This article first appeared in The Edge Malaysia Weekly, on March 7 - 13, 2016.

WHEN Joel Kornreich took the helm at Alliance Financial Group Bhd (AFG) more than a year ago, the economic climate was turning gloomy. Many in the banking circles as well as the investing fraternity wondered what this newcomer would do to grow the country’s smallest bank in terms of asset size.

Not many people know this but group CEO Kornreich is used to navigating banking businesses through choppy waters. Financial crises? Well, he was in the eye of the economic storm in Europe in 2009 when he was with Citigroup. He was tasked with turning around the group’s operations in Greece, Spain and Belgium, which he did. The unemployment rate in Spain at the time was 26% (see next page).

As the new captain of AFG, Kornreich is unperturbed by the increasingly hostile environment. A confluence of factors — margin compression, a tougher macroeconomic environment, escalating costs and depreciation of the ringgit — may bother many in the banking industry, but not him, he says.

“Frankly, I feel very lucky because Alliance Bank [the banking subsidiary of AFG] has extraordinarily strong bases to grow from, and that’s not given to everybody. There are cycles. It’s not exactly horrible. It’s just a lot more constrained than previously,” he tells The Edge in his first interview since taking charge of AFG.

When he took over from his predecessor Sng Seow Wah, Kornreich, a big believer in “doing your homework”, did not waste any time but immediately hunkered down to do research on the local landscape. Sng is now heading PT Bank Danamon in Indonesia. Bank Danamon and AFG have a common shareholder in Singapore sovereign fund Temasek Holdings.

Kornreich found that there was a huge opportunity to expand the group on the strength of the bank.

“In order to have a successful development of the bank, it is also necessary to focus on strengthening the balance sheet and making the bank more efficient. We spent a big part of the year doing that,” he says.

A senior executive with AFG acknowledges that Kornriech is very data driven. “In the first few months, we all had to compile a lot of data and we number-crunched non-stop. It was a bit of a culture shock for some of us,” the executive quips.

Over the past year, the banking group concentrated on equipping itself with analytics and research as well as improving the efficiencies of its asset generation so that it could refine its brand positioning and define a proper new strategy — and execute it.

“Some of this may not sound sexy but it is really helpful in laying the foundations and making the group stable. That’s why we embark on things that are more transformational for the bank,” Kornreich states.

He believes that after a year, the foundations have been laid for the banking group and it is now ready to fire on all cylinders.

In the nine months ended Dec 31, 2015, AFG’s total capital ratio strengthened to 17.1% with its common equity Tier 1 ratio now one of the highest in the industry at 11.3%. Its CASA ratio increased to 35% and gross impaired loans ratio remained stable at 1.1% versus the industry’s 1.6% while loan loss coverage improved to 125.4% from 94.2% previously.

However, AFG saw the allowance made for loan advances and financing nearly double year on year to RM42.8 million during the nine-month period.

It also saw its cost-to-income ratio rise to 47.4% during the period from 46.8% in FY2015 ended March 31 on the back of higher operating expenses. The group’s return on equity declined to 11.4% from 12.3% in FY2015 while net asset value per share expanded to RM3.02 from RM2.90.

On the bright side, the group saw its loan portfolio yields improve to 5.13% — higher than the industry average of 4.54%. This was partly due to its high-risk adjusted return loans growing twice as fast as its low-risk adjusted return loans, which was the reverse previously .

So, how does the investing community view Kornreich’s efforts? Banking analysts are mixed in their opinions of AFG adopting a riskier lending strategy, such as unsecured consumer loans. “Yields will improve but it remains to be seen whether this will come with a spike in delinquencies. In this current tough macroeconomic environment, with high household debts and the recent job cuts in the market across sectors, it could be risky,” says a local head of research.

Maybank Investment Bank Equity Research says it continues to like AFG for its niche SME focus and its risk adjusted return strategy, which has had a positive impact on yields.

“As one of our top picks in the sector, AFG is a ‘buy’ with an unchanged target price of RM4.20, pegged to a CY16 P/BV of 1.3 times (CY16E ROE: 11.1%),” states the local research house in a Feb 22 note.

