SMALL MEDIUM ENTERPRISE DEVELOPMENT BANK MALAYSIA BERHAD - 2019

MARC has assigned a financial institution (FI) rating of AAA to Small Medium Enterprise Development Bank Malaysia Berhad (SME Bank) with a stable outlook.

The AAA rating primarily reflects SME Bank’s status as a development financial institution (DFI) that has received support from the government for its mandated role to assist in the growth of small and medium enterprises (SME), a key focus of the government. Wholly owned by the government through the Ministry of Finance, SME Bank is regulated by Bank Negara Malaysia (BNM) and supervised by the Ministry of Entrepreneur Development (MED). The rating agency observes that government support has been evident through the conversion of government borrowings into capital of SME Bank and by government guarantees on SME Bank’s sukuk issuances. Any signs of the government withdrawing material direct or indirect support would exert downward pressure on SME Bank’s FI rating.

SME Bank mainly provides Shariah-based financing facilities to SMEs for asset acquisitions and working capital requirements as well as revolving financing. Since its inception in 2005, SME Bank has approved about RM30 billion in financing to over 17,000 SMEs in various sectors. The group accounts for a substantial 44.2% of all DFI financing to SMEs, underscoring the importance of its position in the SME space. Nonetheless, the group’s market share of total SME financing stood at 2.2% as at end-2018, reflecting the prevailing stiff competition from commercial banks in financing and lending to the SME segment. As at end-2018, the group’s financing book stood marginally lower at RM7.0 billion (2017: RM7.1 billion); its portfolio is largely skewed towards the services sector (63%), followed by construction (19%) and manufacturing (17%).

The group’s gross impaired financing (GIF) ratio rose sharply to 28.6% in 2018 (2017: 19.4%), with the increase mainly reflecting the adoption of MFRS 9 in that year. This aside, the DFI’s asset quality has historically been weak, due to its developmental role to fund unserved and underserved SMEs. Adoption of the accounting standard has also led to higher provisioning charges of RM701.9 million during the year (2017: RM81.0 million). As a result, financing loss reserve ratio rose to a healthier 67.4% (2017: 34.2%). The significant increase in provisioning led to the group registering a net loss of RM556.1 million in 2018 (2017: net profit of RM63.8 million). For 1H2019, the DFI recorded a turnaround in earnings, with net profit for the period totalling RM42.0 million.

In recognition of its challenging past performance, SME Bank’s new management team, that was put in place in September 2018, has been focusing on account management initiatives to improve asset quality and recovery. It has also rolled out a two-year transformation programme which includes a new digital platform aimed at enhancing the DFI’s mandated role in assisting the development of SMEs.

The group’s funding profile remained largely supported by deposits and borrowings from the government and government-related entities as well as by government-guaranteed borrowings and sukuk issuances, which accounted for 85.5% of total funding as at end-2018. As a DFI, SME Bank should expect to enjoy some level of access to reliable long-term funding from the government and its related entities. MARC also takes comfort in the strong liquidity coverage ratio of 163% in addition to the more than adequate liquid-asset ratio of 40.8%.

The group’s core capital ratio and risk-weighted capital ratio fell to 11.6% and 18.8% in 2018 (2017: 17.5%, 22.4%) due to the MFRS 9 impact. The DFI’s capital ratios remain lower than its peers. Capital support from the government has been forthcoming; government borrowings of RM500.0 million was converted into equity to improve its capital adequacy position in 2017.

Major Rating Factors

Strengths

• Benefits from strong government support as a wholly government-owned institution;
• Continued government focus on the growth of the SME sector; and
• Strong regulatory oversight.

Challenges/Risks

• High impairment levels;
• Rising delinquencies in the SME sector; and
• Competition from other financial institutions for lending to the SME sector.