We retain our NEUTRAL call with a lower TP of MYR3.45 (3% upside). We think asset quality will increasingly be on the forefront of investors’ concerns ahead as we head into softer macroeconomic conditions, but AFG’s asset quality should remain relatively more resilient due to its focus on the retail segment. That said, after having benefitted from last year’s rate hike, earnings ahead are unlikely to excite.

Watching out for asset quality issues ahead. Generally, we think asset quality will increasingly be on the forefront of investors’ concerns as we head into softer macroeconomic conditions. Post the Global Financial Crisis (GFC), Alliance Financial Group’s (AFG) loan growth of 11% (2009-2014) was in line with system loan growth, driven by retail and SME lending. Generally, we believe retail-focused banks will offer a safer hideout for investors from asset quality issues, as retail loan ticket sizes are smaller and are generally asset-based. Loan loss coverage (LLC) levels are also relatively higher as compared to corporate -focused banks. While we think AFG’s asset quality should remain relatively more resilient, credit cost is still expected trend up, partly from normalising recoveries.

Forecasts. We toned down our FY16-18F operating income forecasts by up to 3% as we think markets-related income may not recover meaningfully anytime soon, given the softer macroeconomic conditions. We also raised our FY16F/FY17F/FY18F credit cost assumptions to20bps/24bps/24bps from 14bps/17bps/17bps respectively, to factor in potential asset quality issues. Overall, we reduced our FY16F/FY17F/FY18F net profit projections by 5%/7%/8% respectively.

Investment case. We trim our GGM-derived TP to MYR3.45 from MYR3.90, reflecting the earnings revisions above as well as a rollforward in valuations to 2016. Our GGM assumes: i) cost of equity of 10.3%, ii) revised ROE assumption of 10.75% (from 12%), and iii) longterm growth of 4.5%. Our TP is based on fair 2016F P/BV of 1.08x, which is at a discount to the 10-year average P/BV of 1.6x. We believe the discount is fair, given our FY16-18 ROE projections of c.10.5-11.2%, compared with the 10-year average ROE of 12.6%. AFG’s focus on riskadjusted returns and growing non-interest income should be positive for ROEs if successfully executed, but we think this will take time. Asset quality is also less of an issue for AFG. That said, plans to scale down loan growth and bulk up on deposits are likely to keep income growth under pressure in the near term. We maintain our NEUTRAL call.