Malaysia Industry Focus Islamic Banks

Transcription

1 Malaysia Industry Focus Refer to important disclosures at the end of this report DBS Group Research. Equity 2 Feb 217 The unconventional banking aspect Domestic Islamic financing growth expected to continue outpacing conventional loan growth, driven by regulatory push for internationalization of Islamic finance Hopes for further growth pinned on increase in financial inclusion through product innovation Main Islamic banking proxy BIMB as the largest Bursa-listed Shariah compliant financial institution with strong potential to lead product innovation Traction on BURSA s commodity trading platform makes it an indirect proxy; MBSB is a potential M&A play Profit-sharing principle of banking. Islamic banking is based on Islamic principle transactions of which profit (and loss) sharing is a major feature ensuring justice and equity in an economy. The financial relationships established are deemed to be participatory in nature. Islamic banking technically bans the receipt and payment of interest in any of its operations. In the most basic way, this sets Islamic banking apart from conventional banking. To realize the full potential of demand for Islamic banking from sizeable Muslim population and other Muslim-dominant countries, issues to overcome include non-uniformity in Shariah views, establishing an even playing field, and strengthening resources and awareness are among the key issues for this segment. Product innovation to be the game-changer for industry. Given the knowledge and expertise acquired through actively pioneering initiatives and delivering solutions in the Islamic banking industry, Malaysia is indisputably making inroads to becoming the global hub for Islamic finance. We expect domestic Islamic financing growth to continue outpacing conventional loan growth with a 4-year CAGR of 12 over FY15-2F, as opposed to 2 for conventional loans. This is mainly underpinned by a growing push by the banks to fulfil BNM s target of 4 proportion of Islamic financing to total system loans. Further upside to this could come from improvement in financial inclusion and regionalisation of Islamic finance. In order to achieve this, we believe Islamic banks should differentiate itself from their conventional peers through product innovation. BIMB, the main Islamic banking proxy in Malaysia. We like BIMB (holding company of Bank Islam) for its deep-rooted expertise in the industry, which we believe forms a strong competitive advantage as it positions them as a likely leader in product innovation. Maybank Islamic complements the Islamic banking scene for its size and established regional presence which will work to its advantage in competing on the global front. A new wave of M&A activities in the Islamic banking space is plausible although the timing remains the key risk. Potential M&A candidates include MBSB (whose appeal lies in its lucrative personal financing business and sizeable Islamic banking asset; featured as an Equity Explorer in this report) and unlisted MUAMALAT (from a long-awaited pare-down in stake by its largest shareholder, DRB). Albeit more indirectly, Bursa Malaysia is an indirect proxy as transactions on its commodity trading platform are expected to increase in conjunction with Islamic financing growth. KLCI : 1,77.68 Analyst Lynette CHENG Sue Lin LIM lynettecheng@alliancedbs.com suelinlim@dbs.com STOCKS Source: DBS Bank, Bloomberg Finance L.P. Closing price as of 17 Feb 217 Financing growth for Islamic banking to outpace conventional banking in Malaysia RM bn 2, 1,5 1, Islamic banking Conventional banking growth Total banking system growth Source: BNM, DBS Bank, AllianceDBS Price Mkt Cap Target Price Performance () RM US$m RM 3 mth 12 mth Rating Maybank , (1.2) HOLD BIMB Holdings , BUY Bursa Malaysia , BUY Malaysia Building Society Berhad ,497 NA 27.8 (14.5) NOT RATED Maybank Islamic and BIMB among the biggest global Islamic banks Source: World Islamic Banking Conference Leaderboard, DBS Bank, AllianceDBS F 218F 219F 22F Conventional banking Islamic banking growth 3 BANK ISLAM (MY) 13.3 CIMB ISLAMIC (MY) 13.6 TURKIYE FINANS (TU) 14.5 KUWAIT TURKISH (KU) 14.6 BANK AL-JAZIRA (SA) 16.9 ALINMA BANK (SA) 21.5 MASRAF AL RAYAN (QA) 22.8 ALBARAKA BANKING (BAH) 23.6 BANK RAKYAT (MY) 24.6 QATAR ISLAMIC (QA) 32.2 ABU DHABI ISLAMIC (UAE) 34.9 DUBAI ISLAMIC (UAE) 36.4 MAYBANK ISLAMIC (MY) 4.8 KUWAIT FINANCE HOUSE (KU) 54.5 AL RAJHI BANK (SA) Total Assets (US$ bn) ed-ck / sa- WMT, PY

2 Table of Contents Malaysia s journey to becoming the Global Hub for Islamic Finance 3 Unleashing the potential 9 Two of a kind 12 Opportunities in Islamic Financing 17 Challenges for the industry 2 Industry players at a glance 21 Islamic banking proxies 22 Conclusion 24 Company profiles 25 BIMB Company Guide 26 Bursa Malaysia Company Guide 34 Malaysia Building Society Equity Explorer 42 Maybank Islamic 5 Bank Rakyat 52 Bank Muamalat 54 Appendix: OIC members: Selected economic data points 57 Industry benchmarking 58 Islamic Banking: Definition of terms 61 Page 2

3 MALAYSIA S JOURNEY TO BECOMING THE GLOBAL HUB FOR ISLAMIC FINANCE Malaysia is the global leader in Islamic finance. Malaysia is the global leader in Islamic Finance, with Saudi Arabia and Iran trailing just behind. Although Malaysia ranks third by Islamic banking assets, Malaysia s runaway success in the sukuk market boosted its global position by finance assets to the top of the table. Four Malaysian banks (Maybank Islamic, Bank Rakyat, CIMB and Bank Islam) are ranked among the top 15 largest Islamic banks (by assets). The roadmap to success was not without a great deal of effort. Malaysia s competitive advantage in the sector was driven by strong government support, which brought about among others, regulatory changes, tax incentives and expanded educational resources to promote growth in the industry. Targets for 22. To take advantage of this strong footing gained, the government has set the targets for the industry to achieve by 22. This includes: (1) increasing the global share of Islamic banking assets from 8 in 29 to 13 in 22, (2) increasing the global share of takaful (insurance based on Islamic principles) contribution from 11 in 29 to 2 in 22, (3) increasing Islamic financing s share of total financing in Malaysia from 29 in 21 to 4 in 22, and (4) propelling at least one Islamic financial institution to become one of the global top 1 players by asset size by 22. Global Islamic finance assets Top 1 countries Global: Asset size of major BANK ISLAM (MY) 13.3 CIMB ISLAMIC (MY) 13.6 TURKIYE FINANS (TU) 14.5 KUWAIT TURKISH (KU) 14.6 BANK AL-JAZIRA (SA) 16.9 ALINMA BANK (SA) 21.5 MASRAF AL RAYAN (QA) 22.8 ALBARAKA BANKING (BAH) 23.6 BANK RAKYAT (MY) 24.6 QATAR ISLAMIC (QA) 32.2 ABU DHABI ISLAMIC (UAE) 34.9 DUBAI ISLAMIC (UAE) 36.4 MAYBANK ISLAMIC (MY) 4.8 KUWAIT FINANCE HOUSE (KU) 54.5 AL RAJHI BANK (SA) Total Assets (US$ bn) Source: World Islamic Banking Conference Leaderboard Malaysia: Asset size of Islamic banks RM bn MAY ISL 92 BANK RAKYAT 57 BIMB 55 CIMB ISL 46 PUBLIC ISL 44 RHB ISL Source: Companies, DBS Bank, AllianceDBS Malaysia Saudi Arabia Iran UAE 41 Kuwait MBSB Qatar 38 Bahrain Turkey Indonesia Bangladesh Other AMISL 26 HL ISL 23 Muamalat 19 HSBC AMAN 15 OCBC AL- 13 AFFIN ISL 11 SC SAADIQ 11 KFH 1 ALLCE ISL 7 Al-Rajhi 3 AFB Total Assets (US$ bn) Islamic Banking Islamic Funds OIFI Sukuk Takaful No of Islamic FIs (RHS) Source: Thomson Reuters Islamic Finance Development Report 215 Page 3

4 Global: Top Islamic economies Country Islamic Finance Assets Islamic Banking Assets Islamic Financial Institutions Number of Islamic Banks/ Windows Takaful / Retakaful Assets Number of Takaful / Retakaful Operators Other Financial Institutions Assets Number of Other Financial Institutions Value of Outstanding Sukuk Net Asset Value of Islamic Funds USD mil USD mil USD mil USD mil USD mil USD mil Global 1,814,86 1,345,891 1, , , ,94 55,794 Malaysia 415, , , , ,256 17,797 Saudi Arabia 412, , ,38 4 4, ,89 23,363 Iran 345, , , , ,538 UAE 161, , , , , Kuwait 97,576 87, , ,236 Qatar 86,524 71, , Bahrain 72,825 68, ,585 9 Turkey 53,883 44, ,283 3 Indonesia 4,396 21, , Bangladesh 23,15 22, Pakistan 18,279 12, ,58 99 Egypt 13,487 12, Sudan 1,651 1, Jordan 8,219 7, Switzerland 6, , Source: Thomson Reuters Islamic Finance Development Report 215 How did Malaysia get here? The evolution of Islamic finance in Malaysia began as early as 1963 with the establishment of the Pilgrims Management and Fund Board (Lembaga Tabung Haji). In 198, a seminar on National Development from Islamic Perspective proposed the establishment of Bank Islam. Three years later, Bank Islam opened its doors for business once Malaysia passed the Islamic Banking Act. Takaful companies were incorporated under the Takaful Act 1984 subsequent to its enactment. In 1991, Bank Islam was listed on the stock market. The second Islamic bank, Bank Muamalat was established in Dual financial system structure. Conventional financial institutions were then allowed to create Islamic windows which enabled them to offer Shariah-compliant banking products and services. This further facilitated the creation of a dual-financial system, in which Islamic finance operates alongside the conventional financial system. In 1993, the Islamic Interbank Money Market was launched, which continued to lend support to the Islamic banking industry. A Shariah Advisory Council was established in 1997 by BNM, to ensure the conformity of Islamic banking and takaful products to the Shariah principles. Creation of sukuk market. An important agreement was signed in 21 between institutions in Bahrain, Indonesia, Sudan, Saudi Arabia, and Malaysia to create the International Islamic Financial Market (IIFM) which strived to develop an international secondary market for the trading of sukuk and other Islamic financial instruments. To facilitate liquidity management further, International Islamic Liquidity Management Corporation (IILM) was established in Malaysia in 21 to create and issue shortterm Shariah-compliant financial instruments. Invitation to foreign Islamic banks to operate in Malaysia. The industry progressively liberalised, as licenses were granted to three foreign banks AFB, Al-Rajhi and KFH in 23 to allow more foreign participation. Towards this end, the requirements imposed include a minimum capital of RM3m as well as submissions of a sound business plan and ownership structure to BNM. Islamic Financial Services Board (IFSB) started operations Page 4

5 in Malaysia in 23, to serve as an international standard-setting body of regulatory and supervisory agencies. In 26, the Malaysia International Islamic Financial Centre (MIFC) initiative was launched with the aim of providing a platform for participants in the industry to communicate with each other. International Centre for Education in Islamic Finance (INCEIF) was established in Malaysia to develop and nurture talents and experts for the global Islamic finance industry. Two new Islamic banking licences were offered in 29, with the requirement of paid-up capital of at least USD1bn. Finally, the Islamic Financial Service Act (IFSA) was passed by Parliament in 213. Malaysia: Evolution of Islamic banking Year Milestones 1963 Establishment of Lembaga Tabung Haji 198 The Seminar on National Development from Islamic Perspective (198) proposes the establishment of Bank Islam 1983 Malaysia passes the Islamic Banking Act Bank Islam begins operations in 1 July Enactment of Takaful Act Bank Islam is listed in the Stock Market 1993 Interbank Money Market is established 1997 BNM establishes Shariah Advisory Council 1999 The second Islamic bank is established, Bank Muamalat 21 Establishment of International Islamic Financial Market 23 Islamic Financial Services Board (IFSB) started operations in Malaysia 23 Licences are given to three foreign banks AFB, Al-Rajhi and KFH 26 The Malaysia International Islamic Financial Centre (MIFC) initiative is launched and International Centre For Education In Islamic Finance (INCEIF) was set up 29 Two new Islamic banking licenses offered 21 International Islamic Liquidity Management Corporation (IILM) was established 213 Islamic Financial Service Act 213 is passed by Parliament Source: Companies, DBS Bank, AllianceDBS establishing a separate regulatory framework that harmonised the Shariah principles, ensured a competitive playing field for Islamic banks to operate in and fostered an enabling environment to nurture more talent development (more on page 2). A giant leap with IFSA 213. The regulatory environment for Islamic banks found itself at a crossroad when the Islamic Financial Services Act (IFSA) was implemented in 213. This supersedes the Islamic Banking Act 1983 and the Takaful Act 1984, while incorporating elements of the Payment System Act 23 and the Exchange Control Act The IFSA enforced enhanced requirements for Shariah Governance by requiring Islamic banks to comply with the Shariah and operational standards issued by Bank Negara Malaysia (BNM) and the International Shariah Research Academy in all aspects of their business objectives and operations. By doing so, BNM aspires to elevate the operationalization of Shariah contracts/concepts, ensure higher compliance standards and ensure global acceptability of Malaysian financial products. The introduction of new standards remains an ongoing process. To date, there have been 14 new standards issued since 213. In our view, the enactment of the IFSA 213 clearly illustrates BNM s intention to encourage the industry to move to a risk-sharing model as opposed to a risk-transfer model. We believe this encourages more product innovation within the industry, thus allowing Islamic finance players to differentiate their products from conventional ones. Rising to the challenges. Malaysia has successfully addressed the key issues confronting the Islamic banking sector. This includes Page 5

6 Malaysian Islamic banking: IFSA 213 Shariah Standards Compliance with fundamental requirements of respective Shariah contracts Islamic Finance: Islamic banks conduct financial intermediation functions using Shariah contracts Distinct risk and reward profiles based on Shariah contracts End-to-end Shariah compliance under the Islamic Financial Services Act 213 Operational Standards Oversight Functions Strengthened risk Codification of the role of the management, governance, Shariah committee and board transparency and disclosure, of directors of financial market conduct and other institutions in ensuring Shariah operational aspects of applying Compliace Shariah standards. Resolution Priority of payment reflective of underlying Shariah contracts Sales Based Murabahah Istisna' Ijarah Tawarruq ASSETS Equity Based Mudharabah Musharakah Fee Based Wakalah Kafalah Rahnu Islamic Deposits Wadi'ah Qard Tawarruq LIABILITIES Investment Accounts (Equity) Mudharabah Musharakah Investment Accounts (Other) Wakalah Source: BNM Malaysian Islamic banking: Shariah Governance framework Shariah as overarching principle in Islamic finance BOARD RISK MANAGEMENT COMMITTEE BOARD Overall oversight on Shariah governance structure & Shariah Compliance SHARIAH COMMITTEE Oversight accountability on Shariah related matters BOARD AUDIT COMMITTEE MANAGEMENT Ensure executions of business & operations are in accordance with the Shariah principles Provide necessary support to the Shariah Committee Shariah Risk Management Control Function Shariah Review Function Shariah Research Function Shariah Audit Function Identify, measure, monitor, report & control Shariah non-compliance risk Review business operations on a regular basis to ensure Shariah compliance Conduct in-depth Shariah research prior to submission to the Shariah Committee Provide independent assessment & objective assurance designed to value add & improve IFI's compliance with Shariah Source: BNM Shariah Compliance and research functions Page 6

