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Bank Muamalat announced its plans to issue a perpetual AT1 sukuk that is callable in 5 year at the initial price guidance of 6.35%. If uncalled, the sukuk will be reset at the prevailing 5-year MGS plus the initial margin as determined upon issuance.
The sukuk is rated at BBB with a stable outlook by MARC.
Highlights
- Bank Muamalat Malaysia is 70% owned by DRB-Hicom and 30% owned by Khazanah Nasional.
- The bank recorded a profit before zakat and tax of RM111.2 million in 1H23, which is lower by 22.7% y-o-y. Net profit margin fell from 2.58% in FY22 to 1.92% in 1H23.
- CET1 ratio is weighed down by financing growth which raise one’s eye at the bank's diminishing buffer.
- AT1 is inherently a high-risk investment as it is designed to absorb losses (written off) in distress occasion to protect depositors and senior bondholders. There is also the lack of step-up feature to incentivise the issuer to call back.
- Hence, Bank Muamalat perpetual AT1 sukuk might not cater to all investors given its barely passable credit profile and the risky nature of AT1 instrument.
- We would only suggest aggressive investors with conviction in Bank Muamalat and who do understand the downside risk to consider the underlined perpetual AT1 sukuk that is callable in 5 year.
Company background
Bank Muamalat Malaysia is an Islamic bank with a total of 68 branches nationwide. The bank offers shariah-compliant financial services ranging from consumer, business, investment banking to wealth management. In terms of shareholding composition, the bank is 70% owned by DRB-Hicom, one of the largest conglomerates in Malaysia with the national car brand Proton Holdings under their helm. The remaining 30% ownership is held by Khazanah Nasional, the investment arm of the Malaysia government.
We wish to highlight that DRB-Hicom would need to pare down its ownership to 40% as a condition precedent to its purchase of Bank Muamalat in 2008. However, there has been no firm development on this matter up to date. The bank has explored the feasibility of public listing and merger with other bank in the past to pare down DRB-Hicom stake, but to no avail.
Lower profit before tax and zakat in 1H23
For the first half ended 30 June 2023 (1H23), Bank Muamalat recorded a profit before zakat and tax of RM111.2 million, which is lower by 22.7% y-o-y. This is due to the higher income attributable to depositors and the higher allowance for impairment. Net profit margin also fell from 2.58% in FY22 to 1.92% in 1H23. On top of that, although Bank Muamalata’s cost to income ratio has been trending down from the high of 59.8% in FY19 to 55.5% in 1H23, it is still relatively higher than most of its peers as illustrated in chart 3.
Chart
1: Bank Muamalat’s total net income and profit before tax and zakat
Chart 2: Comparison of net profit margin on yielding assets
between banks
Chart 3: Comparison of cost to income ratio between banks
From the balance sheet standpoint, the bank’s total assets grew by 25% y-o-y to RM35.4 billion as a result of growth in gross financing of customers. Loan to deposit ratio stood at 87%, which is well in progress towards the management guidance. Bank Muamalat’s management intends to bring down the loan to deposit ratio to a comfortable range of circa 80%.
CET1 ratio weighed down by financing growth
Bank Muamalat’s CET1 ratio stood at 11.7% as of June 2023, falling from 12.5% in FY22. This isn’t something out of the blue for Bank Muamalat as the bank has been grappling with the decline in CET1 ratio for years. The primary reason is because of Bank Muamalat’s robust financing growth that has outpaced its growth in retained earnings, which also implies that the bank is taking on a higher leverage position. Correspondingly, the rise in risk weighted assets has dragged the total capital ratio down to 16.4% (FY22:17.6%).
Although it is rosy to see an increase in Bank Muamalat’s loan demand, it does raise one’s eye at the bank’s diminishing buffer especially when compared with its peers. This is magnified when other banks in general have seen an uptick in their CET1 ratio while Bank Muamalat does the complete opposite over the years.
Chart
4: Bank Muamalat’s capital adequacy ratio
Chart 5: Comparison of CET1 ratio between banks
Malaysia is likely at the end of the tightening cycle, which would help Bank Muamalat to keep its impairment in check
Household financing (house financing, personal financing, credit card etc) forms the lion’s share of Bank Muamalat’s financing book at 71%, which is susceptible to interest rate changes. Fortunately, it is surmised that Malaysia is at the tail end of the rate hike cycle where the likelihood of further interest rate hike is low. Thus, household loan commitments that typically enlarge in tandem with interest rate hike is expected to maintain at the current modest level, which shall keep the bank’s impairments in check.
On the other hand, nearly half of Bank Muamalat’s customer deposit base is from government and statutory bodies. This may be perceived as concentration risk, but it is alleviated by the bank’s long-standing relationship with the government depositors. The sizable deposit proportion from government and statutory bodies also serve as a deposit base “stabiliser” which reduces the prospect of bank run.
Chart 6: Bank Muamalat’s financing portfolio by customer
type 
Chart 7: Bank Muamalat’s deposit base by customer type
Offering higher yield than the AT1 bonds in the market (but it comes with higher risk!)
