Review

• AFG posted softer 3QFY17 results. YTD net profit stood little changed, climbing marginally to RM394.7mn from RM392.2mn a year ago. ROE softened to 10.8% (9MFY16: 11.4%). Results came within expectations with 9M net profit representing 72% and 74% of ours and consensus’ full year estimates.

• Accounting for 72% of our forecast, operating income expanded by 2.9% YoY, underpinned by stronger earnings contribution from Islamic Banking operations (+20.6% YoY). Gains from Islamic Banking was however, muted by decreases reported in the net interest income (NII) (-0.3% YoY) and non-interest income (non-NII) (-2.0% YoY).

• Combined with Islamic net financing income, total NII advanced by 5% YoY. Impact from the OPR cut – which saw loan yields decline by 11 bps, was cushioned by efforts to price for risk and improve loan origination mix. We also believe competitive pressures are pushing down yields in AFG’s targeted market segments. YTD, we note that the risk adjusted return (RAR) of SME and commercial and unsecured consumer lending had fallen to 1.86% from 2.1% in the previous quarter. Nevertheless, this segment grew at a stronger pace of 14.6% YoY while lower RAR loans of 0.76%, such as residential and non-residential loans, hire purchase and corporate loans contracted by some 1.4% YoY. Falling short of management’s guidance, total net loans are up 1.6% YoY

• Net interest margin (NIM) expanded YoY to 2.31% from 2.15% in 3QFY16. Despite impact from the OPR cut and competition, NIM widened by 9 bps YoY. The encouraging YoY increase in NIM was partly attributed to faster deposit growth of 4.2% (vs. loans) and 8 bps QoQ drop in COF due to more efficient funding mix and repricing of FDs. Gross interest margin increased by 1 bps due to higher RAR loan growth.

• Including Islamic Banking, non-NII contracted by 2.4% YoY but improved 10.6% sequentially mainly due to higher treasury income from derivatives and foreign exchange trading. Compared to 9MFY16, client-based fee income expanded by some 11.4% YoY (+RM23.8mn), led by stronger banking services fees (+13.9% YoY), wealth management fee (+11.6% YoY), and FX treasury sales (+11.3% YoY). Non client based non-NII however, declined both on a YoY and QoQ basis due to lower treasury income from derivatives and foreign exchange.

• Gross impaired loans ratio strengthened to 1.0% (9MFY16: 1.1%). Loan loss coverage climbed to 137%, enhanced by Regulatory Reserve provision amounting to RM156.6mn. The amount of restructured & rescheduled loans softened during the quarter, falling by some RM9.9mn QoQ due to the reclassification of some R&R loans into performing. Total R&R loans stood at RM75.9mn (2QFY17: RM85.8mn), accounting for only 0.2% of total loans.

• Total provisions climbed to RM68.6mn vs. RM40.4mn in 9MFY16 due to higher impairment allowances on loans and financing, lower recoveries and higher non-loan impairment charges. Annualised net credit cost normalised to 22.9bps from 12.8bps in FY16. The increase is expected as management guides that the net credit cost for FY17 should increase to c.25-30 bps on the back of a reduction in recoveries.
• Elsewhere, total overhead expenses broadened by 0.5% YoY (+RM2.4mn) to RM510.7mn mainly due to higher personnel cost and IT investment. According to management, efforts undertaken under the new transformation programme to improve on costs include: 1) streamlining the number of FTEs through branch operation optimisation, 2) streamline operational processes, and 3) migration of over-the-counter transactions to self-service. On the back of stronger revenue growth, AFG’s cost to income (CTI) ratio improved to 46.3% in 9MFY17 from 47.4% a year ago.
• Lastly, the CET1 Capital Ratio for the bank and group stood above regulatory requirements at 11.2% and 12.0% respectively.

Impact

• No change to our earnings estimates.

Outlook

• Despite overall weak demand for loans, focusing on Risk Adjusted Returns should translate to better use of capital, ensuring more efficient growth of loans with better margins. Nevertheless, loan growth are falling slightly short of management, and our loans and advances assumption of c. 5% this FY.

• Elsewhere, management will intensify efforts in the SME space. Although we envisage competition to remain intense, growth in this lucrative market with plenty of cross selling opportunities could help boost future ROEs.

• Continued cost discipline and the launch of the new transformation programme in FY17 could lend support to earnings, going into FY18. Management expects topline growth to be supported by the introduction of a new investment product in the next FY. We foresee the offering of a new loan service, which consolidates the borrower’s existing loans from other banks to only one account, for convenience and at a lower blended rate of 6.88% could see some migration of new customers into Alliance Bank.

• We believe the other exciting new product launched is the mobile foreign remittance, where transfers are conducted via the mobile phones of the employers of the foreign workers directly from the employees’ salary accounts. We see opportunities of rising fee income and larger CASA deposits via this new product.

• Asset quality also appears intact for now, although management remains cautious and will likely guide for higher credit charges in FY18.

Valuation

• Rolling valuations forward to FY18, we adjust TP to RM3.90/share from RM3.70/share. This translates to an implied FY17 PBV of 1.15x. We reiterate our SELL recommendation on AFG.

Source: TA Research - 23 Feb 2017