7 Malaysia: Islamic Finance Tax Neutrality Tax neutrality The equal footing provision in the Income Tax Act ensures that the Islamic financial transactions are not taxed differently from conventional financing transactions, regardless of the fundamental differences between the two. This means that, for tax purpose, profits received in Shariahcompliant transactions are treated in the same way as interest rate gains in conventional finance. Conversely, the payment of profits (equivalent to the payment of interest in conventional finance) by the borrower is treated as interest costs from a tax perspective. Similarly, partnerships formed under the Shariah concept of a joint venture entailing the sharing of profits and/or losses are not recognised as partnerships from a tax perspective. The equal footing provision in the Stamp Act ensures that Islamic banking and investment products, which require additional sales and purchases of the underlying assets due to the profit-and-loss sharing agreements, are as attractive and cost-efficient as their conventional counterparts. The provision ensures that where assets are required to be transferred (which would not otherwise be necessary under conventional financing schemes), the transferor is not subject to balancing adjustments on the sale/purchase and thus the transaction remains tax neutral. Similarly, partnerships formed under the Shariah concept of a joint venture entailing the sharing of profits and/or losses are not recognised as partnerships from a tax perspective. Source: IMF Working Paper Malaysia ranks highly in terms of governance index globally. The efforts in developing strong regulations have resulted in Malaysia becoming one of the strongest countries in terms of governance index ranking globally. This is supported by a whopping number of Shariah scholars in the country (at 23) and an average disclosure index of 47 as at 215. Islamic finance governance index Top 1 countries Oman Maldives Malaysia Bahrain Pakistan Number of Shariah Scholars Average Disclosure Index Centralised/National Shariah Board present Regulation strength indicator: Strong Medium Weak Source: Thomson Reuters Islamic Finance Development Report 215 BNM successfully spearheaded the resolution to Islamic banks problem of lack of high-quality liquid assets (HQLA) by becoming the largest issuer of short-term sukuk (BNM switched to other instruments for liquidity management in 215). To date, Malaysia remains one of the few countries with an active and liquid Islamic money market. Malaysian Islamic institutions have a higher percentage of liquid assets available for investing at 46 vs 35 and 12 for the GCC and other regions, respectively. Malaysia s deep suite of products and instruments available in the domestic market also increased the Malaysian Islamic institution s concentration of short-term assets, which make up more than half of their total assets. Qatar Indonesia UAE Kuwait Sudan Average percentage of liquid assets available for investing () Source: Thomson Reuters Average percentage of liquid assets available for investing () Source: Thomson Reuters 46 GCC Malaysia Others Creating a level playing field in Malaysia. As evidenced by the competitive rates offered for Islamic banking products vis-à-vis conventional banking products, Islamic banks have established a level playing field in Malaysia. To enhance the attractiveness of Islamic banking products, on top of ensuring tax neutrality in Islamic financing transactions, regulators have introduced incentives to facilitate growth in this nascent industry. This includes granting tax exemptions to several facets in the Islamic finance industry, including financing, sukuk, fund management and stock broking. 22 GCC Malaysia Other Short term Medium term Long term Page 7

8 MY: Islamic Finance Tax Incentives Tax incentives Tax exemption for profits derived from sukuk 1-year tax exemption for Islamic banks and Islamic insurance companies on income derived from business conducted in foreign currencies, including transactions with Malaysian residents. This exemption was given to encourage foreign participation in Malaysia s Islamic finance and to encourage Islamic financial institutions to transact internationally in making Malaysia an international Islamic financial hub. 1-year income tax exemption for domestic and foreign fund managers who manage Islamic funds for foreign investors. 3-year stamp duty exemption of 2 on instruments related to Islamic financing. Tax deductions on expenses incurred in establishing an Islamic stock broking firm. Tax exemption on profits paid by licensed Islamic banks in Malaysia to non-resident customers Source: IMF Working Paper Topping the table for efforts in spreading awareness. Indeed, the Malaysian regulatory support in creating a level playing field, along with efforts in spreading awareness of Islamic financing have spurred the take-up of Islamic products by non-muslim consumers. Malaysia has the most number of conferences (at 24) and seminars (at 27) held on Islamic banking and second highest amount of news reported on the topic (at 3,9; just behind UAE at 3,944) - as at 215. Once again, this has propelled Malaysia to becoming the top ranked country globally in terms of awareness indicator. Islamic finance awareness indicator Top 1 countries UAE Malaysia Pakistan Bahrain Saudi Arabia Conferences (LHS) Seminars (LHS) News (RHS) Source: Thomson Reuters Islamic Finance Development Report Shortage of talent is one of the most frequently mentioned challenges within the Islamic banking industry. To address this, the government has lent strong support to the provision of education on Islamic finance. In 25, BNM set up the International Centre for Education in Islamic Finance (INCEIF) to offer postgraduates studies in Islamic Finance. The intensive focus on providing quality education and research has led to Malaysian institutions such as International Islamic University, University Sains Islam Malaysia, International Shariah Research Academy for Islamic Finance and Insaniyah University College to the top of the table in terms of Islamic Finance education and research. Unsurprisingly, Thomson Reuters ranked Malaysia as Oman Qatar UK Indonesia Turkey the top country under its knowledge indicator, attributable to the vast number of degrees and courses (at 3 and 16, respectively) as well as published research paper (at 522) on Islamic finance compared to its global peers as at when 215. Islamic finance knowledge indicator - Top 1 countries Malaysia UK Pakistan Indonesia USA Source: Thomson Reuters Islamic Finance Development Report 215 Discrepancy in Shariah practices still a hurdle. Nevertheless, a key challenge to the industry in Malaysia lies with the lack of uniformity in Shariah views because of the differing views among religious scholars. For instance, particularly in Malaysia, commodity murabahah is widely used, but its compliance with Shariah remains a debatable issue. To this end, a call to establish a global Shariah body has been made, which can then address the issue of inconsistencies in practices across the region. While the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic Financial Services Board (IFSB) have provided some Shariah standards and governance guidelines, the level of compliance to these standards differ across the region. Regulators in Bahrain, Qatar, Sudan, and Syria have made the AAOIFI standards mandatory for Islamic financial institutions while most other countries have considered these standards as recommendations. Saudi Arabia UAE Bahrain India Degrees Courses Research papers Jordan Page 8

9 UNLEASHING THE POTENTIAL We expect domestic Islamic financing growth to continue outpacing conventional banking loan growth, driven by the regulatory push to fortify domestic Islamic banking entities to enhance global competitiveness. To that end, we envisage Islamic financing growth to reach a 4-year CAGR of 12 from FY16 to FY2F, as opposed to 2 for conventional banking loan growth. This is underpinned by the assumption that system loan growth stands at a 4-year CAGR of 5 and the proportion of Islamic financing to the total system grows from 29 currently to 37 in 22F (note that BNM s target is 4). Malaysia: Asset growth in conventional and Islamic banking RM bn 3, 3 2,5 2, 1,5 1, Islamic banking Conventional banking growth Total banking system growth Source: BNM, DBS Bank, AllianceDBS Source: BNM, DBS Bank, AllianceDBS Conventional banking Islamic banking growth Malaysia: Financing growth in conventional and Islamic banking RM bn 2, 1,5 1, Islamic banking Conventional banking growth Total banking system growth F 218F 219F 22F Conventional banking Islamic banking growth Malaysia: Proportion of conventional and Islamic banking financing Source: Companies, BNM, DBS Bank, AllianceDBS Limited room to grow without substantially increasing financial inclusion. Given that seven out of the eight major banks in Malaysia have yet to reach BNM s targeted Islamic financing to total loan proportion of 4, we believe there is still room for Islamic financing growth to continue outpacing conventional loan growth. However, we feel that an increase in financial inclusion would have to materialize for further boost in growth. Malaysia: Major banks proportion of Islamic financing to total domestic loans Conventional banking 32 Source: Companies, DBS Bank, AllianceDBS What does this mean to the players in the industry? We view Islamic product offerings as complementary to the product suite of a bank, especially in Muslim-majority countries such as Malaysia. Banks without Islamic product offerings risk forfeiting the portion of the market with a natural bias towards Islamic products. Malaysian banks appear to be well aware of the said risk, as evidenced by the availability of Islamic product offerings across all banks F F Islamic banking F F BNM's 4 MAY AMMB RHB CIMB AFFIN AFG HLB PBK Page 9

10 Challenging to improve financial inclusion with current product offering. According to the Global Findex by World Bank, while the percentage of Malaysian population that owns an account in financial institutions stands at 81, the percentage of Malaysian population that has borrowed from a financial institution is only at 2 in 214. We believe further improvement in access to borrowing is challenging, as the current product offering has limited suitability for the remaining portion of the unserved population. However, product innovation could act as the game changer in this aspect as new offerings could increasingly meet the different risk and return requirements of this dissimilar segment of consumers. Product innovation will be the game changer for the Islamic banking industry... Currently, Islamic products largely mirror their conventional equivalents, rendering minimal product differentiation between the two models. However, since the implementation of IFSA 213 which encouraged a move towards a risk-sharing model (from risk-transfer model), we have seen some developments on the product innovation aspect. For example, a new guideline on distinguishing Islamic deposits and investment accounts was introduced in early 213, with the aim of improving the alignment of the salient features of Shariah contracts to its legal recognition. Consequently, Islamic banks now offer investment accounts as an additional alternative on top of the typical current account, savings account and term deposit products...especially with sufficient consumer education. Insufficient education on these products could result in customers finding difficulty in accepting the differences of the new product offerings. In the case of investment accounts, despite higher returns to compensate for the higher risk assigned, differences such as the absence of principal guarantee, loss of insurance deposit coverage and the additional disclosure requirements and terminologies pose a risk of a customer exodus back to more familiar conventional products. Nonetheless, in our view, it is crucial for Islamic banks to take this risk in order to enable differentiation from banks operating under the conventional model. Hence, the ability of Islamic banks in executing this is the critical success factor of the industry. We expect the industry s ability to offer a wider range of products to meet risk and return requirements of consumers, to serve as a stepping-stone in producing real growth (as opposed to displacement of conventional loan growth) in Islamic financing. Hence, we advise investors to keep a lookout for developments in this space. Digital disruption or enabler? Digital disruption has indeed intensified in the past few years, with services such as crowdfunding and peer-to-peer lending gradually creeping into the banking industry. Notably, these alternatives are based on a risk-sharing model, which overlaps with the premise of Islamic banking. In peer-to-peer lending and crowdfunding, lenders are matched directly to the borrowers. To that end, we opine that these new digital innovations have opened up more alternatives for the Islamic banks, in particular to embark on more product innovation and align its products and services more towards the true spirit of Islamic banking. Case in point: Investment account platform. We have seen Islamic banks riding the digital wave through the launch of the Investment Account Platform (IAP; more on page 13). The IAP works in the same vein as a crowdfunding platform where investors can participate in the funding of ventures or projects by making monetary contributions to the projects listed on the platform. The key factor distinguishing IAP from other technology-based fund raising platforms lies in the intermediation roles played by the Islamic banks (for e.g., duediligence, performance monitoring, suitability assessment and investment management). While other fund raising platforms largely feature ventures by SMEs and start-ups, the IAP also includes ventures by listed companies and multinational companies. Independent ratings are also provided to facilitate the users investment decisions. IAP yet to gain traction. There are four sponsoring banks (MAY ISL, AFFIN ISL, Bank Islam, Bank Muamalat) involved in the IAP, but to date, only three projects have been listed on the IAP (since its launch in Feb 216). Nevertheless, we expect this platform to gain traction in the near future as participating banks have expressed keen interest in improving the flow of project listing. Regionalising Islamic banking products and services is the other engine to fire up. Another growth lever for Islamic finance lies in the ability of Islamic banking players to leverage on the strong regulatory support from domestic authorities, to extend their presence regionally to countries whose Islamic finance industry remains under-developed and banking penetration remains low. Consistently, we still expect the successful aforementioned product innovation to be the key success factor in fuelling substantial growth traction within the region. Case in point: Indonesia. The closest market for the Malaysian Islamic bank players to explore is the Indonesian market. With 13 of the world s Muslim population, Indonesia is the world s most populous Muslim nation (29.1m Muslim population as at 21). Banking penetration in terms of both conventional and Islamic is low (13 of population have borrowed from a financial institution, 5 of total banking assets are Islamic), thus implying ample room for growth. Page 1

11 Top 1 countries with the largest Muslim populations, 21 and 25 Country 21 population (mil) of world's Muslim Country Projected 25 population (mil) of world's Muslim Indonesia India India Pakistan Pakistan Indonesia Bangladesh Nigeria Nigeria Bangladesh Egypt Egypt Iran Turkey Turkey Iran Algeria Iraq Morocco Afghanistan Subtotal 1, Subtotal 1, Subtotal for rest of world Subtotal for rest of world 1, World total 1, World total 2, Source: The Future of World Religion by Pew Research Centre Islamic banking has yet to take off in a meaningful way in Indonesia. Based on Otoritas Jasa Keuangan s (OJK) observation, challenges in developing Islamic banking in Indonesia include (1) the lack of coordination between the government and authorities in Islamic banking development, (2) the inability to establish a level playing field, causing the industry to be dragged by inadequate scale and efficiency, high cost of funds as well as insufficient depth in product offerings, (3) shortage of resources (human resource and information technology) to support growth, (4) low consumer awareness, and (5) suboptimal level of regulation and supervision within the industry. Under the roadmap of Indonesian Islamic banking, OJK has expressed willingness to address the issues at hand. Within 215 to 219, OJK aspires to implement seven policy directions and 41 priority programmes to develop the industry in Indonesia. Among the measures listed by OJK are the inclusion of Islamic investment banks in financing government projects, establishing a research and development centre of Islamic banking, further spread Islamic finance financial literacy and introduce incentive framework to encourage the expansion of productive financing in infrastructure and corporate sectors to improve the funding structure. Drawing support from home market. While we believe these initiatives may take time as financial inclusion sits higher on the priority list for OJK, the Malaysian Islamic banking players are in a better position to make inroads in the industry, as they are able to leverage on their home market s rich expertise and deeprooted knowledge in Islamic banking. For instance, MAY has successfully rolled out Islamic financial services in Singapore and Indonesia in the past three years, with the support of its Shariah Centre of Excellence based in Malaysia. Challenges rest on extent of foreign bank participation in Indonesia. OJK stated it would not grant new permits for foreign bank branches. However, it will allow the current foreign bank branches to operate as they are. Going forward, a foreign entity can only penetrate the Indonesian banking industry through ownership in a limited liability (PT/perseroan terbatas) legal entity. While there are no caps on foreign ownership, a single entity is prohibited from holding more than 4 ownership of a bank, although this will be subject to any further approvals by OJK. The regulation was effective after 212 and was not applied retroactively. In that vein, MAY and CIMB have the upper hand given their existing presence in the Indonesian market through Maybank Indonesia and CIMB Niaga, respectively. Page 11

