CIMB Niaga’s (Niaga) 3Q15 net profit fell 74% YoY to IDR89bn (-5% QoQ), hampered by IDR471bn MSS cost and elevated loan provisioning. We maintain our SELL call on CIMB and MYR4.15 TP. Special mentioned loans jumped 38% QoQ, which reaffirms our view that asset quality issues are likely to persist and credit cost may remain at elevated levels for a prolonged period.

Results highlights. Excluding the MSS cost, 3Q5 net profit was up 375% QoQ (+29% YoY) with the sequential improvement coming from a combination of stronger net interest income, cost savings from the MSS filtering through and lower loan provisioning , albeit still at elevated levels. 3Q15 credit cost (annualised) was 264bps (2Q15: 298bps; 3Q14: 229bps) while absolute gross NPLs fell 27% QoQ (flat YoY) resulting from Niaga selling bad loans (c. USD200m, mainly from the coal sector) to a SPV. The SPV is owned by CIMB and hence, CIMB group consolidated figures will still capture these NPLs. Thanks to the sale, reported gross NPL ratio eased to 3.2% from 4.3% at end-2Q15 (3Q14: 3.4%). Otherwise, the gross NPL ratio would have been 150bps higher. More disconcertingly, special mentioned loans were up 38% QoQ. Thus,Niaga’s gross impaired loan (reflects NPLs and some special mentioned loans that may potentially turn NPL) ratio including the bad loans sold stood at 6.7% (vs. 5.2% reported) from 5.7% in 2Q15 (3Q14: 5.4%).

Briefing highlights. Niaga’s MSS exercise was completed in Jul while the annual cost savings from the exercise amounts to IDR350bn, would be felt from 1Q16 onwards. Niaga said economic activities remains slow and this is translating to the broad-based weakness in asset quality. 4Q15 credit cost is expected to remain elevated, but on a declining trend, while Niaga thinks 2016 should see credit cost improve further. Management also explained the rationale for the sale of bad loans, which includes freeing up capital, improving asset quality ratios while offering a better focus on the underlying operations. The loans sold were valued independently and the impact is neutral to Niaga’s income statement.

Forecasts and investment case. We keep our earnings forecasts for now, which already factors in restructuring costs and related savings. The continued rise in special mentioned loans reaffirms our view that asset quality issues are likely to persist and prolong the elevated credit cost. We assumed 2015F/2016F credit cost of 69bps/64bps (2014: 61bps) for CIMB group. Maintain SELL recommendation and GGMderived TP of MYR4.15.