This article first appeared in The Edge Malaysia Weekly, on November 16 - November 22, 2015.

MERGER talks between Malaysia Building Society Bhd (MBSB) and Bank Muamalat Malaysia Bhd, which began in October, have picked up pace and are on track to conclude by year end, sources say.

A merger of the two Islamic lenders would create the country’s largest standalone Islamic bank with assets of about RM62.1 billion.

“Things are progressing as planned, notwithstanding a few hiccups here and there. Due diligence is still ongoing and should be completed by the end of the month. Right now, the parties are in the process of preparing a business plan for the combined entity. 

“They should be able to submit a proposal on the merger structure, pricing and business plan to the central bank by year end,” a source familiar with the talks tells The Edge.

Bank Negara Malaysia gave the nod for the shareholders of the two lenders to explore a merger on Sept 30, with the requirement that they complete their negotiations within three months — which gives them a year-end deadline.

As things stand, the plan is for the merger to be effected entirely through a share swap, although Khazanah Nasional Bhd — the government investment arm which holds a 30% stake in Bank Muamalat — is pushing for a cash portion to be included as it is looking to exit, sources say. 

The shareholding structure of the merged entity is expected to be such that the Employees Provident Fund (EPF) is the controlling shareholder with a stake of 40% to 43%, followed by DRB-Hicom Bhd with about 20%, Khazanah with about 10% (if it does not exit first) and the rest to be in public hands, a source says. The ownership structure is still subject to change, the source adds.

Analysts have speculated about the possibility of Bank Muamalat’s other shareholder, DRB-Hicom, buying out Khazanah’s 30% stake prior to the merger, given that the conglomerate wants to remain in the banking business.

DRB-Hicom (fundamental: 0; valuation: 2), controlled by tycoon Tan Sri Syed Mokhtar Albukhary, holds 70% of Bank Muamalat.

MBSB (fundamental: 1.20; valuation: 2.55) is controlled by the EPF through its 65% stake in the non-bank lender. MBSB, twice the size of Bank Muamalat in terms of assets, is in the driving seat of this merger. 

Just last Friday, MBSB released its financial results for the third quarter ended Sept 30, 2015 (3QFY2015). While it managed to grow revenue by 13.1% to RM768.02 million in 3Q, net profit nevertheless fell by a sharp 67% to RM63.53 million, mainly due to higher allowances for impairment losses on loans, advances and financing. The net profit was also lower than the RM85.55 million it made in 2Q.

In its bid to become more like a bank, MBSB embarked on an impairment programme in 4QFY2014, which helped improve its net impaired financing ratio but hit profit.

The ratio stood at 3.2% as at end-September, compared with 3.9% three months ago and 5% a year ago. “The impairment programme, collection recovery strategies and individual assessment of accounts being implemented in December 2014 are contributing factors to the improvement. Hence, we will continue with the impairment programme to ensure the group’s reporting standards are in the direction of the industry’s,” MBSB president and CEO Datuk Ahmad Zaini Othman says in a press release on its results.

In the third quarter, MBSB’s allowances for impairment losses on loans, advances and financing stood at RM195.57 million, compared with RM28.08 million in the same quarter a year ago and RM134.25 million in 2QFY2015. 

On its planned corporate merger with Bank Muamalat, Ahmad Zaini says: “We will continue with our business growth plans and operational improvements moving into 2016 as these will only bring value to the new entity.”

He says MBSB has set up a new initiative under its treasury division. “The fixed income desk is created to further strengthen our liquid assets. MBSB recently made a sukuk purchase of RM376 million to increase the company’s liquidity coverage ratio under this initiative.”

For the nine months to date, MBSB’s net profit fell by 56% to RM273.4 million, even as revenue improved by 10.2% to RM2.22 billion.  

It said its annualised net return on equity of 7.5% did not meet the 12.5% target it had set for 2015, mainly because its operating profit was lower as a result of the higher impairment losses on loans, advances and financing.

Bank Muamalat is not listed, but a snapshot of its performance will be available when its parent DRB-Hicom announces its consolidated results for the second quarter ended Sept 30 by the end of this month.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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