ed-CK / sa- WMT, PY

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 FY15-20F, as opposed to 2% for conventional loans. This is mainly underpinned by a growing push by the banks to fulfil BNM’s target of 40% 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 : 1,707.68

Analyst Lynette CHENG +60 32604 3907 Sue Lin LIM +65 8332 6843 lynettecheng@alliancedbs.com suelinlim@dbs.com

STOCKS

Source: DBS Bank, Bloomberg Finance L.P. Closing price as of 17 Feb 2017 Financing growth for Islamic banking to outpace conventional banking in Malaysia

Source: BNM, DBS Bank, AllianceDBS Maybank Islamic and BIMB among the biggest global Islamic banks

Source: World Islamic Banking Conference Leaderboard, DBS Bank, AllianceDBS

0

5

10

15

20

25

30

-

500

1,000

1,500

2,000

2009

2010

2011

2012

2013

2014

2015

2016

2017

F

2018

F

2019

F

2020

F

%RM bn

Islamic banking Conventional bankingConventional banking growth Islamic banking growthTotal banking system growth

84.154.5

40.836.4

34.932.2

24.623.622.8

21.516.9

14.614.513.613.3

0 10 20 30 40 50 60 70 80 90

AL RAJHI BANK (SA)KUWAIT FINANCE HOUSE (KU)

MAYBANK ISLAMIC (MY)DUBAI ISLAMIC (UAE)

ABU DHABI ISLAMIC (UAE)QATAR ISLAMIC (QA)BANK RAKYAT (MY)

ALBARAKA BANKING (BAH)MASRAF AL RAYAN (QA)

ALINMA BANK (SA)BANK AL-JAZIRA (SA)

KUWAIT TURKISH (KU)TURKIYE FINANS (TU)

CIMB ISLAMIC (MY)BANK ISLAM (MY)

Total Assets (US$ bn)

DBS Group Research . Equity

20 Feb 2017

Malaysia Industry Focus

Islamic Banks

Refer to important disclosures at the end of this report

Price Mkt Cap Target Price Performance (%)

RM US$m RM 3 mth 12 mth Rating

Maybank 8.46 19,363 7.50 10.2 (1.2) HOLD BIMB Holdings

4.43 1,629 5.00 4.5 25.5 BUY

Bursa Malaysia 8.81 1,061 10.00 3.0 5.3 BUY Malaysia Building Society Berhad

1.15 1,497 NA 27.8 (14.5) NOT RATED

Industry Focus

Islamic Banks

Page 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 20

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 50

Bank Rakyat 52

Bank Muamalat 54

Appendix:

OIC members: Selected economic data points 57

Industry benchmarking 58

Islamic Banking: Definition of terms 61

Industry Focus

Islamic Banks

Page 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 2020. To take advantage of this strong footing gained, the government has set the targets for the industry to achieve by 2020. This includes: (1) increasing the global share of Islamic banking assets from 8% in 2009 to 13% in 2020, (2) increasing the global share of takaful (insurance based on Islamic principles) contribution from 11% in 2009 to 20% in 2020, (3) increasing Islamic financing’s share of total financing in Malaysia from 29% in 2010 to 40% in 2020, and (4) propelling at least one Islamic financial institution to become one of the global top 10 players by asset size by 2020. Global Islamic finance assets – Top 10 countries

Source: Thomson Reuters Islamic Finance Development Report 2015

Global: Asset size of major Islamic Banks

Source: World Islamic Banking Conference Leaderboard Malaysia: Asset size of Islamic banks

Source: Companies, DBS Bank, AllianceDBS

415

413

345

161

98 87 73 54 40 23

104

0

50

100

150

200

250

300

350

400

450

0

50

100

150

200

250

300

350

400

450

Mal

aysi

a

Saud

i Ara

bia

Iran

UA

E

Kuw

ait

Qat

ar

Bahr

ain

Turk

ey

Indo

nesi

a

Bang

lade

sh

Oth

er

Tota

l Ass

ets

(US$

bn)

Islamic Banking Islamic Funds OIFI Sukuk Takaful No of Islamic FIs (RHS)

84.154.5

40.836.4

34.932.2

24.623.622.8

21.516.9

14.614.513.613.3

0 10 20 30 40 50 60 70 80 90

AL RAJHI BANK (SA)KUWAIT FINANCE HOUSE (KU)

MAYBANK ISLAMIC (MY)DUBAI ISLAMIC (UAE)

ABU DHABI ISLAMIC (UAE)QATAR ISLAMIC (QA)BANK RAKYAT (MY)

ALBARAKA BANKING (BAH)MASRAF AL RAYAN (QA)

ALINMA BANK (SA)BANK AL-JAZIRA (SA)

KUWAIT TURKISH (KU)TURKIYE FINANS (TU)

CIMB ISLAMIC (MY)BANK ISLAM (MY)

Total Assets (US$ bn)

156

92

57

55

46

44

41

38

26

23

19

15

13

11

11

10

7 3

0

20

40

60

80

100

120

140

160

180M

AY

ISL

BAN

K R

AK

YA

T

BIM

B

CIM

B IS

L

PUBL

IC IS

L

RHB

ISL

MBS

B

AM

ISL

HL

ISL

Mua

mal

at

HSB

C A

MA

N

OC

BC A

L-…

AFF

IN IS

L

SC S

AA

DIQ

KFH

ALL

CE

ISL

Al-R

ajhi

AFB

RM bn

Industry Focus

Islamic Banks

Page 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 1,814,086 1,345,891 1,143 436 33,390 308 83,916 399 295,094 55,794

Malaysia 415,418 173,956 77 38 8,205 21 48,204 18 167,256 17,797 Saudi Arabia 412,955 325,394 105 16 12,380 40 4,928 49 46,890 23,363

Iran 345,447 328,777 82 39 8,180 27 6,833 16 120 1,538

UAE 161,443 127,281 85 24 1,792 17 5,158 44 26,885 328

Kuwait 97,576 87,749 100 9 132 15 7,645 76 814 1,236

Qatar 86,524 71,620 38 8 323 19 756 11 13,566 259

Bahrain 72,825 68,367 59 32 450 10 415 17 3,585 9

Turkey 53,883 44,597 5 4 - - - 1 9,283 3

Indonesia 40,396 21,711 145 33 933 63 428 49 16,425 898

Bangladesh 23,150 22,471 42 26 608 15 71 1 - -

Pakistan 18,279 12,563 57 23 127 6 541 28 4,058 990

Egypt 13,487 12,869 26 9 - 8 377 9 - 242

Sudan 10,651 10,651 44 28 - 14 - 2 - -

Jordan 8,219 7,872 12 3 48 3 170 6 120 9

Switzerland 6,885 - 3 1 - - 6,879 2 - 6 Source: Thomson Reuters Islamic Finance Development Report 2015 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 1980, 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 1999. 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 2001 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 2010 to create and issue short-term 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 2003 to allow more foreign participation. Towards this end, the requirements imposed include a minimum capital of RM300m as well as submissions of a sound business plan and ownership structure to BNM. Islamic Financial Services Board (IFSB) started operations

Industry Focus

Islamic Banks

Page 5

in Malaysia in 2003, to serve as an international standard-setting body of regulatory and supervisory agencies. In 2006, 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 2009, with the requirement of paid-up capital of at least USD1bn. Finally, the Islamic Financial Service Act (IFSA) was passed by Parliament in 2013. Malaysia: Evolution of Islamic banking Year Milestones 1963 Establishment of Lembaga Tabung Haji 1980 The Seminar on National Development from Islamic

Perspective (1980) proposes the establishment of Bank Islam

1983 Malaysia passes the Islamic Banking Act Bank Islam begins operations in 1 July 1983

1984 Enactment of Takaful Act 1984 1991 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 2001 Establishment of International Islamic Financial Market 2003 Islamic Financial Services Board (IFSB) started operations

in Malaysia 2003 Licences are given to three foreign banks – AFB, Al-Rajhi

and KFH 2006 The Malaysia International Islamic Financial Centre (MIFC)

initiative is launched and International Centre For Education In Islamic Finance (INCEIF) was set up

2009 Two new Islamic banking licenses offered 2010 International Islamic Liquidity Management Corporation

(IILM) was established 2013 Islamic Financial Service Act 2013 is passed by Parliament

Source: Companies, DBS Bank, AllianceDBS Rising to the challenges. Malaysia has successfully addressed the key issues confronting the Islamic banking sector. This includes

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 20). A giant leap with IFSA 2013. The regulatory environment for Islamic banks found itself at a crossroad when the Islamic Financial Services Act (IFSA) was implemented in 2013. This supersedes the Islamic Banking Act 1983 and the Takaful Act 1984, while incorporating elements of the Payment System Act 2003 and the Exchange Control Act 1953. 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 2013. In our view, the enactment of the IFSA 2013 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.

Industry Focus

Islamic Banks

Page 6

Malaysian Islamic banking: IFSA 2013

Source: BNM Malaysian Islamic banking: Shariah Governance framework

Source: BNM

End-to-end Shariah compliance under the Is lamic Financia l Services Act 2013

Is lamic Finance:Islamic banks conduct financial intermediation functions using Shariah contracts

Distinct risk and reward profiles based on Shariah contracts

ASSETS LIABILIT IES

Shariah StandardsCompliance with fundamental

requirements of respective Shariah contracts

Operationa l S tandardsStrengthened risk

management, governance, transparency and disclosure, market conduct and other

operational aspects of applying Shariah standards.

Overs ight FunctionsCodification of the role of the Shariah committee and board

of directors of financial institutions in ensuring Shariah

Compliace

Res olutionPriority of payment reflective of

underlying Shariah contracts

Inves tment Accounts (Other)Wakalah

Equity Bas ed

MudharabahMusharakah

Tawarruq

Fee Bas ed

WakalahKafalahRahnu

Is lamic Depos its

Wadi'ahQardTawarruq

MudharabahMusharakah

Inves tment Accounts (Equity)

Sa les Bas ed

MurabahahIstisna'Ijarah

BOARD RISK MANAGEMENT

COMMITTEEOverall oversight on Shariah governance

structure & Shariah ComplianceOversight accountability

on Shariah related matters

BOARD AUDIT COMMITTEE

Shariah as overarching principle in Islamic finance

SHARIAH COMMITTEE

BOARD

Provide independent assessment & objective assurance designed

to value add & improve IFI's compliance with Shariah

Shariah Audit Funct ionShariah Research

Funct ion

Conduct in-depth Shariah research prior to submission to the

Shariah Committee

Shariah Compliance and research funct ions

Shariah Review Funct ion

Review business operations on a regular basis to ensure

Shariah compliance

MANAGEMENT

Ensure executions of business & operations are in accordance with the

Shariah principles

Shariah Risk Management Cont ro l Funct ion

Identify, measure, monitor, report & control Shariah non-Compliance risk

Provide necessary support to the Shariah Committee

Industry Focus

Islamic Banks

Page 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 Shariah-compliant 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 203) and an average disclosure index of 47 as at 2015. Islamic finance governance index – Top 10 countries

Source: Thomson Reuters Islamic Finance Development Report 2015 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 2015). 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.

Average percentage of liquid assets available for investing (%)

Source: Thomson Reuters Average percentage of liquid assets available for investing (%)

Source: Thomson Reuters 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.

0

50

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Suda

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Number of Shariah Scholars Average Disclosure IndexCentralised/National Shariah Board present

Regulation strength indicator:● Strong ● Medium ● Weak

35

46

12

0

5

10

15

20

25

30

35

40

45

50

GCC Malaysia Others

46 51

22

2322

25

31 27

52

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

GCC Malaysia Other

Short term Medium term Long term

Industry Focus

Islamic Banks

Page 8

MY: Islamic Finance Tax Incentives Tax incentives Tax exemption for profits derived from sukuk 10-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. 10-year income tax exemption for domestic and foreign fund managers who manage Islamic funds for foreign investors. 3-year stamp duty exemption of 20% 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 3,900; just behind UAE at 3,944) - as at 2015. Once again, this has propelled Malaysia to becoming the top ranked country globally in terms of awareness indicator. Islamic finance awareness indicator – Top 10 countries

Source: Thomson Reuters Islamic Finance Development Report 2015 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 2005, 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

the top country under its knowledge indicator, attributable to the vast number of degrees and courses (at 30 and 16, respectively) as well as published research paper (at 522) on Islamic finance compared to its global peers – as at when 2015. Islamic finance knowledge indicator - Top 10 countries

Source: Thomson Reuters Islamic Finance Development Report 2015 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.

050010001500200025003000350040004500

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Om

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Indo

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Turk

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Conferences (LHS) Seminars (LHS) News (RHS)

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Degrees Courses Research papers

Industry Focus

Islamic Banks

Page 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 FY20F, 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 2020F (note that BNM’s target is 40%). Malaysia: Asset growth in conventional and Islamic banking

Source: BNM, DBS Bank, AllianceDBS Malaysia: Financing growth in conventional and Islamic banking

Source: BNM, DBS Bank, AllianceDBS

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 40%, 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

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.

0

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-

500

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2,500

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2009 2010 2011 2012 2013 2014 2015 2016

%RM bn

Islamic banking Conventional bankingConventional banking growth Islamic banking growthTotal banking system growth

0

5

10

15

20

25

30

-

500

1,000

1,500

2,000

2009

2010

2011

2012

2013

2014

2015

2016

2017

F

2018

F

2019

F

2020

F

%RM bn

Islamic banking Conventional bankingConventional banking growth Islamic banking growthTotal banking system growth

83

82

80

79

77

75

73

71

69

67

65

63

17

18

20

21

23

25

27

29

31

33

35

37

0%10%20%30%40%50%60%70%80%90%

100%

2009

2010

2011

2012

2013

2014

2015

2016

2017

F

2018

F

2019

F

2020

F

Conventional banking Islamic banking

53

32

26 25 25

18 16 13

-

10

20

30

40

50

60

MAY AMMB RHB CIMB AFFIN AFG HLB PBK

BNM's target @ 40%

Industry Focus

Islamic Banks

Page 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 20% in 2014. 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 2013 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 2013, 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., due-diligence, 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 2016). 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 (209.1m Muslim population as at 2010). 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.

Industry Focus

Islamic Banks

Page 11

Top 10 countries with the largest Muslim populations, 2010 and 2050 Country 2010 population

(mil) % of world's Muslim

Country Projected 2050 population (mil)

% of world's Muslim

Indonesia 209.1 13.1 India 310.7 11.2 India 176.2 11.0 Pakistan 273.1 9.9 Pakistan 167.4 10.5 Indonesia 256.8 9.3 Bangladesh 134.4 8.4 Nigeria 230.7 8.4 Nigeria 77.3 4.8 Bangladesh 182.4 6.6 Egypt 77.0 4.8 Egypt 119.5 4.3 Iran 73.6 4.6 Turkey 89.3 3.2 Turkey 71.3 4.5 Iran 86.2 3.1 Algeria 34.7 2.2 Iraq 80.2 2.9 Morocco 31.9 2.0 Afghanistan 72.2 2.6 Subtotal 1,053.0 65.8 Subtotal 1,701.1 61.6 Subtotal for rest of world 546.7 34.2 Subtotal for rest of world 1,060.4 38.4 World total 1,599.7 100.0 World total 2,761.5 100.0 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 2015 to 2019, 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 deep-rooted 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 40% ownership of a bank, although this will be subject to any further approvals by OJK. The regulation was effective after 2012 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.

Industry Focus

Islamic Banks

Page 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 contract-based 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 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 banking: Key differences in concept CONVENTIONAL MODEL ISLAMIC MODEL Lender and borrower Custodian, entrepreneur, financier Interest-based deposits Safe custody, investment Interest-based financing Debt financing, equity financing Functions and operating models based on manmade principles (capitalism theory)

Functions and operating models based on Shariah Law

Governance as per conventional model Governance inclusive of Shariah Governance Framework requirements Financial Services Act Islamic Financial Services Act Lenders/Investors are guaranteed of a predetermined rate of interest or returns

Profit/Risk is shared between capital provider (investor) and user of funds (entrepreneur)

Time value is the basis of charging interest on capital Profit on trade of goods or charging on providing service is the basis for earning profit

Source: Alliance Islamic Bank, AllianceDBS

Industry Focus

Islamic Banks

Page 13

Islamic banking: Types of Shariah contracts being applied to products

Source: Bank Islam, IMF, BNM, DBS Bank, AllianceDBS 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

Shariah Contracts

Wadi'ah

Qardh

Hiwalah

Mudarabah

Mudarabah

Fee-based productsProfit and loss sharing

Deferred PaymentImmediate PaymentMusyarakah Rahnu

Debt-like financing

Bai' Sarf

Bay' Dayn

Ibra' & Muqasah

Bai' Murabahah & Bai' Bithaman Ajil

Bai' Tawliyyah

Bai' Salam

Bai' Istisna'

Bai' Istijrar

Kafalah

Wakalah

Ijarah /Al-ijarah thumma al-bai' (AITAB) / Ijarah muntahia bi al-tamlik (IMBT)

Tabarru', Waqf & HibahBai' Inah

Industry Focus

Islamic Banks

Page 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 RM20 N/A 0.25% - 1.00%

Basic savings Islamic RM20 N/A 0.25% - 1.00%

Term deposits Conventional RM500 12 months 3.15%

Term deposits Islamic RM500 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 contracts

None Wadiah, Tawarruq, Bai' 'Inah Mudarabah, Musharakah, Wakalah

Principal guarantee

Will be repaid in full on maturity and/or on demand

Will be repaid in full on maturity and/or on demand

No expressed or implied obligation to repay the money in full and/or on demand (Principal and/or profit)

Deposit insurance protection

Yes Yes No

Source: BIMB, DBS Bank, AllianceDBS Comparison of unrestricted and restricted investment accounts

Unrestricted Investment Account Restricted Investment Account

Mandate General mandate (allows the bank to make ultimate investment decision without restriction or any conditions)

Specific Investment Mandate/Asset Class

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 10)

Off-balance sheet

Source: BIMB, DBS Bank, AllianceDBS

Industry Focus

Islamic Banks

Page 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 20% discount for consumers taking a new or top- up 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: 20% discount Full

2. Refinancing: Waived (100% discount) for refinancing cases (i.e. Conventional loans from other financial institutions to Islamic financing)

Full

Margin of Finance 90% + 5% MRTT and/or Financing Entry Cost 90% + 5% MRTA and/or Financing Entry Cost Tenure 35 years/70 years of age 35 years/70 years of age

Source: Alliance Islamic Bank, DBS Bank, AllianceDBS

Mortgage loans under BBA: Two additional documentation requirement under Islamic financing

The documents MUST be executed in the particular order above at different intervals i.e. the time must not be the same.

