The proposed CIMB-RHBCAP-MBSB merger and acquisition (M&A) has been officially scrapped. Consequently, MBSB’s share price has plummeted. In terms of fundamentals, the Group’s full year FY14 earnings were bolstered by a one-off recognition of RM366.1m in deferred tax assets. On exclusion, full year earnings would have only narrowly met our expectation, coming in at 96% of our forecast. Premised on this and our expectation of slower loans growth and lower yield, we are downgrading MBSB to MARKET PERFORM.

Proposed mega-Islamic bank scrapped. We were caught by surprised that the proposed merger of CIMB Islamic, RHB Islamic and MBSB was also called off, given that the proposed creation of the mega-Islamic bank was independent of the CIMB-RHBCAP merger and acquisition. However, we do not rule out that this could be due in part to the differences in MBSB’s provisioning standards, which arose in the course of the due diligence process. Nevertheless, we are encouraged by MBSB initiative in bringing forward its adoption of industry’s standards to FY14.

Brief Recap. Unlike for RHBCAP, and to some extent CIMB, the proposed M&A was positive news for MBSB given that the value attached to the shares of MBSB was even higher than our then OUTPERFORM TP of RM2.65 (fwd PB ratio: 1.5x). Furthermore, the structure was such that MSBS’s shareholders could elect to receive cash or shares in the unlisted enlarged Islamic banking entity. Given the favourable scenario, we advised investors to accept offer at RM2.82 (fwd PB ratio: 1.6x) should the merger go through back then. The market seemed agreed with the afore-mentioned view. MBSB’s share price rose from its initial price of RM2.37 (fwd PB ratio: 1.3x) on 8 Oct 2014 to an all-time high of RM2.66 (fwd PB ratio: 1.5x) (+12%) on 13 Oct 2014. The dismissal by Bursa of the appeal to allow EPF to vote, however, saw the Group’s share price falling from RM2.51 (fwd PB ratio: 1.4x) prior to the announcement on 10 Dec 2014 to RM2.16 as of yesterday (fwd PB ratio: 1.2x) (-14%).

FY14 earnings narrowly met our expectation at 96%. In terms of fundamentals, the Group’s recent FY14 results ran way ahead of expectations, accounting for 150/142% of our estimate/street numbers, owing to a one-off recognition of RM366.1m in deferred tax assets (DTA). If this item is excluded, we estimate that core net profit would have narrowly met our expectation at 96%.

Key results highlight. YoY, FY14 net profit advanced 69.9% to RM1.0b due in part to an outstanding 149.8% growth in net interest income (NII) to RM244.5m. The other income segments did not fare as well with Islamic banking income (IBI) (-18.8%) and non-interest income (NOII) (-34.7%) both recording declines. The net result was a 9.3% fall in total income to RM1.0b. The decline was reversed at the net profit level on: (i) lower loan loss provision to RM126.2m (-54.2%), and (ii) the recognition of DTA amounting to a large RM366.1m. A higher cost-to-income (CI) ratio of 30.7% (+5.7ppts), however, capped growth. If the DTA were to be excluded, estimated core net profit would have been much lower at RM649.0m, representing 8.6% advancement. Gross loan-to-deposit (LD) ratio was up 5.5ppts to 118.7% with gross loans growth gaining 2.4% while deposits slipped 2.3%. Asset quality deteriorated with gross impaired loans (GIL) ratio increasing to 6.6% (+1.4ppts). Nevertheless, credit cost ratio was lower 39bpts (-47bpts) on a lumpy RM15.6m write-back in 2Q14. Consequently, loan loss coverage (LLC) ratio plunged to 67% (-31.2ppts).Meanwhile, return on equity (ROE) came in 4.9ppts lower at 22.7%, given an enlarged share base. QoQ, 4Q14 net profit doubled (+104.3%) to RM393.1m partly on an increase in NOII (-42.2%) to RM26.8m. On the downside, NII (-9.5%) and IBI (34.8%) both reported declines. As such, total income plunged to RM270.5m (-26.6%). Nevertheless, the decline was more than offset at the net profit level given that the large DTA was recognised during the quarter (vs. tax of RM114.8m in 4Q13). Growth in net profit, however, was capped by: (i) a higher CI ratio of 30.7% (+5.7ppts), (ii) sticky operating expenses (+11.0%), and (iii) higher loan loss provision (+>100%). On exclusion of the DTA, estimated core net profit could have been 86.0% lower to RM27.0m.

FY15 forecast trimmed by 7%. Judging from the reported numbers, recent industry statistics as well as our expectation of a slower growth in economy, we have adjusted FY15 earnings downwards by 7%. Essentially, we have reduced our gross loans growth assumption to 2-2.5% and yield assumption for Islamic banking activities by 70bpts on expectation of weaker loans demand and more selective lending activities.

Downgrade to MARKET PERFORM. In line with our lower revised numbers and in expectation of a moderation in loans growth and yields, we are downgrading MBSB to MARKET PERFORM. We cut our target price (TP) to RM2.40 (from RM2.65), based on blended Price-Book (PB)/Price-Earnings (PE) ratio of 1.4/7x. The PB ratio applied is 1SD below the group’s 3-year mean in anticipation of a lower ROE of 14-15% for FY15 vis-à-vis its 3-year range of 30%-33%. The P/E ratio, on the other hand, represents the group’s historical average P/E ratio up to end-2014.

Source: Kenanga