inflationary environment, spurred by subsidy rationalisation efforts by the Government and impending GST implementation next year. In turn, higher cost of living coupled with the rise in cost of borrowing (as a result of the 25bpts hike in OPR on 10 July) is likely to exert pressure on asset quality.

 Over the short-term, we expect operational headwinds in Indonesia to persist. Although the recent move by Otoritas Jasa Keuangan (OJK) to cap interest rates on deposits can help mitigate the risk of higher cost of funds (COF), NIM pressure is likely to stay. This is because: (i) lower lending rates should follow, in tandem with the fall in COF and (ii) the shift in management focus to accrue higher credit quality loan customers will in turn generate lower yields. In view of CIMB Niaga’s high LDR of 100% along with more selective and prudent credit practices, we expect loans growth to taper. As for asset quality, it is poised to deteriorate further on the back of rising inflation given President Jokowi’s move to raise fuel prices two days ago. Furthermore, management has guided for further loan loss provisioning for its coal & coal-related loan portfolio in 4Q14. This segment now accounts for ~4% of its total loan book from ~9% two years ago.

 In Thailand, the economy remained on a weak recovery path given modest consumption, investment and exports growth, which consequently weighed down 3Q14 GDP numbers. However, it should gain traction moving forward given that, last month, Junta leader and Prime Minister Prayuth Chan-ocha has already introduced fiscal stimulus package worth THB365bn to jumpstart the sluggish economy – this is targeted towards public investment, job creation and cash handouts to rice and rubber farmers. Thus, we expect CIMB Thai to perform better sequentially.

 While in Singapore, the trade-dependent country should continue to benefit from the uplift in the US economy, although domestic growth is currently capped by labour and land limitation. Accordingly, we expect its growth momentum to persist, as Singapore’s economic condition remains status quo.

 We expect activities in the debt and equity capital markets to pick up, as it appears to have bottom-out in 3Q14. CIMB is set to capitalise on this given its strong investment banking franchise.

 Overall NIM should come under pressure from higher COF given the pressing need to replenish its deposit book. We observed that 82% of its fixed deposits and negotiable instruments of deposit are due to mature within the next six months. This makes up 36% of the Group’s total customer deposit base. Furthermore, 3Q14 LDR is at a high of 95%.

 Despite the weak performance, management did not alter its FY14 KPI targets: (i) ROE at 13.5%-14% (9M14: 12%), (ii) 40% dividend payout (9M14: 40%), (iii) total loan growth of 14% (9M14: +9%), and (iv) loan loss charge of 35-40btps (9M14: 33bpts).

 Nothing new was shared on the proposed merger with RHBCAP and MBSB.

Change to Forecasts

 To reflect the weak set of results, we cut our FY14/FY15 core earnings estimates by 7%/10% to RM3,946m/RM4,211m from RM4,258m/RM4,656m. Essentially, we toned down our FY14/FY15 growth assumptions on all fronts; (i) net interest income by 3%/6%, (ii) Islamic banking income by 10%/17%, (iii) non-interest income by 10%/5%, (iv) loans by 2%/4%, while loan loss provision, however, was bumped up by 15%/17%.

 In turn, FY14/FY15 ROE is estimated at 11%-12% from 12%-13% previously.

 For dividend, we forecast CIMB to declare DPS of 20 sen-21 sen instead of 21 sen-22 sen previously estimated – this is in tandem with the downward revision in its core earnings.

Rating Maintain OUTPERFORM

 Given the disappointing set of results, we expect CIMB’s share price to pull back on a knee-jerk reaction. We opine that this represents an opportunity to accumulate the stock on further weakness.

 To note, (i) it is currently trading at -2SD below its 5-year mean of 2.0x Fwd P/B, (ii) CIMB’s foreign shareholding is near its 8-year low (at 34.4% on Sept-14) and our 9-year regression analysis on foreign shareholding vs. Fwd P/B suggests that CIMB should trade at 1.6x Fwd P/B, and (iii) its share price had already plunged 12% relative to FBMKLCI since the beginning of Oct-14.

Valuation  Our TP is reduced to RM6.83 from RM7.15 based on 1.46x FY15 P/B (previously pegged to 1.6x FY15 P/B). The lower P/B multiple is to reflect slower growth and lower ROE generation moving forward. This is based on Gordon Growth Model (GGM), where we utilised: (i) COE of 8.9%, (ii) FY15 ROE of 11.7%, and (iii) terminal growth rate of 3%.

 Recall, the stock traded at 2.0x P/B for the past two years when it generated ROE of more than 15%.

 The implied GGM FY15 P/B of 1.46x is also in-line with our 2-year regression analysis on ROE vs. P/B, suggesting that CIMB should trade at 1.48x P/B.

Risks to Our Call  Further margin squeeze from tighter lending rules and stronger-than-expected competition.

 Slower-than-expected loan growth and deterioration in asset quality.

 Rising credit charge as result of an up-cycle in non-performing loan (NPL).

 Slowdown in capital market activities.

 Unfavourable regulatory changes.

 Adverse currency fluctuations.

Source: Kenanga