What’s New

• 4Q/FY16 earnings disappointed on higher-thanexpected provisions; gross impaired loans ratio shot up to 2.37% in FY16
• Loan growth dimmed by deliberate contraction in loans for securities and mortgages
• Slashed earnings by 9-13% for FY17-19F to reflect weaker asset quality position
• Downgrade to HOLD with lower RM4.90 TP; valuations expected to be saddled by asset quality concerns

Asset quality woes

Double trouble from steel and oil & gas exposure; Downgrade to HOLD. RHB Bank (RHB) successfully delivered on improvements in cost efficiency in FY16 but this was more than offset by a significant increase in credit cost. Loan loss coverage ratio of 57% (75% including regulatory reserves), the lowest among peers, implies there is little room for earnings protection, in the event of further asset quality upsets. FY17 appears to be another challenging year for RHB. Apart from lingering asset quality issues, net interest margin (NIM) is expected to be under pressure. Earnings growth in FY17-18F is largely due to normalisation of credit costs, which is expected to be lower than FY16, but higher compared to trends in the previous five years.

Disappointing 4Q/FY16 earnings due to hefty provisions, caused by higher impaired loans from its steel, and oil and gas exposure. Pre-provision profit was in line with our expectations. Net interest income was stable despite sluggish loan growth, thanks to high NIM in 4Q16. Loan growth was driven by mortgage and SME loans, while deposit growth was underpinned by CASA. Non-interest income was negatively impacted by the volatility in the forex as well as capital and financial markets. Positively, RHB delivered well on its cost efficiency, as seen in the 15% decline in expenses. Cost-to- income ratio hit 50%, the lowest in five years. RHB declared a final DPS of 7sen, bringing full year DPS to 12sen (29% payout).

Cut earnings by 9-13% on higher charge-off rate assumption. To better reflect RHB’s current asset quality standing, we raised gross impaired loans ratio (from 2.2%/2.1% to 2.4%/2.3% for FY17-18F) and charge-off rate assumption (from 35/27bps to 37/35bps). We remain watchful on its exposure to vulnerable sectors such as oil and gas (3.6% of total loans) as well as steel (1.2% of total loans).

Valuation:

Downgrade to HOLD; TP lowered to RM4.90. After accounting for the earnings adjustments, our TP, which is based on Gordon Growth model, drops to RM4.90. Our TP assumes 10% ROE, 11% cost of equity and 4% growth and implies 0.8x BV. Although RHB has successfully delivered on improvements in cost efficiency, lingering asset quality issues and NIM contraction pose as risks to earnings.

Key Risks to Our View:

Better-than-expected traction in asset quality is an upside risk to our earnings. RHB had booked high provisions in FY16. We still expect credit costs to stay relatively high in FY17-18F.

Source: Alliance Research - 27 Feb 2017