Post meeting with management, we think BIMB’s outlook could be more complex  than our  previous cost  and deposit-taking  assumptions. Thus, we  trim  our  earnings  forecast  and  SOP-based  to  MYR4.70  (from MYR5.05)  –  a  10%  upside,  and  downgrade  our  call  to  NEUTRAL.  We think  the  prolonged  regulatory  changes  in  the  market  may  offset  the new IA revenue stream revealed in last Friday’s 2015 Budget.

Management meeting. We met BIMB recently with a group of investorsand understood  from management that the  Islamic banking  environment is facing rising deposit costs, challenges in deposit-taking and regulatory uncertainties  over  capital  requirements.  Upcoming  hurdles  from  the implementation of the Islamic Financial Services Act (IFSA) by July 2015could complicate the bank’s ability to retain depositors, as customers can choose to  take up investment/equity risks  via investment accounts (IA).IAs  may  complicate  its  Bank  Islam  (BI)  subsidiary’s  recognition  of financing-to-deposit ratios. There are also no updates  yet on off-balance sheet accounting. We think these uncertainties offset the prospects of IA, which was  unveiled  in  the  2015  Budget  speech,  as the exact method of implantation and customer reception  is  unclear. See Page 2 for our view on the budget’s impact to the Islamic banks. 

Forecast  changes.  Accordingly,  we  revise  our  FY14F/FY15F  EPS downwards  by  2%/4%  respectively.  Our  main  adjustment  is  on  net interest  margin  (NIM)  projection  to  2.6%  from  2.7%.  We  previously factored  in  rising  funding  costs  and  regulatory  hiccups,  but  with  NIM stabilising  to  2.7%  on  BIMB’s  asset  growth  strategy  in  high-yielding portfolios mix. Management now expects a further 10bps reduction in net financing  margins  on  the  pre-emptive  hike  in  deposit  rates  and  the continuous  challenge  in  offering  competitive  financing  products.  We expect  BIMB’s  financing growth to be in line with our 17% assumption with asset quality to remain stable.  

Downgrade to NEUTRAL  with  SOP  MYR4.70  TP  (from MYR5.05)  at an  implied  1.8x  P/BV.  Our TP adjustment is from Bank Islam’s revised book value  and  on an  update in  Syarikat Takaful  Malaysia  (STMB MK, BUY,  TP:  MYR15.00)’s  stake  to  60%  (from  61%).  We  see  long-term value in the stock,  being a quality bank  with above-industry growth  and as  a  standalone  domestic  Islamic  financial  institution.  Yet,  near-term upside  is  capped  by  the  aforementioned  uncertainties.  BI’s  plans  to expand into Indonesia are also on hold given the uncertainties on foreign participation  there. Risks could entail a high deposit run-off rate, though we believe there will be criteria for customers to quality for IA.

Our  SOP  FV  is  premised  on  1.7x  P/BV valuations on Bank Islam (GGM valuation for the  bank  is  based  on  14%  ROE  and  4.5% long-term growth)  –  which was changed from 1.9x  P/BV  previously  –  and  2.8x  P/BV  for Syarikat Takaful Malaysia 

We  also  assumed  that  BIMB’s  current  60% stake  in  Syarikat  Takaful  Malaysia  vs  61% previously. We believe that  it  will continue to hold  >55%  of  this  subsidiary,  its  main  fee income driver. 

Our TP is fully diluted for the warrants

Budget 2015 On Islamic Finance: Our View

The Government will introduce a new  shariah-compliant investment product in 2015 called  the  Investment  Account  Platform  (IAP).  IAP  will  provide  opportunities  forinvestors  in  financing  entrepreneurial  activities  and  developing  viable  small  and medium  enterprises  (SMEs).  At  the  same  time,  IAP  will  be  a  platform  to  attract institutional and individual investors  –  including high net worth individuals  –  to invest in the Islamic financial market. Initially, IAP will be implemented with a startup fund of MYR150m. To promote investment in this platform, the Government has proposed for individual  investors  to  be  given  income  tax  exemption  on  profits  earned  from qualifying investments for three consecutive years.

We think that the IAP  –  which is linked to  a banks’ financing portfolio like project and entrepreneurial financing  –  will be an  innovative product  that provides  Islamic bank customers  the  opportunity  to  earn  investment  returns  and  tax  incentives.  IAs  (aliability item on  a  banks’ balance sheet)  will also  benefit Islamic banks, as there are zero  capital  charges  on  assets  tagged  to  IAs.  Such  accounts  do  not  carry  capital charges,  as  the  risk  is  borne  by  investors  and  is  excluded  from  statutory  reserve requirement  (SRR).  Additionally,  there  will  be  further  tax  deduction  for  expenses incurred for issuances of sukuk. 

However, we are NEUTRAL on this impact to BIMB despite the fact that it could spur its  fee  income  stream.  We  are  still  concerned  over  the  uncertainties  on  the implementation and customers’ reception . Also,  the industry has yet to update on the possibilities of off-balance sheet accounting. Given that IA is not a form of deposit, it may  affect  the  Islamic  bank’s  ability  to  retain  depositors  and,  hence,  its  loan-todeposit ratio (LDR). This is because such depositors  may switch to IAs  for potential higher returns. However,  we  believe  that  not every customer  can  qualify  for  an  IA. Ultimately, we expect operational costs to rise in the near term as the industry  adaptsto the new platform and incentivises  customers to partake  in  the product.  While this could propel wealth management avenues for Islamic finance, it  is yet to be known if such a platform can spur innovative solutions for takaful and financing products. 
In  addition,  management  foresees  greater  challenge s  in  retaining  its  depositors, given more competitive deposit rates across conventional and Islamic banks for both high-cost  and  low-cost  deposits.  Customers  will  also  get  more  opportunities  to choose between deposits and IAs, which we think could be effective from June 2015. BIMB  is  now  focusing  on  capturing  more  retail/individual  deposits,  which  currently stands at only 14.4% of total deposits as at 2Q14 (1Q14:  15.5%). Nevertheless, we view that this is an industry-wide issue. BIMB has some advantages, given the bank’s high current and savings (CASA) composition of 36.6%. The industry has yet to finalise the accounting methods of IA (which can be on- or offbalane  sheet)  and  the  method  to  compute  LDR,  given  that  IA  is  not  a  form  of deposit. While no profit guidance was given, we believe our adjustment to  net profit growth to 8-9% (from 10-11%) takes into account management’s current expectations of NIM compression  by  another  10bps  or  more.  Previously,  we  had  expected  NIMs  to stabilise at 2.7% as  BIMB  went  on an  8% asset growth strategy vs 20-25% target 
financing growth.

Source: RHB