Islamic Conventional 1. Product Disclosure Sheet (PDS)

Sales/Branch Staff 1. Product Disclosure Sheet (PDS)

2. Application Form 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)

Solicitors Office

5. N/A 6. Asset Sale Agreement (ASA) 6 . N/A 7. Facility Agreement (FA) 7. Facility Agreement (FA) 8. Other Documents 8. Other Documents

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 90% of total value of car 90% of total value of car Tenure Max 9 years Max 9 years

Source: Alliance Islamic Bank, DBS Bank, AllianceDBS

Industry Focus

Islamic Banks

Page 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 non-compliant activities to the overall revenue and profit before tax is below the 5% benchmark (20% 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.

Industry Focus

Islamic Banks

Page 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

Source: World Bank, Global Findex database Fast growing Muslim population. Given that the Muslim population makes up more than 20% 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 2050. The proportion of Muslims to the global population is expected to hit 30% in 2050, 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

woman vs the global average of 2.5) and comparatively high concentration of children as of end-2010 (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

2010 population

(mil) % of

world

Projected 2050

population (mil)

% of world

Christians 2,168.3 31.4 2,918.1 31.4 Muslims 1,599.7 23.2 2,761.5 29.7 Unaffiliated 1,131.2 16.4 1,230.3 13.2 Hindus 1,032.2 15.0 1,384.4 14.9 Buddhists 487.8 7.1 486.3 5.2 Folk religions 404.7 5.9 449.1 4.8 Other religions 58.2 0.8 61.5 0.7 Jews 13.9 0.2 16.1 0.2 World total 6,895.9 100.0 9,307.2 100.0 Source: The Future of World Religion by Pew Research Centre Fertility rate by religion

Source: The Future of World Religion by Pew Research Centre

94

69

51 51 46 34 32 29

14

- 10 20 30 40 50 60 70 80 90

100

Hig

h-in

com

eO

ECD

eco

nom

ies

East

Asi

a &

Pac

ific

Euro

pe &

Cen

tral

Asi

a

Latin

Am

eric

a &

Car

ibb

ean

Sou

th A

sia

Sub

-Sah

aran

Afr

ica O

IC

Mus

lims

Mid

dle

Eas

t

%

Global average = 62%

1.6

1.7

1.7

1.8

2.3

2.4

2.5

2.7

3.1

0 0.5 1 1.5 2 2.5 3 3.5

Buddhists

Other religions

Unaffliated

Folk religions

Jews

Hindus

World

Christians

Muslims

Industry Focus

Islamic Banks

Page 18

Age distribution by religious group in 2010

Source: The Future of World Religion by Pew Research Centre Projected age distribution by religious group in 2050

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 60, 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 risk-sharing 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-

Muslim consumers that would be agreeable to adopting Islamic banking products. 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 2014. 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 2015 (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. Global sukuk issuance

Source: International Islamic Financial Market Top 15 crude oil exporting country, in barrels per day (bbl/day)

Country bbl/day % of world Saudi Arabia 7,658,000 17.3 Russia 4,594,000 10.4 Canada 2,900,000 6.6 United Arab Emirates 2,500,000 5.7 Nigeria 2,411,000 5.5 Iraq 2,390,000 5.4 Kuwait 1,824,000 4.1 Angola 1,815,000 4.1 Kazakhstan 1,365,000 3.1 Venezuela 1,358,000 3.1 Iran 1,322,000 3.0 Qatar 1,232,000 2.8 Mexico 1,220,000 2.8 Norway 1,218,000 2.8 Algeria 1,158,000 2.6 Note: OIC members highlighted Source: The World Factbook

34%

30%

27%

22%

21%

21%

20%

19%

27%

60%

62%

60%

67%

65%

59%

65%

68%

62%

7%

8%

14%

11%

14%

20%

15%

13%

11%

0% 20% 40% 60% 80% 100%

Muslims

Hindus

Christians

Folk religions

Other religions

Jews

Buddhists

Unaffliated

World

Age 0-14 Age 15-59 Age 60+

24%

23%

19%

18%

17%

15%

14%

14%

20%

60%

56%

53%

62%

54%

56%

54%

54%

58%

16%

21%

28%

20%

29%

29%

32%

32%

22%

0% 20% 40% 60% 80% 100%

Muslims

Christians

Jews

Hindus

Folk religions

Other religions

Unaffliated

Buddhists

World

Age 0-14 Age 15-59 Age 60+

Industry Focus

Islamic Banks

Page 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 2005 to 19.9% in 2014, close to the OIC’s 2015 target of 20%. Under the OIC’s ten-year programme of action leading up to 2025, the target for intra-OIC trade is to hit 6% north of 2015 levels.

Intra-OIC merchandise exports and imports (USD bn)

Source: OIC Economic Outlook 2015

Industry Focus

Islamic Banks

Page 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. 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 10 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.

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.

Industry Focus

Islamic Banks

Page 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 banks/financial institutions that offer Shariah-Compliant Products

Bank Rakyat Agro Bank Bank Simpanan Nasional SME Bank EXIM Bank Bank Pembangunan Malaysia Malaysia Building Society

Source: BNM, DBS Bank, AllianceDBS MY: Asset size of Islamic banks

Source: Companies, DBS Bank, AllianceDBS

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 200%) 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.

156

92

57

55

46

44

41

38

26

23

19

15

13

11

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20

40

60

80

100

120

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IN IS

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Industry Focus

Islamic Banks

Page 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 2011. 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 2011, 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 50% mark in FY15 (from 39% in FY13). MAY ISL emulated the “Islamic First” strategy in Indonesia in 2014. 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 12th in FY13 to 5th 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 2013, and Islamic Business Term Financing and Islamic trade facilities and foreign currency deposits in 2014.

MAY ISL: Proportion to MAY’s domestic financing

Source: Company, DBS Bank, AllianceDBS Global Sukuk League table

2015 2016

Bank Amount (USD m)

Market share (%)

Amount (USD m)

Market share (%)

CIMB 5,234.7 15.0 5,329.5 12.8 Maybank 2,959.8 8.5 4,602.4 11.0 Standard Chartered Bank 2,255.0 6.5 3,878.4 9.3 RHB 3,300.1 9.5 3,037.5 7.3 HSBC 4,453.0 12.8 2,905.4 7.0 Dubai Islamic Bank 1,302.6 3.7 2,636.2 6.3 AmInvestment Bank Bhd 1,914.3 5.5 2,633.9 6.3 JP Morgan 1,483.0 4.3 1,464.8 3.5 National Bank of Abu Dhabi 1,181.9 3.4 1,463.7 3.5 Emirates NBD PJSC 664.8 1.9 1,389.8 3.3

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).

38,7

10

52,3

69

61,9

98

86,8

79

108,

540

131,

123

25.6 29.1 30.8

38.7 44.5

50.7

0

10

20

30

40

50

60

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2010

2011

2012

2013

2014

2015

%RM m

Financing (LHS) % to domestic financing (RHS)

Industry Focus

Islamic Banks

Page 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 70% stake in MUAMALAT), had been required by BNM to pare down its significant stake to 40%. 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 0.5x BV, Bank Muamalat could be listed at a market capitalisation of close to RM1bn. BIMB (2011), Affin (2013) and MBSB (2016) 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 2010 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 2014, 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.

Industry Focus

Islamic Banks

Page 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 1,104 2.53 2.00 FULLY

VALUED 13.3x 9.9x 9.7x 17.3 0.6x 0.6x 0.6x 5.8% 4.1% Alliance* 1,332 3.89 NA NA 11.5x 11.5x 11.1x 1.7 1.3x 1.2x 1.2x 11.1% 4.2% AMMB 3,100 4.58 5.00 BUY 9.8x 10.9x 10.1x -1.3 0.9x 0.9x 0.8x 8.5% 4.1% CIMB Group 10,116 5.08 4.80 HOLD 15.1x 12.2x 11.1x 16.8 1.1x 1.0x 0.9x 8.6% 3.9% Hong Leong 6,165 13.38 15.00 BUY 13.8x 13.9x 12.2x 6.3 1.5x 1.3x 1.2x 10.5% 3.0% Maybank 19,363 8.46 7.50 HOLD 11.8x 14.1x 12.7x -3.7 1.3x 1.3x 1.3x 10.0% 5.5% Public Bank 17,341 20.00 22.50 BUY 15.3x 14.9x 14.2x 4.0 2.5x 2.3x 2.1x 15.3% 2.8% RHB Bank 3,514 5.09 5.40 BUY 9.5x 10.3x 9.2x 1.5 0.9x 0.8x 0.8x 8.6% 3.2%

Weighted average 13.3x 13.5x 12.4x 3.7 1.6x 1.5x 1.4x 11.1% 4.0% Weighted average (ex-Public Bank) 12.5x 12.9x 11.7x 3.6 1.2x 1.1x 1.1x 9.5% 4.5% Simple average 12.5x 12.2x 11.3x 5.3 1.3x 1.2x 1.1x 10.1% 3.9% Simple average (ex-Public Bank) 12.1x 11.8x 10.9x 5.5 1.1x 1.0x 1.0x 9.5% 4.0% BIMB 1,629 4.43 5.00 BUY 12.3x 12.4x 11.2x 2.8 2.0x 1.8x 1.7x 17.2% 3.3% Hong Leong Financial Group

3,909 15.20 17.00 BUY 11.2x 11.6x 10.2x 4.4 1.2x 1.1x 1.0x 10.5% 3.0%

* Based on Bloomberg consensus

^ Refers to a 2-year EPS CAGR for CY15-17F

Source: Companies, Bloomberg Finance L.P., DBS Bank, AllianceDBS

Industry Focus

Islamic Banks

Page 25

Company ProfilesCompany ProfilesCompany ProfilesCompany Profiles

ASIAN INSIGHTS VICKERS SECURITIES ed: CK / sa: WMT, PY

BUY Last Traded Price ( 17 Feb 2017): RM4.43 (KLCI : 1,707.68) Price Target 12-mth : RM5.00 (13% upside) (Prev RM4.80) 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 +60 32604 3907 lynettecheng@alliancedbs.com Sue Lin LIM +65 8332 6843 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 RM5.00

Price Relative

Forecasts and Valuation FY Dec (RMm) 2015A 2016F 2017F 2018F Pre-prov. Profit 992 1,110 1,237 1,400 Net Profit 547 561 638 692 Net Pft (Pre Ex.) 547 561 638 692 Net Pft Gth (Pre-ex) (%) 2.8 2.5 13.6 8.5 EPS (sen) 36.1 35.8 39.5 41.6 EPS Pre Ex. (sen) 36.1 35.8 39.5 41.6 EPS Gth Pre Ex (%) 1 (1) 10 5 Diluted EPS (sen) 35.5 35.3 39.0 41.0 PE Pre Ex. (X) 12.3 12.4 11.2 10.6 Net DPS (sen) 12.2 13.1 14.4 15.2 Div Yield (%) 2.8 3.0 3.3 3.4 ROAE Pre Ex. (%) 17.2 15.5 15.8 15.4 ROAE (%) 17.2 15.5 15.8 15.4 ROA (%) 1.1 1.0 1.1 1.1 BV Per Share (sen) 221 240 261 282 P/Book Value (x) 2.0 1.8 1.7 1.6 Earnings Rev (%): 0 4 2 Consensus EPS (sen): 36.8 38.0 41.0 Other Broker Recs: B: 5 S: 0 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 RM5.00 TP is derived from the Gordon Growth Model (assumes 16% ROE, 4% long-term growth and 10% 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 (%) 50.8 EPF (%) 12.4 KWAP (%) 5.5

Free Float (%) 21.1 3m Avg. Daily Val (US$m) 0.84 ICB Industry : Financials / Banks

DBS Group Research . Equity

20 Feb 2017

Malaysia Company Guide

BIMB Holdings Version 6 | Bloomberg: BIMB MK | Reuters: BIMB.KL Refer to important disclosures at the end of this report

90

110

130

150

170

190

210

2.7

3.2

3.7

4.2

4.7

5.2

Feb-13 Feb-14 Feb-15 Feb-16 Feb-17

Relative IndexRM

BIMB Holdings (LHS) Relative KLCI (RHS)

ASIAN INSIGHTS VICKERS SECURITIES Page 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 2012 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 2011. 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. 90% of its personal financing portfolio (which makes up 30% of its financing book) is structured under packaged financing scheme, where customers repay their financing either through a salary-deduction or salary-transfer 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 non-packaged 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 10%, 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 asset-quality 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 100%, even if impaired financing increases by a whopping 70%.

Valuation and recommendation

Maintain BUY with higher TP of RM5.00 post earnings adjustment. Our TP implies 1.9x BV, which we believe is fair for a franchise delivering ROEs of more than 15% and better-than-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 2016 in this link.

ASIAN INSIGHTS VICKERS SECURITIES Page 28

Company Guide

BIMB Holdings

Chart 1: BIMB financing growth vs system financing growth

BIMB’s financing growth outpaced system financing growth since 2012 Source: Company, AllianceDBS, DBS Bank

Chart 2: Financing loss coverage vs impaired financing ratio

Solid asset quality indicators with high financing loss coverage ratio and low impaired financing ratio Source: Company, AllianceDBS, DBS Bank

Chart 3: Indonesia potential addressable market

Country 2010

population (mil) % of world's

Muslim Country Projected 2050 population (mil)

% of world's Muslim

Indonesia 209.1 13.1 India 310.7 11.2 India 176.2 11.0 Pakistan 273.1 9.9 Pakistan 167.4 10.5 Indonesia 256.8 9.3 Bangladesh 134.4 8.4 Nigeria 230.7 8.4 Nigeria 77.3 4.8 Bangladesh 182.4 6.6 Egypt 77.0 4.8 Egypt 119.5 4.3 Iran 73.6 4.6 Turkey 89.3 3.2 Turkey 71.3 4.5 Iran 86.2 3.1 Algeria 34.7 2.2 Iraq 80.2 2.9 Morocco 31.9 2.0 Afghanistan 72.2 2.6 Subtotal 1,053.0 65.8 Subtotal 1,701.1 61.6 Subtotal for rest of world 546.7 34.2

Subtotal for rest of world 1,060.4 38.4

World total 1,599.7 100.0 World total 2,761.5 100.0 Source: The Future of World Religion by Pew Research Centre, Company, AllianceDBS, DBS Bank

0

5

10

15

20

25

30

35

40

2011 2012 2013 2014 2015 2016F

BIMB Financing growth Conventional loan growthIslamic banking financing growth Total system loan growth

77%

112%

143%

176% 170% 175% 175%

4.5%

2.6%

1.5%1.2% 1.1% 1.1% 1.0%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

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4.5%

5.0%

0%

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80%

100%

120%

140%

160%

180%

200%

2010 2011 2012 2013 2014 2015 2016F

Financing loss coverage Impaired financing

Impaired financing ratio Financing loss coverage

ASIAN INSIGHTS VICKERS SECURITIES Page 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-30% 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 floating-rate financing to achieve a portfolio mix of floating-to-fixed-rate financing of 80:20. Targeting to grow investment accounts. A mandate to distinguish Islamic deposits and Islamic investment accounts was released in 2013, requiring the transition to commence in June 2015. 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 60% 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 2,700 agents. Contribution from STMB makes up slightly less than 70% of BIMB’s non-fund based income. Stable cost-to-income ratio. BIMB expects it to keep its cost to income ratio at mid-50%. Management expects provision charge-off rate to be similar to the FY15 level (20bps), but we have conservatively assumed charge-off rate of 30/31/39bps 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

