MARC has affirmed its long-term and short-term financial institution ratings of AA-/MARC-1 on KAF Investment Bank Berhad (KAF Investment). The affirmed ratings are underpinned by the bank’s commendable earnings performance, prudent risk management and well- positioned franchise in fixed income securities trading. 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 RM7.1 billion as at end-February 2011. Formerly a discount house, it is mainly involved in money market instruments and trading of debt securities. The majority shareholder of the bank is its founder and managing director Datuk Khatijah Ahmad through her 80% stake in the bank’s ultimate holding company, AKKA Sdn Bhd.

While KAF Investment’s revenue diversification is more limited compared to other major domestic investment banks, the investment bank has carved a niche for itself in the fixed income trading space where the domestic investment banking sector is concerned. KAF Investment’s corporate lending activity is essentially geared to provide bridging loans for companies pending the completion of fundraising exercises. As a money market intermediary, KAF Investment accepts short-term deposits and funds from the banking sector, private sector and public sector, and invests these funds in fixed income securities.

For the nine months ended February 2011 (9MFY2011), pre-tax profits were RM149.1 million against RM76.1 million for the full fiscal year 2010. The surge in profits was mainly due to capital gains realised from the disposal of securities held to maturity and profits from trading activities. In terms of profitability, KAF Investment appears well placed among domestic investment banks. It has kept to its core competency in money market operations and avoided a high reliance on cyclical equity, debt origination-related revenues and mergers and acquisitions advisory revenues. The investment bank’s business model has performed very well in an environment of benign interest rates and relatively stable corporate bond spreads.

With the tainting of its held to maturity portfolio of debt investments in FY2011, and the consequent accounting of a large part of its assets under fair value, the bank’s earnings will be exposed to higher volatility in the near term. However, MARC opines that volatility risk is moderated by KAF Investment’s downsized securities portfolio and active management of its securities portfolio. During 9MFY2011, the non-distributable reserves were revalued upward by RM22.7 million due to the reclassification of held to maturity investments as available for sale investments.

Despite the increase in overnight policy rates by 25 basis points, the bank’s net interest margin deteriorated to 0.67% in 9MFY2011 from 1.41% in FY2010 due to higher funding costs. The bank’s cost to income ratio increased substantially to 58.4% in FY2010 (FY2009: 14.8%) due to the negative impact of non-recurring expenses (one-off litigation fees). The bank benefits from the flexibility in its cost base; historically the larger part of the bank’s operating costs are related to staff costs which can be adjusted during industry troughs. The bank’s return to assets (ROA) and return on equity (ROE), which came in at 1.77% and 15.07% during 9MFY2011 should show a strong recovery for the full FY2011.

A substantial part of the bank’s funding requirements continue to be sourced from institutional deposits which comprise approximately 80% of customer deposits. However, deposits from customers contracted by 28.4% to RM3.1 billion as at end-9MFY2011 (FY2010: RM4.4 billion). In line with the bank’s reduced securities holdings, deposits from financial institutions also decreased by 22.4% to RM2.9 billion (FY2010: RM3.8 billion). The liquidity of the asset side of KAF Investment’s balance sheet remains good.

KAF Investment’s risk-weighted capital ratio stood at 77.7% as at end-February 2011, which was significantly higher than the industry average of 33.5%. The solid capitalisation level was largely due to the bank’s high equity base as well as its balance sheet composition of largely low risk-weighted assets. The bank’s low credit risk appetite ensures that only government securities and low-risk corporate bonds (rated AA- and above) are held in its securities portfolio.

Backed by an experienced management team, KAF Investment has built a commendable track record with a strong reputation in the dealing of money market instruments and trading in debt securities. MARC is maintaining a stable outlook on KAF Investment premised on the bank’s track record of resilient performance, asset/liability management competencies, strong risk culture and solid capital adequacy.

Contacts:
Lim Mei Ching, +603-2082 2267/ meiching@marc.com.my;
Anandakumar Jegarasasingam, +603-2082 2250/ kumar@marc.com.my.