Current yield for MYR Perp AT1 in the market is around the range of 5%. At the IPG of 6.35%, Bank Muamalat AT1 does yield higher than the existing AT1 bonds found in the market, but investors should take heed that Bank Muamalat has a weaker credit profile in particular of its continuously declining CET1 ratio.
Table 1: AT1 issuances in the market
| Ask price | Years to next call | Yield to next call/ current yield | Bond credit rating | |
| HLBKMK 4.450% Perpetual Corp (MYR) |
101.12 | 3.65 | 3.95%/4.40% | A1 |
| BIMBMK 5.160% Perpetual Corp (MYR) |
102.21 | 3.97 | 4.57%/5.05% | A3 |
| AHBMK 5.700% Perpetual Corp (MYR) |
103.12 | 4.79 | 5.03%/5.53% | A3 |
| AFGMK 5.500% Perpetual Corp (MYR) | 103.45 | 3.82 | 4.87%/5.31% | BBB1 |
| Bank Muamalat Perpetual Corp (MYR)* |
100.00* | 5.00* | 6.35%/6.35%* | BBB |
| Source: Bloomberg Finance L.P., Bondsupermart, iFAST compilations as of 7 September 2023 | ||||
| Current yield is calculated as coupon/ask price | ||||
| *: yet to be issued | ||||
The risky nature of AT1
AT1 is inherently a high-risk investment as it is designed to absorb losses when a bank is in financial distress, particularly when bank’s capital levels fall below a mandated threshold. The AT1 will be written off in such occasion to protect depositors and senior bondholders. Investors should also note that a write-off is not deemed as a default by the issuer and is irrevocable.
In Bank Muamalat case, the AT1 sukuk shall be written off if
1) the CET1 ratio falls below 5.125% to the extent that the CET1 ratio is restored to a minimum of 5.75%. Otherwise, the full principal value of the AT1 shall be written off.
2) the occurrence of non-viability event.
*Non-viability event refers to i) Bank Negara Malaysia (BNM), jointly with the Malaysian Deposit Insurance Corporation (PIDM) are of the opinion that a write off is necessary, as the bank is or will become non-viable or ii) Decision has been made by BNM, PIDM or any other federal or state government in Malaysia to provide capital injection or equivalent support to the issuer, without which the issuer would cease to be viable.
Do take note that there is no equity conversion feature for this AT1 sukuk.
Extension risk
Under Basel III regime, it is forbidden to include step-up feature in an AT1 instrument and Bank Muamalat AT1 sukuk is no exception. This significantly increases extension risk for investors as the sukuk won’t carry additional step-up rate when not called.
If Bank Muamalat does call, they must ensure that the level of capital is still above their minimum capital requirement. Often, this means refinancing the called bond.
Hence, the probability of Bank Muamalat calling back its AT1 could be boiled down to whether the fixed rate payable on a new issuance (refinancing) in 5-years later will be lower than the adjusted rate payable on its existing security (the discussed Bank Muamalat perp AT1). Failing this and Bank Muamalat might just elect to not call back the AT1 as it is more economically wise for the bank.
Our thoughts
Bank Muamalat is a bank with rough edges, namely with its continuously declining CET1 ratio, toppled net profit margin and higher cost to income ratio compared to its peers. While management has hinted on the potential public listing of the bank that should help in alleviating the plummeting CET1 ratio, there is no clear plan of when will that transpire. On top of that, AT1 instrument itself is risky with the built-in write off feature and the lack of step-up feature to incentivise the issuer to call back.
Given the bank’s barely passable credit profile and the highly risky AT1 instrument, we would only suggest aggressive investors with conviction in Bank Muamalat and who do understand the downside risk to consider the Bank Muamalat perpetual AT1 sukuk that is callable in 5 year. A better time for the consideration of this AT1 might be upon the announcement of further details of the public listing, which we expect to improve the bank’s credit profile.
Conclusion
Bank Muamalat announced its plans to issue a perpetual AT1 sukuk that is callable in 5 year at the initial price guidance of 6.35%. For the first half ended 30 June 2023 (1H23), Bank Muamalat recorded a lower profit before zakat and tax by 22.7% y-o-y. On the other hand, the bank’s CET1 ratio is weighed down by financing growth and raise one’s eye at the diminishing buffer the bank has in the event of adverse scenario.
AT1 is inherently a high-risk investment as it is designed to absorb losses when a bank is in financial distress. There’s also the risk of extension in duration that shouldn’t be overlook by investors. Given the bank’s barely passable credit profile and the highly risky AT1 instrument, we would only suggest aggressive investors with conviction in Bank Muamalat and who do understand the downside risk to consider the Bank Muamalat perpetual AT1 sukuk that is callable in 5 year. A better time for the consideration of this AT1 might be upon the announcement of further details of the public listing, which we expect to improve the bank’s credit profile.
Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) does not hold a position in Bank Muamalat 6.350% IPG Perpetual Corp (MYR) and the analyst who produced this report hold a NIL position in the abovementioned securities.
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