Gross Financing & Growth

Customer Deposit & Growth

Financing-to-Deposit Ratio Trend

Cost & Income Structure

Source: Company, AllianceDBS

2.20%2.25%2.30%2.35%2.40%2.45%2.50%2.55%2.60%2.65%

0200400600800

1,0001,2001,4001,6001,800

2014A 2015A 2016F 2017F 2018F

RM m

Fund based income (LHS) Net financing margin (RHS)

0%

5%

10%

15%

20%

25%

30%

- 5,000

10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000

2014A 2015A 2016F 2017F 2018F

RM m

Gross Financing (LHS) Gross Financing y-o-y Growth (RHS)

0%2%4%6%8%10%12%14%16%18%20%

0

10,000

20,000

30,000

40,000

50,000

2014A 2015A 2016F 2017F 2018F

RM m

Customer Deposits (LHS)

Customer Deposits Growth (%) (YoY) (RHS)

0%10%20%30%40%50%60%70%80%90%100%110%

- 5,000

10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000 55,000

2014A 2015A 2016F 2017F 2018F

RM m

Financing (LHS) Deposit (LHS) Financing to deposit ratio (RHS)

48%

50%

52%

54%

56%

58%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2014A 2015A 2016F 2017F 2018F

RM m

Fund based income (LHS) Non-fund based income (LHS)Cost-to-income ratio (RHS)

ASIAN INSIGHTS VICKERS SECURITIES Page 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 2009. 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 170%. 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 2014. Separately, STMB’s capital ratio is well above the minimum requirement of 130%. 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 60% 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 2015. 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

Capitalisation (%)

ROE (%)

Forward PE Band (x)

PB Band (x)

Source: Company, AllianceDBS

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

2014A 2015A 2016F 2017F 2018F

RM m

Impaired financing ratio Provision charge-off rate

11.0%

11.5%

12.0%

12.5%

13.0%

13.5%

14.0%

14.5%

15.0%

15.5%

16.0%

2014A 2015A 2016F 2017F 2018F

Tier-1 CAR Total CAR

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

2014A 2015A 2016F 2017F 2018F

Avg: 11.8x

+1sd: 13.3x

+2sd: 14.8x

-1sd: 10.4x

-2sd: 8.9x8.0

10.0

12.0

14.0

16.0

18.0

Feb-13 Feb-14 Feb-15 Feb-16

(x)

Avg: 2.01x

+1sd: 2.28x

+2sd: 2.55x

-1sd: 1.74x

-2sd: 1.47x1.3

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

Feb-13 Feb-14 Feb-15 Feb-16

(x)

ASIAN INSIGHTS VICKERS SECURITIES Page 31

Company Guide

BIMB Holdings

Key Assumptions

FY Dec 2014A 2015A 2016F 2017F 2018F

Gross Financing Growth 24.2 16.1 12.0 12.0 12.0 Customer Deposits Growth 10.2 7.7 2.0 6.0 6.0 Yld. On Earnings Assets 4.3 4.4 4.4 4.4 4.4 Avg Cost Of Funds 2.2 2.5 2.4 2.5 2.5 Income Statement (RMm)

FY Dec 2014A 2015A 2016F 2017F 2018F Fund-based Income 1,280 1,320 1,402 1,510 1,648 Non-fund based Income 824 947 1,056 1,153 1,261

Operating Income 2,105 2,267 2,458 2,663 2,908 Operating Expenses (1,165) (1,275) (1,348) (1,426) (1,509)

Pre-provision Profit 940 992 1,110 1,237 1,400 Provisions (56.3) (73.8) (119) (136) (191) Associates (68.2) (83.4) (100) (120) (144) Exceptionals 0.0 0.0 0.0 0.0 0.0

Pre-tax Profit 815 834 891 981 1,064 Taxation (228) (221) (258) (265) (287) Minority Interests (54.6) (65.7) (71.3) (78.5) (85.1) Preference Dividend 0.0 0.0 0.0 0.0 0.0

Net Profit 532 547 561 638 692 Net Profit bef Except 532 547 561 638 692 Growth (%) Net fund based Income Gth 10.1 3.1 6.2 7.7 9.1 Net Profit Gth 108.3 2.8 2.5 13.6 8.5

Margins, Costs & Efficiency (%) Spread 2.1 1.9 1.9 1.9 1.9 Net Financing Margin 2.6 2.5 2.4 2.3 2.3 Cost-to-Income Ratio 55.3 56.3 54.9 53.5 51.9

Business Mix (%) Net fund based Inc / Opg Inc. 60.8 58.2 57.0 56.7 56.6 Non-fund based Inc / Opg inc. 25.8 28.4 28.8 29.2 29.4 Fee Inc / Opg Income 7.7 8.5 8.2 8.0 7.7 Oth Non-Int Inc/Opg Inc 5.7 4.9 5.9 6.1 6.2

Profitability (%) ROAE Pre Ex. 18.8 17.2 15.5 15.8 15.4 ROAE 18.8 17.2 15.5 15.8 15.4 ROA Pre Ex. 1.1 1.1 1.0 1.1 1.1 ROA 1.1 1.1 1.0 1.1 1.1

Source: Company, AllianceDBS

Expect ROE to stay in the range of 15%.

ASIAN INSIGHTS VICKERS SECURITIES Page 32

Company Guide

BIMB Holdings

Quarterly / Interim Income Statement (RMm)

FY Dec 3Q2015 4Q2015 1Q2016 2Q2016 3Q2016 Net fund-based Income 337 336 344 361 357 Non-fund based Income 205 277 270 264 252

Operating Income 542 613 615 625 610 Operating Expenses (321) (367) (339) (341) (332)

Pre-Provision Profit 221 246 276 284 277 Provisions 5.34 (23.2) (34.9) (30.3) (22.2) Associates (22.0) (22.8) (28.3) (28.2) (28.3) Exceptionals 0.0 0.0 0.0 0.0 0.0

Pretax Profit 204 200 213 226 227 Taxation (69.3) (22.0) (59.1) (63.4) (68.6) Minority Interests (14.9) (16.4) (18.2) (18.6) (17.7) Net Profit 120 162 135 144 141 Growth (%) Net fund-based Income Gth 2.5 (0.1) 2.4 4.9 (1.0) Net Profit Gth (7.8) 35.1 (16.4) 6.3 (2.2)

Balance Sheet (RMm) FY Dec 2014A 2015A 2016F 2017F 2018F Cash/Bank Balance 3,898 3,304 4,467 4,735 5,019 Government Securities 1,335 1,591 1,464 1,620 1,793 Inter Bank Assets 721 977 783 877 982 Total Net Financing & Advs. 29,525 34,295 38,444 43,099 48,281 Investment 15,529 15,110 15,899 16,731 17,608 Associates 0.0 0.0 0.0 0.0 0.0 Fixed Assets 458 461 484 509 534 Goodwill 0.0 56.2 0.0 0.0 0.0 Other Assets 753 718 754 792 831

Total Assets 53,030 57,364 63,189 69,300 76,034 Customer Deposits 40,678 43,795 44,671 47,351 50,192 Inter Bank Deposits 300 0.0 4,118 6,643 9,570 Debts/Borrowings 1,133 1,883 1,883 1,883 1,883 Others 1,406 1,402 1,433 1,465 1,497 Minorities 240 282 353 432 517 Shareholders' Funds 2,949 3,414 3,813 4,263 4,748

Total Liab& S/H’s Funds 53,030 57,364 63,189 69,300 76,034

Source: Company, AllianceDBS

Bottomline driven by strong financing growth of 15% y-o-y

ASIAN INSIGHTS VICKERS SECURITIES Page 33

Company Guide

BIMB Holdings

Financial Stability Measures (%)

FY Dec 2014A 2015A 2016F 2017F 2018F Balance Sheet Structure

Financing-to-Deposit Ratio 72.6 78.3 86.1 91.0 96.2 Net Financing / Total Assets 55.7 59.8 60.8 62.2 63.5 Investment / Total Assets 29.3 26.3 25.2 24.1 23.2 Cust . Dep./Int. Bear. Liab. 96.6 95.9 88.2 84.7 81.4 Interbank Dep / Int. Bear. 0.7 0.0 8.1 11.9 15.5

Asset Quality NPF / Total Gross Financing 1.1 1.1 1.1 1.1 1.1 NPF / Total Assets 0.6 0.7 0.7 0.7 0.7

Financing Loss Reserve Coverage

170.4 174.6 173.0 164.0 162.0

Provision Charge-Off Rate 0.2 0.2 0.3 0.3 0.4

Capital Strength Total CAR 13.4 15.3 15.0 14.8 14.5 Tier-1 CAR 12.2 12.1 12.0 11.7 11.3

Source: Company, AllianceDBS

Target Price & Ratings History

Source: AllianceDBS

Analyst: Lynette CHENG Sue Lin LIM

S.No.Date of Report

Closing Price

12-mth Target Price

Rat ing

1: 25 Feb 16 3.54 3.85 HOLD

2: 29 Feb 16 3.60 3.85 HOLD

3: 03 Mar 16 3.61 3.85 HOLD

4: 24 Mar 16 3.80 3.85 HOLD

5: 03 May 16 3.92 3.85 HOLD

6: 12 May 16 3.86 3.85 HOLD

7: 02 Jun 16 4.06 3.85 HOLD

8: 12 Jul 16 4.00 3.85 HOLD

9: 14 Jul 16 4.09 3.85 HOLD

10: 28 Jul 16 4.00 3.85 HOLD

11: 01 Aug 16 3.99 3.85 HOLD12: 29 Aug 16 4.00 4.15 HOLD13: 05 Sep 16 4.02 4.15 HOLD14: 31 Oct 16 4.40 4.15 HOLD

Note : Share price and Target price are adjusted for corporate actions. 15: 07 Dec 16 4.18 4.15 HOLD16: 22 Dec 16 4.32 4.80 BUY17: 10 Jan 17 4.20 4.80 BUY18: 07 Feb 17 4.32 4.80 BUY

1

2

3

45

6 7

89

10

11

12

13

14

15

16

17

18

3.29

3.49

3.69

3.89

4.09

4.29

4.49

Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16

RM

Healthy asset-quality indicators with low impaired financing ratio and high coverage ratio

ASIAN INSIGHTS VICKERS SECURITIES ed: CK / sa:WMT, PY

BUYBUYBUYBUY Last Traded PriceLast Traded PriceLast Traded PriceLast Traded Price (((( 17 Feb 201717 Feb 201717 Feb 201717 Feb 2017)))): : : : RM8.81 (KLCIKLCIKLCIKLCI : : : : 1,707.68) Price Target Price Target Price Target Price Target 12121212----mthmthmthmth :::: RM10.00 (14% upside) Potential Catalyst: Potential Catalyst: Potential Catalyst: Potential Catalyst: Structural changes such as streamlining of

surveillance role, revision in listing fees and revamp in fee structure

Where we differWhere we differWhere we differWhere 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 +60 32604 3907 lynettecheng@alliancedbs.com Sue Lin LIM +65 8332 6843 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 RM10.00 TP

Price Relative

Forecasts and Valuation FY FY FY FY DecDecDecDec ((((RMRMRMRM m) m) m) m) 2016201620162016AAAA 2017201720172017FFFF 2018201820182018FFFF 2019201920192019FFFF

Revenue 473 490 511 533 EBITDA 295 318 342 368 Pre-tax Profit 271 293 318 345 Net Profit 194 210 228 248 Net Pft (Pre Ex.) 194 210 228 248 Net Pft Gth (Pre-ex) (%) (2.5) 8.5 8.6 8.5 EPS (sen) 36.1 39.2 42.5 46.2 EPS Pre Ex. (sen) 36.1 39.2 42.5 46.2 EPS Gth Pre Ex (%) (3) 9 9 9 Diluted EPS (sen) 36.1 39.2 42.5 46.2 Net DPS (sen) 34.0 36.9 40.1 43.5 BV Per Share (sen) 162 164 167 169 PE (X) 24.4 22.5 20.7 19.1 PE Pre Ex. (X) 24.4 22.5 20.7 19.1 P/Cash Flow (X) 23.4 7.9 6.7 5.6 EV/EBITDA (X) 9.8 7.9 6.0 4.0 Net Div Yield (%) 3.9 4.2 4.5 4.9 P/Book Value (X) 5.4 5.4 5.3 5.2 Net Debt/Equity (X) CASH CASH CASH CASH ROAE (%) 23.2 24.0 25.7 27.5 Earnings Rev (%):Earnings Rev (%):Earnings Rev (%):Earnings Rev (%): 0 0 0 Consensus EPS Consensus EPS Consensus EPS Consensus EPS (sensensensen):::: 39.9 42.1 N/A Other Broker Recs:Other Broker Recs:Other Broker Recs: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.Moving beyond equities; BUY.Moving beyond equities; BUY.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.Diversifying income base.Diversifying income base.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 RM4.50 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 Higher average daily value traded on BSAS contributes positively Higher average daily value traded on BSAS contributes positively Higher average daily value traded on BSAS contributes positively to revenue.to revenue.to revenue.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 RM10 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.Weaker market sentiment.Weaker market sentiment.Weaker market sentiment. Our sensitivity analysis shows that

every 1% decrease in average daily trading value assumption

would lower FY17 net profit by 0.4%. At A Glance Issued Capital (m shrs) 536

Mkt. Cap (RMm/US$m) 4,725 / 1,061

Major Shareholders (%)

Kumpulan Wang Persaraan Diperbadankan (%) 19.8

Capital Market Development Fund (%) 18.7

EPF (%) 7.2

Free Float (%) 54.3

3m Avg. Daily Val (US$m) 1.7

ICB IndustryICB IndustryICB IndustryICB Industry : Financials / General Financial

DBS Group Research . Equity

20 Feb 2017

Malaysia Company Guide

Bursa Malaysia Version 7 | Bloomberg: BURSA MK | Reuters: BMYS.KL Refer to important disclosures at the end of this report

88

108

128

148

168

188

208

5.9

6.4

6.9

7.4

7.9

8.4

8.9

9.4

9.9

Feb-13 Feb-14 Feb-15 Feb-16 Feb-17

Relative IndexRM

Bursa Malaysia (LHS) Relative KLCI (RHS)

ASIAN INSIGHTS VICKERS SECURITIES

Page 35

Company Guide

Bursa Malaysia

WHAT’S NEW

Indirect proxy to Islamic banking

Bursa Suq alBursa Suq alBursa Suq alBursa Suq al----Sila (BSAS) serves as the trading platformSila (BSAS) serves as the trading platformSila (BSAS) serves as the trading platformSila (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 Higher average daily value traded on BSAS contributes Higher average daily value traded on BSAS contributes Higher average daily value traded on BSAS contributes

positively to revenue.positively to revenue.positively to revenue.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

RM10 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?How does Bursa benefit from the growth in Islamic banking?How does Bursa benefit from the growth in Islamic banking?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 RM4.50 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 2015 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 conBSAS conBSAS conBSAS contribution expected to improve but remain small.tribution expected to improve but remain small.tribution expected to improve but remain small.tribution 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 RM10.00. Maintain BUY and TP of RM10.00. Maintain BUY and TP of RM10.00. Maintain BUY and TP of RM10.00. 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.Potential upside to dividend yield.Potential upside to dividend yield.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 2013 and 2014. 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 36

Company Guide

Bursa Malaysia

Chart 1:BSAS revenue vs ADVChart 1:BSAS revenue vs ADVChart 1:BSAS revenue vs ADVChart 1:BSAS revenue vs ADV

BSAS revenue moves in tandem with the average daily value traded

Chart 2: BSAS statistics Chart 2: BSAS statistics Chart 2: BSAS statistics Chart 2: BSAS statistics

Growing number of trading participants and foreign participants

Chart 3: BSAS performanceChart 3: BSAS performanceChart 3: BSAS performanceChart 3: BSAS performance

BSAS remains a small contributor to Bursa’s revenue, but diversification in revenue base positive to the company

Chart 4: Equity Chart 4: Equity Chart 4: Equity Chart 4: Equity ---- average daily volume and value trendsaverage daily volume and value trendsaverage daily volume and value trendsaverage daily volume and value trends

Subdued average daily volume and value trends in the equity market since 2014.

Source: Company, DBS Bank, AllianceDBS, Bloomberg Finance L.P.

