We retain our SELL call and MYR4.15 TP (10% downside). 9M15 results were within our but below consensus estimates as loan provisioning stayed elevated amid a further deterioration in asset quality, mainly from Indonesia. Together with restructuring costs and adverse forex translation effects, the group’s capital position eroded further, raising the risk of another capital call.

CIMB reported 3Q15 net profit of MYR804m (-10% YoY, +26% QoQ), within our but below consensus expectations with 9M15 net profit of MYR2bn (-30% YoY) accounting for 70% of our and 64% of consensus full-year estimates. CIMB Niaga’s (Niaga) MSS cost amounted to MYR134m in 3Q15 vs. MYR316m for the Malaysia operations in 2Q15. Excluding restructuring costs (which we had already factored in our forecasts), 3Q15 underlying net profit growth was +1% YoY/+3% QoQ while 9M15 underlying net profit fell 12% YoY.

Results highlights. Net interest income (+11% YoY/+5% QoQ) was the main positive this quarter due to favourable foreign currency translation impact and 7bps QoQ expansion in net interest margin (NIM) - driven partly by Niaga’s NIM expansion and liquidity management at the domestic operations. Otherwise: 1) non-interest income was down 11% QoQ due to weaker markets-related income; 2) overheads (underlying) were flat QoQ while the cost-to-income ratio (CIR) was stable at 55.5%; and 3) loan impairment allowances remained sticky. Although Niaga had reported a 11% QoQ drop in loan provisions, higher allowances were required for the domestic retail business.

Loan and deposit growth. 3Q15 loan growth was 19% YoY/7% QoQ (+11% YoY/+2% QoQ, excluding forex impact). Wholesale lending was strong in 3Q (+27% YoY/+11% QoQ). Deposit growth was 18% YoY (+6% QoQ) or +10% YoY/+2% QoQ in constant currency terms.

Asset quality. Gross impaired loans rose 10% QoQ (+24% YoY) due to the continued deterioration in asset quality largely in Indonesia. Loan loss coverage (LLC) eased to 77% from 78% in 2Q15 (3Q14: 74%).

Capital. A combination of factors such as elevated loan provisioning, restructuring costs and forex translation impact on risk-weighted assets led to group CET-1 ratio slipping by another 40bps QoQ to 9.3%, with the fully-loaded ratio 20-30bps lower than the above. We think the risk of a capital call has risen further on the back of the latest numbers.

Forecasts and investment case. No change to our earnings forecasts. GGM-derived TP of MYR4.15 and SELL call maintained.

Briefing highlights

Outlook challenging. Management’s outlook was similar to the previous results briefing, ie. the operating environment remains challenging amid a softer economic outlook. This is expected to lead to slower loan growth ahead while capital market activities are expected to stay muted for the next two quarters. Income growth will be further dampened by NIM pressure as deposit competition heats up. In recent years, competition for deposits has been stiff in 4Q/1Q, and this will be further exacerbated by the higher regulatory requirements with respect to the minimum liquidity coverage ratio banks need to meet come 2016. CIMB sees NIM compressing sequentially in 4Q15 but on a full-year basis, the contraction should be within the 20bps guidance (9M15: -16bps YoY).

No lumpy cost items … Management guided that there would not be any further lumpy restructuring costs in 4Q15. While some cost savings from the MSS would be felt in the final quarter, the full impact of the cost savings will only be seen next year. … but loan provisioning to stay elevated. There was an increase in delinquencies for the domestic retail portfolio in 3Q15, but management thinks this was largely seasonal due to the various festivities. CIMB has seen an improvement in collections in Oct. Overall, management expects loan impairment allowances to stay elevated in 4Q15 due to Indonesia. CIMB guided for 4Q15 credit cost of c. 70bps vs. 73bps in 3Q15 and 75bps in 9M15 (figures annualised). As for 2016 credit cost, guidance will only be provided next year. 2015 ROE target will not be met. Due to the stickiness of loan provisioning, CIMB now thinks that 2015 ROE (ex-restructuring costs) would likely end up around 8.5-9%, below the earlier 11% target (excludes restructuring costs). Ex-restructuring costs, our 2015F ROE of 8.8% is in line with management’s revised expectations. Capital – No equity raising required for now. Despite the drop in the group’s CET-1 ratio, management said there were no plans for an equity raising exercise at this juncture. Management explained that some RWA initiatives should kick-in in 4Q15 and expects group CET-1 ratio to end 2015 at around the 9.5-9.75% mark. There was also no change to the T18 target of CET-1 ratio of >11%.

Risks The risks include: i) stronger-than-expected loan growth, ii) better-than-expected NIMs, iii) stronger-than-expected capital market activities, iv) asset quality holding up well, v) favourable forex movements, which should positively impact the translation of its foreign subsidiaries’ results, and vi) good execution of T18. Forecasts No change to our earnings forecasts. Our numbers are below consensus likely due to our more conservative stance on credit costs. We have assumed credit cost peaks in 2015 at 69bps (2014: 61bps), before easing to 64bps and 55bps in 2016 and 2017 respectively

Valuations and recommendation Our GGM-derived TP of MYR4.15 assumes: i) COE of 10.6%, ii) ROE of 9.75%, and iii) 5.5% long-term growth. Our 2016 fair P/BV of 0.84x is at a discount to the 10-year average of 2x. We believe this is fair, given lower projected ROEs of c.9.2% (2016-2017) ahead, due to lower returns and more stringent capital requirements vs the 10-year average ROE of 14%. Our 2016-2017 earnings projections have already factored in annual cost savings of MYR500m from the cost restructuring exercise. No change to our SELL call on the stock. We expect the results, coupled with CIMB’s guidance that 4Q15 loan impairment allowances should remain elevated, to trigger another round of downgrade in earnings estimates by consensus. In addition, the challenging operating environment, both domestic and overseas, means that concerns over topline growth and asset quality issues will likely persist in 2016. Apart from asset quality concerns, we had highlighted previously that should earnings stay weak, this would eat into capital and the risk of another capital call rises significantly. The deterioration in the group’s capital position this quarter has served to reaffirm our concerns regarding such a possibility. Finally, dividend yields currently are about 3-4%, which are not too attractive in our view (relative to some of the other banks) to tide investors through this transition period.

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Company Profile

CIMB is a fully integrated financial services group and the second largest domestic bank in Malaysia. The group's core markets are Malaysia, Indonesia, Singapore and Thailand.

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Source: RHB Research - 26 Nov 2015