UOB Kay Hian research notes that AFG has managed to sustain its positive asset yield rebalancing strategy. “This is crucial to ensure earnings resilience outperformance for AFG as NIM (net interest margin) pressure has been the major industry-wide structural challenge, given a record-high industry LDR (loan deposit ratio) of 91% as well as lacklustre deposit growth,” the foreign house notes in a Feb 23 report. It has a “buy” call on the stock with a target price of RM3.95.

Like all the other banking stocks, AFG’s share price has been on a downward trend since the middle of last year. From a high of RM4.65 at end-April 2015, it hit a four-year low of RM3.07 on Jan 21, 2016. It has since regained some ground and closed at RM3.69 on March 2. The stock is currently trading at an indicative yield of 2.2%, according to Bloomberg.

Banking on relationships Kornreich reveals that together with his team, he has set out to make the group “the most important relationship for the financial success of business owners”.

“This means we share information to help business owners derive more value [from their businesses]. We also realised that business owners are very open to us helping them with their personal relationships, to manage their business through their employees, and to work together to generate more business, especially with retail clients,” he says.

“The strategy is to focus first on the financial success of the owners which, by the way, I view is also in the interest of the bank. The more successful the business owner, the better it is for the bank. There is less risk [of failure] and the business owner will be able to survive the tough times and thrive in good times. It is really a win-win situation,” he adds.

Without divulging too much, Kornreich shares that the group has started building and testing these “innovative propositions”.

“So, what you can expect over the next three years or so is that we will be building the technology infrastructure to support these value propositions and we will be rolling them out,” he says, adding that a few will be rolled out in the next financial year starting April 1.

On top of the new value propositions, Kornreich says the different units today have a “much closer relationship” and they see clients together.

“It was pretty classic in the past where a corporate banking unit would compete with the investment bank unit. It is not the case for us anymore. We give each other credit. What really matters to us is that the client can talk to all units. It doesn’t matter if the dollar is lent out of the investment bank set-up or corporate bank set-up. We make sure it is completely neutral,” he says.

This, he acknowledges, is where AFG’s small size works to its benefit. “There is no hiding because we all end up in the same room. I think that is a great advantage,” he says.

“Actually, the fact that the bank is small helps us be more nimble in rolling out the value propositions and focusing on the customers,” he adds.

Kornreich notes that being small helped the bank stay close to its customers and spot red flags before it was too late. This is why he says, despite having a large SME portfolio of 90,000 customers, the segment’s portfolio — from a credit perspective — is very healthy.

The Alliance Banking Group was founded in 2001 from the merger of seven financial institutions — Multi-Purpose Bank, International Bank Malaysia, Bolton Finance, Bumiputra Merchant Bankers, Sabah Bank, Sabah Finance and Amanah Merchant Bank. It is the smallest bank in terms of assets in the country. Using market capitalisation as a benchmark, it is the second smallest after Affin Group.

Kornreich wants to improve the group’s financial profile and grow its financial assets, but this does not necessarily mean growing its footprint outside Malaysia. “I think the fact that it’s nimble and quite close-knit is very valuable,” he says, adding that there are no merger and acquisition plans for the group at the moment.

Its small size has made it an M&A target but it does have a strong major shareholder — Temasek, which has an effective 14.8% stake — and AFG is its only platform in the Malaysian banking market.

Moving forward

There is no change in the long-term ROE target of 15% for FY2018, says Kornreich. This is despite a tougher operating landscape. “That is quite a challenging number but I think if we execute our strategy well, we have a fair chance to achieve that.”

He shares that the group is likely to achieve close to 12% ROE target for FY2016. He also expects to do better than the guided net credit loss of between 20 and 25 basis points and compression of margins of between 10 and 15 points.

“In the short term, some of the things we have done are not necessarily P&L friendly. When we improved our capital ratios and reviewed the maturity profile of our deposits, clearly, there is a cost to that. But we feel that it is the right thing to do as it puts us on a stable footing to move forward.

“Because the strategy is exciting, it is motivating and we get people to work together. I am optimistic about that. But I’m also clear that it is not an immediate transformation. It takes time,” Kornreich says.

“So, I don’t think we’re going to see explosive growth in FY2017 but what we’re going to see is the emergence of more clarity in terms of our strategy, and proof points of that strategy and value propositions. Things are going to be quite exciting,” he adds.

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