12 TWO OF A KIND What makes Islamic banking different? Islamic finance refers to the provision of financial services according to Islamic jurisprudence (Shariah). Islamic finance differs from the conventional banking model due to the prohibition of: (1) Interest or Riba As it represents an increase in wealth that is not related to engaging in any productive activity (2) Excessive uncertainty or Gharar To honour principles of fair treatment and the sanctity of contracts by reducing information asymmetry (for e.g., contract ambiguity or elusiveness of payoff) (3) Short-selling Based on the principle of ownership where it is believed that one should not sell what one does not own (4) Financing activities considered harmful to the society (for e.g., gambling) How does the banking model fit in Shariah? To ensure a link between financing activities and real activities, return on capital is legitimised by risk-taking. Return is then determined ex post based on asset performance or project productivity. Asset-based financing establishes the link between financing activities and real activities, hence overcoming the issue of prohibition of short-selling. How is this executed? Islamic finance products are contractbased and can be classified into three broad categories: (1) Profit-and-loss-sharing (PLS) financing PLS financing is based on the core principles of equity and participation, deeming it the closest to the spirit of Islamic banking: Key differences in concept CONVENTIONAL MODEL Lender and borrower Interest-based deposits Interest-based financing Functions and operating models based on manmade principles (capitalism theory) Governance as per conventional model Financial Services Act Lenders/Investors are guaranteed of a predetermined rate of interest or returns Time value is the basis of charging interest on capital Source: Alliance Islamic Bank, AllianceDBS Islamic finance. Examples of PLS financing include musharakah (equity-like financing of project and with pure profit-and-loss sharing) and mudarabah (profits shared, but losses borne by financier) (2) Debt-like financing Refers to contracts of exchange. The four debt-like financing instrument include: o Murabahah: Cost-plus agreement with buyers making deferred payments o Salam: Forward agreement where the Islamic financial institution act as the buyer of goods on behalf of the customer, with deferred delivery of the products o Istisna: Forward agreement where the Islamic financial institution act as the buyer of a project on behalf of the customer, with the completion and delivery of the project on a later date o Ijarah: Lease contract with the sale of the right to use an asset for a period of time (3) Fee-based products Refers to contracts of safety and security, such as Wadiah (safe-keeping contracts) and Wakalah (agency contracts) Neutral treatment for conventional and Islamic financing ensures similar returns. The underlying principles of banking between the two models are vastly different, and deliberately so. However, consumers should not confuse the seemingly higher level of intricacy in Islamic financing transactions to higher costs, as regulatory support in Malaysia has ensured neutrality in treatment for conventional and Islamic products. This is further supported by the similar returns offered for conventional and Islamic products in Malaysia. ISLAMIC MODEL Custodian, entrepreneur, financier Safe custody, investment Debt financing, equity financing Functions and operating models based on Shariah Law Governance inclusive of Shariah Governance Framework requirements Islamic Financial Services Act Profit/Risk is shared between capital provider (investor) and user of funds (entrepreneur) Profit on trade of goods or charging on providing service is the basis for earning profit Page 12

13 Islamic banking: Types of Shariah contracts being applied to products Shariah Contracts Profit and loss sharing Debt-like financing Fee-based products Musyarakah Immediate Payment Deferred Payment Rahnu Mudarabah Bai' Sarf Bai' Murabahah & Bai' Bithaman Ajil Kafalah Mudarabah Bay' Dayn Bai' Tawliyyah Wakalah Bai' Salam Wadi'ah Bai' Istisna' Qardh Bai' Istijrar Hiwalah Bai' Inah Tabarru', Waqf & Hibah Source: Bank Islam, IMF, BNM, DBS Bank, AllianceDBS Ijarah /Al-ijarah thumma al-bai' (AITAB) / Ijarah muntahia bi altamlik (IMBT) Ibra' & Muqasah Deposits No rate differential in deposit products. Typically, Islamic deposits apply safekeeping or Wadiah contract. While term deposit rates vary according to promotional rates, we see minimal difference in rate between conventional and Islamic deposit products across most banks, as exemplified by the rates offered by Alliance Bank shown in table below. Nonetheless, documentation-wise, a declaration form appointing the bank as an agent to sell and purchase commodities is required to be signed, for deposits under commodity murabahah. Investment accounts are specific to Islamic banks, and differ from the typical Islamic deposit accounts mainly on the type of Shariah contract involved, guarantee of principal and availability of PIDM protection (see table below). The introduction of investment accounts stemmed from BNM s initiative to enhance the legal clarity on the application of Shariah contracts. The investment account is further separated into two types, i.e. the unrestricted investment account (URIA) and the restricted investment account (RIA). The key difference between the two is on the mandate where URIA, the investment account holder, allows the bank to make the ultimate investment decision without posing any restrictions or conditions while in RIA, the investment account holder provides a specific investment mandate (purpose, asset class economic sector, period of investment). Indicative returns for investment accounts are typically higher, which are commensurate with the higher risk to consumers (no principal guarantee and deposit insurance protection). Consumers should also bear in mind that the indicative returns shown at inception is not a guaranteed rate, as profit rates are determined ex post, based on the performance of the asset or project tagged to the account. Financing rate is also dependent on the pre-agreed profit sharing ratio. Thus, while profits are distributed according to the pre-agreed ratio, the same applies to losses incurred by the asset or project. Investment Account Platform, a new avenue to participate in investment accounts. While retail investors can enquire on investment accounts through Islamic bank branches, an alternative way to participate in restricted investment accounts is via the Investment Account Platform (IAP). Here, individual investors register themselves as an IAP user through the designated website and select their preferred venture to invest in. First- time users are given a suitability assessment to ensure investors are choosing ventures that are within their risk tolerance. The suitability assessment is a requirement by BNM for individual investors for evaluating investors based on their financial capabilities, investment Page 13

14 needs and appetite, and investment knowledge and experience. Institutional investors are not required to take the suitability assessment as they are deemed to have sufficient resources to make an informed investment decision. Upon completion of the suitability assessment, the results are compared against the chosen venture. Investors who have chosen ventures beyond their risk tolerance will be alerted and asked to seek additional consultation at dedicated branches of participating Islamic banks before proceeding with the chosen venture. Once the investor declares an understanding of the risk involved and agrees to proceed with the investment, the Islamic bank creates the investment account for the investor and sends periodical reports on the venture. Impact to the banks. Although banks provide better returns to the customers under the investment accounts, the benefits to the bank comes in the form of (1) savings from non-payment of Malaysia Deposit Insurance Corporation (PIDM) premium, (2) more effective capital management as tagged assets are excluded from capital adequacy ratio calculation, and (3) reduced regulatory cost as investment accounts are excluded from Eligible Liabilities base for the purposes of statutory reserve requirement computations. AFG deposits: Key features similar for conventional and Islamic products Product Name Type Initial/ Minimum deposit Tenure Profit/Interest rate Basic savings Conventional RM2 N/A Basic savings Islamic RM2 N/A Term deposits Conventional RM5 12 months 3.15 Term deposits Islamic RM5 12 months 3.15 Source: Alliance Islamic Bank, DBS Bank, AllianceDBS Comparison of investment account and conventional Islamic deposit accounts Conventional product Islamic products Conventional deposit Islamic deposit Investment account Nature of deposit Sum of money accepted or paid not in accordance with Shariah Sum of money accepted or paid in accordance with Shariah Money is paid and accepted for the purpose of investment in accordance with Shariah Shariah None Wadiah, Tawarruq, Bai' 'Inah Mudarabah, Musharakah, Wakalah contracts Principal guarantee Deposit insurance protection Source: BIMB, DBS Bank, AllianceDBS Will be repaid in full on maturity and/or on demand Will be repaid in full on maturity and/or on demand Yes Yes No No expressed or implied obligation to repay the money in full and/or on demand (Principal and/or profit) Comparison of unrestricted and restricted investment accounts Unrestricted Investment Account Restricted Investment Account Mandate General mandate (allows the bank to Specific Investment Mandate/Asset Class make ultimate investment decision without restriction or any conditions) Withdrawal Unlimited Fixed tenure Maturity Mismatch Redemption upon maturity of assets; or redemption only upon realisation of underlying assets to a third party; or redemption only upon finding replacement of funds from other Investment Account Holder (other than the Bank) Balance Sheet treatment On-balance sheet (subject to compliance with principles of FRS 1) Off-balance sheet Source: BIMB, DBS Bank, AllianceDBS Page 14

15 Financing Similar reference rate used. Islamic banks use the Base Rate (BR) and Base Financing Rate (BFR; conventional banks equivalent to Base Lending Rate or BLR) as the reference rates in pricing their financing products. Typically, banks with both conventional and Islamic arms use the same rate for BR and BLR/BFR. Unique features of Islamic financing. In principle, Islamic financing offers a rebate (also known as Ibra) on early settlement, termination or maturity of an account. Islamic financing also places a ceiling on financing rate, protecting consumers from paying high interest rates in the event of a steep increase in the Base Rate. In accordance with BNM s guideline, Islamic banks can impose late payment charges, but the amount recognised as income is limited to the administrative cost incurred to manage the late payment. The remaining portion must be channelled to charitable organizations. Mortgage loans under Islamic financing offer additional incentives. Mortgage under Islamic principles similarly offer rates that are competitive relative to those of conventional loans. On top of the salient features mentioned above, additional incentives for mortgages under Islamic principles come in the form of the discounts on stamp duty charges. There is a 2 discount for consumers taking a new or topup loan, as well as a full discount for refinancing a conventional loan to Islamic financing. To enjoy these benefits, customers are merely required to complete two additional documents (vs conventional loans) for mortgage financing based on Bai Bithaman Ajil (BBA or sale contract based on deferred payment at certain price), i.e. Asset Purchase Agreement (APA) and Asset Sale Agreement (ASA) in the solicitor s office. For mortgage loans under Tawarruq (or commodity murabahah) contract, the process is similar to a conventional mortgage loan application, except that the document would contain an additional agency agreement (appointing the bank as an agent to sell and purchase commodities). Meanwhile, the application for car financing requires customers to submit two agreements - Al-Ijarah Contract (hiring agreement) and Al-Bai Contract (purchasing agreement) - as opposed to just one HP agreement under conventional loans. AFG mortgage loans: Key features similar for conventional and Islamic products; stamp duty more advantageous in Islamic product Feature i-wish Home Financing-I (Islamic) Home Loan (Conventional) Stamp Duty 1. New & Top Up: 2 discount Full 2. Refinancing: Waived (1 discount) for Full refinancing cases (i.e. Conventional loans from other financial institutions to Islamic financing) Margin of Finance MRTT and/or Financing Entry Cost MRTA and/or Financing Entry Cost Tenure 35 years/7 years of age 35 years/7 years of age Source: Alliance Islamic Bank, DBS Bank, AllianceDBS Mortgage loans under BBA: Two additional documentation requirement under Islamic financing Islamic Conventional 1. Product Disclosure Sheet (PDS) 1. Product Disclosure Sheet (PDS) 2. Application Form Sales/Branch Staff 2. Application Form 3. Letter of Offer (LO) 3. Letter of Offer (LO) 4. Sales and Purchase Agreement (SPA) Customer 4. Sales and Purchase Agreement (SPA) 5. Asset Purchase Agreement (APA) 5. N/A 6. Asset Sale Agreement (ASA) 6. N/A Solicitors Office 7. Facility Agreement (FA) 7. Facility Agreement (FA) 8. Other Documents 8. Other Documents The documents MUST be executed in the particular order above at different intervals i.e. the time must not be the same. Source: Alliance Islamic Bank, DBS Bank, AllianceDBS AFG hire purchase loans: Key features similar for conventional and Islamic products Islamic Hire purchase Conventional Hire Purchase Margin of finance 9 of total value of car 9 of total value of car Tenure Max 9 years Max 9 years Source: Alliance Islamic Bank, DBS Bank, AllianceDBS Page 15

16 Islamic financing provided to listed companies aiming to attain Shariah-compliant status. While the terms of business loans are negotiated on a case-by-case basis between the bank and customer, we understand that banks generally do not practice price discrimination whether the loans are under conventional or Islamic. However, listed companies seeking to attain Shariah-compliant status should apply for lines under Islamic banks. Shariah-compliant status are granted to listed companies provided that (1) contribution of Shariah noncompliant activities to the overall revenue and profit before tax is below the 5 benchmark (2 for activities such as hotels and resorts, stock broking and share trading), (2) the company s ratio of cash (placed in conventional accounts and instruments) over total assets does not exceed 33, and (3) the company s ratio of debt (under conventional financing) over total assets does not exceed 33. Listed companies are generally inclined to seek Shariah-compliant status in order to attract a larger pool of investors. Other incentives offered include waiver of commitment fees for the unutilised portion of the facility limit and full exemption of stamp duty for refinancing of conventional financing facility to Islamic facility. Page 16

17 OPPORTUNITIES IN ISLAMIC FINANCING Natural bias to Islamic financing under homogeneous pricing. Banking penetration (defined as percentage of adults with an account at a formal financial institution) remains low within the Organisation of Islamic Cooperation (OIC) member countries and the Muslim population as a whole, with an average of around 32 and 29, vs the global average of 62. According to findings by the World Bank, the main reason to the low banking penetration rate is attributable to insufficient money to use an account, whereas the expensiveness of financial service comes in second as the most frequently cited barrier. Only 7 of adults in OIC countries cited religious reasons to resisting financial services. Hence, we believe Muslims do not reject conventional finance solely due to religious reasons. Nonetheless, in an environment of homogeneous pricing (between conventional and Islamic banking products), in our opinion, Muslims will have a natural bias to Islamic banking products given the ability to fulfil their religious duties concurrently. Banking penetration comparison High-income OECD economies 69 East Asia & Pacific Europe & Central Asia Latin America & Caribbean South Asia Source: World Bank, Global Findex database Sub-Saharan Africa Global average = 62 Fast growing Muslim population. Given that the Muslim population makes up more than 2 of the global population and banking penetration is low within the OIC countries, we opine that attending to the needs of the underserved Muslim population is the low-hanging growth driver for Islamic banking. The Muslim population is also projected (by Pew Research Centre) to be the fastest growing religious group up to year 25. The proportion of Muslims to the global population is expected to hit 3 in 25, closing the gap to that of the Christian population, which stands at 31. The key drivers underpinning the strong growth in the Muslim population include the higher-than-average fertility rate (3.1 children per OIC Muslims 14 Middle East woman vs the global average of 2.5) and comparatively high concentration of children as of end-21 (34 for Muslims vs global average of 27). Populations that begin with a larger proportion of people who are in or soon will enter their prime childbearing years are expected to grow faster than a population that begins with a larger proportion of people that are beyond their prime reproductive years. The Pew Research Centre also accounts for other factors such as life expectancy, religious conversion and migration in its growth projections. Caveats to the findings of the Pew Research Centre include changes in current trends that could alter the trajectories. Size and projected growth of major religious groups 21 population (mil) Projected 25 population (mil) of world of world Christians 2, , Muslims 1, , Unaffiliated 1, , Hindus 1, , Buddhists Folk religions Other religions Jews World total 6, , Source: The Future of World Religion by Pew Research Centre Fertility rate by religion Muslims Christians World Hindus Jews Folk religions Unaffliated Other religions Buddhists Source: The Future of World Religion by Pew Research Centre Page 17

