Period

1Q15

Actual vs. Expectations

1Q15 net profit of RM124.3m was below expectations, accounting for 17/20% of our estimate/street numbers as loan loss allowance remained elevated on continued high collective impairments.

Dividends

No dividend was declared, as expected.

Key Results Highlights

YoY, 1Q15 net profit fell 36.8% due in part to decrease in Islamic banking income (IBI) (-8.2%) and non-interest income (NOII) (- 2.4%), resulting in a lower total income of RM343.1m (-4.8%). Nevertheless, those declines were partially offset by the sustained growth in net interest income (NII) (+18.5%) despite net interest margin (NIM) having slipped 25bps to 3.6%.

A larger decline was reported at the bottom line (i) mainly due to the continued elevation in loan loss allowance (>100%) at RM101.3m bolstered by high collective impairments amounting to RM93.7m, but also (ii) due to the an incline in cost-income (CI) (+2.8ppts).

Coupled with the larger share base (on on-going shares issuances pursuant to the Group’s ESOS), earnings per share dropped by a higher 45.2% to RM4.59, while return on equity (ROE) tumbled 14.6ppts to 11.6%.

Meanwhile, gross loan-deposit (LD) stood higher at 120% (+9.8ppts) despite muted loans growth of 2.9%, as deposits declined 5.5%.

On the upside, asset quality slightly improved (gross impaired loans ratio (GIL): -82bps), while credit cost was much higher (+1.0ppts to 1.2%), thus pushing coverage up to a healthier 78% (+11.2ppts) (management’s target is 100%).

QoQ, 1Q15 net profit registered a more severe decline, plunging 68.4% despite a 26.8% increase in total income supported by strong growth in IBI (+46.9%). NII (-12.2%) and NOII (-31.2%), on the other hand, retraced.

The decline was caused by the recognition of a large RM366.1m in deferred tax asset (DTA) in 4Q14. Excluding the DTA, net profit would have advanced by >100%.

CI, however, improved 6.2ppts while NIM was flat.

Outlook

Given its aspiration to become an Islamic bank, the Group is in the process of converting its loans (and deposits) into Islamic offerings. Hence, NII contribution will continue to dwindle.

There appears also to be continued openness to corporate exercises, which could help it achieve said aspiration. Therefore, another merger and acquisition (M&A) could be possible. Media reported today that such M&A could involve KFH Malaysia.

With regards to its loan portfolio, the Group is in a transitional phase as its core retail segment in personal financing and mortgages have been hit by a slew of tightening measures.

Expect diversification into corporate business lending, which is targeted to make up 30% of the Group’s portfolio by 2020 (1Q15: 12.3%).

Impaired loans remain high but management appears committed to improving its asset quality and we are seeing progressive improvements coming through. GIL is now closer to the midsingle digit vs. the high single digit achieved a year ago.

Change to Forecasts

FY15/16E earnings slashed by 36/33% to accommodate the Group’s impairment programme which we understand will see two years of elevated credit cost. We have assumed 1.4/1.3% for FY15/16E (vs. FY14: 0.4%).

Rating

Downgrade to UNDERPERFORM (from MARKET PERFORM)

Given the magnitude of the impairments headed its way (c.RM62- 63m/quarter), downside potential is apparent.

Furthermore, additional downwards pressure could result if the Group embarks on capital raising activities (as expressed by management is the intention) involving equity.

Valuation

For now, target price reduced to RM1.78 (from RM2.40), based on a lower blended Price-Book (PB)/Price-Earnings (PE) ratio of 1.2x/6.5x (from 1.4x/7.0x previously), given the lower earnings expectations.

The PB ratio applied reflects the historical level achieved when the Group’s ROE traded between 8-11%, while the PE ratio is 0.5 standard deviation below its historical 3-year mean taking into consideration our expectation of slower (FY15E: +2.1% vs. FY14: +2.4%) and sub-par loans growth (vs. Industry FY15E: 7-8% & FY14: 8.7%).

Risks to Our Call

Capital raising activities which could dilute ROE.

Potential corporate exercises or M&As.

Slower-than-expected growth in household lending.

Higher credit cost arising from faster-than-expected deterioration in asset quality or lower disposable income.

Source: Kenanga Research - 8 May 2015