5.1

5

.1

5.1

5

.1

5.2

5.2

5.2

5.2

7.3

7

.3

7.3

7

.3

9.9

9.9

9.9

9.9

11

.9

11

.9

11

.9

11

.9 13.6

1

3.6

1

3.6

1

3.6

16

.0

16

.0

16

.0

16

.0

19

.0

19

.0

19

.0

19

.0

18

.7

18

.7

18

.7

18

.7

15

.4

15

.4

15

.4

15

.4

15

.2

15

.2

15

.2

15

.2

15

.8

15

.8

15

.8

15

.8

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

-

1.0

2.0

3.0

4.0

5.0

6.0

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1Q

16

2Q

16

3Q

16

4Q

16

%%%%RM mRM mRM mRM m

BSAS revenue (LHS) ADV (RHS)

5.1

5

.1

5.1

5

.1

5.1

5

.1

5.1

5

.1 5

.8

5.8

5

.8

5.8

6.9

6

.9

6.9

6

.9 11

.9

11

.9

11

.9

11

.9 1

2.8

1

2.8

1

2.8

1

2.8

13.8

1

3.8

1

3.8

1

3.8

15

.2

15

.2

15

.2

15

.2

18

.7

18

.7

18

.7

18

.7

17

.0

17

.0

17

.0

17

.0

3.0

3.0

3.0

3.0 3.2

3.2

3.2

3.2

0

20

40

60

80

100

120

140

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1Q

16

2Q

16

3Q

16

4Q

16

RM bnRM bnRM bnRM bn

Foreign ADV (LHS) Domestic ADV (LHS)No of trading participants (RHS)

1.3

1

.3

1.3

1

.3

2.1

2

.1

2.1

2

.1

3.4

3

.4

3.4

3

.4

3.5

3

.5

3.5

3

.5

3.4

3

.4

3.4

3

.4

1.6

1

.6

1.6

1

.6

1.7

1

.7

1.7

1

.7 2

.2

2.2

2

.2

2.2

3.0

3

.0

3.0

3

.0

3.1

3

.1

3.1

3

.1

3.1

3

.1

3.1

3

.1 3

.5

3.5

3

.5

3.5

4.0

4

.0

4.0

4

.0

3.8

3

.8

3.8

3

.8

3.3

3

.3

3.3

3

.3

3.3

3

.3

3.3

3

.3

3.4

3

.4

3.4

3

.4

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

FY1

3

FY1

4

FY1

5

FY1

5

FY1

6

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1Q

16

2Q

16

3Q

16

4Q

16

%%%%RM mRM mRM mRM m

BSAS revenue (LHS) BSAS % to rev (RHS)

0

500

1,000

1,500

2,000

2,500

3,0004Q

09

1Q

10

2Q

10

3Q

10

4Q

10

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

4Q

13

1Q

14

2Q

14

3Q

14

4Q

14

1Q

15

2Q

15

3Q

15

4Q

15

1Q

16

2Q

16

3Q

16

4Q

16

Ave Daily Volume (m) Ave Daily Value (RMm)

ASIAN INSIGHTS VICKERS SECURITIES

Page 37

Company Guide

Bursa Malaysia

CRITICAL DATA POINTS TO WATCH

Earnings Drivers:

Revision in clearing fee.Revision in clearing fee.Revision in clearing fee.Revision in clearing fee. Close to 50% 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 RM1,000 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 RM1,000 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 earningsHigher listing fee will boost Bursa’s earningsHigher listing fee will boost Bursa’s earningsHigher listing fee will boost Bursa’s earnings. Revenue from

derivatives trading comprises sub-20% of Bursa’s operating

revenue, with CPO Futures making up 80% 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

2008 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 rolePotential streamlining in regulatory watchdog rolePotential streamlining in regulatory watchdog rolePotential 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.Revamp of tax structure.Revamp of tax structure.Revamp of tax structure. Currently, on top of the 0.1% stamp

duty (with a cap of RM200) 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).

To further enhance retail participation,To further enhance retail participation,To further enhance retail participation,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.

Average Daily Volume (m)

Average Daily Value (RMm)

Average Value/Volume

Velocity (%)

Revenue breakdown by segmentRevenue breakdown by segmentRevenue breakdown by segmentRevenue breakdown by segment

Source: Company, AllianceDBS

1975

1666 1716 1768 1821

0.0

284.9

569.9

854.8

1139.7

1424.6

1709.6

1994.5

2015A 2016A 2017F 2018F 2019F

1999

1812 1854 1892 1930

0.0

407.8

815.6

1223.4

1631.2

2039.0

2015A 2016A 2017F 2018F 2019F

1.011.09 1.08 1.07 1.06

0.00

0.22

0.44

0.67

0.89

1.11

2015A 2016A 2017F 2018F 2019F

29.3 29.3

26.1 25.3 24.6

0.0

5.9

11.8

17.7

23.7

29.6

2015A 2016A 2017F 2018F 2019F

49% 51% 48% 45% 45% 44% 43%

16% 15% 18% 19% 19% 19% 20%

35% 34% 35% 36% 36% 37% 37%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2013 2014 2015 2016 2017F 2018F 2019F

Equity Derivatives Other operating revenue

ASIAN INSIGHTS VICKERS SECURITIES

Page 38

Company Guide

Bursa Malaysia

Balance Sheet:

Net cash position. Net cash position. Net cash position. 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 Lucrative dividend Lucrative dividend Lucrative dividend payout. payout. payout. payout. Bursa generously pays out more

than 90% of its net profit historically. Special dividends were

paid out in 2013 and 2014. 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 10Currently trading below 10Currently trading below 10Currently trading below 10----year mean valuation.year mean valuation.year mean valuation.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.Strong market volumes and values a boon for Bursa.Strong market volumes and values a boon for Bursa.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.Sustainability of market liquidity.Sustainability of market liquidity.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 0.4%. Our assumptions for average

daily trading volume and value for 2017 are 1.72bn shares and

RM1.85bn respectively.

Structural changes would take time to implementStructural changes would take time to implementStructural changes would take time to implementStructural 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)

Capital Expenditure

ROE (%)

Forward PE Band (x)

PB Band (x)

Source: Company, AllianceDBS

0.1

0.2

0.2

0.3

0.3

0.00

0.01

0.01

0.02

0.02

0.03

0.03

0.04

0.04

0.05

0.05

2015A 2016A 2017F 2018F 2019F

Gross Debt to Equity (LHS) Asset Turnover (RHS)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

2015A 2016A 2017F 2018F 2019F

Capital Expenditure (-)

RMm

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2015A 2016A 2017F 2018F 2019F

Avg: 22.2x

+1sd: 23.2x

+2sd: 24.2x

-1sd: 21.1x

-2sd: 20.1x

17.7

18.7

19.7

20.7

21.7

22.7

23.7

24.7

25.7

26.7

Feb-13 Feb-14 Feb-15 Feb-16

(x)

Avg: 5.39x

+1sd: 5.79x

+2sd: 6.18x

-1sd: 5x

-2sd: 4.6x

3.6

4.1

4.6

5.1

5.6

6.1

6.6

Feb-13 Feb-14 Feb-15 Feb-16

(x)

ASIAN INSIGHTS VICKERS SECURITIES

Page 39

Company Guide

Bursa Malaysia

Key Assumptions

FY FY FY FY DecDecDecDec 2015201520152015AAAA 2016201620162016AAAA 2017201720172017FFFF 2018201820182018FFFF 2019201920192019FFFF

Average Daily Volume (m) 1,975 1,667 1,716 1,768 1,821 Average Daily Value (RMm)

1,999 1,812 1,854 1,892 1,930

Average Value/Volume 1.01 1.09 1.08 1.07 1.06

Velocity (%) 29.3 29.3 26.1 25.3 24.6

Segmental Breakdown

FY FY FY FY DecDecDecDec 2015201520152015AAAA 2016201620162016AAAA 2017201720172017FFFF 2018201820182018FFFF 2019201920192019FFFF Revenues (RMm)

Equity 233 213 219 225 231

Derivatives 86.2 88.7 93.7 99.0 105

Stable revenue 163 165 171 181 191

Other operating revenue 5.85 5.75 6.04 6.34 6.66

TotalTotalTotalTotal 488488488488 473473473473 490490490490 511511511511 533533533533

Income Statement (RMm)

FY FY FY FY DecDecDecDec 2015201520152015AAAA 2016201620162016AAAA 2017201720172017FFFF 2018201820182018FFFF 2019201920192019FFFF Revenue 488 473 490 511 533

Other Opng (Exp)/Inc (209) (202) (197) (192) (187)

Operating ProfitOperating ProfitOperating ProfitOperating Profit 279279279279 271271271271 293293293293 318318318318 345345345345 Other Non Opg (Exp)/Inc 0.0 0.0 0.0 0.0 0.0

Associates & JV Inc 0.0 0.0 0.0 0.0 0.0

Net Interest (Exp)/Inc 0.0 0.0 0.0 0.0 0.0

Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0

PrePrePrePre----tax Profittax Profittax Profittax Profit 279279279279 271271271271 293293293293 318318318318 345345345345 Tax (72.3) (67.9) (73.3) (79.6) (86.4)

Minority Interest (7.8) (9.0) (9.8) (10.7) (11.6)

Preference Dividend 0.0 0.0 0.0 0.0 0.0

Net ProfitNet ProfitNet ProfitNet Profit 199199199199 194194194194 210210210210 228228228228 248248248248 Net Profit before Except. 199 194 210 228 248

EBITDA 303 295 318 342 368

Growth

Revenue Gth (%) 3.5 (3.1) 3.6 4.3 4.3

EBITDA Gth (%) 1.8 (2.5) 7.8 7.6 7.7

Opg Profit Gth (%) 2.6 (2.9) 8.4 8.6 8.5

Net Profit Gth (Pre-ex) (%) 0.2 (2.5) 8.5 8.6 8.5

Margins & Ratio

Opg Profit Margin (%) 57.2 57.2 59.9 62.3 64.9

Net Profit Margin (%) 40.7 41.0 42.9 44.7 46.5

ROAE (%) 25.6 23.2 24.0 25.7 27.5

ROA (%) 10.6 8.6 8.0 7.5 6.9

ROCE (%) 24.9 22.9 23.7 25.1 26.5

Div Payout Ratio (%) 92.9 94.2 94.2 94.2 94.2

Net Interest Cover (x) NM NM NM NM NM

Source: Company, AllianceDBS

Equity revenue makes up bulk of earnings

ASIAN INSIGHTS VICKERS SECURITIES

Page 40

Company Guide

Bursa Malaysia

Quarterly / Interim Income Statement (RMm)

FY FY FY FY DecDecDecDec 4Q4Q4Q4Q2015201520152015 1Q1Q1Q1Q2016201620162016 2Q2Q2Q2Q2016201620162016 3Q3Q3Q3Q2016201620162016 4Q4Q4Q4Q2016201620162016 Revenue 125 126 122 112 113

Other Oper. (Exp)/Inc (54.7) (55.5) (52.8) (50.2) (43.6)

OpeOpeOpeOperating Profitrating Profitrating Profitrating Profit 70.670.670.670.6 70.670.670.670.6 69.469.469.469.4 61.661.661.661.6 69.069.069.069.0 Other Non Opg (Exp)/Inc 0.0 0.0 0.0 0.0 0.0

Associates & JV Inc 0.0 0.0 0.0 0.0 0.0

Net Interest (Exp)/Inc 0.0 0.0 0.0 0.0 0.0

Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0

PrePrePrePre----tax Profittax Profittax Profittax Profit 70.670.670.670.6 70.670.670.670.6 69.469.469.469.4 61.661.661.661.6 69.069.069.069.0 Tax (17.9) (18.0) (17.7) (15.7) (16.6)

Minority Interest (2.0) (2.7) (2.3) (1.9) (2.2)

Net ProfitNet ProfitNet ProfitNet Profit 50.650.650.650.6 49.949.949.949.9 49.549.549.549.5 44.044.044.044.0 50.250.250.250.2 Net profit bef Except. 50.6 49.9 49.5 44.0 50.2

EBITDA 70.6 70.6 69.4 61.6 69.0

Growth

Revenue Gth (%) 2.6 0.7 (3.1) (8.6) 0.7

EBITDA Gth (%) (1.9) 0.1 (1.6) (11.3) 11.9

Opg Profit Gth (%) (1.9) 0.1 (1.6) (11.3) 11.9

Net Profit Gth (Pre-ex) (%) (1.7) (1.3) (0.9) (11.0) 13.9

Margins

Opg Profit Margins (%) 56.4 56.0 56.8 55.1 61.3

Net Profit Margins (%) 40.4 39.6 40.5 39.4 44.6

Balance Sheet (RMm)

FY FY FY FY DecDecDecDec 2015201520152015AAAA 2016201620162016AAAA 2017201720172017FFFF 2018201820182018FFFF 2019201920192019FFFF Net Fixed Assets 244 230 221 212 205

Invts in Associates & JVs 0.0 0.0 0.0 0.0 0.0

Other LT Assets 253 288 288 288 288

Cash & ST Invts 1,514 1,848 2,231 2,707 3,300

Inventory 0.0 0.0 0.0 0.0 0.0

Debtors 48.7 43.5 55.0 69.5 87.7

Other Current Assets 26.4 26.9 26.9 26.9 26.9

Total AssetsTotal AssetsTotal AssetsTotal Assets 2,0862,0862,0862,086 2,4362,4362,4362,436 2,822,822,822,821111 3,3033,3033,3033,303 3,9073,9073,9073,907

ST Debt

0.0 0.0 0.0 0.0 0.0

Creditor 1,084 1,379 1,741 2,199 2,777

Other Current Liab 150 140 140 140 140

LT Debt 0.0 0.0 0.0 0.0 0.0

Other LT Liabilities 33.5 30.3 30.3 30.3 30.3

Shareholder’s Equity 803 869 881 894 909

Minority Interests 16.0 18.3 28.1 38.8 50.3

Total Cap. & Liab.Total Cap. & Liab.Total Cap. & Liab.Total Cap. & Liab. 2,0862,0862,0862,086 2,4362,4362,4362,436 2,8212,8212,8212,821 3,3033,3033,3033,303 3,9073,9073,9073,907

Non-Cash Wkg. Capital (1,158) (1,448) (1,800) (2,243) (2,803)

Net Cash/(Debt) 1,514 1,848 2,231 2,707 3,300

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) 0.3 0.2 0.2 0.2 0.1

Current Ratio (x) 1.3 1.3 1.2 1.2 1.2

Quick Ratio (x) 1.3 1.2 1.2 1.2 1.2

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) 3.3 2.8 2.4 2.0 1.7

Source: Company, AllianceDBS

4Q16 earnings lifted by lower staff cost

ASIAN INSIGHTS VICKERS SECURITIES

Page 41

Company Guide

Bursa Malaysia

Cash Flow Statement (RMm)

FY FY FY FY DecDecDecDec 2015201520152015AAAA 2016201620162016AAAA 2017201720172017FFFF 2222018018018018FFFF 2019201920192019FFFF Pre-Tax Profit 279 271 293 318 345

Dep. & Amort. 23.7 24.2 25.5 24.6 23.7

Tax Paid (77.7) (73.3) (73.3) (79.6) (86.4)

Assoc. & JV Inc/(loss) 0.0 0.0 0.0 0.0 0.0

Chg in Wkg.Cap. 0.0 0.0 351 443 560

Other Operating CF (8.8) (19.6) 0.0 0.0 0.0

Net Operating CFNet Operating CFNet Operating CFNet Operating CF 216216216216 202202202202 597597597597 707707707707 843843843843 Capital Exp.(net) (15.5) (10.9) (15.0) (15.0) (15.0)

Other Invts.(net) (31.5) (29.6) 0.0 0.0 0.0

Invts in Assoc. & JV 0.0 0.0 0.0 0.0 0.0

Div from Assoc & JV 0.0 0.0 0.0 0.0 0.0

Other Investing CF 70.3 (17.4) 0.0 0.0 0.0

Net Investing CFNet Investing CFNet Investing CFNet Investing CF 23.323.323.323.3 (57.9)(57.9)(57.9)(57.9) (15.0)(15.0)(15.0)(15.0) (15.0)(15.0)(15.0)(15.0) (15.0)(15.0)(15.0)(15.0) Div Paid (184) (187) (198) (215) (233)

Chg in Gross Debt 0.0 0.0 0.0 0.0 0.0

Capital Issues 0.0 0.0 0.0 0.0 0.0

Other Financing CF (5.8) (6.8) 0.0 0.0 0.0

Net Financing CFNet Financing CFNet Financing CFNet Financing CF (190)(190)(190)(190) (194)(194)(194)(194) (19(19(19(198)8)8)8) (215)(215)(215)(215) (233)(233)(233)(233)

Currency Adjustments 0.52 0.15 0.0 0.0 0.0

Chg in Cash 49.7 (50.0) 384 477 595

Opg CFPS (sen) 40.4 37.7 45.8 49.1 52.7

Free CFPS (sen) 37.5 35.6 108 129 154

Source: Company, AllianceDBS

Target Price & Ratings History

Source: AllianceDBS

Analyst: Lynette CHENG

Sue Lin LIM

S.No.S.No.S.No.S.No.Date of Date of Date of Date of

ReportReportReportReport

Closing Closing Closing Closing

PricePricePricePrice

12-mth 12-mth 12-mth 12-mth

Target Target Target Target

PricePricePricePrice

Rat ing Rat ing Rat ing Rat ing

1: 26 Apr 16 8.61 10.10 BUY

2: 25 Jul 16 8.89 10.10 BUY

3: 26 Jul 16 8.85 10.20 BUY

4: 11 Oct 16 8.85 10.20 BUY

5: 25 Oct 16 8.70 10.20 BUY

6: 05 Jan 17 8.88 10.20 BUY

7: 06 Feb 17 8.75 10.00 BUY

Note Note Note Note : Share price and Target price are adjusted for corporate actions.