18 Age distribution by religious group in 21 World Muslim consumers that would be agreeable to adopting Islamic banking products. Unaffliated Buddhists Jews Other religions Folk religions Christians Hindus Muslims Age -14 Age Age 6+ Source: The Future of World Religion by Pew Research Centre Projected age distribution by religious group in 25 World Sizeable global Islamic economies. At USD6.9tr, the 57 mostly Muslim-majority member countries of the OIC represented 9.5 of the global GDP in 214. Although growth prospects for several OIC economies have dimmed due to lower oil prices, these economies remain a significant portion of global GDP. Note that nine out of the top 15 oil-exporting countries are members of the OIC. Notwithstanding the correction experienced by the sukuk market in 215 (caused by BNM s decision to stop the issuance of short-term sukuk and switch to other instruments for liquidity management for Islamic financial institutions), the sukuk market has experienced strong growth thanks to the rise of infrastructure projects and the need for large corporate exercises to seek funding from investors in the Gulf States and other Islamic countries which require the products to be Shariah compliant. Buddhists Unaffliated Global sukuk issuance Other religions Folk religions Hindus Jews Christians Muslims Age -14 Age Age 6+ Source: The Future of World Religion by Pew Research Centre Young Muslim population an attractive market to the banks. Despite projections of a narrowing proportion of global population under the age of 6, the Muslim population is expected to remain relatively youthful as the said proportion is expected to remain higher than the global average (84 vs 78). A young market is beneficial to the banks as the financing needs of this group of consumers have yet to peak, implying room for banks to grow further in the long term. Attracting the non-muslim market is the cherry on the cake. Although Islamic banking is based on Islamic teachings, many of these values may also appeal to non-muslims given the risksharing and ethical nature of its business model. In our view, two factors pricing and awareness remain the key determinants to favourable take-up by the non-muslim market. Given the slight incentives offered by Islamic products (lower late payment charges, ceiling rates), we believe that with sufficient education on Islamic banking products, there are non- Source: International Islamic Financial Market Top 15 crude oil exporting country, in barrels per day (bbl/day) Country bbl/day of world Saudi Arabia 7,658, 17.3 Russia 4,594, 1.4 Canada 2,9, 6.6 United Arab Emirates 2,5, 5.7 Nigeria 2,411, 5.5 Iraq 2,39, 5.4 Kuwait 1,824, 4.1 Angola 1,815, 4.1 Kazakhstan 1,365, 3.1 Venezuela 1,358, 3.1 Iran 1,322, 3. Qatar 1,232, 2.8 Mexico 1,22, 2.8 Norway 1,218, 2.8 Algeria 1,158, 2.6 Note: OIC members highlighted Source: The World Factbook Page 18

19 Growing intra-oic trade. The clear drive to develop Intra-OIC trade is also facilitating the development of the Islamic economic sectors. The Intra-OIC trade among the member countries has grown from 13 in 25 to 19.9 in 214, close to the OIC s 215 target of 2. Under the OIC s ten-year programme of action leading up to 225, the target for intra- OIC trade is to hit 6 north of 215 levels. Intra-OIC merchandise exports and imports (USD bn) Source: OIC Economic Outlook 215 Page 19

20 CHALLENGES Regulatory gap. Existing legal and regulatory frameworks should take into consideration the value propositions promulgated by Shariah. For instance, the legal definition of banking and financial services in certain jurisdictions does not recognise Islamic financial transactions, which leads to potential conflict and adverse legal effects. The government should also be supportive in granting neutral tax treatments for Islamic financial transactions to ensure that Islamic banking products are cost efficient. Establishing an even playing field. To avoid an exodus back to conventional finance, at the very least, there is a need for Islamic products to be on par with conventional products in terms of diversity, cost effectiveness, ability to meet the risk and return requirement of investors as well as the service level, while remaining Shariah compliant. On the other hand, to get one up on conventional banking, these Islamic products are expected to be superior to their conventional peers in these aspects. Liquidity management. Liquidity problems exist in the Islamic capital market due to the lack of derivatives and an organised secondary market for dealing with Islamic instruments. An early exit may be difficult or costly for an investor without an effective secondary market where financial instruments are easily tradable. In addition, most central banks have not been very active in issuing short-term sukuk, limiting the availability of high-quality liquid assets (HQLA) in Islamic finance. Talent shortage. Islamic financial industry requires a specific set of competencies and skills, such as Shariah understanding and market insight. The shortage of talents, especially on the expert level such as Shariah scholars, may impede the growth of Islamic finance, as the views of these scholars are highly valuable in product development and innovation. On an extreme case, scarcity in talent may also cause inflated salaries and lead to a drag on the cost structure of the Islamic banks. Hence, the abundance of educational institutions focusing on Islamic banking is crucial for the development of the industry. Lack of uniformity between Shariah s views. Different interpretations of the Shariah lead to different practice and use of concepts across jurisdiction. Certain products may be accepted in some jurisdictions but not in others, thus this may impede the growth and internationalisation of Islamic finance. Differences in opinion among religious scholars regarding the Shariah compliance of specific financial arrangements can expose Islamic banks to the risk of non-compliance with Shariah principles, which may have serious implications on the industry. Harmonising differences in the Shariah compliance of different instruments would reduce uncertainty and foster industry growth. It also ensures that Islamic banks are able to capture opportunities from the entire Muslim market, instead of being sidelined by a portion who perceive Islamic banks are not true to Shariah values. By the same token, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and Islamic Financial Services Board (IFSB) have provided some Shariah standards and governance guidelines. Lack of awareness. Despite the strong presence of Islamic finance in the Gulf Cooperation Council (five out of the six member countries are among the top 1 Islamic economies), findings by PWC show that residents in this region lack familiarity with Islamic banking. 56 of the Muslim respondents believe that they are familiar with Islamic banking while 64 of non-muslims cited insufficient knowledge of Islamic financial products as the reason for not using Islamic financial services. Page 2

21 INDUSTRY PLAYERS AT A GLANCE 23 key players in the Islamic banking industry. The key players in the industry can be segregated to three broad categories, i.e. full Islamic banks, Islamic bank subsidiaries and development banks or financial institutions that offer Shariah-compliant products (see table below for banks under the respective categories). Comparison of the financials of the key players in the industry can be found in the Appendix. We used the latest published financial year numbers for all key players. Apart from BIMB that we have used financial holding company numbers, the numbers of the other entities reflect the Islamic banking unit individually. In our analysis, we included only one development bank, Bank Rakyat which boasts a sizeable market share. MY: Key players in the industry Type Bank Full Islamic banks Bank Islam Bank Muamalat Asian Finance Bank Al Rajhi Bank Kuwait Finance House Islamic bank subsidiaries Maybank Islamic AmIslamic AffinIslamic Alliance Islamic Bank CIMB Islamic Public Islamic Hong Leong Islamic Standard Chartered Saadiq HSBC Amanah RHB Islamic OCBC Al-Amin Development Bank Rakyat banks/financial Agro Bank institutions that offer Bank Simpanan Nasional Shariah-Compliant SME Bank Products EXIM Bank Bank Pembangunan Malaysia Malaysia Building Society Source: BNM, DBS Bank, AllianceDBS MY: Asset size of Islamic banks RM bn MAY ISL 92 BANK RAKYAT 57 BIMB 55 CIMB ISL 46 PUBLIC ISL 44 RHB ISL 41 MBSB 38 AMISL 26 HL ISL 23 Muamalat 19 HSBC AMAN Source: Companies, DBS Bank, AllianceDBS 15 OCBC AL- 13 AFFIN ISL 11 SC SAADIQ 11 KFH 1 ALLCE ISL 7 Al-Rajhi 3 AFB MAY ISL stands head and shoulders above peers. Similar to its positioning in conventional banking space, MAY ISL takes the lead in terms of asset size. In fact, MAY ISL, Bank Rakyat and Bank Islam are among the top global Islamic banks by asset size. While MAY ISL and Bank Rakyat remain at the top of the table when ranked by loans and deposits, CIMB ISL trumps BIMB s position as the third largest in these aspects. Meanwhile, foreign Islamic banks, which are imposed operational restrictions such as branch openings and ATM installations, are typically on the other end of the spectrum. Paltry earnings by Middle Eastern Islamic banks. Due to the relatively small balance sheet and operational restrictions, Middle Eastern Islamic banks struggle in building scale which reflects its growth (lower-than-average loan growth) and profitability (higher-than-average cost-to-income). BIMB has the highest ROE in the industry, thanks to its higher yielding loans and strong CASA. Similarly, MBSB and Bank Rakyat enjoy high NIMs as their portfolios are skewed towards personal financing. However, the CASA ratios of MBSB and Bank Rakyat are lower than the industry as exempt finance companies are restricted from accepting demand deposits (current accounts). Banks that are heavier on mortgage financing (e.g. MAY ISL, HL ISL) tend to have NIMs below 2. Financing-to-deposit ratio is highest at SC Saadiq (more than 2) as it is able to tap interbank funding by its parent through its profit-sharing investment accounts (PSIA). Inclusive of the PSIA placements, the ratio would be lower. Weak asset quality at KFH and MBSB. Banks with strong credit culture (PBK, HLB) congruently have low NPL ratios for their Islamic banking arm. MBSB's impaired financing ratio increased due to its impairment programme. KFH's asset quality is impacted by high impaired financing in the manufacturing sector. KFH and MBSB booked high credit cost, in line with its high impaired financing ratios. All Islamic banks are sufficiently capitalised, with the Middle Eastern Islamic banks registering higher capital ratios compared to peers. Page 21

22 ISLAMIC BANKING PROXIES BIMB, the Islamic banking champ. As the nation s longest standing Islamic bank, BIMB s (the holding company of Bank Islam and Syarikat Takaful) expertise in the industry is undisputable. With its experience and expertise in Islamic Finance, BIMB would be able to step in to meet the growing demand of Islamic finance (domestic and/or abroad). This could be through strategic partnerships or technical collaborations. A strategic partnership could involve taking a strategic stake in the host country bank or a merger or acquisition. For example, Bank Islam assisted in setting up the first Islamic bank in Sri Lanka (Amana Bank Ltd) and acquired a strategic interest in the bank in Feb 211. Such initiatives strengthens Bank Islam s size and market share and drives growth further. While Bank Islam s attempt to pursue a controlling stake in PT Bank Muamalat in Indonesia was to no avail, we would not discount possibilities of another pursuit in the longer term given that Indonesia continue to pack vast potential for Islamic financing growth as the world s most populous Muslim nation. MAY ISL is well-positioned to lead in the internationalisation of Islamic finance as it is the nation s biggest bank (both Islamic and conventional) with the most extensive regional reach. In 211, MAY ISL rolled out the Islamic First strategy in Malaysia, where customers were offered Islamic banking products as the first choice. Their efforts came to fruition as MAY ISL s proportion of financing to the group surpassed the 5 mark in FY15 (from 39 in FY13). MAY ISL emulated the Islamic First strategy in Indonesia in 214. This, along with initiatives such as increasing the awareness of Shariah products and services, a revamp of the Shariah offerings and expansion of distribution network (through conversion of conventional-only branches to dual branches offering both conventional and Shariah products), improved Bank Maybank Indonesia Unit Usaha Shariah industry ranking from 12 th in FY13 to 5 th in FY15, in terms of asset size. Over in Singapore, MAY ISL pioneered several products in the market such as a special savings account for the Hajj pilgrimage, Islamic Auto Finance, Malaysia Residential Property Financing and Malaysia Commercial & Industrial Property Financing in 213, and Islamic Business Term Financing and Islamic trade facilities and foreign currency deposits in 214. MAY ISL: Proportion to MAY s domestic financing RM m 14, 12, 1, 8, 6, 4, 2, - Source: Company, DBS Bank, AllianceDBS Global Sukuk League table Bank CIMB Maybank , , Financing (LHS) Amount (USD m) Market Amount share () (USD m) Market share () 5, , , , Standard Chartered Bank 2, , RHB 3, , HSBC 4, , Dubai Islamic Bank 1, , AmInvestment Bank Bhd 1, , JP Morgan 1, , National Bank of Abu Dhabi 1, , Emirates NBD PJSC , Source: Bloomberg L.P Finance , Potential M&A candidates, MBSB and Bank Muamalat. Banks to watch in the M&A space include Malaysia Building Society (MBSB MK Equity) and Bank Muamalat (subsidiary of DRB MK Equity). In our view, MBSB remains an attractive M&A target, thanks to its lucrative personal financing business and sizeable Islamic banking assets. Furthermore, MBSB s commitment towards closing the gap between it and the banks would further elevate its attractiveness, as it lowers the hurdle to integration. Based on current fundamentals, we believe current valuation is rich for the stock given its weak ROE traction of sub- 5 in the near term (FY16- FY17). Nonetheless, in the event of an M&A (which in our view, will be increasingly imminent in FY18), we believe MBSB can fetch a higher valuation of 1.1x BV (refer to MBSB Equity Explorer) , , to domestic financing (RHS) , Page 22

23 MUAMALAT, a long awaited M&A play. While MUAMALAT is a relatively small entity, M&A talks have surfaced several times as its largest shareholder, DRB-HICOM (which has a 7 stake in MUAMALAT), had been required by BNM to pare down its significant stake to 4. Alternatively, the pare down in shareholding could take the route of an initial public offering (IPO). In such a case, we expect the bank to fetch a valuation that is comparable to Affin (closest comparable to its ROE profile). At a conservative valuation of.5x BV, Bank Muamalat could be listed at a market capitalisation of close to RM1bn. BIMB (211), Affin (213) and MBSB (216) had made an attempt to acquire MUAMALAT, but no firm developments have materialised to date Quest for the next mega Islamic bank. Talks of a mega Islamic bank surfaced as early as 21 when the Central Bank was said to be issuing two mega Islamic bank licences to foreign players with the condition of having a minimum RM1bn in paid-up capital. M&A spin-offs in the Islamic banking space are plausible, in our view, potentially creating a new wave of M&A activities in the Islamic banking space. In 214, MBSB was involved in talks to merge with CIMB and RHB. Together, the merged entity was expected to displace MAY from its #1 ranking in Malaysia by asset size. More interestingly, MBSB was slated to remain listed and to act as a vehicle for any proposed mega Islamic Bank, i.e. the banking operations of CIMB Islamic and RHB Islamic would be injected into MBSB if the three-way merger were to succeed. Page 23

