KAF Investment Bank Bhd - 2015

MARC has affirmed the long-term and short-term financial institution ratings of AA-/MARC-1 on KAF Investment Bank Berhad (KAF Investment). The outlook on the ratings is stable. The affirmed ratings consider the investment bank’s strong capital position and healthy liquidity levels, underpinned by a conservative investment policy. Constraining the ratings is KAF Investment’s business model which remains reliant on domestic capital market conditions and the interest rate environment, leading to a potentially high degree of earnings volatility.

KAF Investment remains mainly focused on trading and investing money market and fixed-income securities, funded largely via interbank and short-term deposits from corporates. The investment bank’s track record of timely adjustments to its deposit-taking activities and investments in response to market conditions has been a key factor in generating appropriate returns against its funding costs. This is evident in the recent strategy to invest in longer-tenure securities to support credit spreads given the increase in wholesale funding rates. The increase was driven by domestic financial institutions seeking to secure more liquid assets to meet the liquidity coverage ratio requirement of 60% effective June 1, 2015.

MARC notes that KAF Investment’s exposure to liquidity risk arising from its reliance on short-term wholesale funding is mitigated by its high liquid asset ratio and prudent investment policy. Its liquid asset ratio increased to 75.7% for the nine-month period ended February 2015 (9MFY2015) (9MFY2014: 62.2%) with holdings of sovereign issuances and private debt securities (PDS) with a domestic rating of AAA increasing to 82.6% of total fixed-income securities (9MFY2014: 71.7%). By investing solely in government securities and higher-rated PDS, KAF Investment mitigates credit risk, although this investment strategy has led to tighter credit spreads.

KAF Investment’s asset size stood at RM9.2 billion as at end-February 2015; financial investments held to maturity rose more than twofold to RM3.5 billion from end-FY2014 while the investment bank’s trading book declined significantly to RM90.5 million. MARC notes that KAF Investment recorded net unrealised gains on revaluation of investments of RM40.5 million in 9MFY2015 (FY2014: loss of RM108.5 million), reflecting the gradual turnaround in prices of its securities. KAF Investment’s Tier 1 capital ratio and total capital ratio remained strong at 72.6% and 73.1% respectively as at end-9MFY2015, albeit slightly lower compared to 75.5% and 76.1% on FY2014, due to higher credit risk-weighted assets stemming from the longer-term PDS securities. KAF Investment’s credit risk-weighted assets increased to RM1.4 billion (FY2014: RM1.1 billion) following an increase in longer-term PDS to RM1.5 billion (FY2014: RM0.6 billion). Nonetheless, KAF Investment’s Tier 1 capital ratio and total capital ratio remained well above the Malaysian investment banking industry average of 29.6% and 29.9% respectively as at end-February 2015.

For 9MFY2015, KAF Investment recorded revenue of RM88.5 million and pre-tax profit of RM67.6 million (9MFY2014: RM83.0 million; RM65.2 million) on the back of higher disposal gains on securities which offset a decline in interest income. In addition, the investment bank’s cost-to-income ratio was also higher at 23.6% (9MFY2014: 21.5%) due to an increase in general administrative and personnel expenses during the period. Nonetheless, KAF Investment’s annualised return on assets and return on equity were relatively higher at 0.75% and 5.89% in 9MFY2015 (9MFY2014: 0.60%; 4.44%). MARC opines that the pressure on the investment bank’s earnings from the weaker market conditions would be exacerbated by any increase in funding costs. The rating agency also notes KAF Investment’s efforts to sustain credit spreads on interest income by investing in longer-term fixed income securities.

MARC also observes that KAF Investment has reduced its exposure to key man risk by shifting responsibilities from the investment bank’s founder and majority shareholder Datuk Khatijah Ahmad to a new management team.

The stable outlook reflects MARC’s expectations that KAF Investment’s ability to manage its credit and market risks in relation to its operations will be maintained through a prudent investment policy.

Major Rating Factors

Strengths

• Strong capitalisation and comfortable liquidity position; and
• Conservative investment strategy.

Challenges/Risks

• Earnings dependent on domestic capital market conditions; and
• Reliance on wholesale funding