1

2

3

4

5

6

7

7.98

8.18

8.38

8.58

8.78

8.98

9.18

9.38

9.58

Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16

RMRMRMRM

*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

NOT RATEDNOT RATEDNOT RATEDNOT RATED RMRMRMRM1.151.151.151.15 KLCIKLCIKLCIKLCI : : : : 1,707.68 Closing price as of 17 Feb 2017 Return *: 3Return *: 3Return *: 3Return *: 3 Risk: ModerateRisk: ModerateRisk: ModerateRisk: Moderate Potential Target Potential Target Potential Target Potential Target 12121212----mthmthmthmth* :* :* :* : 12-month RM 0.90 (-22% downside) Analyst Lynette CHENG +60 32604 3907 lynettecheng@alliancedbs.com Sue Lin LIM +65 8332 6843 suelinlim@dbs.com

Price Relative

Forecasts and Valuation FY FY FY FY DecDecDecDec ((((RMRMRMRMmmmm) ) ) ) 2015201520152015AAAA 2016201620162016FFFF 2017201720172017FFFF 2018201820182018FFFF

Pre-prov. Profit 1,052 1,037 1,074 1,146 Net Profit 258 199 262 548 Net Pft (Pre Ex.) 258 199 262 548 EPS (sen) 8.39 4.64 4.57 9.55 EPS Pre Ex. (sen) 8.39 4.64 4.57 9.55 EPS Gth (%) (80) (45) (1) 109 EPS Gth Pre Ex (%) (80) (45) (1) 109 Diluted EPS (sen) 8.20 3.47 4.57 9.55 PE Pre Ex. (X) 13.7 24.8 25.2 12.0 Net DPS (sen) 2.71 1.04 1.37 2.87 Div Yield (%) 2.4 0.9 1.2 2.5 ROAE Pre Ex. (%) 5.4 3.4 3.9 7.7 ROAE (%) 5.4 3.4 3.9 7.7 ROA (%) 0.7 0.5 0.5 1.0 BV Per Share (sen) 155 117 120 127 P/Book Value (x) 0.7 1.0 1.0 0.9 Consensus EPS Consensus EPS Consensus EPS Consensus EPS (sensensensen):::: 3.90 7.00 10.6 Other Broker Recs:Other Broker Recs:Other Broker Recs:Other Broker Recs: B: 0 S: 1 H: 4 ICB IndustryICB IndustryICB IndustryICB Industry : Financials ICB Sector: ICB Sector: ICB Sector: ICB Sector: Financial Services Principal Business:Principal Business:Principal Business: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 RM0.90, implying 0.8x FY17BV; M&A

a potential catalyst to re-rate the stock to RM1.30

The Business ForteForteForteForte in personal financing.in personal financing.in personal financing.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. Compelling Islamic banking proxy. Compelling Islamic banking proxy. 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 10 players based on asset size (#8) and loan portfolio size (#5). Currently, Islamic banking makes up c.80% of MBSB’s assets, loans and income. The Stock Saddled by hefty provisions.Saddled by hefty provisions.Saddled by hefty provisions.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 RM0.90Fair value of RM0.90Fair value of RM0.90Fair value of RM0.90 based on Gordon Growth model, assuming 8% ROE, 9% cost of equity and 2% long-term growth. Our TP implies 0.8x 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 RM1.30 (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

DBS Group Research . Equity DBS Group Research . Equity DBS Group Research . Equity DBS Group Research . Equity

20 Feb 2017

Malaysia Equity Explorer

Malaysia Building Society Berhad Bloomberg: MBS MK | Reuters: MBSS.KL Refer to important disclosures at the end of this report

SMC Research

Equity Explorer

Malaysia Building Society Berhad

Page 43

COMPANY BACKGROUND

The only exempt finance company in Malaysia. The only exempt finance company in Malaysia. The only exempt finance company in Malaysia. The only exempt finance company in Malaysia. Malaysia Building

Society Berhad (MBSB) started out as Federal and Colonial Building

Society Limited in 1950, and was eventually listed on Bursa Malaysia

in 1972. 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 Differences between an exempt finance company and a Differences between an exempt finance company and a Differences between an exempt finance company and a commercial bank commercial bank commercial bank commercial bank

Exempt Finance Exempt Finance Exempt Finance Exempt Finance CompanyCompanyCompanyCompany

Commercial BankCommercial BankCommercial BankCommercial Bank

Regulated byRegulated byRegulated byRegulated by Ministry of Finance Bank Negara Malaysia

DepositDepositDepositDeposit----taking taking taking taking restrictionrestrictionrestrictionrestriction

Limited to savings and fixed deposits. Not allowed to take demand deposits

No restrictions

Interbank Interbank Interbank Interbank marketmarketmarketmarket

Unable to participate Able to participate

Deposit Deposit Deposit Deposit insuranceinsuranceinsuranceinsurance

Not insured by PIDM Insured by PIDM

Statutory Statutory Statutory Statutory reserve reserve reserve reserve requirementrequirementrequirementrequirement

Not applicable 3.5%

Capital ratiosCapital ratiosCapital ratiosCapital ratios Not applicable Transitional compliance with Basel 3

Source: Company, DBS Bank, AllianceDBS

MBSB is helmed by Chief Executive Officer, Dato’ Ahmad Zaini bin MBSB is helmed by Chief Executive Officer, Dato’ Ahmad Zaini bin MBSB is helmed by Chief Executive Officer, Dato’ Ahmad Zaini bin MBSB is helmed by Chief Executive Officer, Dato’ Ahmad Zaini bin

Othman Othman Othman Othman whom was appointed in Feb 2009. 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).

Closing the gap between itself and the banks.Closing the gap between itself and the banks.Closing the gap between itself and the banks.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

RM2.0bn impairment over FY15-17. 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 2016, strengthening its capital adequacy. MBSB has

also been improving its core banking infrastructure and back-office

operations over the last few years.

On On On On thethethethe path towards becoming a fullpath towards becoming a fullpath towards becoming a fullpath towards becoming a full----fledged Islamic bank.fledged Islamic bank.fledged Islamic bank.fledged Islamic bank. When

stacked against the Islamic banks in Malaysia, MBSB ranks among

the top 10 players based on asset size (#8) and loan portfolio (#5).

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 2003.

Currently, Islamic operation makes up c.80% 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 incomeMBSB: Proportion of Islamic financing income to total incomeMBSB: Proportion of Islamic financing income to total incomeMBSB: Proportion of Islamic financing income to total income

Source: Company, DBS Bank, AllianceDBS

MY: Islamic banks ranked by asset sizeMY: Islamic banks ranked by asset sizeMY: Islamic banks ranked by asset sizeMY: Islamic banks ranked by asset size

Source: Company, DBS Bank, AllianceDBS

MY: Islamic banks ranked by MY: Islamic banks ranked by MY: Islamic banks ranked by MY: Islamic banks ranked by loan portfolio sizeloan portfolio sizeloan portfolio sizeloan portfolio size

Source: Company, DBS Bank, AllianceDBS

-

20

40

60

80

100

-

200

400

600

800

1,000

1,200

1,400

1,600

2012

2013

2014

2015

9M16

%%%%RM mRM mRM mRM m

Islamic financing income (LHS) Total income (LHS)Islamic % (RHS)

156

92

57

55

46

44

41

38

26

23

19

15

13

11

11

10

7

3

0

20

40

60

80

100

120

140

160

180

MAY ISL

BANK RAKYAT

BIMB

CIMB ISL

PUBLIC ISL

RHB ISL

MBSB

AMISL

HL ISL

Muam

alat

HSBC AMAN

OCBC AL-…

AFFIN ISL

SC SAADIQ

KFH

ALLCE ISL

Al-Rajhi

AFB

RM bnRM bnRM bnRM bn

130

63

40

34

32

32

31

27

18

15

12

10

9

7

7

7

5

1

0

20

40

60

80

100

120

140

MAY ISL

BANK RAKYAT

CIM

B ISL

BIM

B

MBSB

PUBLIC ISL

RHB ISL

AMISL

HL ISL

MUAMALA

T

HSBC AMAN

OCBC AL-…

AFFIN ISL

KFH

ALLCE ISL

SC SAADIQ

AL-RAJHI

AFB

RM bnRM bnRM bnRM bn

Equity Explorer

Malaysia Building Society Berhad

Page 44

Stronghold in personal financing. Stronghold in personal financing. Stronghold in personal financing. 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 Co-

operative 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 MBSB: Loan MBSB: Loan MBSB: Loan portfolioportfolioportfolioportfolio

Source: Company, DBS Bank, AllianceDBS

Personal financing growth crimped by macroprudential policies. Personal financing growth crimped by macroprudential policies. Personal financing growth crimped by macroprudential policies. Personal financing growth crimped by macroprudential policies.

MBSB’s personal financing segment recorded stellar growth prior to

2013, 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 2013, BNM enforced a

regulation targeted at personal financing, by limiting its tenure to 10

years (from 25 years). Subsequent to that, personal financing

growth has been on a downtrend for MBSB.

MBSB: Personal financingMBSB: Personal financingMBSB: Personal financingMBSB: Personal financing

Source: Company, DBS Bank, AllianceDBS

Malaysia: BNM tightening measuresMalaysia: BNM tightening measuresMalaysia: BNM tightening measuresMalaysia: BNM tightening measures

DateDateDateDate SegmentSegmentSegmentSegment MeasuresMeasuresMeasuresMeasures 3-Nov-10 Property Loans 70% LTV cap on third and

subsequent property.

1-Jan-11 Property Loans Risk weights applied by banks are raised to 100% from 75%, for housing loans >90% 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 10 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

Personal Financing66%

Home financing16%

Corporate loans17%

Others1%

-50

0

50

100

150

200

250

-

5,000

10,000

15,000

20,000

25,000

2010

2011

2012

2013

2014

2015

%%%%RM mRM mRM mRM m

Personal financing (LHS) Growth y-o-y (RHS)

Equity Explorer

Malaysia Building Society Berhad

Page 45

INVESTMENT CASE

BeatenBeatenBeatenBeaten----down share price due to weak earnings. down share price due to weak earnings. down share price due to weak earnings. down share price due to weak earnings. MBSB’s share price

plummeted by 52% from November 2014 to early Feb 2016.

Valuations have dropped from a high of 2.7x BV to 0.5x 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 financingMBSB: Personal financingMBSB: Personal financingMBSB: Personal financing

Source: Company, DBS Bank, AllianceDBS

Conduit for the making another “pure” Islamic Conduit for the making another “pure” Islamic Conduit for the making another “pure” Islamic Conduit for the making another “pure” Islamic bbbbank. ank. ank. ank. 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 2014 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 2015 as extraction of synergies

were challenging amid a weakening macroeconomic backdrop then.

In Feb 2016, MBSB was also in talks for a merger with Bank

Muamalat.

Still an attractive M&A target.Still an attractive M&A target.Still an attractive M&A target.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.

FINANCIAL REVIEW

Credit cost assumption of 2.2%/1.9%/1.0% across FY16Credit cost assumption of 2.2%/1.9%/1.0% across FY16Credit cost assumption of 2.2%/1.9%/1.0% across FY16Credit cost assumption of 2.2%/1.9%/1.0% across FY16----18F. 18F. 18F. 18F.

Management has guided that the programme will see a total of

RM2.0bn impairment over FY15-17. 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 ratioMBSB: Credit cost and impaired financing ratioMBSB: Credit cost and impaired financing ratioMBSB: Credit cost and impaired financing ratio

Source: Company, DBS Bank, AllianceDBS

We imputed 5%/6%/9% loan growth for FY16We imputed 5%/6%/9% loan growth for FY16We imputed 5%/6%/9% loan growth for FY16We imputed 5%/6%/9% loan growth for FY16----18F18F18F18F. 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 105-107% across the years.

MBSB: Financing and deposit growthMBSB: Financing and deposit growthMBSB: Financing and deposit growthMBSB: Financing and deposit growth

Source: Company, DBS Bank, AllianceDBS

NIM for FY16 is expected to decline by 18bpsNIM for FY16 is expected to decline by 18bpsNIM for FY16 is expected to decline by 18bpsNIM 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.

0.00

0.50

1.00

1.50

2.00

2.50

3.00

Jan-14

Apr-14

Jul-14

Oct-14

Jan-15

Apr-15

Jul-15

Oct-15

Jan-16

Apr-16

Jul-16

Oct-16

Jan-17

RMRMRMRM

Share price fell by 52%

0

2

4

6

8

10

12

-

0.5

1.0

1.5

2.0

2.5

2012

2013

2014

2015

2016F

2017F

2018F

%%

Impaired financing ratio (RHS) Credit cost (LHS)

100

102

104

106

108

110

112

114

(10)

-

10

20

30

40

50

60

70

2012

2013

2014

2015

2016F

2017F

2018F

%%%%%%%%

Financing growth (LHS) Deposit growth (LHS)

Financing to deposit ratio (RHS)

Equity Explorer

Malaysia Building Society Berhad

Page 46

Bottomline improvement post impairment programme.Bottomline improvement post impairment programme.Bottomline improvement post impairment programme.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: NetMBSB: NetMBSB: NetMBSB: Net profitprofitprofitprofit

Source: Company, DBS Bank, AllianceDBS

VALUATIONS

Fair value of RM0.90.Fair value of RM0.90.Fair value of RM0.90.Fair value of RM0.90. We value MBSB using the Gordon Growth

Model, assuming 8% ROE, 10% cost of equity and 2% long-term

growth. With that, we arrive at a fair value of RM0.90, which

implies 0.8x 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

RM1.30, based on FY17 BV.

MBSB: 12MBSB: 12MBSB: 12MBSB: 12----month forward Pmonth forward Pmonth forward Pmonth forward P////BBBBVVVV ratio (x)ratio (x)ratio (x)ratio (x)

Source: Company, DBS Bank, AllianceDBS

RISKS

Further asset quality upsets.Further asset quality upsets.Further asset quality upsets.Further asset quality upsets. While MBSB targets to complete its

impairment programme by 2018, 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. Timing of M&A. Timing of M&A. 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 2018, the

operating environment may remain tough for banks to pursue an

M&A agenda.

MBSB: Risk assessmentMBSB: Risk assessmentMBSB: Risk assessmentMBSB: Risk assessment

CategoryCategoryCategoryCategory Risk RatingRisk RatingRisk RatingRisk Rating WgtWgtWgtWgt Wgtd ScoreWgtd ScoreWgtd ScoreWgtd Score

1 (Low) 1 (Low) 1 (Low) 1 (Low) ---- 3 (High)3 (High)3 (High)3 (High)

EarningsEarningsEarningsEarnings 3 40% 1.2

FinancialsFinancialsFinancialsFinancials 3 20% 0.6

ShareholdingsShareholdingsShareholdingsShareholdings 1 40% 0.4

OverallOverallOverallOverall 2.2

Source: Company, DBS Bank, AllianceDBS

34.0

32.5

29.6

5.4

3.4

3.9 7.7

0

5

10

15

20

25

30

35

40

-

200

400

600

800

1,000

1,200

1,400

2012

2013

2014

2015

2016F

2017F

2018F

%%%%RM mRM mRM mRM m

Net profit (LHS) Pre provision profit (LHS) ROE (RHS)

Avg: 1.5x

+1sd: 2.1x

+2sd: 2.7x

-1sd: 0.9x

-2sd: 0.3x0.2

0.7

1.2

1.7

2.2

2.7

3.2

Feb-07 May-08 Aug-09 Nov-10 Feb-12 May-13 Aug-14 Nov-15 Feb-17

(x)

Equity Explorer

Malaysia Building Society Berhad

Page 47

Key Assumptions

FY FY FY FY DecDecDecDec 2013201320132013AAAA 2014201420142014AAAA 2015201520152015AAAA 2016201620162016FFFF 2017201720172017FFFF 2018201820182018FFFF

Gross Loans Growth 18.9 2.4 4.4 5.0 6.4 8.9

Customer Deposits Growth 31.2 (2.3) 3.8 11.0 7.0 7.0

Yld. On Earnings Assets 5.9 4.8 4.7 4.5 4.5 4.4

Avg Cost Of Funds 1.3 0.8 0.8 0.7 0.7 0.8

Income Statement (RMm)

FY FY FY FY DecDecDecDec 2013201320132013AAAA 2014201420142014AAAA 2015201520152015AAAA 2016201620162016FFFF 2017201720172017FFFF 2018201820182018FFFF

Net Interest Income 97.9 244 209 186 210 240

Non-Interest Income 140 91.8 62.5 57.5 59.3 61.0

Operating IncomeOperating IncomeOperating IncomeOperating Income 1,5031,5031,5031,503 1,3641,3641,3641,364 1,3611,3611,3611,361 1,3541,3541,3541,354 1,3981,3981,3981,398 1,4761,4761,4761,476

Operating Expenses (295) (305) (308) (318) (324) (330)

PrePrePrePre----provision Profitprovision Profitprovision Profitprovision Profit 1,2081,2081,2081,208 1,0591,0591,0591,059 1,0521,0521,0521,052 1,0371,0371,0371,037 1,0741,0741,0741,074 1,1461,1461,1461,146

