1H16 core earnings of RM253m exceeded expectations, accounting for 61%/58% of our/consensus estimates. The positive variance was due to lower-than-expected credit costs. No dividends declared as expected as dividends are usually declared in the 2H. Despite performance exceeding expectations, we reduced TP due to slower loans growth going forward but maintained our Market perform call.

1H16 core net profit (CNP) improved tremendously by 49%, brought about mainly by lower loan loss provisions of RM0.6m vs. amount of RM136m in the previous corresponding period. Income improved marginally by 0.6% as loans growth fell below expectation despite NIMs improving. On a QoQ basis, despite falling loans, income improved by 11.6% with NIMs improving by 8bps.

6M16 vs 6M15, YoY

• Total income improved, brought about by improvements in both Net Interest Income (NII) and Net Islamic Banking Income at +6.0% and +5.0%, respectively (1H15: -1.2% and +2.6%) but dragged by fall from Non-Interest Income (N0II) at 8.4% (1H15: +23.2%).
• NIMs improved by 6bps to 1.73% (vs. our expectation of 9bps compression) despite cost of funds outpacing interest earnings yield by 13bps.
• CIR deteriorated by 3ppts to 62.0% (vs. industry CIR of 49.7%) as opex growth (+5.8%) outpaced total income growth.
• LDR surged by 8ppts to 93.1% (above the industry ratio of 87.5%) as loans (+2.7% vs. industry’s +5.6%) outpaced deposits (-6.5% vs. industry’s -0.5%) vs. our loans & deposit growth forecasts of +6.0% and +3.9%, respectively.
• Loans growth was driven mostly by housing loans and HP at +8.8% and +4%, respectively (Composition: 15% and 28% of total loans). Corporate loans which make up 32% of total loans fell 3.1%. The fall in deposits was across the board with CASA and term deposits falling by 6.6% and 8.3%, respectively. However, CASA was flat making 19.5% of total deposits.
• Asset quality improved with GIL ratio shedding 6bps to 1.98% (against the industry’s GIL ratio of 1.66%) and credit costs shedding 7bps to 0.0% or RM600k. We had anticipated a credit cost of 25bps. Loan loss coverage (LLC) was up by 1.4ppts to 65.2% (vs. industry coverage of 89.5%).
• At the bank level, CET1 fell by 10bps whilst CAR improved by 150bps to 12.1% and 14.9%, (after deducting proposed dividends) and still above the regulatory requirements of 7% and 10.5%, respectively.
• Annualised ROE was recorded at 6.0% (vs. our forecast of 4.9%).

2Q16 vs. 1Q16, QoQ

• On a quarter to quarter basis, CNP surged 18.8%, as NII (+7.7%), Islamic banking (+10.9%) and NOII at +18.6% improved, giving total income growth of 11.6%.
• NII improved bolstered by improvements in NIM by 8bps to 1.78% (1Q16: falling by 27bps).
• However, loans performance was disappointing, falling by 2.1% (1Q16: +0.8%) whilst deposits growth fell by 7.1% (1Q16: -1.0%) forcing LDR to increase by 5ppts to 93.1%. However, CASA improved by 180bps to 19.5%.
• Asset quality was seen holding as GIL ratio was flattish at 1.98%. There was a credit cost of 2bps vs 1Q16 credit recovery of 1bps.

Outlook. We had expected NIMs compression to be unavoidable due to intensive price competition, but this has not been the case for AFFIN. We believe this is due to management being comfortable with its LDR of ~93%; thus, not aggressively shoring up its deposits. Although management has managed to improve on its composition on its three main targets; mortgage (15%), HP (27%) and corporate (32%) loans from the year before (2Q15: 8%, 15% and 19%, respectively) we believe that the challenging environment still poses challenges for AFFIN despite the cut in OPR.

Earnings revised upwards. As earnings exceeded expectations, we change our forecast earnings and our assumptions for FY16/17E such as: (i) credit charge at 0.05% for FY16E/17E (from 0.25% previously as we are still cautious with the challenging environment, (ii) loans growth at +3%/+4% for FY16E/17E (from 6%/6.1%), (iii) deposits growth of -3.5%/2.1% (from 4%/4.1% previously) for FY16E/17E, (iv) NIMs improving by 5 bps for FY16 but compressed by 5bps for FY17E (as management will strive to shore up its deposits), and (v) CIR at 60%/57% % for FY16E/17E. Our forecast earnings are revised upwards by 2.5%/7.4% for FY16E/17E.

Target Price reduced but Rating maintained. We revised our TP downwards to RM2.15 (from RM2.23), based on blended FY17E 0.5x P/B and 8.7x FY17E PER (previously FY17E 0.5x P/B and 10.6x FY17E PER). The lower PE is justified as we expect slower loans growth in FY17. Risks to our call are: (i) higher-than-expected margin squeeze, (ii) higher-than-expected loans and deposits growth and, (iii) worse-than-expected deterioration in asset quality. We maintained our MARKET PERFORM rating as we feel that Group’s allowances for loan loss provisions (credit costs) will likely still be minimal going forward as the economy stabilized. Recall that AFFIN’s had credit recovery (instead of credit costs) since 2012 except for the slight blip in 2015 where there was a credit costs of 44bps.

Source: Kenanga Research - 22 Aug 2016