This article first appeared in The Edge Malaysia Weekly on June 12, 2023 - June 18, 2023

BANK Islam Malaysia Bhd’s lacklustre first-quarter earnings — partly owing to a substantial erosion in its net income margin (NIM) after financial institutions competed intensely for deposits — and its weak share performance this year have left many wondering if the worst is over yet for the country’s biggest standalone Islamic bank.

Group CEO Mohd Muazzam Mohamed is of the view that the lender has turned the corner amid an easing of competition in the deposits space. In an interview with The Edge, he says Bank Islam is likely to turn in stronger earnings for the year ending Dec 31, 2023 (FY2023) compared with a year ago as it is managing its funding cost more efficiently.

The group’s net profit of RM118.09 million in 1QFY2023 — up 11.5% year on year but down 6.5% quarter on quarter — came in below analysts’ expectations, making up just 20% of consensus estimates for the full year.

Analysts say it was the only lender to have missed earnings expectations in the recent financial reporting season. They blame the underperformance on the bank’s higher-than-expected allowances for impaired financing and weaker-than-expected NIM.

Muazzam explains that, unlike previous years, the heightened competition for deposits at the year-end among banks continued right through January and February, which resulted in the bank incurring higher deposit costs in the first quarter. Deposit rates had stayed high as both banks and customers had widely thought that there would be increases in the overnight policy rate (OPR) in the first quarter — which, as it turns out, did not happen.

“There was the assumption that the OPR would go up in January and March, hence, customers who were rolling over their deposits were demanding higher rates — especially the corporates and institutions — and, in the same vein, banks were accommodating. But then, the OPR didn’t go up,” he explains.

Hence, like most banks, Bank Islam’s NIM declined. The margin stood at 2.06% in 1QFY2023, representing a decline of 21 basis points from 2.27% a year earlier and a decline of 16 basis points (bps) from 2.2% in the preceding quarter.

“What we saw in prior years was that [deposit] rates would start to come down in February and March; however, this year, rates continued to be high. So, as a bank, our NIM suffered. However, what is good is that we have been monitoring it closely [and] our NIM has improved in April and May, and we expect it to be able to continue to improve,” Muazzam says.

According to him, the recent improvement in NIM is not only due to an easing in the competition for deposits, but also because of the bank’s efforts since last October to improve its funding mix.

“We put in a lot more effort, especially in the final quarter last year, to go after deposits from individuals and SMEs (small and medium enterprises), which are a cheaper source of funding, while reducing our reliance on short-term placements by institutions,” he says. This, coupled with a 25bps hike in the OPR in May, will aid its NIM for the full year, he adds.

“In 1QFY2023, our quarterly NIM was about 2.06%, but I’m expecting full-year NIM to be nothing less than 2.2%. It’s a realistic target considering the current deposit environment,” he remarks.

Among the banks, Bank Islam tends to benefit the most when the OPR goes up as it has the highest proportion of floating-rate financing in the industry — at 91.6% as at the end of last year.

Muazzam, like most economists, does not expect further increases in the OPR this year. He says the bank is looking at slower financing growth of between 7% and 8% this year after last year’s 11%. This is nevertheless higher than the 4% to 5% growth that analysts anticipate for the banking industry this year.

Bank Islam’s biggest shareholder is Lembaga Tabung Haji with a 48.02% stake, followed by the Employees Provident Fund with 15.82%.

Analysts are concerned over whether Bank Islam’s asset quality will worsen over the year. It incurred a higher net allowance for impaired financing of RM61.97 million in 1QFY2023 compared with RM43.31 million a year earlier and RM37.97 million a quarter earlier.

Its gross impaired financing (GIF) ratio deteriorated to 1.37% from 1.27% a quarter ago due to weakness in the household segment. It was nevertheless better than the industry average of 1.75%.

“Asset quality is a focus for us, but it’s within our control,” Muazzam says, guiding that provisions are likely to trend downward over the remaining quarters provided there are no major setbacks with the economy. He notes that the group has RM140 million management overlays built up over the Covid-19 pandemic that can be used as a buffer in the event of any negative surprises.

“We can close the second quarter with a GIF ratio of under 1.37%. An important indicator that we look at is our past-due-but-not-impaired financing ratio, which is still very healthy at 1.08% [in 1QFY2023] and below the industry average,” he remarks.

He says that there are no corporate accounts that he is particularly worried about. Bank Islam had already fully provided for a problematic “oil and gas (O&G) account” back in FY2021 and FY2022, he adds.

While he did not provide details, it is understood that the O&G account is that of Serba Dinamik Holdings Bhd.

Bank Islam’s share price has declined 35.6% so far this year to close at RM1.73 last Thursday, giving the Main Market-listed company a market value of RM3.92 billion. By comparison, the Bursa Malaysia Financial Services Index gained 8.4% over the period. 

Bank Islam’s stock has shed 36.8% in the last 12 months.

Asked about the decline, Muazzam says he is puzzled by it and indicates that there may be misperception among retail investors about the bank’s ability to weather a more challenging year. He notes that the bank’s top 30 shareholders, comprising mainly institutional investors, have not eased up on their holdings in the bank this year.

“All our key financial metrics point to us being in a strong position. Our GIF ratio, financing loss coverage ratio, CASA (current and savings account) ratio and financing growth, to name a few, are better-than-industry,” he highlights. As such, he says it doesn’t make sense for the stock to be trading at a price-to-book ratio of just 0.6 times.

Despite its weaker-than-expected first-quarter earnings, most analysts continue to have “buy” calls on Bank Islam. Bloomberg data shows that five analysts have a “buy” call, while three have a “hold”. There were no “sell” recommendations.

The average target price was pegged at RM2.13, which implies further upside from last Thursday’s close of RM1.73.

Kenanga Research upgraded Bank Islam to “outperform” from “market perform” following the release of its first-quarter results as it believes the selling on the stock is overdone, presenting a more attractive entry point. It, however, cut the target price by five sen to RM2.25.

“The stock saw a heavy selling down as we believe retail investors crowded towards higher-capitalisation peers. We opine [that] current price levels present a more favourable risk-reward for Bank Islam, given it has continuously sustained stronger-than-industry financing growth. Meanwhile, its dividend yield of 8% could be attractive to yield-seeking investors. The stock also provides a shariah alternative against conventional players, hence, is more accessible to certain institutions,” its analyst Clement Chua says in a May 31 report.

He notes that while the group is seeing poorer marks for asset quality, it could make up for it with more aggressive overall customer acquisition. Nevertheless, he expects Bank Islam’s costs to go up as the group invests in technology and continues its digital efforts.

“Cost pressures are likely to mount in the latter periods, which could drag earnings further,” he says. He cut his FY2023 and FY2024 earnings forecasts by 9% each. He expects Bank Islam to make a slightly higher net profit of about RM512 million in FY2023 compared with RM491.67 million in the previous year.

Hong Leong Investment Bank Research, which has a “buy” call and target price of RM2.35, expects the bank’s NIM contraction to moderate in the second and third quarters. “The GIF ratio is likely to climb but we are not overly worried since Bank Islam’s financing loss coverage is more than 100% [1QFY2023: 135.4%]; this provides a robust buffer to pad any asset-quality weakness in the short term that may potentially stem from macro headwinds and tighter monetary policy,” it says in a May 31 report. 

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