Provisions (276) (126) (697) (788) (724) (415)

Associates 0.0 0.0 0.0 0.0 0.0 0.0

Exceptionals 0.0 0.0 0.0 0.0 0.0 0.0

PrePrePrePre----tax Profittax Profittax Profittax Profit 932932932932 933933933933 355355355355 249249249249 350350350350 731731731731

Taxation (335) 82.5 (97.4) (49.8) (87.4) (183)

Minority Interests 0.0 0.0 0.0 0.0 0.0 0.0

Preference Dividend 0.0 0.0 0.0 0.0 0.0 0.0

Net ProfitNet ProfitNet ProfitNet Profit 598598598598 1,0151,0151,0151,015 258258258258 199199199199 262262262262 548548548548

Net Profit bef Except 598 1,015 258 199 262 548

Growth (%)

Net Interest Income Gth (56.1) 149.8 (14.5) (11.1) 13.2 14.3

Net Profit Gth 33.8 69.9 (74.6) (22.7) 31.8 108.9

Margins, Costs & Efficiency (%)

Spread 4.6 3.9 3.9 3.8 3.7 3.7

Net Interest Margin 4.6 3.9 3.9 3.7 3.6 3.6

Cost-to-Income Ratio 19.6 22.4 22.7 23.4 23.2 22.4

Business Mix (%)

Net Int. Inc / Opg Inc. 6.5 17.9 15.4 13.7 15.0 16.3

Non-Int. Inc / Opg inc. 9.3 6.7 4.6 4.2 4.2 4.1

Fee Inc / Opg Income 0.0 0.0 0.0 0.0 0.0 0.0

Oth Non-Int Inc/Opg Inc 9.3 6.7 4.6 4.2 4.2 4.1

Profitability (%)

ROAE Pre Ex. 32.5 29.6 5.4 3.4 3.9 7.7

ROAE 32.5 29.6 5.4 3.4 3.9 7.7

ROA Pre Ex. 1.9 2.8 0.7 0.5 0.5 1.0

ROA 1.9 2.6 0.7 0.5 0.5 1.0

Source: Company, AllianceDBS

Sensitivity Analysis 2012012012017F7F7F7F

Loan growth +/- 1% Net Profit +/- 0.3% NIM +/- 10bps Net Profit +/- 12%

Margins Trend

Impairment programme to complete in FY17

Equity Explorer

Malaysia Building Society Berhad

Page 48

Quarterly / Interim Income Statement (RMm)

FY FY FY FY DecDecDecDec 2Q2Q2Q2Q2015201520152015 3Q3Q3Q3Q2015201520152015 4Q4Q4Q4Q2015201520152015 1Q1Q1Q1Q2016201620162016 2Q2Q2Q2Q2016201620162016 3Q3Q3Q3Q2016201620162016

Net Interest Income 58.1 47.3 54.1 50.8 37.4 52.6

Non-Interest Income 12.8 14.3 17.0 14.3 17.4 8.77

Operating IncomeOperating IncomeOperating IncomeOperating Income 339339339339 336336336336 343343343343 331331331331 339339339339 362362362362

Operating Expenses (75.2) (73.2) (75.8) (73.3) (83.9) (77.9)

PrePrePrePre----Provision ProfitProvision ProfitProvision ProfitProvision Profit 264264264264 262262262262 267267267267 258258258258 255255255255 284284284284

Provisions (134) (196) (266) (219) (180) (210)

Associates 0.0 0.0 0.0 0.0 0.0 0.0

Exceptionals 0.0 0.0 0.0 0.0 0.0 0.0

Pretax ProfitPretax ProfitPretax ProfitPretax Profit 129129129129 66.866.866.866.8 1.311.311.311.31 39.139.139.139.1 74.774.774.774.7 73.773.773.773.7

Taxation (43.7) (3.3) (17.1) (4.3) (11.7) (15.8)

Minority Interests 0.0 0.0 0.0 0.0 0.0 0.0

Net ProfitNet ProfitNet ProfitNet Profit 85.685.685.685.6 63.563.563.563.5 (15.8)(15.8)(15.8)(15.8) 34.834.834.834.8 63.063.063.063.0 57.957.957.957.9

Growth (%)

Net Interest Income Gth 17.0 (18.6) 14.4 (6.1) (26.3) 40.6

Net Profit Gth (31.2) (25.7) nm nm 80.9 (8.1)

Source: Company, AllianceDBS Balance Sheet (RMm)

FY FY FY FY DecDecDecDec 2013201320132013AAAA 2014201420142014AAAA 2015201520152015AAAA 2016201620162016FFFF 2017201720172017FFFF 2018201820182018FFFF

Cash/Bank Balance 4,584 5,767 6,928 11,942 13,559 14,599

Government Securities 0.0 0.0 0.0 0.0 0.0 0.0

Inter Bank Assets 0.0 0.0 407 0.0 0.0 0.0

Total Net Loans & Advs. 30,296 31,032 31,785 33,349 35,512 38,829

Investment 0.0 0.0 983 993 1,003 1,013

Associates 0.0 0.0 0.0 0.0 0.0 0.0

Fixed Assets 105 144 144 134 123 113

Goodwill 43.0 36.1 28.7 24.6 20.4 16.3

Other Assets 217 687 813 853 909 994

Total AssetsTotal AssetsTotal AssetsTotal Assets 35,24635,24635,24635,246 37,66637,66637,66637,666 41,08941,08941,08941,089 47,29647,29647,29647,296 51,12751,12751,12751,127 55,56455,56455,56455,564

Customer Deposits 28,193 27,531 28,585 31,730 33,951 36,327

Inter Bank Deposits 0.0 0.0 0.0 0.0 0.0 0.0

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 0.0 0.0 0.0 0.0 0.0 0.0

Shareholders' Funds 2,186 4,682 4,862 6,710 6,894 7,277

Total LiabTotal LiabTotal LiabTotal Liab & S/H’s Funds& S/H’s Funds& S/H’s Funds& S/H’s Funds 35,24635,24635,24635,246 37,66637,66637,66637,666 41,08941,08941,08941,089 47,29647,29647,29647,296 51,12751,12751,12751,127 55,56455,56455,56455,564

Source: Company, AllianceDBS

Quarterly Net Profit & Growth

Gross Loan& Growth

Customer Deposit & Growth

High provisions are the key drag on earnings

Equity Explorer

Malaysia Building Society Berhad

Page 49

Financial Stability Measures (%)

FY FY FY FY DecDecDecDec 2013201320132013AAAA 2014201420142014AAAA 2015201520152015AAAA 2016201620162016FFFF 2017201720172017FFFF 2018201820182018FFFF

Balance Sheet Structure

Loan-to-Deposit Ratio 107.5 112.7 111.2 105.1 104.6 106.9

Net Loans / Total Assets 86.0 82.4 77.4 70.5 69.5 69.9

Investment / Total Assets 0.0 0.0 2.4 2.1 2.0 1.8

Cust . Dep./Int. Bear. Liab. 92.8 91.0 86.3 85.4 83.9 82.3

Interbank Dep / Int. Bear. 0.0 0.0 0.0 0.0 0.0 0.0

Asset Quality

NPL / Total Gross Loans 5.2 6.6 7.4 7.5 7.4 7.0

NPL / Total Assets 4.7 5.7 6.1 5.7 5.5 5.2

Loan Loss Reserve Coverage 0.0 0.0 0.0 0.0 0.0 0.0

Provision Charge-Off Rate 0.9 0.4 2.0 2.2 1.9 1.0

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

Source: Company, AllianceDBS

NPL / Total Gross Loans

High impaired financing ratio

Industry Focus

Islamic Banks

Page 50

MAYBANK ISLAMIC

Maybank Islamic (MAY ISL) is a subsidiary under the listed Maybank Group, and is among the top 5 global Islamic banks. MAY ISL holds the leading market share in Islamic financing and deposits domestically. Its extensive branch network and widespread regional representation places them in the best position to expand Islamic financing beyond the Malaysian borders.

Company background: • Maybank Islamic (MAY ISL) is among the top 5 Islamic banks

and sukuk arranger globally, while its parent company, Maybank (MAY) sits among the top 5 biggest banks in ASEAN by asset size. Domestically, MAY ISL holds the leading market share in Islamic financing (33%) and deposits (26%), aided by its extensive branch network of 393 MAY branches (which concurrently offers Islamic banking services) and 15 standalone Islamic branches.

Making inroads with Islamic First strategy • Over the years, MAY ISL has gradually increased its financing

share in the group, from 26% in 2010 to just above 50% in 2015. The success is underpinned by MAY’s Islamic First strategy, where across the group, customers are offered Islamic products first, before an offer for conventional products. The strategy was deployed in 2011 and saw significant uptick in proportion to the group’s domestic financing from 2012 onwards..

• Among its Malaysian peers, MAY is best positioned to propagate Islamic banking within ASEAN. With a presence in all 10 ASEAN countries, we believe MAY has a leg up in leveraging on the growth opportunities presented within the region. MAY has started on this, with the implementation of the Islamic First strategy in Indonesia. This, along with initiatives such as increasing 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 12th in FY13 to 5th in FY15, in terms of asset size. Over in Singapore, MAY 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 2013, and Islamic Business Term Financing and Islamic trade facilities and foreign currency deposits in 2014. In 2015, MAY ISL introduced Islamic financing products at Maybank Hong Kong, marking the beginning of MAY ISL’s reach for corporate clients in Hong Kong and Greater China.

MAY ISL Financial summary RM m 2011 2012 2013 2014 2015

Pre-provision profit 1,267 1,204 1,437 1,735 2,008

Net Profit 389 886 1,049 1,122 1,212

Earnings Gth (%) 26.6 128.1 18.4 7.0 8.0

ROA (%) 0.5 1.0 0.8 0.8 0.8

ROE (%) 9.4 19.5 16.3 15.5 14.7 Impaired financing ratio (%) 1.55 0.84 0.60 0.62 0.67 Loan loss coverage (%) 115 133 143 120 110

CASA ratio (%) 28.2 33.1 32.4 32.0 27.8 Financing to deposit ratio (%) 89 87 105 109 106

Loan growth (%) 35.3 18.4 40.1 24.9 20.8 Deposit growth (%) 59.4 20.8 17.0 20.1 6.1

Source: Company, DBS Bank, AllianceDBS

MAY ISL: Proportion to MAY domestic financing

Source: Company, DBS Bank, AllianceDBS

Global: Sukuk League table

2015 2016

Bank Amount (USD m)

Market share (%)

Amount (USD m)

Market share (%)

CIMB 5,234.7 15.0 5,329.5 12.8 Maybank 2,959.8 8.5 4,602.4 11.0 Standard Chartered Bank 2,255.0 6.5 3,878.4 9.3 RHB 3,300.1 9.5 3,037.5 7.3 HSBC 4,453.0 12.8 2,905.4 7.0 Dubai Islamic Bank 1,302.6 3.7 2,636.2 6.3 AmInvestment Bank Bhd 1,914.3 5.5 2,633.9 6.3 JP Morgan 1,483.0 4.3 1,464.8 3.5 National Bank of Abu Dhabi 1,181.9 3.4 1,463.7 3.5 Emirates NBD PJSC 664.8 1.9 1,389.8 3.3

Source: Company, DBS Bank, AllianceDBS

38,7

10

52,3

69

61,9

98

86,8

79

108,

540

131,

123

25.6 29.1 30.8

38.7 44.5

50.7

0

10

20

30

40

50

60

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

2010

2011

2012

2013

2014

2015

%RM m

Financing (LHS) % to domestic financing (RHS)

Industry Focus

Islamic Banks

Page 51

Watch the next frontier • MAY ISL’s investment account portfolio stands at RM17.7bn

as of end-Dec 2015, making it the largest in the industry. Looking ahead, MAY ISL aspires to sustain its pole position. MAY ISL is also part of the Investment Account Platform (IAP), enabling MAY ISL to act as a facilitator in channelling funds from interested investors to finance projects and ventures listed on the platform. While MAY ISL has yet to list projects on this platform, we understand that the bank is keen to improve the traction in the coming year. We are keenly watching how MAY ISL could use this to its advantage. We believe positive reception of investment accounts could be a prelude to more product innovation within the Islamic banking space.

Financials • MAY ISL’s ROEs are higher (sub-15%) than MAY’s (c.110%),

mainly attributable to the lower cost-to-income ratio. This reflects MAY ISL’s ability to leverage on its parents resources, in terms of branch network, risk-management systems and common infrastructure. MAY ISL’s regional operations are also capable of tapping onto the strong resources built up locally. For example, MAY ISL set up the Shariah Centre of Excellence in 2015, which aims to be the global Islamic Finance industry’s key reference point on matters pertinent to industry best practices using Shariah as the basis.

• MAY ISL’s impaired financing ratio saw a slight uptick since 2013, and this was accelerated particularly in 2Q16. As of end-June 2016, its impaired financing ratio stood at 1.2%, as absolute impaired loans have almost doubled from RM0.87bn to RM1.62bn. These largely stemmed from working capital and construction segments. The increase in 2Q16 was led by deliberate efforts by MAY in extending a hand to its customers amid a weaker operating environment. To that end, restructured and rescheduled (R&R) financing were accelerated for its oil & gas (Singapore and Malaysia) and steel (Malaysia only) exposures. Consequently, its financing loss coverage ratio slid from 110% in Dec 2015 to 75% in June 2016.

Valuation • Our HOLD rating and RM7.50 TP for Maybank Group is

maintained. Our TP implies 1.1x FY17 BV and is based on 11% ROE, 4% growth and 10.3% cost of equity. While MAY ISL is a clear winner in the Islamic banking space, as a whole, asset quality remains a key concern for the Group.

MAY ISL: Financing and deposit growth vs LDR

Source: Company, DBS Bank, AllianceDBS

MAY ISL: Asset quality

Source: Company, DBS Bank, AllianceDBS

MAY ISL: Profitability measures

Source: Company, DBS Bank, AllianceDBS

35.3

18.4

40.1

24.9

20.8

59.4

20.8

17.0

20.1

6.1

89 87

105 109 106

0

20

40

60

80

100

120

0

10

20

30

40

50

60

70

2011

2012

2013

2014

2015

%%

Financing growth (LHS) Deposit growth (LHS)Financing to deposit ratio (RHS)

1.55

0.84

0.60 0.62 0.67

115

133

143

120

110

0

20

40

60

80

100

120

140

160

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2011

2012

2013

2014

2015

%%

Impaired financing ratio (LHS) Financing loss coverage (RHS)

1,26

7

1,20

4

1,43

7

1,73

5

2,00

8

389

886

1,04

9

1,12

2

1,21

2

9.4

19.5

16.3 15.5 14.7

0

5

10

15

20

25

0

500

1,000

1,500

2,000

2,500

2011

2012

2013

2014

2015

%RM m

Pre-provision profit (LHS) Net profit (LHS) ROE (RHS)

Industry Focus

Islamic Banks

Page 52

BANK RAKYAT

Bank Rakyat (not listed) is the second biggest Islamic bank after Maybank Islamic, with a forte in personal financing to civil servants. Due to its heavy skew to personal financing, Bank Rakyat enjoys high net financing margin while its asset quality remains sound thanks to its access to the direct salary deduction code (Angkasa). Listing Bank Rakyat would create an alternate Islamic bank proxy apart from BIMB. Separately, we highlight that the acquisition of Bank Rakyat would give an acquirer an immediate boost in ranking by Islamic asset size.

Company background: • Bank Kerjasama Rakyat (Bank Rakyat) was formed from a

merger of 11 cooperative union backs back in 1954. Today, it stands as the largest cooperative bank in Malaysia. Bank Rakyat is also dubbed a Development Financial Institution (DFI), a specialised institution established by the government of Malaysia to support developments of selected sectors (of strategic importance to the country). Apart from providing specialised products and services catered to the identified sector, DFIs also offer consultation and advisory services to customers. Bank Rakyat is among the six institutions under the purview of the central bank (Bank Negara Malaysia; BNM) through the Development Financial Institutions Act 2002. As part of the cooperative sector, Bank Rakyat also reports to the Ministry of Domestic Trade, Cooperatives and Consumerism.

A valuable Islamic addition • Bank Rakyat’s journey to becoming an Islamic financial

institution began in 1993, by gradually converting its assets from conventional to Shariah-compliant. The conversion was completed a decade after. In August 2013, the press reported that Bank Muamalat was toying with the idea of acquiring a DFI, with one of the candidates being Bank Rakyat. Although nothing has materialised since then, we highlight that the acquisition of Bank Rakyat would significantly boost the size of the acquirer’s Islamic banking assets given that it is not only among the top Islamic banks in Malaysia, but also globally.

Forte in personal financing • At more than 90% of Bank Rakyat’s total loans as of end-

June 2016, personal financing makes up the bulk of Bank Rakyat’s loan portfolio. The bank has carved in niche in personal financing, particularly to the civil servants. This is largely achieved through leveraging on its direct deduction code obtained from Angkasa (Angkatan Koperasi Kebangsaan Malaysia or National Co-operative Organisation of Malaysia). Angkasa is the cooperative mandated to make direct deductions from its borrowers’ salaries.

