This article first appeared in The Edge Malaysia Weekly on December 5, 2022 - December 11, 2022

AFFIN Bank Bhd expects its earnings to normalise from the fourth quarter, having slipped into an unexpected core net loss in the third quarter, which prompted several analyst downgrades on the stock.

The country’s second-smallest banking group by assets reported a net profit of RM872.36 million for the third quarter ended Sept 30, 2022 (3QFY2022) compared with RM133.2 million a year earlier, thanks to a one-off gain of RM1.058 billion from the divestment of its 63% stake in Affin Hwang Asset Management Bhd (AHAM) in late July.

Excluding that gain, however, Affin Bank registered a core net loss in the quarter, as the group made a prudent move to raise its loan loss provisions — in particular, management overlays — so that its loan loss coverage (LLC) ratio would be lifted to above 100%, in line with that of the industry. Provisions that quarter surged about five times to RM233.54 million compared with RM49.24 million a year earlier.

Its low LLC ratio had for many years been a point of discomfort for investors. It now stands at 112.25% versus about 80% three months earlier. “We wanted, from a strategic and financial perspective, to strengthen the bank,” its president and group CEO Datuk Wan Razly Abdullah Wan Ali says, in response to questions from The Edge.

“So, we took additional management provision overlays in the bank [amounting to RM220.2 million] during the third quarter. In the fourth quarter, this will normalise, with the mega-dividend upstream from our subsidiary Affin Hwang Investment Bank (AHIB), which will result in a gain of RM1 billion at Affin Bank, when we flow the profit up.”

Wan Razly explains that, at entity level, Affin Bank showed a loss before tax of RM51.9 million for the nine-month period ended Sept 30, 2022 (9MFY2022), mainly because of “a timing mismatch” of approval on dividend upstream of RM1.28 billion to be received from AHIB to the bank. (Affin Bank’s stake in AHAM was held through AHIB.)

In mid-October, Affin Bank announced a special dividend of 18.09 sen per share, following the AHAM divestment, as well as an interim dividend of 4.53 sen for FY2022.

Wan Razly does not expect the group to have to top up overlays in the coming quarters.

He says that with the divestment gain in 3QFY2022, Affin Bank had taken the decision to strengthen its LLC and loan loss reserve (LLR) by building up the coverage to 112.25% and 150% respectively to protect the group in the face of a potential recession.

Despite the overlays, the group’s gross impaired loan (GIL) ratio improved significantly to 1.91% as at end-September, from 2.28% three months earlier and 3.14% a year earlier. Wan Razly says this was due to its strong recovery efforts and tightening of underwriting standards.

CGS-CIMB Research analyst Winson Ng notes that this indicates that the jump in 3QFY2022 loan loss provisions was not caused by any deterioration in its asset quality.

“We believe the bank’s proactive increase in [provisions] does not signal a pessimistic view on the outlook for asset quality, but rather was aimed at reaching its targeted LLC of above 100%,” he said in a Nov 28 report.

With the overlays, Affin Bank, whose LLC ratio had once been as low as 28% in 2017, has managed to reach its goal of breaching the 100% level a year ahead of schedule.

“The group will continue to closely monitor the asset quality of our portfolios and ensure that LLC and LLR are maintained at above the 100% and 150% levels respectively, where the capital and reserves of the group are sufficiently protected,” Wan Razly says.

As a result of the acceleration of reserves build-up, Affin Bank’s credit cost (with overlays) is at 70 basis points. “This should normalise, however, to lower levels … in the future at 30bps. With tighter underwriting standards and credit policies, we want our GIL ratio to be sub-2%. Today, we are at 1.91%, which is the lowest level recorded since 2017,” he says.

Interestingly, apart from loan loss provisions of RM233.54 million in the third quarter, Affin Bank also made goodwill impairments amounting to RM82.39 million. According to Wan Razly, this was goodwill on its balance sheet that was carried over from its previous acquisitions — namely, the Affin-Hwang merger in 2004, and the purchase of BSN Commercial and Affin Moneybrokers.

“Goodwill is a weight on our balance sheet and it is a non-earning asset, and it reduces our return on equity (ROE). Therefore, we have written off some goodwill to lighten our balance sheet and improve our ROE,” he explains.

He highlights that on a business-as-usual (BAU) basis — that is, without the one-off divestment gain, overlays and goodwill — Affin Bank’s underlying performance remains strong, with profit before tax (PBT) increasing 23.3% year on year to RM578.3 million.

Thus far, the group looks to have improved on all fronts except for its cost-to-income (CIR) ratio, which remains stubbornly high at 63.2% against its year-end target of 55%.

“We expect to break 60% CIR ratio next year. We have been operating against so many economic headwinds — slowdown due to the Covid-19 pandemic, war in Europe, high inflation and now a high interest rate environment. We will not be deterred, however, and will continue to maintain disciplined cost management by concentrating on developing higher productivity in our workforce on the back of the potential income growth, where investments into new revenue streams and digitalisation will start to bear fruit, resulting in lower CIR ratio in the coming quarters,” Wan Razly says.

Following the release of its 3QFY2022 results on Nov 25, three research houses — Kenanga Research, Hong Leong Investment Bank Research and MIDF Research — downgraded the stock to a “hold” (or the various iterations of it) and cut their target prices.

“In our opinion, Affin Bank’s risk-reward profile has become more balanced, seeing that its share price has performed strongly in recent times and there are no new positive catalysts to drive it even higher. Also, sector tailwinds are dissipating and investment fatigue is building up towards the banking sector; thus, it should limit price performance going forward,” says HLIB Research, which cut its target price by 15 sen to RM2.20.

RHB Research raised its call to a “buy” from “trading buy”, however, and raised its target price by 35 sen to RM2.80.

CGS-CIMB Research, which maintained its “add” call and RM2.44 target price, says: “We are not overly concerned about the earnings miss in Affin’s 3Q financial results, as this was mainly due to the bank’s prudent move to increase its LLC. As such, we continue to rate the bank as an ‘add’, predicated on the potential rerating catalysts of [having the] strongest loan growth in the sector (+16.6% at end-September), and an improvement in asset quality, especially LLC. It also boasts a high dividend yield of 11% for FY2022, lifted by its special dividend.”

Bloomberg data shows that three of the seven analysts that track the stock have a “buy” call whereas four have a “hold”, with the average 12-month target price at RM2.35. There were no “sell” calls.

The stock, which has gained 30.5% so far this year to close at RM2.09 last Thursday, is the third-highest gainer among banks after Alliance Bank Malaysia Bhd (32.9%) and AMMB Holdings Bhd (32.5%). With a share price of RM2.09, Affin Bank has a market capitalisation of RM4.62 billion.

The stock is likely to garner more interest from global investors after having recently been included, for the first time, on the MSCI Global Small Cap Index and the FTSE Bursa Malaysia Mid 70 Index, the latter from Dec 19.

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