KAF Investment Bank Bhd - 2012

MARC has affirmed its long-term and short-term financial institution ratings of AA-/MARC-1 on KAF Investment Bank Berhad (KAF Investment). The bank’s focus on trading high quality fixed-income securities continues to underpin its modest credit and market risk profiles, and very strong regulatory capital adequacy position. Other important drivers for affirming the ratings include the bank’s strong earnings performance, prudent risk management, and comfortable levels of liquidity. The ratings are moderated by KAF Investment’s relatively narrow earnings base and exposure to large deposit withdrawals. The outlook on the ratings is stable.

KAF Investment is one of the largest investment banks by assets in Malaysia with an asset base of RM6.2 billion as at end-February 2012. The bank is majority owned by its founder and managing director Datuk Khatijah Ahmad, through an 80% stake in KAF Investment’s ultimate holding company AKKA Sdn Bhd, whose leadership continues to be an important factor in the strength and sustainability of the bank’s franchise.

The bank’s business model has performed well in an environment of benign interest rates. The current lower investment yield environment in the debt capital market has provided opportunities for the bank to dispose its holding of debt securities for capital gain. For the nine months ended February 2012 (9MFY2012), KAF Investment registered higher pre-tax profit of RM162.8 million (9MFY2011: RM149.1 million) mainly due to higher profit from securities trading and disposal of securities held to maturity, litigation recoveries and lower operating expenses. Litigation recoveries amounting to RM15.1 million were related to a legal action taken against the bank in 2009 in which full provision was made in FY2010. Annualised return on assets (ROA) and return on equity (ROE) stood at 1.97% and 15.47% respectively (FY2011: 1.11% and 11.47% respectively).

As an investment bank, KAF Investment’s funding base is mainly derived from deposits from institutional depositors (including financial institutions) which constituted 74% of total liabilities and equities as at end-9MFY2012. Significant deposit withdrawals by institutional depositors during 9MFY2012 saw the deposits decreasing to RM5.0 billion (FY2011: RM9.6 billion). Mitigating liquidity risks are the bank’s holdings of liquid assets, which constituted 47% of total assets as at end-February 2012. Liquid assets mainly comprised of government securities, cash and short-term funds, and money market instruments. Other assets include private debt securities (PDS) which constituted 59% of total investment assets. MARC notes that the PDS mainly consisted of highly rated securities of AA and above.

The investment bank maintained strong capitalisation attributable to continued internal capital generation and lower risk-weighted assets. As at end-February 2012, both the core capital ratio (CCR) and risk-weighted capital ratio (RWCR) increased to 98.3% (FY2011: 84.2%) and 98.9% (FY2011: 84.0%) respectively, which were well above the Malaysian investment banking industry average of 31.9% and 32.5% respectively as at end-February 2012.

Going forward, the bank’s ability to maintain its profitability measures will be challenged as the bank replenished its realised investments with relatively lower yield investments amid the current low interest rate environment. Nonetheless, MARC notes that the bank has increased its exposure in PDS and lowered its short-term funds and money market instrument holdings in recent periods in an effort to support its investment yield.

The stable outlook reflects MARC’s expectation that the bank’s approach in managing risks and conservative credit and market risk profiles will position the bank well under less benign economic and market conditions, including periods of volatility in the capital markets.

Strengths

• Strong earnings performance with a commendable track record
•  Strong capitalisation
•  Disciplined risk appetite, evidenced by the high credit quality of its fixed income securities portfolio.

Challenges/Risks

• Overcoming competition from larger bank-backed investment banks
• Dependence on price-sensitive institutional funding sources; and