24 CONCLUSION The path to success of Islamic banking is a long and winding one. In our view, the Islamic banking industry remains a nascent industry, which still has plenty of hurdles to clear. There is indeed sufficient demand, from the large and fast-growing Muslim population and sizeable Islamic economies to justify the need for Islamic banking, but for the industry to enter into the attractive growth stage, the foundations of the industry need to be further strengthened. The challenges that are crucial for the industry to address include harmonising differences in Shariah compliance across jurisdictions, establishing an even playing field, strengthening the resources (human capital, technology, liquidity management tools) and promoting Islamic banking literacy to the public. Malaysia is in a unique position as the country is at the forefront of the industry. Undeniably, Malaysia has pioneered plenty of Islamic banking initiatives on the global stage, which have deepened the country s knowledge and expertise. The country is a natural candidate to lead the industry to the next stage, especially with the strong support of regulators. Product innovation will be the transformative factor for the industry, in our view, as it enables the Islamic banks to step up their game against its conventional counterparts. In that vein, we believe developments in this space are a crucial factor to monitor in identifying the next growth cycle for the industry. BIMB could lead the path. We like BIMB for its rich experience in the industry, which we believe forms a powerful competitive advantage for them to lead the avant-garde movement in product innovation given its superior knowledge in Islamic banking. MAY ISL complements the Islamic banking scene for its size and established regional presence which will work to its advantage in competing on the global front. MAY ISL and CIMB ISL are also global sukuk players. A new wave of M&A activities in the Islamic banking space is plausible, although timing remains the key risk. Potential M&A candidates include MBSB (whose appeal lies in its lucrative personal financing business and sizeable Islamic banking assets) and unlisted MUAMALAT (from a long awaited pare down in ownership by its largest shareholder, DRB). Albeit indirect, Bursa is also a proxy to growth in Islamic banking as transactions on its commodity trading platform, Bursa Suq al-sila (BSAS), are expected to increase in conjunction with Islamic financing growth. Malaysian Banks: Peer comparison Banking Group Market cap Price Target Price Rating PE (x) CAGR P/BV (x) ROE () Net div () (US$bn) (RM/s) (RM/s) CY15A CY16F CY17F ^ () CY15A CY16F CY17F CY16F CY16F Affin Holdings 1, FULLY VALUED 13.3x 9.9x 9.7x x.6x.6x Alliance* 1, NA NA 11.5x 11.5x 11.1x x 1.2x 1.2x AMMB 3, BUY 9.8x 1.9x 1.1x x.9x.8x CIMB Group 1, HOLD 15.1x 12.2x 11.1x x 1.x.9x Hong Leong 6, BUY 13.8x 13.9x 12.2x x 1.3x 1.2x Maybank 19, HOLD 11.8x 14.1x 12.7x x 1.3x 1.3x Public Bank 17, BUY 15.3x 14.9x 14.2x x 2.3x 2.1x RHB Bank 3, BUY 9.5x 1.3x 9.2x 1.5.9x.8x.8x Weighted average 13.3x 13.5x 12.4x x 1.5x 1.4x Weighted average (ex-public Bank) 12.5x 12.9x 11.7x x 1.1x 1.1x Simple average 12.5x 12.2x 11.3x x 1.2x 1.1x Simple average (ex-public Bank) 12.1x 11.8x 1.9x x 1.x 1.x BIMB 1, BUY 12.3x 12.4x 11.2x x 1.8x 1.7x Hong Leong Financial Group 3, BUY 11.2x 11.6x 1.2x x 1.1x 1.x * Based on Bloomberg consensus ^ Refers to a 2-year EPS CAGR for CY15-17F Source: Companies, Bloomberg Finance L.P., DBS Bank, AllianceDBS Page 24

25 Company Profiles Page 25

26 Malaysia Company Guide BIMB Holdings Version 6 Bloomberg: BIMB MK Reuters: BIMB.KL Refer to important disclosures at the end of this report DBS Group Research. Equity 2 Feb 217 BUY Last Traded Price ( 17 Feb 217): RM4.43 (KLCI : 1,77.68) Price Target 12-mth : RM5. (13 upside) (Prev RM4.8) Potential Catalyst: Positive turn in consumer sentiments Where we differ: Our valuation is higher than consensus as we believe its strong growth deserves a higher premium Analyst Lynette CHENG lynettecheng@alliancedbs.com Sue Lin LIM suelinlim@dbs.com What s New Prime candidate to ride on superior Islamic financing growth Poised to lead market in product innovation, thanks to well-developed know-how in Islamic banking Lower credit cost assumptions led to upward revision in earnings by 2-4 Maintain BUY with higher TP of RM5. Price Relative RM Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 BIMB Holdings (LHS) Relative KLCI (RHS) Relative Index Forecasts and Valuation FY Dec (RMm) 215A 216F 217F 218F Pre-prov. Profit 992 1,11 1,237 1,4 Net Profit Net Pft (Pre Ex.) Net Pft Gth (Pre-ex) () EPS (sen) EPS Pre Ex. (sen) EPS Gth Pre Ex () 1 (1) 1 5 Diluted EPS (sen) PE Pre Ex. (X) Net DPS (sen) Div Yield () ROAE Pre Ex. () ROAE () ROA () BV Per Share (sen) P/Book Value (x) Earnings Rev (): 4 2 Consensus EPS (sen): Other Broker Recs: B: 5 S: H: 4 Source of all data on this page: Company, AllianceDBS, Bloomberg Finance L.P Islamic banking champ Main Islamic banking proxy, BUY. We believe BIMB is the main proxy to ride on the superior growth in Islamic financing. Apart from being the only Bursa-listed Shariah-compliant financial institution, BIMB's deep-rooted expertise and experience in the industry positions it as the prime candidate to lead the market in product innovation. Thus far, investment accounts are the only new product launched, but we see potential for more to come, thanks to regulatory push to move towards the risk-sharing model (vs risk transfer model). The successful deployment of new products could potentially increase financial inclusion, leading to further growth. Standing tall. Islamic business aside, BIMB's superior financial metrics in growth, liquidity and asset quality make it a force to be reckoned with in the Malaysian banking space. BIMB has an arsenal of tools to lean on to weather the current soft operating environment a niche in Islamic banking (which supports financing growth momentum), high CASA ratio and liquid balance sheet (to stave off net financing margin compression) as well as high financing loss coverage (to buffer against potential deterioration in asset quality). Raise earnings by 2-4 as we lower our credit cost assumption to 31/39bps across FY17-18F (from 39/42bps previously), to better reflect BIMB s robust asset quality position. BIMB s personal financing portfolio continues to command robust asset quality, with its low impaired financing ratio of less than 1, thanks to stringent credit assessment processes. Although we would not discount potential asset-quality deterioration going forward, we take comfort in BIMB s high financing loss coverage ratio which mitigates risk to its earnings. Valuation: Our revised RM5. TP is derived from the Gordon Growth Model (assumes 16 ROE, 4 long-term growth and 1 cost of equity) and implies 1.9x FY17F BV. We believe its current valuation presents a good opportunity to gain an inexpensive entry into a solid Islamic banking franchise. Key Risks to Our View: Asset-quality deterioration amid challenging operating environment could result in higher-than-expected provisions. At A Glance Issued Capital (m shrs) 1,638 Mkt. Cap (RMm/US$m) 7,255 / 1,629 Major Shareholders () Tabung Haji () 5.8 EPF () 12.4 KWAP () 5.5 Free Float () m Avg. Daily Val (US$m).84 ICB Industry : Financials / Banks ASIAN INSIGHTS VICKERS SECURITIES ed: CK / sa: WMT, PY

27 Company Guide BIMB Holdings WHAT S NEW At the forefront of Islamic banking Islamic banking champ Undisputed proxy to ride on the growth in Islamic banking. Due to strong regulatory push for the Islamic banking agenda, we believe financing and deposit growth will continue to outpace its conventional peers. As the oldest Islamic bank in Malaysia, we believe BIMB is the prime candidate to ride on this exciting growth. Indeed, BIMB s financing growth outpaced the system s financing growth since 212 and grew relatively similar to the Islamic financing growth (see Chart 1). Furthermore, with its deep-rooted expertise and rich experience in the sector, we believe BIMB is poised to be the market leader in product innovation of Islamic banking offerings. This was evident when the Investment Account was first introduced, as BIMB took the lead in providing consumer education on the product. Further aiding this is the support from government-linked companies (GLCs), whose personnel serve as an avenue for BIMB to roll out salary deduction schemes for personal financing. Further re-rating catalyst could come from spreading its wings regionally. Although this agenda may be placed in the back burner in the near term due to the challenging operating environment, we believe this remains a potential growth lever for BIMB in the long term. This could be through strategic partnerships or technical collaborations. A strategic partnership could involve taking a strategic stake in the host country bank or a merger or acquisition. For example, Bank Islam assisted in setting up the first Islamic bank in Sri Lanka (Amana Bank Ltd) and acquired a strategic interest in the bank in Feb 211. Such initiatives can strengthen Bank Islam s size and market share, and can help accelerate its growth. While Bank Islam s attempt to pursue a controlling stake in PT Bank Muamalat in Indonesia was to no avail, we would not discount the possibility of another pursuit in the longer term given that Indonesia continues to hold vast potential for Islamic financing growth as the world s most populous Muslim nation (refer to Chart 3). Impaired financing ratio of personal financing portfolio remains low at less than 1. While challenges are abound on the retail segment (amid rising cost of living and weak consumer sentiments), BIMB s retail portfolio have thus far remained resilient. 9 of its personal financing portfolio (which makes up 3 of its financing book) is structured under packaged financing scheme, where customers repay their financing either through a salary-deduction or salarytransfer mechanism. Under the salary-deduction mode, salaries of customers are paid into Bank Islam accounts, and the Bank directly debits repayment once their salaries have been credited. Under the salary-transfer mechanism, employers deduct repayments from the salaries of their employees and subsequently remit payments to Bank Islam. While the risk attached to this lies in the change in employment of the customer (thus, turning into a nonpackaged customer), we understand that BIMB s experience with non-packaged financing customers have still been encouraging so far. The low impaired financing ratio of less than 1 is testament to the resiliency of BIMB s personal financing portfolio. Asset quality indicators remain supportive of strong growth potential. Personal financing aside, BIMB has also been growing mortgage financing with a discipline of avoiding speculative spaces. Hence, the typical mortgage customers for BIMB are first time home buyers. 75 of its mortgage portfolio is extended for landed properties. Meanwhile, oil and gas exposure to BIMB stands at 1, inclusive of its retail portfolio. Its banking peers reported less than 5 exposure to oil and gas, but does not include its respective retail exposure. While oil and gas remains a keenly watched segment for BIMB, the portfolio has held up thus far, with no alarming trends noted by management. We understand that BIMB exposure is largely for contract financing and does not have any exposure to the upstream space. Raise earnings by 2-4 as we lower our credit cost assumption to 31/39bps across FY17-18F (from 39/42bps previously), to better reflect BIMB s robust asset quality position. Although we would not discount potential assetquality deterioration going forward, we take comfort in BIMB s high financing loss coverage ratio which mitigates risk to its earnings (refer to Chart 2). BIMB s financing loss coverage ratio is able to stay within 1, even if impaired financing increases by a whopping 7. Valuation and recommendation Maintain BUY with higher TP of RM5. post earnings adjustment. Our TP implies 1.9x BV, which we believe is fair for a franchise delivering ROEs of more than 15 and betterthan-industry metrics. A restructuring exercise to collapse the financial holding structure of BIMB could be in the cards to remove double leverage ratio concerns. In our previous report, we expressed preference towards keeping STMB under Bank Islam as it provides better potential gain. For the full analysis, please refer to the report dated 22 Dec 216 in this link. ASIAN INSIGHTS VICKERS SECURITIES Page 27

28 Company Guide BIMB Holdings Chart 1: BIMB financing growth vs system financing growth F BIMB Financing growth Conventional loan growth Islamic banking financing growth Total system loan growth BIMB s financing growth outpaced system financing growth since 212 Source: Company, AllianceDBS, DBS Bank Chart 3: Indonesia potential addressable market Chart 2: Financing loss coverage vs impaired financing ratio Impaired financing ratio Financing loss coverage F Financing loss coverage Impaired financing Solid asset quality indicators with high financing loss coverage ratio and low impaired financing ratio Source: Company, AllianceDBS, DBS Bank Country 21 population (mil) of world's Muslim Country Projected 25 population (mil) of world's Muslim Indonesia India India Pakistan Pakistan Indonesia Bangladesh Nigeria Nigeria Bangladesh Egypt Egypt Iran Turkey Turkey Iran Algeria Iraq Morocco Afghanistan Subtotal 1, Subtotal 1, Subtotal for rest of world Subtotal for rest of world 1, World total 1, World total 2, Source: The Future of World Religion by Pew Research Centre, Company, AllianceDBS, DBS Bank Page 28 ASIAN INSIGHTS VICKERS SECURITIES

29 Company Guide BIMB Holdings CRITICAL DATA POINTS TO WATCH Earnings Drivers: NFM to remain under pressure, although we expect the quantum to be less compared to the year before, as the intensity of deposit competition has lessened. Positively, BIMB s high CASA ratio could slightly ease the pressure on net financing margin (NFM). BIMB s CASA ratio is currently at the mid-3 range and the bank intends to maintain it at this level. Moderating financing growth. We forecast 12 financing growth for BIMB in FY17F. Targeted areas of growth include the affordable housing segment for its retail segment, while on the corporate segment BIMB favours the infrastructure sector. Among its banking peers, BIMB has one of the strongest financing growth. BIMB is also targeting to grow its floatingrate financing to achieve a portfolio mix of floating-to-fixed-rate financing of 8:2. Targeting to grow investment accounts. A mandate to distinguish Islamic deposits and Islamic investment accounts was released in 213, requiring the transition to commence in June 215. In line with that, BIMB aspires to shore up investment accounts to RM2bn in FY16. BIMB does not expect any significant earnings impact from this transition as the higher cost of funds is expected to be offset by the benefits reaped from the favourable treatment of these accounts in terms of Statutory Reserve Requirement, liquidity and capital. Owns 6 of STMB, a key Takaful player. Syarikat Takaful Malaysia Berhad (STMB) provides insurance protection based on Shariah principles. Its main distribution channel is its agency force which currently boasts 2,7 agents. Contribution from STMB makes up slightly less than 7 of BIMB s non-fund based income. Stable cost-to-income ratio. BIMB expects it to keep its cost to income ratio at mid-5. Management expects provision charge-off rate to be similar to the FY15 level (2bps), but we have conservatively assumed charge-off rate of 3/31/39bps across FY16-18F. At the forefront of Islamic finance. As the pioneer of Islamic banking in Malaysia, BIMB is poised to leverage on the deep growth potential of Islamic finance due to the large Muslim population within the region. On top of opportunities arising from the Malaysian government s initiatives to develop Islamic banking, another potential growth area for BIMB lies with Indonesia as it is the world's most populous Muslim nation. Although BIMB has expressed interest in making its mark in Indonesia, nothing substantial has materialised yet. Margin Trends RM m 1,8 1,6 1,4 1,2 1, A 215A 216F 217F 218F RM m 55, 5, 45, 4, 35, 3, 25, 2, 15, 1, 5, - RM m 5, 4, 3, 2, 1, RM m 55, 5, 45, 4, 35, 3, 25, 2, 15, 1, 5, - Fund based income (LHS) Gross Financing & Growth Customer Deposit & Growth Net financing margin (RHS) 214A 215A 216F 217F 218F Gross Financing (LHS) Gross Financing y-o-y Growth (RHS) 214A 215A 216F 217F 218F Customer Deposits (LHS) Customer Deposits Growth () (YoY) (RHS) Financing-to-Deposit Ratio Trend 214A 215A 216F 217F 218F Financing (LHS) Deposit (LHS) Financing to deposit ratio (RHS) Cost & Income Structure RM m 3,5 58 3, 56 2,5 2, 54 1,5 52 1, A 215A 216F 217F 218F Fund based income (LHS) Non-fund based income (LHS) Cost-to-income ratio (RHS) Source: Company, AllianceDBS ASIAN INSIGHTS VICKERS SECURITIES Page 29

