MARC has affirmed its AA-IS rating on MNRB Holdings Berhad's (MNRB) RM200 million Islamic Medium-Term Notes (IMTN) with a negative outlook. The negative outlook reflects MNRB's weak company-level cash flow coverages and liquidity in addition to the high level of double leverage at the investment holding company level. Dividends received to interest paid coverage at the holding company declined below one time for the 12 months ended March 31, 2010 (FY2010) from 1.9 times a year ago. The investment holding company remains heavily reliant on its core subsidiary Malaysian Reinsurance Berhad's (Malaysian Re) operating performance and ability to upstream dividends. MARC believes that MNRB will require material shareholder support to meet the bullet repayment of the notes due in December 2012 given the restricted dividend payment capacity of its operating subsidiaries and the lack of visibility in its dividend stream. The limited diversification of MNRB's underlying dividend cash flow, structural subordination of the holding company's obligations to that of its operating entities, and significant capital needs of the operating entities remain major rating constraints.

The affirmed rating, meanwhile, incorporates the improving trend in the group's consolidated operating performance in FY2010, with Malaysian Re and the takaful operating entity, Takaful Ikhlas Sdn Bhd, reporting better results. However, MARC notes that the takaful operator does not contribute enough profitability, as yet, to provide meaningful earnings diversification. The rating also implies notching between the senior debt rating at the holding company and MARC's assessment of Malaysian Re's financial strength. National general reinsurer Malaysian Re remains the backbone of the group's fundamental creditworthiness; it provides approximately 76% of MNRB's combined segment pre-tax earnings (excluding losses related to investment holding activities and prior to consolidation eliminations) and houses 79% of the group's equity base. MNRB's rating also benefits from the long-term nature of MNRB's largest shareholders as MARC considers the holding company's ability to raise equity to be highly relevant to the repayment of the notes in 2012. MNRB does not have any debt maturities until December 2012.

Malaysian Re is the market leader in the Malaysian general reinsurance industry with a market share of 61.3% (FY2009: 60.1%), mainly attributed to its voluntary cession arrangements with domestic insurance cedants which allows the company to generate 42.1% of its premium income. Malaysian Re’s underwriting portfolio continues to show improving geographic diversification; its overseas business rose to 28% of the company’s underwriting portfolio in FY2010 from 25% in FY2009. The fire and motor sectors remain the largest revenue contributors, collectively accounting for 58% of premium income in FY2010 (FY2009: 60%).

Malaysian Re’s pre-tax profits doubled to RM113.0 million in FY2010 on the back of improved investment returns (including gains from disposal of investments and dividends from its associate) and increased underwriting surplus. That said, MARC understands that the improvement in the underwriting surplus was mainly due to adjustments of RM52 million in relation to the changes in accounting estimates in the computation of unearned premium reserves (UPR), under which UPR is now computed on an inception date basis instead of statement received dates. MARC opines that the changes provide a more accurate reflection of the company’s earnings. However, notwithstanding the impact of the above changes, underwriting results imply further deterioration of the loss ratio to 67.7% at end-FY2010 from 64.2% at end-FY2009. This is attributed to the overseas portfolio which was negatively impacted by several severe catastrophes during the year. Its local business, meanwhile, remains dampened by consistently high motor claims. MARC opines that the consolidation of its overseas portfolio and potential revamp in motor insurance premium structure are expected to be key factors driving profitability growth for the company.

Malaysian Re’s dividend payout capacity has been significantly affected by the implementation of the risk-based capital framework (RBC) effective 2009. The internal capital adequacy ratio which Malaysian Re is required to maintain under the RBC framework will restrict Malaysian Re’s ability to upstream dividends to its holding company going forward. MNRB’s company-level financial results significantly weakened in FY2010 as a result of the decline in its dividend income. MNRB posted a net loss of RM59.6 million in FY2010 (FY2009: net profit of RM2.1 million) after recording a one-off impairment loss of RM44.5 million for its investment in United Kingdom-based Principle Insurance Company Limited (PIHL). Higher management expenses and finance cost also contributed to the poor performance. MNRB’s takaful and retakaful subsidiaries are still in the midst of building their respective franchise and have yet to make significant contributions to MNRB. At the same time, the capital needs of the operating entities are exerting pressure on MNRB’s balance sheet. MNRB’s subscription to equity issuance of its subsidiaries resulted in cash outflows of RM20.0 million in FY2010 and RM25.8 million in FY2009.

MNRB’s company-level cash balances are nominal at RM0.14 million as at end-FY2010 and additional liquidity is provided by RM16.9 million in liquid investments. While MARC views that the company would most likely be able to service its finance cost of RM9.5 million per year from internal liquidity resources, the repayment of RM200 million IMTN, or RM150 million excluding notes held by its subsidiaries will have to be met from external sources.

Rating stability will be dependent on measures taken by MNRB to restore its liquidity and debt service capacity to levels consistent with its current rating.

Contacts:
Lim Kok Seng, +603-2082 2272/ kokseng@marc.com.my;
Anandakumar Jegarasasingam, +603-2082 2250/ kumar@marc.com.my