1QFY20 results missed forecasts, as CIMB now expects the >100bps credit cost in 1Q to be sustained for the rest of the year (vs. our earlier expectation of just in 1HFY20). We cut FY20-21E CNP by 23-15% and downgrade our call to UNDERPERFORM from MARKET PERFORM. In our view, CIMB has less headroom to support earnings and capital ahead, which means capital levels could be exposed to sharp erosion risk if macro conditions pan out worse than expected.

1QFY20 CNP slumped to RM508m (-57% YoY/-51% QoQ), as loan impairments jumped 252% YoY/47% QoQ to RM968m, resulting in credit cost of 106bps (1QFY19: 34bps; 4QFY19: 66bps) The results were below expectations, making up just 15%/10% of our/consensus FY20E CNP. Although CIMB had earlier flagged that there would be lumpy provisions made in 1Q (RM430m) and 2Q (c. RM550m) relating to two oil and gas traders, it now guides that the charge-off run rate is expected to continue into 2HFY20 due to asset quality weakness in Singapore, Indonesia and domestic. Non-Interest Income was also trailing estimates due to softer fee and treasury income.

Other highlights. Loans expanded 4% YoY (-2% QoQ) with domestic growing by a slightly stronger clip. NIM slipped 9bps QoQ (-2bps YoY) reflecting OPR cut in Malaysia (MY) and continued pressure in Indonesia (ID) from policy rate cuts last year. Non-interest income dropped 22% YoY (-28% QoQ) with fees down (-5% YoY/-15% QoQ) on lower loan-related fees and a drop in treasury contribution (-62% YoY/-60% QOQ). Deposit growth was 5% YoY (-1% QoQ), broadly in line with loan growth. Gross impaired loans (GIL) rose 19% YoY (+10% QoQ) led by ID, Singapore (SG) and MY. Loan loss coverage (LLC), including regulatory reserves, eased to 75.9% (4QFY19: 99.6%; 1QFY19: 103.5%) as CIMB transferred its entire regulatory reserves (RM2.1b) to retained earnings, possibly to shore up CET-1 ratio to face the weaker environment ahead. This transfer added 35bps to CET-1 ratio of 12.5%, after netting off a capital charge relating to shortfall in provisions over expected losses. Finally, fair value reserves in shareholders’ equity for financial assets were -RM624m, i.e. revaluation losses.

Key takeaways from conference call: CIMB now guides for credit cost of 100-120bps in FY20, with credit cost staying elevated in FY21 (GFC: 70- 75bps). Asset quality in SG is under significant pressure while CIMB expects delinquencies to increase post moratorium in MY and ID. However, as MFRS 9 is forward-looking and based on expected losses, banks can start booking in provisions ahead of the rise in GIL. Guidance on NIM squeeze was raised to 10-15bps from 5-10bps with one more policy rate cut expected in MY and ID. CIMB did not provide any details regarding modification losses (our estimate is RM360m) but pointed out that its portfolio is smaller than peers. CIMB is comfortable that it would be able to sustain a CET-1 level >12% but that could change if the deterioration in asset quality was worse than expected. Dividend payout of 40-60% to be kept, as CIMB reverts to a full DRP option.

FY20E/FY21E net profit cut by 23%/15%, mainly as we raised our credit cost forecast to 109bps/99bps from 79bps/62bps, respectively. We now expect a 41% YoY drop in FY20E CNP mainly from higher loan allowances, but as credit cost eases, we forecast a 27% YoY rebound in FY21. Correspondingly, FY20E/FY21E ROE revised to 4.9%/5.9%. DPS lowered by 3.5-5 sen to 13.5sen/16.5 sen for FY20/FY21, based on 50% payout ratio.

TP cut to RM3.05 from RM3.65, following CNP revisions. Our TP is based on a GGM-derived FY20E PBV of 0.54x. With c.12% potential downside, we reduced our rating to UNDERPERFORM from MARKET PERFORM.

Potential de-rating catalysts include: (i) earnings downgrades, (ii) lack of headroom to support earnings and capital, e.g. zero regulatory reserves and revaluation losses on financial assets, (iii) capital being drained resulting in lower levels vs large-cap peers; and (iv) higher asset quality risks from overseas book.

Source: Kenanga Research - 27 May 2020