30 Company Guide BIMB Holdings Balance Sheet: Stable asset quality. BIMB has improved its asset quality over the years, exemplified by the lowering of its gross impaired financing ratio to 1 from 13 back in 29. Management aims to keep asset-quality deterioration at bay and maintain its gross impaired financing ratio within the current level. BIMB s coverage ratio is high, at close to 17. High capital ratio. BIMB s CET-1 ratio is at 12, which is higher compared to its banking peers. To ensure sustainable levels of capital, BIMB rolled out its Dividend Reinvestment Plan in Aug 214. Separately, STMB s capital ratio is well above the minimum requirement of 13. Share Price Drivers: Trading lower than mean P/BV multiples. BIMB is trading at 1.7x FY17F BV, which is below the 5-year mean valuation of 2x. We believe the market is not attributing sufficient premium to the arsenal of tools that BIMB has built up to prevail in the current tough operating environment. Key Risks: Softer consumer financing growth. Consumer financing make up just over 6 of BIMB s financing portfolio, with the bulk being personal and housing financing. Given the high proportion of consumer financing, softer growth in this segment would be unfavourable for BIMB. Tightening measures by BNM. Although the growth in household debt has moderated over the years, thanks to responsible lending measures administered by BNM, household debt-to-gdp ratio remains high at 89 in 215. More tightening measures could dampen the robust growth momentum in the personal financing segment. Asset-quality deterioration amid challenging operating environment could result in higher-than-expected provisions. Company Background BIMB Holdings Berhad provides all aspects of Islamic banking services and is the only listed Shariah-compliant bank in Malaysia. Through its subsidiaries, the bank also underwrites family and general Takaful (Islamic insurance) and provides stockbroking and other related services. Asset Quality RM m A 215A 216F 217F 218F Impaired financing ratio Provision charge-off rate Capitalisation () A 215A 216F 217F 218F Tier-1 CAR Total CAR ROE () A 215A 216F 217F 218F Forward PE Band (x) (x) sd: 14.8x sd: 13.3x 12. Avg: 11.8x 1. -1sd: 1.4x -2sd: 8.9x 8. Feb-13 Feb-14 Feb-15 Feb-16 (x) 2.9 PB Band (x) Feb-13 Feb-14 Feb-15 Feb-16 +2sd: 2.55x +1sd: 2.28x Avg: 2.1x -1sd: 1.74x -2sd: 1.47x Source: Company, AllianceDBS Page 3 ASIAN INSIGHTS VICKERS SECURITIES

31 Company Guide BIMB Holdings Key Assumptions FY Dec 214A 215A 216F 217F 218F Gross Financing Growth Customer Deposits Growth Yld. On Earnings Assets Avg Cost Of Funds Income Statement (RMm) FY Dec 214A 215A 216F 217F 218F Fund-based Income 1,28 1,32 1,42 1,51 1,648 Non-fund based Income ,56 1,153 1,261 Operating Income 2,15 2,267 2,458 2,663 2,98 Operating Expenses (1,165) (1,275) (1,348) (1,426) (1,59) Pre-provision Profit ,11 1,237 1,4 Provisions (56.3) (73.8) (119) (136) (191) Associates (68.2) (83.4) (1) (12) (144) Exceptionals..... Pre-tax Profit ,64 Taxation (228) (221) (258) (265) (287) Minority Interests (54.6) (65.7) (71.3) (78.5) (85.1) Preference Dividend..... Net Profit Net Profit bef Except Growth () Net fund based Income Gth Net Profit Gth Margins, Costs & Efficiency () Spread Net Financing Margin Cost-to-Income Ratio Business Mix () Net fund based Inc / Opg Inc Non-fund based Inc / Opg inc Fee Inc / Opg Income Oth Non-Int Inc/Opg Inc Profitability () ROAE Pre Ex ROAE ROA Pre Ex ROA Expect ROE to stay in the range of 15. Source: Company, AllianceDBS ASIAN INSIGHTS VICKERS SECURITIES Page 31

32 Company Guide BIMB Holdings Quarterly / Interim Income Statement (RMm) FY Dec 3Q215 4Q215 1Q216 2Q216 3Q216 Net fund-based Income Non-fund based Income Operating Income Operating Expenses (321) (367) (339) (341) (332) Pre-Provision Profit Provisions 5.34 (23.2) (34.9) (3.3) (22.2) Associates (22.) (22.8) (28.3) (28.2) (28.3) Exceptionals..... Pretax Profit Taxation (69.3) (22.) (59.1) (63.4) (68.6) Minority Interests (14.9) (16.4) (18.2) (18.6) (17.7) Net Profit Growth () Net fund-based Income Gth 2.5 (.1) (1.) Net Profit Gth (7.8) 35.1 (16.4) 6.3 (2.2) Bottomline driven by strong financing growth of 15 y- o-y Balance Sheet (RMm) FY Dec 214A 215A 216F 217F 218F Cash/Bank Balance 3,898 3,34 4,467 4,735 5,19 Government Securities 1,335 1,591 1,464 1,62 1,793 Inter Bank Assets Total Net Financing & Advs. 29,525 34,295 38,444 43,99 48,281 Investment 15,529 15,11 15,899 16,731 17,68 Associates..... Fixed Assets Goodwill Other Assets Total Assets 53,3 57,364 63,189 69,3 76,34 Customer Deposits 4,678 43,795 44,671 47,351 5,192 Inter Bank Deposits 3. 4,118 6,643 9,57 Debts/Borrowings 1,133 1,883 1,883 1,883 1,883 Others 1,46 1,42 1,433 1,465 1,497 Minorities Shareholders' Funds 2,949 3,414 3,813 4,263 4,748 Total Liab& S/H s Funds 53,3 57,364 63,189 69,3 76,34 Source: Company, AllianceDBS ASIAN INSIGHTS VICKERS SECURITIES Page 32

33 Company Guide BIMB Holdings Financial Stability Measures () FY Dec 214A 215A 216F 217F 218F Balance Sheet Structure Financing-to-Deposit Ratio Net Financing / Total Assets Investment / Total Assets Cust. Dep./Int. Bear. Liab Interbank Dep / Int. Bear Asset Quality NPF / Total Gross Financing NPF / Total Assets Financing Loss Reserve Coverage Provision Charge-Off Rate Capital Strength Total CAR Tier-1 CAR Healthy asset-quality indicators with low impaired financing ratio and high coverage ratio Source: Company, AllianceDBS Target Price & Ratings History RM S.No. Date of Report Closing Price 12-mth Target Price Rating 1: 25 Feb HOLD 2: 29 Feb HOLD 3: 3 Mar HOLD 4: 24 Mar HOLD 5: 3 May HOLD 6: 12 May HOLD 7: 2 J un HOLD 8: 12 J ul HOLD 9: 14 J ul HOLD 1 1: 28 J ul HOLD 11: 1 Aug HOLD : 29 Aug HOLD Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 13: 5 Sep HOLD 14: 31 Oct HOLD Note : Share price and Target price are adjusted for corporate actions. 15: 7 Dec HOLD 16: 22 Dec BUY 17: 1 Jan BUY 18: 7 Feb BUY 18 Source: AllianceDBS Analyst: Lynette CHENG Sue Lin LIM ASIAN INSIGHTS VICKERS SECURITIES Page 33

34 Malaysia Company Guide Bursa Malaysia Version 7 Bloomberg: BURSA MK Reuters: BMYS.KL Refer to important disclosures at the end of this report DBS Group Research. Equity 2 Feb 217 BUY Last Traded Price ( 17 Feb 217): RM8.81 (KLCI : 1,77.68) Price Target 12-mth : RM1. (14 upside) Potential Catalyst: Structural changes such as streamlining of surveillance role, revision in listing fees and revamp in fee structure Where we differ: Our TP is higher than consensus as we are pegging it to a higher valuation, given the upside potential to earnings Analyst Lynette CHENG lynettecheng@alliancedbs.com Sue Lin LIM suelinlim@dbs.com What s New Indirect proxy to Islamic financing growth via commodity trading platform, Bursa Suq al-sila (BSAS) Average daily value traded on BSAS expected to grow on continued growth in Islamic financing Diversified revenue base positive in times of subdued equity market Maintain BUY with RM1. TP Price Relative RM Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Bursa Malaysia (LHS) Relative KLCI (RHS) Relative Index Forecasts and Valuation FY Dec (RM m) 216A 217F 218F 219F Revenue EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex.) Net Pft Gth (Pre-ex) () (2.5) EPS (sen) EPS Pre Ex. (sen) EPS Gth Pre Ex () (3) Diluted EPS (sen) Net DPS (sen) BV Per Share (sen) PE (X) PE Pre Ex. (X) P/Cash Flow (X) EV/EBITDA (X) Net Div Yield () P/Book Value (X) Net Debt/Equity (X) CASH CASH CASH CASH ROAE () Earnings Rev (): Consensus EPS (sen sen): N/A Other Broker Recs: B: 4 S: 2 H: 9 Source of all data on this page: Company, AllianceDBS, Bloomberg Finance L.P Indirect proxy to Islamic banking growth Moving beyond equities; BUY. Albeit indirect, Bursa is also a proxy to growth in Islamic banking as transactions on its commodity trading platform, Bursa Suq al-sila (BSAS) is expected to increase in conjunction with Islamic financing growth. Furthermore, BSAS global accreditation implies a potential to grow alongside global growth in Islamic financing rather than just domestically. We expect BSAS contribution to remain small, but view the diversification in revenue base a boon to its earnings profile. Separately, we continue to like Bursa for its strong cashflow generation as an exchange operator, which will continue to support its high dividend payouts. Diversifying income base. With the increasing prevalence of Islamic banking, more transactions are expected be performed under BSAS, increasing the average daily value traded on BSAS. Assuming an average blended rate of RM4.5 per contract, every RM225bn worth of transaction would add RM1m to BSAS revenue. As of end-fy16, ADV stood at RM16bn, growing by more than 3-fold in the last three years. Strong traction from BSAS also aids in diversifying Bursa s reliance on equity-related income. This is particularly crucial currently, as the equity market is expected to remain subdued in the foreseeable future. Higher average daily value traded on BSAS contributes positively to revenue. Bursa earns trading fee for transactions performed on BSAS. A charge of RM3 is imposed per contract worth RM1m if it is settled within four days. A charge of RM1 and RM15 is imposed if it takes 5-21 days and more than 22 days, respectively. Hence, BSAS revenue typically moves in tandem with the average daily value traded on BSAS. However, the quantum may differ slightly, according to the average blended trading fee charged. Valuation: Our TP is based on the Dividend Discount Model and assumes 94 dividend payout and 4 long-term growth. Potential upside from higher liquidity and velocity as well as structural changes, will help re-rate Bursa's share price, in our view. Key Risks to Our View: Weaker market sentiment. Our sensitivity analysis shows that every 1 decrease in average daily trading value assumption would lower FY17 net profit by.4. At A Glance Issued Capital (m shrs) 536 Mkt. Cap (RMm/US$m) 4,725 / 1,61 Major Shareholders () Kumpulan Wang Persaraan Diperbadankan () 19.8 Capital Market Development Fund () 18.7 EPF () 7.2 Free Float () m Avg. Daily Val (US$m) 1.7 ICB Industry : Financials / General Financial ASIAN INSIGHTS VICKERS SECURITIES ed: CK / sa:wmt, PY

35 Company Guide Bursa Malaysia WHAT S NEW Indirect proxy to Islamic banking Bursa Suq al-sila (BSAS) serves as the trading platform for Islamic financial institutions to trade commodities. Islamic financial institutions use BSAS to facilitate liquidity management, risk management in Islamic financial market and Islamic financial product offerings. The Shariah contract pertinent to the transactions performed in BSAS is the murabahah contract, where commodities (in this case) are sold at cost plus profit, on deferred payment basis. Islamic financial institutions locally as well as globally can participate in BSAS. Higher average daily value traded on BSAS contributes positively to revenue. Bursa earns trading fee for transactions performed on BSAS. A charge of RM3 is imposed per contract worth RM1m if it is settled within four days. A charge of RM1 and RM15 is imposed if it takes 5-21 days and more than 22 days, respectively. Hence, BSAS revenue typically moves in tandem with the average daily value traded on BSAS (see Chart 1). However, the quantum may differ slightly, according to the average blended trading fee charged. How does Bursa benefit from the growth in Islamic banking? With the increasing prevalence of Islamic banking, more transactions are expected be performed under BSAS, increasing the average daily value traded on BSAS. Assuming an average blended rate of RM4.5 per contract, every RM225bn worth of transaction would add RM1m to BSAS revenue. Evidently, BSAS have grown over the years, as ADV continues to grow from strength to strength sequentially (see Chart 2). As of end-fy16, ADV stood at RM16bn, growing by more than 3-fold in the last three years. This was largely driven domestically, particularly in 215 when the Islamic Financial Services Act was enacted, which resulted in higher conversion of deposits to murabahah. Foreign ADV has also grown gradually, albeit at a slow pace. The number of participants has also grown by 59 to 124 participants as of end-fy16 (from 78 participants in 1Q14) BSAS contribution expected to improve but remain small. As a result of the strong growth in ADV, revenue from BSAS improved concurrently. In FY13, BSAS contributed 1.3 to Bursa s total revenue. In FY16, this has grown to 3.4 (see Chart 3). With Islamic financing expected to continue outpacing conventional financing, we believe this momentum will persist but remain a small contributor to Bursa s overall earnings given the low charges imposed on BSAS transactions. That said, we view the diversification in revenue base positively, as it reduces the concentration risk with regard to equity-related income. This is particularly crucial currently, as the equity market is expected to remain subdued in the foreseeable future (see Chart 4). Maintain BUY and TP of RM1.. Despite the bright prospects for BSAS, contribution to bottomline remains minute for Bursa. A significant pick-up in transaction value is required before BSAS revenue begins to contribute significantly. Thus, we keep our earnings and recommendation unchanged. Our TP is based on the Dividend Discount Model and assumes 94 dividend payout (excluding special dividends) and 4 long-term growth, implying 25x FY17 EPS. Potential upside to dividend yield. The stock currently provides a decent 4-5 yield, with room for further upside given its sizeable cash hoard. Bursa s dividend payout was higher y-o-y in FY16 and the company has declared special dividends in 213 and 214. However, management indicated a preference to keep its cash buffer in preparation for possible regulatory changes the International Organization of Securities Commissions (IOSCO) has yet to finalise the guideline for capital requirements. Meanwhile, potential structural changes (revision in listing fees, revamp in fee structure and streamlining of its surveillance role) could unlock its earnings potential. ASIAN INSIGHTS VICKERS SECURITIES Page 35

36 Company Guide Bursa Malaysia Chart 1:BSAS revenue vs ADV Chart 2: BSAS statistics RM m Q Q Q Q Q Q Q Q Q Q Q Q RM bn Q Q Q Q Q Q Q Q Q Q Q Q BSAS revenue (LHS) ADV (RHS) Foreign ADV (LHS) No of trading participants (RHS) Domestic ADV (LHS) BSAS revenue moves in tandem with the average daily value traded Chart 3: BSAS performance Growing number of trading participants and foreign participants Chart 4: Equity - average daily volume and value trends RM m , 2,5 2, 1,5 1, FY13 FY14 FY15 FY15 FY16 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 4Q9 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 BSAS revenue (LHS) BSAS to rev (RHS) Ave Daily Volume (m) Ave Daily Value (RMm) BSAS remains a small contributor to Bursa s revenue, but diversification in revenue base positive to the company Subdued average daily volume and value trends in the equity market since 214. Source: Company, DBS Bank, AllianceDBS, Bloomberg Finance L.P. Page 36 ASIAN INSIGHTS VICKERS SECURITIES

