KUALA LUMPUR: Much of Malaysia Building Society Bhd’s (MBSB) net profit decline for the first quarter ended March 31, 2015 (1QFY15) was attributed to a jump in the non-bank lender’s bad loan allowance but analysts are more surprised that high loan loss provisions will be the norm for the next two years.

MBSB last week announced a sharp fall of 37% in net profit to RM124.3 million for the 1QFY15 from RM196.73 million, dragged down by the provision for impairment loss on loans, advances and financing that came in at RM101.32 million.

This is a significantly larger provision for loan losses when compared with the RM15.19 million made in the previous corresponding period, creeping close to FY14’s whole-year provision for loan losses at RM126.2 million.

This, along with a weaker Islamic banking net income, led to the big drop in MBSB’s net profit for the 1QFY15.

On a quarter-to-quarter basis, however, the 1QFY15’s loan loss allowance is comparable with the 4QFY14’s sum of RM100.1 million. This means that the non-bank lender has made a provision of over RM200 million for loan losses in just two quarters.

This could be a “kitchen-sinking” process to clean up the books.

The group explained that such high provisions for bad loans are made because the financial group is undertaking a two-year impairment programme that started in the 4QFY14.

The move is aimed at bringing MBSB closer to banking institutions’ banking standards of classifying non-performing loans (NPLs) from a six-month basis to three months.

AmResearch said in its latest note that MBSB’s collective impairment stood at RM177 million for FY14.

“Looking ahead, the collective expense is expected to be at current elevated levels for the remaining quarters of FY15, implying a total collective expense of RM250 million in total for FY15, arising from the impairment programme,” it added.

Tan Ei Leen, an analyst at Affin Hwang DBS told The Edge Financial Daily that the “surprise” impairment programme lacks transparency and will hit MBSB’s earnings for the next two years.

“In the past, we have asked if the management would take initiatives or make provisions for NPLs but there has been no mention about having an ‘impairment plan’ like this. This plan actually started in the 4QFY14 but was only revealed in a recent meeting,” she said.

According to Tan, the two-year impairment programme will help clean up MBSB’s “hidden toxic assets” and clear the NPLs, which have been sitting in MBSB’s books for the last six years — issues that could have surfaced during MBSB’s mega bank merger negotiations with CIMB Group Holdings Bhd (fundamental: 1.05; valuation: 2.25) and RHB Capital Bhd (fundamental: 1.5; valuation: 2.1).

Affin Hwang Capital showed in a note last Friday that MBSB’s gross NPL ratio as at the 1QFY15 stood at 7.5%, despite having progressively declined for the last two years.

Now that the impairment programme has started, Tan said investors would have to bite the bullet of “uncertain and unpredictable” MBSB earnings for FY15 and FY16.

“The outlook for MBSB is going to be very challenging. It is going to be very difficult to forecast top-line growth for the next few years, but what is certain is that it will be lower than FY14.”

“You can expect impairment levels to stay the same as what we have seen for the 1QFY15 for the next two years and credit costs to go up to between 130 basis points (bps) and 150bps (from 34bps for FY14),” she explained.

As a result, Affin Hwang downgraded its “buy” rating on MBSB with a previous target price of RM2.80 to “sell” with a reduced target price of RM1.80, in anticipation of more provisions due to expected retail loans turning into NPL status.

The research kept MBSB’s earnings forecast for FY15 at RM406.8 million but has slashed the FY16 net profit estimates by 35% to RM471.6 million.

Similarly, Kenanga Research has changed its “market perform” rating to “underperform” with a target price of RM1.78, given the magnitude of the impairments heading MBSB’s way. Net profit forecast for FY15 has been cut by 36% to RM456.7 million, while forecast for FY16 has been slashed 33% to RM501.9 million.

MBSB, which specialises in lending to civil servants, was once the darling of fund managers mainly because of the belief that the financial group is unlikely to have much bad debt as government officers’ loan payments are made through an automated salary deduction scheme. The outstanding loan payments would have been deducted from the civil servants’ salary before the pay cheques reach them.

Nonetheless, AmResearch analyst Rachel Huang said MBSB’s two-year impairment plan is “prudent” and “positive in the longer run” in her research note.

However, she concurred that MBSB’s earnings will be hit by the impairment expense. AmResearch has kept its “hold” rating on MBSB (fundamental: 1.2; valuation: 3) with a lowered target price of RM1.80 in a note last Friday.

“Given that there is now a two-year impairment programme expected to last until FY15, we have revised our credit costs assumptions to 130bps for FY15, from 89bps previously.”

“Our net earnings have been downgraded accordingly by 16.9% for FY15 (to RM520.2 million), 8.2% for FY16 (to RM585.7 million) and 8.2% for FY17 (to RM641.4 million),” she said.

MBSB’s share price closed lower at RM1.99, down 1% or two sen, with a market capitalisation of RM5.4 billion.

This article first appeared in The Edge Financial Daily, on May 11, 2015.