Bank Rakyat: Financial summary

FYE Dec 2012 2013 2014 2015

Pre-provision profit (RM m) 2,769 2,894 2,894 2,485 Net Profit (RM m) 1,752 1,920 1,976 1,824 EPS (sen) 61.1 64.6 66.4 61.1 EPS Gth (%) (29.0) 5.6 2.9 (8.0) BV Per Share (sen) 363 388 428 470 ROA (%) 2.2 2.3 2.2 2.0 ROE (%) 16.8 16.6 15.5 13.0 Impaired financing ratio (%) 2.52 2.22 2.04 1.89 Loan loss coverage (%) 106 115 128 109 CASA ratio (%) 5.4 5.0 5.2 5.3 Financing to deposit ratio (%) 91 90 91 91 Loan growth (%) 11.9 3.6 5.6 3.8 Deposit growth (%) 7.1 4.2 4.9 3.6

Source: Company, DBS Bank, AllianceDBS

Bank Rakyat: Financing portfolio (as of end-Jun 2016)

Source: Company, DBS Bank, AllianceDBS

Bank Rakyat: Financing and deposit growth vs LDR

Source: Company, DBS Bank, AllianceDBS

Home financing

3%

Consumption credit91%

Financial services

4%

Construction1%

Others1%

8.8

11.9

3.6

5.6

3.8

18.0

7.1

4.2

4.9

3.6

87

91 90

91 91

84

85

86

87

88

89

90

91

92

0

2

4

6

8

10

12

14

16

18

20

2011

2012

2013

2014

2015

%%

Financing growth (LHS) Deposit growth (LHS)Financing to deposit ratio (RHS)

Industry Focus

Islamic Banks

Page 53

Diversification efforts going forward • Given the headwinds in growing personal financing, Bank

Rakyat aspires to reduce its exposure to personal financing by growing its commercial financing segment. While this reduces its concentration risk, margins will be dragged as commercial financing typically yields a lower rate as opposed to personal financing.

Financials • Financing growth dipped from FY12 onwards, since BNM

introduced regulations to control household debt, which included measures specific to personal financing, such as a cap of 10 years on its loan tenure and tighter underwriting criteria. Although Bank Rakyat is taking the initiative to grow other segments of its portfolio, loan growth is expected to remain sluggish given the still heavy skew towards personal financing.

• Bank Rakyat’s asset quality is sound, with impaired financing ratio showing a consistent decline y-o-y. Although the non-discretionary salary deductions by Angkasa reduces the risk of non-repayment by its personal financing customers to a certain extent, further deterioration in asset quality remains plausible against the tepid macroeconomic backdrop. In 2Q16, Bank Rakyat’s impaired financing grew 24% q-o-q, mainly from the construction segment.

• The main culprit behind the contraction in earnings in FY12

and FY15 was lower margins on the back of intense competition and dilution from growing lower-yielding commercial financing. Although margin compression is expected to continue as Bank Rakyat ramps up its commercial financing, we expect the bank’s net financing margin to remain higher than the industry average, as higher-yielding unsecured loans makes up a sizeable portion of its portfolio. High credit cost was also a drag on earnings across the years.

Valuation • Bank Rakyat is not listed on Bursa Malaysia. Nonetheless, we

highlight that listing Bank Rakyat would create an alternate Islamic bank proxy apart from BIMB. With an ROE of 13%, we believe a valuation of 1.2x BV is prudent for the bank. At such valuations, Bank Rakyat could command a market capitalisation of RM17bn (based on FY16 book value), more than twice the market capitalisation of BIMB.

Bank Rakyat: Asset quality

Source: Company, DBS Bank, AllianceDBS

Bank Rakyat: Earnings growth

Source: Company, DBS Bank, AllianceDBS

Bank Rakyat: ROE vs BVPS

Source: Company, DBS Bank, AllianceDBS

2.80

2.52

2.22

2.04

1.89

107 106

115

128

109

95

100

105

110

115

120

125

130

1.8

2.0

2.2

2.4

2.6

2.8

3.0

2011

2012

2013

2014

2015

%%

Impaired financing ratio (LHS) Financing coverage ratio (RHS)

2,74

4

2,76

9

2,89

4

2,89

4

2,48

5

2,02

4

1,75

2

1,92

0

1,97

6

1,82

4

49.9

(13.4)

9.6 2.9

(7.7)

-20

-10

0

10

20

30

40

50

60

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2011

2012

2013

2014

2015

%RM m

Pre-provision profit (LHS) Net profit (LHS)Net profit growth (RHS)

367

363

388

428

470

23.5

16.8 16.6 15.5

13.0

0

5

10

15

20

25

0

50

100

150

200

250

300

350

400

450

500

2011

2012

2013

2014

2015

%sen

Book val/sh (LHS) ROE (RHS)

Industry Focus

Islamic Banks

Page 54

BANK MUAMALAT

Bank Muamalat is among the top 10 (by asset size) Islamic banks in Malaysia and is the second full-fledged Islamic bank established in the country. The bank has been widely touted for a merger and acquisition deal over the years, as the market has long anticipated a pare down in shareholding by its largest shareholder, DRB Hicom. Alternatively, DRB Hicom could take Bank Muamalat down the listing route, which we expect could command a market capitalisation of close to RM1bn.

Company background: • Bank Muamalat is the second full-fledged Islamic bank

established in Malaysia, after Bank Islam. The bank is a product of combining the assets and liabilities of Islamic windows of three banks, i.e. Bank Bumiputra Malaysia (Bank Bumi), Bank of Commerce (M) and BBMB Kewangan. With an asset size of RM23bn, Bank Muamalat is one of the smallest banks in the industry.

• Bank Muamalat is jointly owned by DRB-Hicom (70%) and Khazanah Nasional (30%). DRB-Hicom is a conglomerate operating in Malaysia. Its subsidiaries include Pos Malaysia (POS MK Equity) and national carmaker, Proton. DRB-Hicom is in turn, 56% owned by Etika Strategi Sdn Bhd, a company controlled by a prominent businessman, Tan Sri Dato’ Seri Syed Mokhtar. Operationally, Bank Muamalat is led by CEO, Dato’ Haji Mohd Redza Shah Abdul Wahid.

• The three biggest segments of Bank Muamalat’s financing

portfolio are residential property, personal financing and working capital financing. Akin to Bank Rakyat and MBSB, Bank Muamalat is also granted access to the direct salary deduction code by Angkasa.

Long-awaited M&A play • Bank Muamalat has been widely touted as a potential merger

and acquisition candidate. This arose from the understanding that BNM had requested DRB-Hicom to pare down its stake to 40%. Bank Islam (2011), Affin (2013) and MBSB (2016) had made an attempt to acquire Muamalat, but no firm developments have materialised to date. Although Bank Muamalat is a small player in the industry as a whole, Muamalat is still within the top 10 (by asset size) among Islamic banks. Its asset size is bigger than Affin Islamic and if merged with MBSB, its Islamic asset size would eclipse Bank Islam’s.

Bank Muamalat: Financial summary

FYE Mar 2013 2014 2015 2016

Pre-provision profit (RM m)

238 163 159 273

Net Profit (RM m) 168 152 89 132

EPS (sen) 16.8 12.7 7.5 11.0

EPS Gth (%) 142.5 (24.5) (41.1) 47.7

BV Per Share (sen) 160 146 155 167

ROA (%) 0.8 0.8 0.4 0.6

ROE (%) 10.5 8.7 4.8 6.6 Impaired financing ratio (%)

2.50 2.18 2.48 2.21

Loan loss coverage (%)

102 102 83 89

CASA ratio (%) 20.6 24.4 24.3 24.3 Financing to deposit ratio (%)

57 69 70 75

Loan growth (%) 11.9 14.6 12.5 8.0

Deposit growth (%) 3.3 (5.9) 10.9 0.5 Source: Company, DBS Bank, AllianceDBS

Bank Muamalat: Financing portfolio

Source: Company, DBS Bank, AllianceDBS

Bank Muamalat: Financing and deposit growth vs FDR

Source: Company, DBS Bank, AllianceDBS

Hire purchase

6%

Mortgage31%

Personal use26%

Construction4%

Working capital24%

Others9%

21.0

11.9

14.6

12.5

8.0

11.9

3.3

(5.9

)

10.9

0.5

52 57

69 70 75

0

10

20

30

40

50

60

70

80

-10

-5

0

5

10

15

20

25

FY12

FY13

FY14

FY15

FY16

%%

Financing growth (LHS) Deposit growth (LHS)Financing to deposit ratio (RHS)

Industry Focus

Islamic Banks

Page 55

Financials • Bank Muamalat’s financing grew by 8% in FY16, led by home

and personal financing. Going forward, the bank is managing growth in home financing (due to high competition in the market) and focusing on loan growth in personal financing. While its financing-to-deposit ratio is low at 75% (vs the industry’s 90%), the ratio has crept up y-o-y as deposit growth has not kept up with financing growth. In FY14, deposits contracted due to a deliberate reduction of its high- cost wholesale deposit to manage net financing margins and to ensure compliance with the liquidity coverage ratio requirements (wholesale deposits have a higher run-off rate). We understand that liquidity coverage ratio treads above the minimum requirement of 70% but lower than the industry average of 125%. The bank is focusing on growing its CASA franchise to improve its deposit profile.

• At 2.21% gross impaired financing ratio, Bank Muamalat’s asset quality is less robust compared to its peers. The bulk of its impaired financing comes from the personal financing and working capital financing segments, which have impaired financing ratios of 2.4% and 3.0%, respectively.

• Earnings growth was strong in FY16, as cost savings from its

voluntary separation scheme (completed the year before) started to kick in. Despite commanding high net financing margins (thanks to a sizeable proportion of higher-yielding personal financing), the bank’s overall profitability is dragged by a relatively high cost-to-income ratio (c.56%). When stacked against its peers, Bank Muamalat’s ROE lies at the lower end, at sub-7%.

Valuation • Bank Muamalat is under the ambit of listed company DRB

Hicom (DRB MK Equity), which trades at 0.4x FY17 PB. DRB is a conglomerate with interests in automotive, property, banking, and services (waste management, national vehicle inspection, and O&M of power plants).

• Given that Bank Muamalat has yet to make significant progress in closing a merger and acquisition transaction thus far, the listing of Bank Muamalat is an alternative option for DRB-Hicom to consider. In April 2016, Bank Muamalat’s CEO was quoted by the media, saying that listing is an available option for shareholders. Nonetheless, he added that it is not an issue being discussed in the immediate term, given the currently weak market sentiments. We highlight that if this route is taken, the bank could fetch a valuation that is comparable to Affin (closest comparable to its ROE profile). At a conservative valuation of 0.5x BV, Bank Muamalat could be listed at a market capitalisation of close to RM1bn.

Bank Muamalat: Asset quality

Source: Company, DBS Bank, AllianceDBS

Bank Muamalat: Earnings growth

Source: Company, DBS Bank, AllianceDBS

Bank Muamalat: ROE vs BVPS

Source: Company, DBS Bank, AllianceDBS

4.70

2.50 2.18

2.48 2.21

96 102

102

83

89

0

20

40

60

80

100

120

1.8

2.3

2.8

3.3

3.8

4.3

4.8

5.3

FY12

FY13

FY14

FY15

FY16

%%

Impaired financing ratio (LHS) Financing coverage ratio (RHS)

179

238

163

159

273

69

168

152

89

132

(48.2)

142.5

(9.7)

(41.1)

47.7

-100

-50

0

50

100

150

200

0

50

100

150

200

250

300

FY12

FY13

FY14

FY15

FY16

%RM m

Pre-provision profit (LHS) Net profit (LHS) Net profit growth (RHS)

140

160

146

155

167

4.9

10.5

8.7

4.8

6.6

0

2

4

6

8

10

12

125

130

135

140

145

150

155

160

165

170

FY12

FY13

FY14

FY15

FY16

%sen

Book val/sh (LHS) ROE (RHS)

Industry Focus

Islamic Banks

Page 56

Appendix

Industry Focus

Islamic Banks

Page 57

OIC members: Selected economic data points (latest available data)

Country GDP Banking

penetration Population

Density Total

population Ages 0-14 Ages 15-

64 Ages 65+

Account at fin inst

Borrowed from fin inst

Unit USD per

capita % per sq km mil % of Total % of Total

% of Total

% of Total

% of Total

Afghanistan 668 10.0 50 32.5 44.0 53.5 2.5 10.0 3.6 Albania 4,634 38.0 105 2.9 18.6 69.1 12.4 38.0 10.2 Algeria 5,484 50.5 17 39.7 28.5 65.5 5.9 50.5 2.2 Azerbaijan 7,884 29.2 117 9.7 21.9 72.5 5.6 29.2 18.9 Bahrain 24,854 81.9 1,940 1.4 21.5 76.1 2.4 81.9 21.3 Bangladesh 1,088 29.1 1,237 161.0 29.5 65.6 5.0 29.1 9.9 Benin 903 16.0 98 10.9 42.2 55.0 2.9 16.0 7.6 Brunei 40,979 N/A 80 0.4 23.1 72.5 4.4 N/A N/A Burkina Faso 725 13.4 66 18.1 45.6 52.0 2.4 13.4 5.0 Cameroon 1,407 11.4 49 23.3 42.5 54.3 3.2 11.4 1.9 Chad 941 7.7 11 14.0 47.7 49.8 2.5 7.7 2.4 Comoros 841 21.7 424 0.8 40.3 56.9 2.8 21.7 7.2 Cote d'Ivoire 1,546 15.1 71 22.7 42.5 54.5 3.0 N/A 2.3 Djibouti 1,814 N/A 38 0.9 32.7 63.1 4.2 12.3 4.5 Egypt 3,151 N/A 92 91.5 33.2 61.6 5.2 13.7 6.3 Gabon 10,317 30.2 7 1.7 37.1 57.8 5.1 30.2 4.3 Gambia 441 N/A 199 2.0 46.2 51.5 2.3 N/A N/A Guinea 536 6.2 51 12.6 42.5 54.4 3.1 6.2 2.0 Guinea-Bissau 672 N/A 66 1.8 40.8 56.0 3.2 N/A N/A Guyana 4,040 N/A 4 0.8 28.8 66.2 5.0 N/A N/A Indonesia 3,492 35.9 142 257.6 27.7 67.1 5.2 35.9 13.1 Iran 5,443 N/A 49 79.1 23.6 71.3 5.1 92.2 31.6 Iraq 6,475 11.0 83 36.4 41.0 56.0 3.1 11.0 4.2 Jordan 5,423 24.6 86 7.6 35.5 60.7 3.8 24.6 13.6 Kazakhstan 12,496 53.9 7 17.5 26.7 66.6 6.7 53.9 16.5 Kuwait 43,600 72.9 218 3.9 22.3 75.7 2.0 72.9 14.1 Kyrgyzstan 1,269 N/A 31 6.0 31.4 64.4 4.2 18.5 13.5 Lebanon 10,916 46.9 572 5.9 24.0 67.9 8.1 46.9 15.6 Libya 6,602 N/A 4 6.3 29.8 65.6 4.5 N/A N/A Malaysia 10,934 80.7 92 30.3 25.0 69.1 5.9 80.7 19.5 Maldives 8,484 N/A 1,364 0.4 27.5 67.8 4.7 N/A N/A Mali 701 13.3 14 17.6 47.5 50.0 2.5 13.3 2.7 Mauritania 1,283 20.4 4 4.1 40.0 56.8 3.2 20.4 7.7 Morocco 3,243 39.1 48 34.4 27.2 66.6 6.2 39.1 4.3 Mozambique 628 N/A 36 28.0 45.3 51.4 3.4 N/A N/A Niger 427 3.5 16 19.9 50.5 47.0 2.6 3.5 1.4 Nigeria 3,203 44.2 200 182.2 44.0 53.3 2.7 44.2 5.3 Oman 19,310 73.6 15 4.5 20.5 76.9 2.6 73.6 9.2 Pakistan 1,358 8.7 245 188.9 35.0 60.5 4.5 8.7 1.5 Palestine 2,972 N/A 735 4.4 40.2 56.8 3.0 N/A N/A Qatar 97,519 65.9 193 2.2 15.5 83.3 1.2 65.9 12.6 Saudi Arabia 24,362 69.4 15 31.5 28.6 68.6 2.9 69.4 12.2 Senegal 1,067 11.9 79 15.1 43.8 53.3 2.9 11.9 3.5 Sierra Leone 775 14.1 90 6.5 42.4 55.0 2.7 14.1 4.0 Somalia 131 7.9 17 10.8 46.7 50.5 2.8 7.9 2.0 Sudan 2,081 15.3 17 40.2 40.5 56.2 3.3 15.3 4.2 Suriname 9,680 N/A 3 0.5 26.8 66.3 6.9 N/A N/A Syria 9,680 N/A 101 18.5 37.1 58.8 4.1 23.3 13.1 Tajikistan 1,114 11.5 61 8.5 34.8 62.2 3.0 11.5 3.8 Togo 643 17.6 134 7.3 42.2 55.0 2.8 17.6 3.7 Tunisia 4,313 27.3 72 11.1 23.4 69.1 7.6 27.3 8.0 Turkey 10,515 56.5 102 78.7 25.7 66.8 7.5 56.5 20.0 Turkmenistan 9,032 1.8 11 5.4 28.2 67.6 4.2 1.8 2.2 Uganda 727 27.8 198 39.0 48.1 49.4 2.5 27.8 15.7 United Arab Emirates 43,963 83.2 110 9.2 13.9 84.9 1.1 83.2 15.4 Uzbekistan 2,049 40.7 74 31.3 28.5 66.8 4.7 40.7 1.3 Yemen 1,418 N/A 51 26.8 40.3 57.0 2.8 6.4 0.4 OIC 4,012 31.9 10,009 1,726.3 34.0 61.9 4.0 31.7 8.4 Note: Percentage of adults with account in financial institution is used as a proxy to banking penetration Source: OIC, Global Findex 2014