37 Company Guide Bursa Malaysia CRITICAL DATA POINTS TO WATCH Earnings Drivers: Revision in clearing fee. Close to 5 of Bursa s operating revenue consists of revenue from securities trading, the bulk of which comprises clearing fees. Bursa currently imposes a maximum cap of RM1, on its clearing fees which typically benefits institutional investors, due to their larger contract values. In our view, Bursa could lower clearing fees to promote retail participation while raising the RM1, cap to enhance revenue from institutional investors. A balancing act is required as higher transaction costs could reduce market participation (specifically from retail investors). Higher listing fee will boost Bursa s earnings. Revenue from derivatives trading comprises sub-2 of Bursa s operating revenue, with CPO Futures making up 8 of the total derivative volume traded in the bourse. Meanwhile, the remainder of Bursa s revenue is derived from other fee income such as listing fees, depository fees and revenue from information services. Bursa s last revision in listing fee was in 28 and is currently lower vis-à-vis its closest peer, Singapore Exchange (SGX). Although the timing of such a revision remains fluid, the exercise will indeed boost Bursa s earnings. Potential streamlining in regulatory watchdog role. This would be positive for Bursa as it could then redirect its time and resources to more revenue-generating activities, such as developing more initiatives to stimulate trading activities and velocity, promoting capital markets and raising the exchange s competitiveness in the ASEAN region. As duplications will be removed, we expect to see better cost efficiencies for Bursa. Revamp of tax structure. Currently, on top of the.1 stamp duty (with a cap of RM2) charged, investors are also charged GST on clearing fees. Replacing stamp duty with GST could reduce investors' transaction costs. Taxes currently make up a large proportion (76) of transaction costs (excluding brokerage) Average Daily Volume (m) A 216A 217F 218F 219F Average Daily Value (RMm) A 216A 217F 218F 219F Average Value/Volume A 216A 217F 218F 219F Velocity () To further enhance retail participation, Bursa can offer incentives to encourage companies to voluntarily raise their free floats. For instance, by offering incentives for share splits and increasing minimum free float requirements, trading liquidity can be enhanced and Bursa will benefit from a broader and deeper securities market A 216A 217F 218F 219F Revenue breakdown by segment F 218F 219F Equity Derivatives Other operating revenue Source: Company, AllianceDBS ASIAN INSIGHTS VICKERS SECURITIES Page 37

38 Company Guide Bursa Malaysia Balance Sheet: Net cash position. Bursa s net cash position is largely supported by its highly cash-generative business as an exchange operator. We do not foresee a change in this position as no major capex requirement is expected. Lucrative dividend payout. Bursa generously pays out more than 9 of its net profit historically. Special dividends were paid out in 213 and 214. Although there is still room for another special dividend, management intends to maintain its cash buffer for the time being. Share Price Drivers: Currently trading below 1-year mean valuation. The market has not priced in the positives from structural changes. These changes will boost Bursa s earnings and act as re-rating catalysts for the stock, in our view. Strong market volumes and values a boon for Bursa. Bursa is a good proxy to a recovery in market volume and value. Nevertheless, we believe this is unlikely to be a catalyst for the stock in the near term due to the weaker sentiment of late. Key Risks: Sustainability of market liquidity. Bursa s earnings are reliant on market volumes and capital market activity which are volatile. A negative macro sentiment could dampen market volumes and values. Our sensitivity analysis shows that every 1 decrease in average daily trading value assumption would lower FY17 net profit by.4. Our assumptions for average daily trading volume and value for 217 are 1.72bn shares and RM1.85bn respectively. Structural changes would take time to implement. The timing of approval for the aforementioned measures is still fluid and implementation may take time. Company Background Bursa Malaysia is an exchange holding company principally involved in treasury management and the provision of management services to its subsidiaries which operate the securities exchange, derivatives exchange and depository and clearing house in Malaysia. Leverage & Asset Turnover (x) A 216A 217F 218F 219F Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure RMm A 216A 217F 218F 219F Capital Expenditure (-) ROE () A 216A 217F 218F 219F 26.7 Forward PE Band (x) (x) sd: 24.2x sd: 23.2x 22.7 Avg: 22.2x sd: 21.1x 2.7-2sd: 2.1x Feb-13 Feb-14 Feb-15 Feb-16 PB Band (x) (x) sd: 6.18x +1sd: 5.79x Avg: 5.39x -1sd: 5x -2sd: 4.6x Feb-13 Feb-14 Feb-15 Feb-16 Source: Company, AllianceDBS Page 38 ASIAN INSIGHTS VICKERS SECURITIES

39 Company Guide Bursa Malaysia Key Assumptions FY Dec 215A 216A 217F 218F 219F Average Daily Volume (m) 1,975 1,667 1,716 1,768 1,821 Average Daily Value 1,999 1,812 1,854 1,892 1,93 Average Value/Volume Velocity () Segmental Breakdown FY Dec 215A 216A 217F 218F 219F Revenues (RMm) Equity Derivatives Stable revenue Other operating revenue Total Equity revenue makes up bulk of earnings Income Statement (RMm) FY Dec 215A 216A 217F 218F 219F Revenue Other Opng (Exp)/Inc (29) (22) (197) (192) (187) Operating Profit Other Non Opg (Exp)/Inc..... Associates & JV Inc..... Net Interest (Exp)/Inc..... Exceptional Gain/(Loss)..... Pre-tax Profit Tax (72.3) (67.9) (73.3) (79.6) (86.4) Minority Interest (7.8) (9.) (9.8) (1.7) (11.6) Preference Dividend..... Net Profit Net Profit before Except EBITDA Growth Revenue Gth () 3.5 (3.1) EBITDA Gth () 1.8 (2.5) Opg Profit Gth () 2.6 (2.9) Net Profit Gth (Pre-ex) ().2 (2.5) Margins & Ratio Opg Profit Margin () Net Profit Margin () ROAE () ROA () ROCE () Div Payout Ratio () Net Interest Cover (x) NM NM NM NM NM Source: Company, AllianceDBS ASIAN INSIGHTS VICKERS SECURITIES Page 39

40 Company Guide Bursa Malaysia Quarterly / Interim Income Statement (RMm) FY Dec 4Q215 1Q216 2Q Q216 4Q216 Revenue Other Oper. (Exp)/Inc (54.7) (55.5) (52.8) (5.2) (43.6) Operating Profit Other Non Opg (Exp)/Inc..... Associates & JV Inc..... Net Interest (Exp)/Inc..... Exceptional Gain/(Loss)..... Pre-tax Profit Tax (17.9) (18.) (17.7) (15.7) (16.6) Minority Interest (2.) (2.7) (2.3) (1.9) (2.2) Net Profit Net profit bef Except EBITDA Growth Revenue Gth () (3.1) (8.6).7 EBITDA Gth () (1.9).1 (1.6) (11.3) 11.9 Opg Profit Gth () (1.9).1 (1.6) (11.3) 11.9 Net Profit Gth (Pre-ex) () (1.7) (1.3) (.9) (11.) 13.9 Margins Opg Profit Margins () Net Profit Margins () Q16 earnings lifted by lower staff cost Balance Sheet (RMm) FY Dec 215A 216A 217F 218F 219F Net Fixed Assets Invts in Associates & JVs..... Other LT Assets Cash & ST Invts 1,514 1,848 2,231 2,77 3,3 Inventory..... Debtors Other Current Assets Total Assets 2,86 2,436 2,821 3,33 3,97 ST Debt..... Creditor 1,84 1,379 1,741 2,199 2,777 Other Current Liab LT Debt..... Other LT Liabilities Shareholder s Equity Minority Interests Total Cap. & Liab. 2,86 2,436 2,821 3,33 3,97 Non-Cash Wkg. Capital (1,158) (1,448) (1,8) (2,243) (2,83) Net Cash/(Debt) 1,514 1,848 2,231 2,77 3,3 Debtors Turn (avg days) N/A N/A N/A N/A N/A Creditors Turn (avg days) N/A N/A N/A N/A N/A Inventory Turn (avg days) N/A N/A N/A N/A N/A Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) CASH CASH CASH CASH CASH Net Debt/Equity ex MI (X) CASH CASH CASH CASH CASH Capex to Debt () N/A N/A N/A N/A N/A Z-Score (X) Source: Company, AllianceDBS Page 4 ASIAN INSIGHTS VICKERS SECURITIES

41 Company Guide Bursa Malaysia Cash Flow Statement (RMm) FY Dec 215A 216A 217F F 219F Pre-Tax Profit Dep. & Amort Tax Paid (77.7) (73.3) (73.3) (79.6) (86.4) Assoc. & JV Inc/(loss)..... Chg in Wkg.Cap Other Operating CF (8.8) (19.6)... Net Operating CF Capital Exp.(net) (15.5) (1.9) (15.) (15.) (15.) Other Invts.(net) (31.5) (29.6)... Invts in Assoc. & JV..... Div from Assoc & JV..... Other Investing CF 7.3 (17.4)... Net Investing CF 23.3 (57.9) (15.) (15.) (15.) Div Paid (184) (187) (198) (215) (233) Chg in Gross Debt..... Capital Issues..... Other Financing CF (5.8) (6.8)... Net Financing CF (19) (194) (198) (215) (233) Currency Adjustments Chg in Cash 49.7 (5.) Opg CFPS (sen) Free CFPS (sen) Source: Company, AllianceDBS Target Price & Ratings History RM S.No. 12-mth Date of Closing Target Rating Report Price Price 1: 26 Apr BUY 2: 25 Jul BUY 3: 26 Jul BUY 4: 11 Oct BUY 5: 25 Oct BUY 6: 5 Jan BUY 7: 6 Feb BUY Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Note : Share price and Target price are adjusted for corporate actions. Source: AllianceDBS Analyst: Lynette CHENG Sue Lin LIM ASIAN INSIGHTS VICKERS SECURITIES Page 41

42 SMC Research Malaysia Equity Explorer Malaysia Building Society Berhad Bloomberg: MBS MK Reuters: MBSS.KL Refer to important disclosures at the end of this report DBS Group Research. Equity 2 Feb 217 NOT RATED RM1.15 Closing price as of 17 Feb KLCI : 1,77.68 Return *: 3 Risk: Moderate Potential Target 12-mth mth* : 12-month RM.9 (- 22 downside) Analyst Lynette CHENG lynettecheng@alliancedbs.com Sue Lin LIM suelinlim@dbs.com Price Relative Forecasts and Valuation FY Dec (RM RMm) 215A 216F 217F 218F Pre-prov. Profit 1,52 1,37 1,74 1,146 Net Profit Net Pft (Pre Ex.) EPS (sen) EPS Pre Ex. (sen) EPS Gth () (8) (45) (1) 19 EPS Gth Pre Ex () (8) (45) (1) 19 Diluted EPS (sen) PE Pre Ex. (X) Net DPS (sen) Div Yield () ROAE Pre Ex. () ROAE () ROA () BV Per Share (sen) P/Book Value (x) Consensus EPS (sen sen): Other Broker Recs: B: S: 1 H: 4 ICB Industry : Financials ICB Sector: Financial Services Principal Business: Consumer Finance Source of all data on this page: Company, AllianceDBS, Bloomberg Finance L.P. Looking beyond provisions MBSB is an exempt finance company equipped with a lucrative personal financing portfolio Sizeable Islamic banking asset renders MBSB a compelling conduit in creating another pure Islamic bank, aside from BIMB and Muamalat Heavy provisions remain a near-term drag but M&A appeal could resurface in FY18 Fair value of RM.9, implying.8x FY17BV; M&A a potential catalyst to re-rate the stock to RM1.3 The Business Forte in personal financing. MBSB is the only exempt finance company in Malaysia. What differentiates an exempt finance company from a bank is mainly from its prohibition in participating in the interbank market and in accepting demand deposits. MBSB has carved a strong niche in the segment of personal financing to civil servants, thanks its access to the direct deduction code obtained from Angkasa which provides it with the first cut of a civil servant s salary at repayment. Compelling Islamic banking proxy. We believe institutions with an intention to compete on the global Islamic banking space will keep an eye on opportunities to take MBSB into its coffers, given its sizeable Islamic banking asset and lucrative personal financing business. When stacked against the Islamic banks in Malaysia, MBSB ranks among the top 1 players based on asset size (#8) and loan portfolio size (#5). Currently, Islamic banking makes up c.8 of MBSB s assets, loans and income. The Stock Saddled by hefty provisions. MBSB has delivered weak earnings traction since FY15 and is expected to remain so up to FY17, attributable to its impairment programme deployed to narrow the gap between MBSB and that of the industry. However, we expect credit cost to decline to 1 in FY18 (from c.2 in FY16-17F), which will be the main factor lifting ROE to 8. Fair value of RM.9 based on Gordon Growth model, assuming 8 ROE, 9 cost of equity and 2 long-term growth. Our TP implies.8x FY17 BV, which we believe justly reflects its weak ROE traction of sub-5. However, in the event of an M&A (which in our view, will be increasingly imminent in FY18), we believe MBSB could fetch a valuation of 1.1x BV, which translates to a fair value of RM1.3 (based on FY17 BV). At A Glance Issued Capital (m shrs) 5,799 Mkt. Cap (RMm/US$m) 6,669 / 1,497 Major Shareholders () EPF 65.1 Tan Sri Dato Chua Ma Yu 5.2 Free Float () 3m Avg. Daily Val (US$m) 2.4 *This Equity Explorer report represents a preliminary assessment of the subject company, and does not represent initiation into DBSV s coverage universe. As such DBSV does not commit to regular updates on an ongoing basis. The rating system is distinct from stocks in our regular coverage universe and is explained further on the back page of this report. ed: CK / sa: WMT, PY

