This article first appeared in The Edge Financial Daily, on November 3, 2015.

CIMB Group Holdings Bhd
(Nov 2, RM4.59)
Maintain sell with a target price of RM4.15: The group’s Indonesian outfit, PT Bank CIMB Niaga Tbk’s (CIMB Niaga) net profit for the third quarter ended Sept 30, 2015 (3QFY15) fell 74% year-on-year (y-o-y), or 5% quarter-on-quarter (q-o-q) to 89 billion rupiah (RM28 million), hampered by 471 billion rupiah mutual separation scheme (MSS) costs and elevated loan provisioning.

Special-mention loans jumped 38% q-o-q, which reaffirms our view that asset quality issues are likely to persist and credit costs may remain at elevated levels for a prolonged period.  

Excluding the MSS costs, 3QFY15 net profit was up 375% q-o-q (up 29% y-o-y) with the sequential improvement coming from a combination of stronger net interest income, cost savings from MSS filtering and lower loan provisioning, albeit still at elevated levels. 

3QFY15 credit cost (annualised) was 264 basis points (bps), while absolute gross non-performing-loans (NPLs) fell 27% q-o-q (flat y-o-y), resulting from CIMB Niaga selling bad loans (about US$200 million [RM860 million], mainly from the coal sector) to a special purpose vehicle (SPV). 

The SPV is owned by CIMB Group and hence, CIMB Group’s consolidated figures will still capture these NPLs. Thanks to the sale, the reported gross NPL ratio eased to 3.2% from 4.3% at end-2QFY15 (3QFY14: 3.4%). Otherwise, the gross NPL ratio would have been 150bps higher. 

More disconcertingly, special-mention loans were up 38% q-o-q. Thus, CIMB Niaga’s gross impaired loan (reflects NPLs and some special-mention loans that may potentially turn into NPLs) ratio, including the bad loans sold, stood at 6.7% (versus 5.2% as reported) from 5.7% in 2QFY15 (3QFY14: 5.4%).  

CIMB Niaga’s MSS exercise was completed in July, while the annual cost savings from the exercise amounting to 350 billion rupiah will be felt from 1QFY16.

CIMB Niaga said economic activities remained slow, translating into the broad-based weakness in asset quality.

Credit cost for 4QFY15 is expected to remain elevated, but on a declining trend, while CIMB Niaga thinks FY16 should see credit costs improve further. 

The management also explained the rationale for the sale of bad loans, which included freeing up capital, improving asset quality ratios and offering a better focus on the underlying operations. The loans sold were valued independently, and the impact was neutral on CIMB Niaga’s income statement. 

We keep our earnings forecasts for now, which already factor in restructuring costs and related savings. 

The continued rise in special-mention loans reaffirms our view that asset quality issues are likely to persist and prolong the elevated credit costs. 

We assume FY15F/FY16F credit costs of 69bps/64bps (FY14: 61bps) for CIMB Group. — RHB Research, Nov 1