This article first appeared in The Edge Malaysia Weekly on April 11, 2022 - April 17, 2022

A planned merger between Malaysia Building Society Bhd (MBSB) and Malaysian Industrial Development Finance Bhd (MIDF), expected to be done via a share swap, would solidify MBSB’s position as the country’s second-largest standalone Islamic bank by assets and profit after Bank Islam Malaysia Bhd.

“They’re expected to do a share swap,” a source familiar with the matter tells The Edge.

The planned merger will put state-owned fund management giants Permodalan Nasional Bhd (PNB) and the Employees Provident Fund (EPF) on opposite sides of the negotiation table. MIDF is wholly-owned by PNB, whereas MBSB is 65.87%-owned by the EPF.

Key to the success of the merger is whether they can agree on the valuations. It is envisioned that the EPF will end up with a controlling stake of about 50% in the merged entity, with PNB holding about 20%, according to another source.

In 2019, when Al Rajhi Banking & Investment Corp (M) Bhd attempted a merger with MIDF, its proposal had valued MIDF around one time its book value of RM1.7 billion at the time, The Edge reported in November that year, citing sources.

“Based on the latest published accounts of MIDF as at the third quarter ended Sept 30, 2021 (3QFY2021), its book value still stands at RM1.7 billion versus MBSB’s RM8.7 billion. We reckon any merger transaction [now] could involve fundraising or share swaps, as MBSB’s internal cash pool stands at only RM655 million,” says Kenanga Research banking analyst Clement Chua.

The Al Rajhi-MIDF merger fell through because the parties could not resolve an impasse relating to the application of shariah rules in the merger.

For MBSB, this will be the first merger it is pursuing since having acquired Asian Finance Bank Bhd for RM645 million in a cash-and-share deal in 2017, which enabled it to clinch an Islamic banking licence.

In a stock exchange filing last Wednesday, MBSB announced that Bank Negara Malaysia had given it the green light to enter into discussions with PNB on the possibility of acquiring MIDF. The central bank gave them six months for negotiations.

“We are positively surprised by this ­, as the possible acquisition of MIDF would inject new diversified businesses into MBSB, which we believe requires further boons to uplift sentiment amid disappointments in its key financing business,” says Kenanga’s Chua.

MIDF, the smaller of the two lenders, had an asset size of RM8.69 billion going by its most recent 3QFY2021 financial results; in contrast, MBSB’s asset size was RM50.6 billion in the comparative quarter.

Combined, they would have total assets of RM59.29 billion, which would still be behind Bank Islam’s RM76.34 billion in the same period.

Interestingly, though, the combined entity’s net profit of RM401.15 million would not be too far off from Bank Islam’s RM454.67 million.

A merger of the two lenders would be complementary from a business standpoint, according to an analyst.

“MIDF has investment banking and asset management businesses, which MBSB does not, and its lending is mainly to SMEs [small and medium enterprises]. In contrast, MBSB is focused mainly on retail lending,” the analyst tells The Edge.

Merging with MBSB would enable MIDF, which does not have an Islamic banking licence,  to widen its business scope.

MIDF, a non-prescribed development financial institution set up by the government to help develop key sectors considered important for the socioeconomic development of the country, focuses on three main businesses — investment banking, asset management and development finance.

It made a lower net profit of RM38.9 million in the first nine months last year compared with RM43.64 million in the same period a year earlier. Investment banking was the biggest earnings contributor, while the asset management business was loss-making.

MIDF is part of a consortium that includes AirAsia Group’s eWallet, Big Pay, and private equity firm Ikhlas Capital that applied for a digital banking licence last year.

As for MBSB,  a merger would be good for it as it needs to grow in size to compete more effectively in the highly competitive market. It also needs a more solid growth strategy to remain relevant in the future, an industry observer points out.

There are currently 16 Islamic banks in the country, five of which are standalone — MBSB, Bank Islam, Al Rajhi, Bank Muamalat Malaysia Bhd and Kuwait Finance House (Malaysia) Bhd.

 It has been more than seven months since MBSB president and CEO Datuk Seri Ahmad Zaini Othman passed away from Covid-19 complications in mid-August last year, and the bank has yet to appoint a replacement. Deputy CEO Datuk Nor Azam M Taib has been acting president and CEO during this time.

Industry observers point out that it is rare for a bank to be without an official leader for so long.

“There are certain processes that need to be adhered to in line with the industry’s regulations,” MBSB tells The Edge when asked about the delay in appointing a new CEO.

MBSB was one of very few banks to have turned in a financial performance last year that fell below analysts’ expectations. Its net profit rose 62.5% to RM438.71 million on lower impairment losses, but net modification losses — which arose as a result of loan/financing relief programmes — remained elevated at RM311.69 million compared with RM504.75 million a year earlier.

“FY2021 net profit of RM438.7 million was below expectations, merely making up 63%/67% of our/consensus estimates. The negative deviation was due to continually wide exposure to modification losses in 4QFY2021 and also failure to generate loan growth,” Kenanga Research said in a Feb 25 report, following the results.  It currently has an “underperform” call on the stock, with a target price of 52 sen.

Nevertheless, MBSB says it is optimistic about the current year, given the resumption of economic activity and reopening of borders as well as numerous indications that the economy will progressively return to pre-pandemic levels.

“We expect activities to accelerate during the year across both our consumer banking and corporate banking business segments. We are encouraged as our customers continue their recovery. Meanwhile, MBSB continues to roll out its initiatives as planned under the Journey 25 [strategy], with the aim of becoming a top progressive Islamic bank,” it tells The Edge.

MBSB closed at 65 sen last Friday, giving it a market capitalisation of RM4.63 billion.

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