The high modification loss was a surprise but top-line performed better than expected on account of treasury gains and elevated net profit margin. Its fixed rate portfolio should cushion its margins from further potential rate cuts with its book value likely to improve on further revaluation gains. Undemanding, upgrade to OUTPERFORM with a higher TP of RM0.70

Losses due to modification. 1HFY20 core net losses (CNL) of RM85m were below expectation due to the high unexpected modification loss of RM513m recorded in 2Q. Stripping of the modification loss, CNP would have been at RM427m on account of write-backs, higher treasury income and better-than-expected net profit margin (NPM). No dividend declared as expected as its dividends are declared only in Q4.

Better top-line. Top-line was better at RM892m driven by its Islamic Operations (+17%) to RM645m and Other Income (+123%) to RM162m - the surge coming from gain in sale of Financial Instruments (at RM136m) mostly in 2Q. Islamic Income and Conventional Income improved due to the better-than-expected NPM as cost of funds fell (on OPR cut, reduction in deposits and Sukuk) in contrast with its fixed portfolio assets which remained sticky. However, loans as expected fell 2% led by PF. Impairment allowances (credit charge of 134bps - within guidance) saw a slight dip of 3% to RM238m due to write-backs of RM54m in 2Q (as collection improved). Gross Impaired Loans (GIL) saw a 50bps uptick to 6.1% attributed to delinquency of some its Corporate Financing accounts which management indicated that these impaired accounts will be regularised by year-end. Note that RM1b of its impaired loans are conventional which management expects to dispose in 2021.

The high modification loss was a surprise but not unexpected given that 92% of the loss came from PF (or 92% coming from fixed rate loans). Management guided for a potential additional RM30m-RM50m losses given the moratorium will be extended for selected accounts. The large exposure to fixed rate financing/loans (52%) cushioned the impact of the OPR cut and coupled with sale of some of its sukuk, NPM is likely to remain >3% for the rest of the year. We expect to see better NOII (from previous estimation) for FY20 given further sale/gains of its investment securities in the coming quarters.

Post result, we slashed our FY20E earnings by 59% to RM128m on account of the modification loss mitigated by higher NPM (>+3%) and a lower credit charge (at 125bps). However, FY21E earnings is revised on account of stable NPM and still elevated credit charge (c.115bps).

TP and call revised. Our TP raised to RM0.70 (from RM0.60) based on a GGM-derived FY21E PBV of 0.57 (from 0.46x). While the huge modification loss is a dampener, we expect earnings ahead to be supported by elevated NPM, lower credit charge plus potential revaluation gains from its equity reserves which should boost its book value – mitigating the impact of its modification losses. Furthermore, its fixed rate portfolio should cushion the impact of further OPR cuts. Trading at an undemanding 0.4x, we revised our call to OUTPERFORM.

Risks to our call include: (i) higher-than-expected margin squeeze, (ii) lower-than-expected loans & deposits, (iii) worse-than-expected deterioration in asset quality, and (iv) higher than expected modification losses

Source: Kenanga Research - 27 Aug 2020