This article first appeared in The Edge Malaysia Weekly on September 10, 2018 - September 16, 2018

MOST Malaysian banks saw a weakening of asset quality in the second quarter on a sequential basis, but Affin Bank Bhd’s was the most pronounced as it had the biggest impact on earnings, no thanks to two problematic accounts.

The country’s second smallest bank by assets saw a larger-than-expected surge in loan loss provisions of RM91.9 million in 2Q compared with a writeback of RM15.7 million in 1Q. Year-on-year, they jumped 156%.

As a result, Affin Bank’s 2Q net profit declined 48.2% quarter on quarter to RM73.3 million, which was far below analysts’ expectations as it made up only 41% of a consensus forecast for the full year.

Kenanga Research described the result as “hugely disappointing” while CIMB Research downgraded its call on the stock to “hold” from “add” due to the deterioration in asset quality.

Controlled by Lembaga Tabungan Angkatan Tentera, Affin Bank saw its gross impaired loans (GIL) ratio — an indicator of asset quality — worsen 27 basis points to 2.81% as at end-June, compared with 2.54% three months earlier.

In contrast, the banking system’s GIL ratio deteriorated only slightly over the same period, by two basis points to 1.59%. It improved slightly to 1.58% in July, Bank Negara Malaysia’s latest monthly statistics show.

Affin Bank’s higher provisions were mainly for two accounts — in real estate development and oil and gas. “It is the two chunky accounts that is causing the spike in our GIL. For the real estate account, we expect a resolution by the end of the year and for the O&G, in FY2019. Both accounts are fully collateralised, with collateral cover at more than two times for the real estate one. As for the O&G, we only provided around 25% and the account continues to generate positive cash flow,” Affin Bank’s group CEO Kamarul Ariffin Mohd Jamil tells The Edge.

The resolution timelines appear to be slightly later than the group initially expected. Back in April, Kamarul Ariffin had said that both the accounts were expected to be reclassified back to performing by end-FY2018.

Excluding the two accounts, Affin Bank’s GIL ratio would have actually improved to 2.28% from 2.48%.

For the rest of the year, he says the group does not expect any significant provision and has intensified efforts to monitor all accounts. It is maintaining its expectation for gross credit cost to be about 30 basis points for FY2018.

TA Securities Research, however, believes its asset quality may worsen in 1H2018. “High-risk sectors in which Affin Bank has exposure to include construction and non-residential properties,” it says in a report.

Meanwhile, Affin Bank’s plan to build a new 47-storey headquarters at Tun Razak Exchange in Kuala Lumpur — it awarded a RM505 million contract to builder IJM Corp Bhd last week — is expected to have a depreciation impact on the group’s profit and loss statement (P&L) in 2020.

“The building is expected to be completed towards the end of 2020. The depreciation impact will hit the P&L in 2020. However, we expect this to be mitigated from the rental saving by the group, aside from the revenue generation from letting a portion of the building,” Kamarul Ariffin says.

How the other banks fared

To be sure, other banks — with the exception of CIMB Group Holdings Bhd — also saw their asset quality weaken on a q-o-q basis.

Apart from Affin, Malayan Banking Bhd (Maybank) and Alliance Bank Bhd were the ones with the strongest uptick in the GIL ratio.

In Maybank’s case, it was impacted by its provisions of S$106.3 million (RM315.1 million) for the Hyflux group, a financially-troubled Singapore-based client. As a result, Maybank’s overall provisions rose 14.3% q-o-q to RM582.15 million.

This led to Maybank seeing a 27 basis point decline in its GIL ratio, to 2.64%. However, analysts are less worried about Maybank’s provisions going forward as concerns about the exposure to Hyflux have been cleared up.

Maybank explained that its total exposure to Hyflux, at S$658.6 million (RM1.95 billion) as at end-June — through its financing of two infrastructure projects, namely the Tuaspring water-and-power plant and the TuasOne waste-to-energy power plant — is fully secured against the projects’ assets.

UOB Kay Hian Research notes that Maybank is expecting some form of resolution to its Hyflux loan exposure by 1Q2019 on the back of a potential sale of one of Hyflux’s power plants – the Tuaspring Integrated Water & Power Project.

Despite the Hyflux provisions, Maybank’s 2Q results were up by a strong 18% to RM1.96 billion.

The other bank on analysts’ watchlist for asset quality is Alliance Bank Bhd, which saw its GIL ratio worsen by 14 basis points to 1.57% q-o-q, mainly because of provisions for non-residential property and working capital loans.

The bank’s GIL ratio is nevertheless the best in the industry after Public Bank Bhd (0.5%) and Hong Leong Bank Bhd (0.87%).

“We understand that the management expects the GIL ratio to taper off in coming quarters,” says MIDF Research.

CIMB Group’s GIL ratio improved by 5 basis points to 3.17%, but the ratio remained the highest of all the banks.

Going forward, Maybank Investment Bank Research says it has conservatively factored in an uptick in GIL ratios for the banks under its coverage —which excludes only Affin Bank — over the next two years, amid prevailing uncertainties on the global front and potentially slower domestic economic growth ahead.

“Household asset quality is likely to see some mild deterioration amid higher living costs, and we continue to keep a watchful eye still on the O&G and non-residential property loan books,” it says.

It expects the GIL ratio to move up to 2.19% this year from 2% last year, and further up to 2.27% in 2019 and 2.29% in 2020.

Note: The story has been corrected to say that Hyflux is selling only one of its power plants. 

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