43 Equity Explorer Malaysia Building Society Berhad COMPANY BACKGROUND The only exempt finance company in Malaysia. Malaysia Building Society Berhad (MBSB) started out as Federal and Colonial Building Society Limited in 195, and was eventually listed on Bursa Malaysia in MBSB was granted the status of an exempt finance company in 1972 by the Ministry of Finance, allowing the company to undertake financing business without a banking licence. The main difference between an exempt finance company and a commercial bank is that an exempt finance company is not allowed to participate in the interbank market and accept demand deposits. Apart from that, MBSB is also not subject to statutory reserve requirements. Differences between an exempt finance company and a commercial bank Exempt Finance Commercial Bank Company Regulated by Ministry of Finance Bank Negara Malaysia Deposit- Limited to savings and No restrictions taking restriction fixed deposits. Not allowed to take demand deposits Interbank Unable to participate Able to participate market Deposit Not insured by PIDM Insured by PIDM insurance Statutory Not applicable 3.5 reserve requirement Capital ratios Not applicable Transitional compliance with Basel 3 Source: Company, DBS Bank, AllianceDBS MBSB is helmed by Chief Executive Officer, Dato Ahmad Zaini bin Othman whom was appointed in Feb 29. Prior to his stint in MBSB, Dato Ahmad Zaini was the CEO of AmIslamic Bank, managing all the group s affairs pertaining to Islamic banking in commercial and corporate finance and was responsible for setting up the Islamic business model for the group. He is also a member of the Chartered Institute of Islamic Finance Professionals (CIIF). In recognition of his contributions to Islamic banking he was appointed a faculty member (industry expert) to the International Centre for Education in Islamic Finance (INCEIF). Hence, for any bank apart from MAY ISL, adding MBSB to the coffers could make a difference to its ranking. Nonetheless, we highlight that MBSB has yet to achieve the status of a full-fledged Islamic institution as it is still in the midst of converting its conventional assets to Islamic. The initiative to move towards the Islamic status started when the financial institution introduced a dual banking system of conventional and Islamic banking in 23. Currently, Islamic operation makes up c.8 of its assets, loans and income. We understand that what is leftover is a portion of corporate and mortgage accounts. All accounts under personal financing are Islamic. MBSB: Proportion of Islamic financing income to total income RM m 1,6 1,4 1,2 1, Islamic financing income (LHS) Islamic (RHS) Source: Company, DBS Bank, AllianceDBS MY: Islamic banks ranked by asset size RM bn MAY ISL 92 BANK RAKYAT 57 BIMB 55 CIMB ISL 46 PUBLIC ISL 44 RHB ISL 41 MBSB 38 AMISL 26 HL ISL 23 Muamalat 19 HSBC AMAN Source: Company, DBS Bank, AllianceDBS 215 9M16 Total income (LHS) 15 OCBC AL- 13 AFFIN ISL 11 SC SAADIQ 11 KFH 1 ALLCE ISL 7 Al-Rajhi AFB Closing the gap between itself and the banks. A key initiative under MBSB s agenda to close the gap, is its impairment programme. Management has guided that the programme will see a total of RM2.bn impairment over FY To date, MBSB crossed the halfway mark of this programme, with more than RM1bn of impairment booked. Apart from that, MBSB completed a rights issue exercise in July 216, strengthening its capital adequacy. MBSB has also been improving its core banking infrastructure and back-office operations over the last few years. On the path towards becoming a full-fledged fledged Islamic bank. When stacked against the Islamic banks in Malaysia, MBSB ranks among the top 1 players based on asset size (#8) and loan portfolio (#5). MY: Islamic banks ranked by loan portfolio size RM bn MAY ISL BANK RAKYAT CIMB ISL BIMB MBSB PUBLIC ISL RHB ISL AMISL HL ISL MUAMALAT HSBC AMAN Source: Company, DBS Bank, AllianceDBS OCBC AL- AFFIN ISL KFH ALLCE ISL SC SAADIQ 5 AL-RAJHI 1 AFB Page 43

44 Equity Explorer Malaysia Building Society Berhad Stronghold in personal financing. At 66 of total financing portfolio, personal financing is MBSB s key segment. This is followed by corporate loans (17) and home financing (16). MBSB managed to build a niche in the personal financing segment through its access to the direct deduction code obtained from Angkasa (Angkatan Koperasi Kebangsaan Malaysia or National Cooperative Organisation of Malaysia). Angkasa is the central collection agency that manages the salary deduction of government servants on behalf of cooperatives and certain non-cooperatives. Financial institutions with access to this code get the first cut of a civil servant s salary, hence reducing the chances of default. MBSB: Loan portfolio Home financing 16 Corporate loans 17 Others 1 Source: Company, DBS Bank, AllianceDBS Personal financing growth crimped by macroprudential policies. MBSB s personal financing segment recorded stellar growth prior to 213, with its portfolio more than doubling up from year to year. However, with concerns relating to the high household debt in Malaysia, BNM introduced macroprudential policies stating cautiousness in household loans. In 213, BNM enforced a regulation targeted at personal financing, by limiting its tenure to 1 years (from 25 years). Subsequent to that, personal financing growth has been on a downtrend for MBSB. Personal Financing 66 Malaysia: BNM tightening measures Date Segment Measures 3-Nov-1 Property Loans 7 LTV cap on third and subsequent property. 1-Jan-11 Property Loans Risk weights applied by banks are raised to 1 from 75, for housing loans >9 LTV. 15-Mar-11 Credit Cards Credit card eligibility raised to RM24k per annum from RM18k per annum. Cardholders earning <RM36k p.a. can hold credit cards from only two issuers. The credit card limit for cardholders earning <RM36k p.a. are capped at double the monthly income of the holder from each issuing bank. 15-Jun-11 Auto Loans A hire purchase agreement can only be prepared after the actual car unit has been allocated to the dealer, as the car's chassis number has to be included in the agreement, and the buyer needs to be present at the bank to finalise the hire purchase agreement. 1-Jan-12 Retail Loans Banks should use net income (after tax, EPF and other debt obligations) rather than gross income in assessing borrowers' affordability. 8-Jul-13 Personal Loans Lowered maximum tenure for personal loans to 1 years (from 25 years) and pre-approved personal financing products are prohibited. 8-Jul-13 Property Loans Lowered maximum tenure for property loans to 35 years (from 45 years). Source: Company, DBS Bank, AllianceDBS MBSB: Personal financing RM m 25, 25 2, 15, 1, 5, Personal financing (LHS) Growth y-o-y (RHS) Source: Company, DBS Bank, AllianceDBS Page 44

45 Equity Explorer Malaysia Building Society Berhad INVESTMENT CASE Beaten-down share price due to weak earnings. MBSB s share price plummeted by 52 from November 214 to early Feb 216. Valuations have dropped from a high of 2.7x BV to.5x FY16 BV currently. While we believe current valuation justly reflects MBSB s weak earnings momentum due to its ongoing impairment programme, we believe MBSB s appeal as an M&A target will resurface in FY18, once the impairment programme is completed. MBSB: Personal financing RM Jan-14 Source: Company, DBS Bank, AllianceDBS Conduit for the making another pure Islamic bank. News of MBSB in negotiations for a potential merger and acquisition (M&A) with Asian Finance Bank emerged on 22 Nov. This did not come as a surprise as M&A speculations involving MBSB has surfaced in the media several times historically, but all attempts have been futile thus far. While a merger with Asian Finance Bank does not enlarge its portfolio in a significant way, MBSB will attain an Islamic banking licence from the acquisition. Hence, the merger will speed up MBSB s aspirations of attaining Islamic as well as a bank status. Apart from this, the most talked about attempt was one by CIMB and RHB in 214 where MBSB was slated to remain listed and to act as a vehicle for any proposed Islamic bank, in line with the government s agenda to create a Mega Islamic Bank. However, negotiations were halted in January 215 as extraction of synergies were challenging amid a weakening macroeconomic backdrop then. In Feb 216, MBSB was also in talks for a merger with Bank Muamalat. Apr-14 Jul-14 Oct-14 Jan-15 Still an attractive M&A target. Despite several failed attempts in M&A, we believe institutions with an intention to compete on the global Islamic banking space will continue to keep an eye on opportunities to take MBSB into its coffers, given its sizeable Islamic banking asset and lucrative personal financing business. In fact, we believe MBSB s M&A appeal will heighten in FY18, after the completion of its impairment programme and more progress is made in narrowing the gap between them and banks as it lowers the hurdle to integration. Apr-15 Jul-15 Oct-15 Jan-16 Share price fell by 52 Apr-16 Jul-16 Oct-16 Jan-17 FINANCIAL REVIEW Credit cost assumption of 2.2/1.9/1. across FY16-18F. 18F. Management has guided that the programme will see a total of RM2.bn impairment over FY To date, MBSB crossed the halfway mark of this programme, with more than RM1bn of impairment booked. Our credit cost assumption in FY18 remains conservative as it is higher than the credit cost booked prior to the impairment programme (sub-1). We expect impaired financing ratio to remain high in FY16 and FY17, with a slight improvement in FY18 to 7 (from 7.5 and 7.4 in FY16 and FY17). MBSB: Credit cost and impaired financing ratio F 217F 218F Impaired financing ratio (RHS) Credit cost (LHS) Source: Company, DBS Bank, AllianceDBS We imputed 5/6/9 loan growth for FY16-18F 18F. Loan growth is expected to be driven by corporate loans as MBSB continue to place an emphasis on this segment. Deposit growth was encouraging this year, driven mainly by fixed deposits. Hence, we pencilled in deposit growth of 11/7/7 for FY16-18F, resulting in the financing to deposit ratio to come in around across the years. MBSB: Financing and deposit growth (1) F 217F 218F Financing growth (LHS) Deposit growth (LHS) Financing to deposit ratio (RHS) Source: Company, DBS Bank, AllianceDBS NIM for FY16 is expected to decline by 18bps as management plans to reduce higher-yielding retail financing portfolio and increase lower-yielding corporate loans. We expect this portfolio rebalancing to continue in the years to come, resulting in a further decline in NIM of 9bps in FY17F and 7bps in FY18F, respectively. Page 45

46 Equity Explorer Malaysia Building Society Berhad Bottomline improvement post impairment programme. While high provisions may continue to be a feature in FY16 and FY17, we expect bottomline to improve significantly in FY18 to close to FY13 levels, on the back of narrowing credit cost. Consequently, ROE is envisaged to climb towards 8 in FY18. MBSB: Net profit RM m 1,4 1,2 1, F 217F 218F Net profit (LHS) Pre provision profit (LHS) ROE (RHS) Source: Company, DBS Bank, AllianceDBS VALUATIONS RISKS Further asset quality upsets. While MBSB targets to complete its impairment programme by 218, the current weak macroeconomic backdrop may exert pressure on MBSB s asset-quality indicators, hence necessitating more impairments. If this materialises, MBSB s weak earnings momentum may not end in FY18 as expected. Timing of M&A. The current operating environment for the banks remains challenging, with revenue growth being limited by the moderating loan growth, narrowing NIM and weak capital markets. These challenges are not expected to taper off in the near term. Hence, while MBSB s M&A appeal may heighten in 218, the operating environment may remain tough for banks to pursue an M&A agenda. MBSB: Risk assessment Category Risk Rating Wgt Wgtd Score 1 (Low) - 3 (High) Earnings Financials Shareholdings Overall 2.2 Source: Company, DBS Bank, AllianceDBS Fair value of RM.9. We value MBSB using the Gordon Growth Model, assuming 8 ROE, 1 cost of equity and 2 long-term growth. With that, we arrive at a fair value of RM.9, which implies.8x FY17 BV. We believe the current valuation is fair for the stock given its weak ROE traction of sub-5 in the near term (FY16- FY17). Nonetheless, in the event of an M&A (which in our view, will be increasingly imminent in FY18), we believe MBSB can fetch a higher valuation. While historical M&A transaction implies an average valuation of 1.3x BV, a discount is necessary as ROEs have de-rated compared to the past. We find that a valuation of 1.1x BV for MBSB s franchise is fair, which translates into a fair value of RM1.3, based on FY17 BV. MBSB: 12-month forward P/BV P ratio (x) (x) sd: 2.7x +1sd: 2.1x 1.7 Avg: 1.5x 1.2-1sd:.9x.7.2-2sd:.3x Feb-7 May-8 Aug-9 Nov-1 Feb-12 May-13 Aug-14 Nov-15 Feb-17 Source: Company, DBS Bank, AllianceDBS Page 46

47 Equity Explorer Malaysia Building Society Berhad Key Assumptions FY Dec 213A 214A 215A 216F 217F 218F Gross Loans Growth Customer Deposits Growth 31.2 (2.3) Yld. On Earnings Assets Avg Cost Of Funds Sensitivity Analysis 217F Loan growth +/- 1 Net Profit +/-.3 NIM +/- 1bps Net Profit +/- 12 Income Statement (RMm) FY Dec 213A 214A 215A 216F 217F 218F Net Interest Income Non-Interest Income Operating Income 1,53 1,364 1,361 1,354 1,398 1,476 Operating Expenses (295) (35) (38) (318) (324) (33) Pre-provision Profit 1,28 1,59 1,52 1,37 1,74 1,146 Provisions (276) (126) (697) (788) (724) (415) Associates Exceptionals Pre-tax Profit Taxation (335) 82.5 (97.4) (49.8) (87.4) (183) Minority Interests Preference Dividend Net Profit 598 1, Net Profit bef Except 598 1, Growth () Net Interest Income Gth (56.1) (14.5) (11.1) Net Profit Gth (74.6) (22.7) Margins, Costs & Efficiency () Spread Net Interest Margin Cost-to-Income Ratio Business Mix () Net Int. Inc / Opg Inc Non-Int. Inc / Opg inc Fee Inc / Opg Income Oth Non-Int Inc/Opg Inc Profitability () ROAE Pre Ex ROAE ROA Pre Ex ROA Impairment programme to complete in FY17 Margins Trend Source: Company, AllianceDBS Page 47

48 Equity Explorer Malaysia Building Society Berhad Quarterly / Interim Income Statement (RMm) FY Dec 2Q Q215 4Q215 1Q216 2Q Q216 Quarterly Net Profit & Growth Net Interest Income Non-Interest Income Operating Income Operating Expenses (75.2) (73.2) (75.8) (73.3) (83.9) (77.9) Pre-Provision Provision Profit Provisions (134) (196) (266) (219) (18) (21) Associates Exceptionals Pretax Profit Taxation (43.7) (3.3) (17.1) (4.3) (11.7) (15.8) Minority Interests Net Profit (15.8) High provisions are the key drag on earnings Growth () Net Interest Income Gth 17. (18.6) 14.4 (6.1) (26.3) 4.6 Net Profit Gth (31.2) (25.7) nm nm 8.9 (8.1) Source: Company, AllianceDBS Balance Sheet (RMm) FY Dec 213A 214A 215A 216F 217F 218F Gross Loan& Growth Cash/Bank Balance 4,584 5,767 6,928 11,942 13,559 14,599 Government Securities Inter Bank Assets Total Net Loans & Advs. 3,296 31,32 31,785 33,349 35,512 38,829 Investment ,3 1,13 Associates Fixed Assets Goodwill Other Assets Total Assets 35,246 37,666 41,89 47,296 51,127 55,564 Customer Deposits 28,193 27,531 28,585 31,73 33,951 36,327 Inter Bank Deposits Debts/Borrowings 2,184 2,717 4,524 5,428 6,514 7,817 Others 2,683 2,736 3,118 3,428 3,768 4,142 Minorities Shareholders' Funds 2,186 4,682 4,862 6,71 6,894 7,277 Total Liab & S/H s Funds 35,246 37,666 41,89 47,296 51,127 55,564 Customer Deposit & Growth Source: Company, AllianceDBS Page 48

49 Equity Explorer Malaysia Building Society Berhad Financial Stability Measures () FY Dec 213A 214A 215A 216F 217F 218F NPL / Total Gross Loans Balance Sheet Structure Loan-to-Deposit Ratio Net Loans / Total Assets Investment / Total Assets Cust. Dep./Int. Bear. Liab Interbank Dep / Int. Bear Asset Quality NPL / Total Gross Loans NPL / Total Assets Loan Loss Reserve Coverage Provision Charge-Off Rate Capital Strength Total CAR N/A N/A N/A N/A N/A N/A Tier-1 CAR N/A N/A N/A N/A N/A N/A High impaired financing ratio Source: Company, AllianceDBS Page 49