INVESTMENT HIGHLIGHTS

• Management held a briefing yesterday and addressed the issue of higher OPEX and credit cost.

• Higher OPEX not only due to VSS but also cost of doing business of its asset management.

• OPEX and credit cost will normalise in FY18.

• Loans growth expected to reach target.

• Adjusting our FY17 and FY18 forecast by -14.3% and - 10.6% downwards respectively.

• Maintain BUY with adjusted TP of RM2.90 (from RM3.30) based on PBV of 0.6x.

Earnings expected to recover. We dialled in to an analyst briefing yesterday for an update in regards to its 3QFY17 earnings. Our main concerns following from the Group’s result release were the high OPEX and elevated credit cost. This was partly addressed by the management. Other key take away are:

• OPEX surge was driven by one-time cost and necessary for its transformation.

• Certain costs were result of increased business.

• Credit cost will normalise in coming quarters.

• Loans growth expected to accelerate.

• Reorganization will ensure Group is stronger.

One time cost led to OPEX increase. As part of its transformation initiatives, the Group embarked on a voluntary separation scheme (VSS) in 3QFY17. This had resulted in a one-time cost of RM48m, affecting approx. 330 staff. The intended effect is not purely to reduce headcount as some of these staff will be replaced. We understand that it is also to reduce the salary base of certain job function. However, the management indicated that it is also expecting to add 350 more personnel to execute its transformation initiatives. Management expect that the positive impact of the VSS will likely come in around a period of 2.5 years via cost savings. In addition, the management noted that the mix of support to front end staff had moved to 50:50 from 65:35 since the start of its Affinity program. We believe that the cost incurred due to personnel is currently necessary to ensure that it is operating efficiently. We like the fact that percentage of front end personnel to total staff had increase as this has a direct impact to income growth.

Other cause for rise in OPEX was from increased business. Besides the VSS, the other cause for the higher OPEX was from increased commission paid by Affin Hwang Asset Management as highlighted by the rise in promotion and marketing related expenses. These expenses rose +81.8%yoy to RM200.5m. However, we understand that it was due to increase in securities trading volume and asset under management. Consequently, Investment Banking profit before tax after zakat grew +53.1%yoy to RM139.2m.

Credit cost and impaired loans will normalise towards end of FY17. Management expects that credit cost will normalise towards end FY17 as it expects several of its large R&R accounts, with majority in the property sector, to be reclassified as performing. This is due to the fact that these loan accounts were rescheduled or restructured during 1HFY17. Recall, credit cost came in +12bps yoy higher to 0.23% in 9MFY17. Similarly, GIL ratio was 2.16% as at 3QFY17 vs. 2.08% as at 3QFY16. Without these R&R accounts GIL ratio would have been 1.46%. To put into context, out of RM976.7m of impaired loans, RM318.7m was from R&R accounts. However, we understand that 100% of the loans are secured. We believe that the reclassification of these accounts will provide a boost to earnings in FY19, given the potential write backs.

Loans growth expected to reach target. We understand that the management is confident that it will be able to reach a loans growth target of 4-5% for FY17. The management foresees loan growth momentum accelerate in 4QFY17 from several disbursements of corporate accounts, and from consume and SME segments. The focus will be on growing good yielding asset as per its Affinity Transformation Programme. Amongst the completed transformation initiatives that we believe will drive its business are; (1) the new relationship management model that is expected to improve cross-selling activities, (2) product profitability methodology which will improve costing of products and improve yield, and (3) new credit management model which will improve lag time for credit decisions.

Significant benefit from reorganization. The reorganization of its group structure where Affin Bank Berhad will take over the listing status of Affin Holdings Bhd is expected to be completed by 1QFY18. Amongst the benefits are the reduction in cost, better capital adequacy and better implementation of Affinity program through its other subsidiaries. We understand that Investment Banking is expected to further transform and benefit from the reorganization. We also believe that shareholders will gain via participating at the bank level, benefitting directly from the result of the transformation program.

Getting ready for MFRS 9. The management expect only marginal impact to capital due to MFRS 9. The impact is expected to be no more than 50bps reduction. Discussions are still being held on the utilising regulatory buffer as additional buffer.

FORECAST

Taking into account the higher OPEX, credit cost and potential impact from MFRS 9, we are adjusting our FY17 and FY18 forecasts downward by -14.3% and -10.6% respectively.

VALUATION AND RECOMMENDATION

We opine that any increase in expenses is temporary and will eventually normalise once the Group's transformation is completed. We also expect that income will continue to grow and its growth will overtake the pace of increase in OPEX. We believe that the transformation will leave the Group on a better footing. We also maintain our view that the Group is building its niche and believe that this will ensure future profitability. Taking everything into consideration, we are maintain our BUY call for the stock, with an adjusted TP of TM2.90 (from RM3.30) based on pegging our FY18 BVPS forecast to PBV of 0.6x.

Source: MIDF Research - 5 Dec 2017