Industry Focus

Islamic Banks

Page 58

Islamic banking: Industry benchmarking

Total assets

Gross financing

Total deposits

Net profit

Return on equity (ROE)

Return on assets (ROA)

Source: Companies, DBS Bank, AllianceDBS

156

92

57

55

46

44

41

38

26

23

19

15

13

11

11

10

7 3 0

20

40

60

80

100

120

140

160

180

MA

Y IS

L

BAN

K R

AK

YA

T

BIM

B

CIM

B IS

L

PUBL

IC IS

L

RHB

ISL

MBS

B

AM

ISL

HL

ISL

Mua

mal

at

HSB

C A

MA

N

OC

BC A

L-…

AFF

IN IS

L

SC S

AA

DIQ

KFH

ALL

CE

ISL

Al-R

ajhi

AFB

RM bn

130

63

40

34

32

32

31

27

18

15

12

10

9 7 7 7 5 1

0

20

40

60

80

100

120

140

MA

Y IS

L

BAN

K R

AK

YA

T

CIM

B IS

L

BIM

B

MBS

B

PUBL

IC IS

L

RHB

ISL

AM

ISL

HL

ISL

MU

AM

ALA

T

HSB

C A

MA

N

OC

BC A

L-…

AFF

IN IS

L

KFH

ALL

CE

ISL

SC S

AA

DIQ

AL-

RAJH

I

AFB

RM bn

145

73

48

44

41

40

31

30

23

20

14

13

12

10

9 8 6 2

0

20

40

60

80

100

120

140

160

MA

Y IS

L

BAN

K R

AK

YA

T

CIM

B IS

L

BIM

B

PUBL

IC IS

L

RHB

ISL

AM

ISL

MBS

B

HL

ISL

MU

AM

ALA

T

HSB

C A

MA

N

OC

BC A

L-…

AFF

IN IS

L

SC S

AA

DIQ

ALL

CE

ISL

KFH

AL-

RAJH

I

AFB

RM bn

1,82

4.1

1,21

2.5

547.

3

404.

0

340.

4

257.

6

254.

9

233.

0

197.

0

137.

6

131.

9

122.

1

84.8

52.4

14.5

11.8

0.5

-37.

2

-500

0

500

1,000

1,500

2,000

BAN

K R

AK

YA

T

MA

Y IS

L

BIM

B

CIM

B IS

L

PUBL

IC IS

L

MBS

B

RHB

ISL

AM

ISL

HL

ISL

OC

BC A

L-A

MIN

MU

AM

ALA

T

HSB

C A

MA

N

AFF

IN IS

L

ALL

CE

ISL

SC S

AA

DIQ

AL-

RAJH

I

AFB

KFH

RM m

16.0

14.7

14.0

13.0

11.5

11.2

10.9

10.2

8.8

8.4

6.6

6.4

5.3

5.1

2.5

1.6

0.1

(2.2

)

-5

0

5

10

15

20

BIM

B

MA

Y IS

L

OC

BC A

L-A

MIN

BAN

K R

AK

YA

T

PUBL

IC IS

L

CIM

B IS

L

HL

ISL

RHB

ISL

AM

ISL

HSB

C A

MA

N

MU

AM

ALA

T

ALL

CE

ISL

MBS

B

AFF

IN IS

L

SC S

AA

DIQ

AL-

RAJH

I

AFB

KFH

%

2.0

1.0

0.9

0.8

0.8

0.8

0.7

0.7

0.6

0.6

0.6

0.6

0.6

0.5

0.2

0.1

0.0

(0.3

)

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

BAN

K R

AK

YA

T

BIM

B

OC

BC A

L-A

MIN

AFF

IN IS

L

MA

Y IS

L

HL

ISL

PUBL

IC IS

L

CIM

B IS

L

HSB

C A

MA

N

MBS

B

AM

ISL

MU

AM

ALA

T

RHB

ISL

ALL

CE

ISL

AL-

RAJH

I

SC S

AA

DIQ

AFB

KFH

%

Industry Focus

Islamic Banks

Page 59

Islamic banking: Industry benchmarking

Financing growth (y-o-y)

Deposit growth (y-o-y)

Net profit growth (y-o-y)

Pre-provision profit growth (y-o-y)

CASA ratio

Financing-to-deposit ratio

Source: Companies, DBS Bank, AllianceDBS

28

24

22

21

16

15

14

11

8 8 7

4 4 4 4

(1)

(5)

(15)

-20-15-10

-505

101520253035

AFF

IN IS

L

PUBL

IC IS

L

RHB

ISL

MA

Y IS

L

BIM

B

HL

ISL

HSB

C A

MA

N

CIM

B IS

L

OC

BC A

L-A

MIN

MU

AM

ALA

T

ALL

CE

ISL

MBS

B

KFH

BAN

K R

AK

YA

T

AL-

RAJH

I

AM

ISL

SC S

AA

DIQ

AFB

%

27

18

15

9

7 6 6 4 4 2 1 1 (5)

(7)

(10)

(13)

(14)

(21)

-30

-20

-10

0

10

20

30

PUBL

IC IS

L

HL

ISL

RHB

ISL

ALL

CE

ISL

CIM

B IS

L

MA

Y IS

L

BIM

B

MBS

B

BAN

K R

AK

YA

T

OC

BC A

L-A

MIN

AFF

IN IS

L

MU

AM

ALA

T

AM

ISL

AL-

RAJH

I

KFH AFB

HSB

C A

MA

N

SC S

AA

DIQ

%

145

95

48

42

27

14

8 3 3 (2)

(2)

(4) (8

)

(13)

(14)

(75)

(96)

(140

)

-200

-150

-100

-50

0

50

100

150

200

AL-

RAJH

I

OC

BC A

L-A

MIN

MU

AM

ALA

T

SC S

AA

DIQ

AFF

IN IS

L

RHB

ISL

MA

Y IS

L

CIM

B IS

L

BIM

B

HL

ISL

AM

ISL

PUBL

IC IS

L

BAN

K R

AK

YA

T

ALL

CE

ISL

HSB

C A

MA

N

MBS

B

AFB

KFH

%

71

31

24

21

19

16

15

14

9 6

2

(1)

(6)

(7)

(13)

(14)

(23)

(59)

-80

-60

-40

-20

0

20

40

60

80

MU

AM

ALA

T

AFF

IN IS

L

RHB

ISL

OC

BC A

L-A

MIN

KFH

MA

Y IS

L

HL

ISL

ALL

CE

ISL

AL-

RAJH

I

BIM

B

CIM

B IS

L

MBS

B

HSB

C A

MA

N

PUBL

IC IS

L

AM

ISL

BAN

K R

AK

YA

T

AFB

SC S

AA

DIQ

%

37

35

32

32

28

28

28

27

25

24

23

21

21

20

18

16

5

0

0

5

10

15

20

25

30

35

40

HSB

C A

MA

N

BIM

B

SC S

AA

DIQ

OC

BC A

L-…

AFF

IN IS

L

MA

Y IS

L

ALL

CE

ISL

CIM

B IS

L

HL

ISL

MU

AM

ALA

T

PUBL

IC IS

L

AM

ISL

AL-

RAJH

I

KFH AFB

RHB

ISL

BAN

K R

AK

YA

T

MBS

B

%

74

80

80

81

84

89

91

92

97

97

98 11

1

111 12

3

128 14

1

192

244

0

50

100

150

200

250

300

MU

AM

ALA

T

BIM

B

ALL

CE

ISL

PUBL

IC IS

L

HL

ISL

BAN

K R

AK

YA

T

CIM

B IS

L

AFF

IN IS

L

AM

ISL

OC

BC A

L-…

AL-

RAJH

I

RHB

ISL

MBS

B

MA

Y IS

L

HSB

C A

MA

N

AFB

KFH

SC S

AA

DIQ

%

Industry Focus

Islamic Banks

Page 60

Islamic banking: Industry benchmarking

Net financing margin

Cost-to-income ratio

Net credit cost

Gross impaired financing ratio

Financing loss coverage ratio

Capital ratios

Source: Companies, DBS Bank, AllianceDBS

3.2

3.0

3.0

2.4

2.4

2.3

2.1

2.1

2.1

1.9

1.8

1.7

1.7

1.7

1.6

1.6

1.2

1.2

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

MBS

B

OC

BC A

L-A

MIN

BAN

K R

AK

YA

T

BIM

B

MU

AM

ALA

T

HSB

C A

MA

N

AM

ISL

KFH

ALL

CE

ISL

CIM

B IS

L

MA

Y IS

L

PUBL

IC IS

L

HL

ISL

SC S

AA

DIQ

AFB

AFF

IN IS

L

RHB

ISL

AL-

RAJH

I

%

23 29

36

36

37

39

41 44

47

48

48

51 56

56 63

66

79 86

0102030405060708090

100

MBS

B

BAN

K R

AK

YA

T

RHB

ISL

MA

Y IS

L

PUBL

IC IS

L

OC

BC A

L-…

HL

ISL

CIM

B IS

L

ALL

CE

ISL

AFF

IN IS

L

AM

ISL

HSB

C A

MA

N

MU

AM

ALA

T

BIM

B

KFH AFB

SC S

AA

DIQ

AL-

RAJH

I

%

(3)

5

7 9 18

20

21

21

23

23

57

62

68

73

112 12

6 150

204

-50

0

50

100

150

200

250

AM

ISL

HL

ISL

AL-

RAJH

I

AFF

IN IS

L

RHB

ISL

MA

Y IS

L

BIM

B

PUBL

IC IS

L

CIM

B IS

L

SC S

AA

DIQ

MU

AM

ALA

T

ALL

CE

ISL

HSB

C A

MA

N

BAN

K R

AK

YA

T

AFB

OC

BC A

L-A

MIN

KFH

MBS

B

%

0.5

0.6

0.7

0.7 0.9

0.9 1.0

1.1

1.1

1.2 1.

5 1.9

1.9 2.2

2.2 2.

8

7.4

7.4

0

1

2

3

4

5

6

7

8

SC S

AA

DIQ

AL-

RAJH

I

PUBL

IC IS

L

MA

Y IS

L

HL

ISL

AFB

CIM

B IS

L

BIM

B

ALL

CE

ISL

RHB

ISL

AFF

IN IS

L

BAN

K R

AK

YA

T

HSB

C A

MA

N

AM

ISL

MU

AM

ALA

T

OC

BC A

L-…

MBS

B

KFH

%

331

307

294

175

149

110

109

97

96

92

89

89

89

85

75

65

61

53

0

50

100

150

200

250

300

350

SC S

AA

DIQ

AL-

RAJH

I

AFB

BIM

B

PUBL

IC IS

L

MA

Y IS

L

BAN

K R

AK

YA

T

ALL

CE

ISL

OC

BC A

L-…

MBS

B

HL

ISL

HSB

C A

MA

N

MU

AM

ALA

T

CIM

B IS

L

KFH

AM

ISL

RHB

ISL

AFF

IN IS

L

%

24

19 19

15 14 14 13 13 13 13 13 12 12 12 11 11 10 10

25

20

25

22

16 16

14

16

14 15 15

16 15

18

15 13 14

15

0

5

10

15

20

25

30

AFB

BAN

K R

AK

YA

T

KFH

AL-

RAJH

I

MU

AM

ALA

T

CIM

B IS

L

AFF

IN IS

L

SC S

AA

DIQ

ALL

CE

ISL

MBS

B

OC

BC A

L-A

MIN

MA

Y IS

L

BIM

B

HSB

C A

MA

N

RHB

ISL

PUBL

IC IS

L

HL

ISL

AM

ISL

%

Tier 1 Total Capital

Industry Focus

Islamic Banks

Page 61

Islamic Banking: Definition of terms

Terms Definitions or equivalent terms in conventional model Al-ijarah thumma al-bai (AITAB) Lease contract followed by ownership of asset through a sale contract Bai' bithaman ajil (BBA) Sale contract based on deferred payment at a certain price Bai' dayn Sale of debt Bai' 'inah Sale contract followed by repurchase by the seller at a different price Bai' salam Sale contract based on order of certain asset with certain specifications. Full payment is made in

cash at the time of conclusion of the contract whereas the delivery of the asset is deferred to a specific time

Bai' sarf Sale of currency Financing Loans Financing loss coverage Loan loss coverage Financing-to-deposit ratio Loans-to-deposit ratio Fund-based Income Interest income Ibra' Rebate/waiver of partial or total claim against certain right or debt Ijarah Lease or service contract that involves benefit/usufruct of certain asset or work for an agreed

payment or commission within an agreed period Impaired financing ratio Impaired loan ratio Istisna Sale contract by way of order for certain product with certain specifications and certain mode of

delivery and payment (either in cash or deferred) Kafalah Guarantee Mudarabah Profit-sharing contract Muqasah Offsetting Murabahah Sale contract with a disclosure of the asset cost price and profit margin to the buyer Musawamah Sale contract without the disclosure of the asset cost price and profit margin to the buyer Musyarakah Profit and loss sharing Net financing margin (NFM) Net interest margin Non Fund-based Income (Fee-based)

Non-interest income

Profit attributable to depositors Interest expense Profit rate Interest rates Qard Loan contract Rahn Pledge/charge Sukuk Bonds Tabarru' Voluntary donation/contribution Tawarruq/commodity murabahah Purchasing an asset with deferred price, either on the basis of musawamah or murabahah, then

selling it to a third party to obtain cash Wadi'ah Safe keeping a contract in which a party entrusted his property to another party for safe keeping

and to be returned upon request Wakaf A form of endowment by an owner of a property for public benefit and wellbeing which is allowed

by Shariah Wakalah Agency contract Zakat Almsgiving

Source: BNM, AllianceDBS

Industry Focus

Islamic Banks

Page 62

DBS Bank recommendations are based an Absolute Total Return* Rating system, defined as follows:

STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)

BUY (>15% total return over the next 12 months for small caps, >10% for large caps)

HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)

FULLY VALUED (negative total return i.e. > -10% over the next 12 months)

SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends Completed Date: 18 Feb 2017 16:26:09 (MYT) Dissemination Date: 20 Feb 2017 08:53:38 (MYT)

GENERAL DISCLOSURE/DISCLAIMER

This report is prepared by DBS Bank Ltd. This report is solely intended for the clients of DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd,

its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated

in any form or by any means or (ii) redistributed without the prior written consent of DBS Bank Ltd.

The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS

Bank Ltd, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively,

the “DBS Group”)) do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to

change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard

to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of

addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal

or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of

profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This

document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or

persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group may have

positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and

other banking services for these companies.

Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the company (or companies) referred to in this report and the DBS Group is under no obligation to update the information in this report. This publication has not been reviewed or authorized by any regulatory authority in Singapore, Hong Kong or elsewhere. There is no planned schedule or frequency for updating research publication relating to any issuer.

The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and

assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on

which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual

results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED

UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that:

(a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and

(b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk

assessments stated therein.

Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies)

mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the

commodity referred to in this report.

DBS Vickers Securities (USA) Inc ("DBSVUSA")"), a U.S.-registered broker-dealer, does not have its own investment banking or research

department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction

in the past twelve months and does not engage in market-making.

Industry Focus

Islamic Banks

Page 63

ANANANANALYST CERTIFICATIONALYST CERTIFICATIONALYST CERTIFICATIONALYST CERTIFICATION

The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the

companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her

compensation was, is, or will be, directly, or indirectly, related to specific recommendations or views expressed in the report. The DBS Group has

procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of

research reports. As of 20 Feb 2017, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold

interests in the securities recommended in this report (“interest” includes direct or indirect ownership of securities). The research analyst(s)

responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and

procedures are in place to ensure that confidential information held by either the research or investment banking function is handled

appropriately.

COMPANYCOMPANYCOMPANYCOMPANY----SPECIFIC / REGULATORY DISCLOSURES SPECIFIC / REGULATORY DISCLOSURES SPECIFIC / REGULATORY DISCLOSURES SPECIFIC / REGULATORY DISCLOSURES

1. DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd (''DBSVS''), their subsidiaries and/or other affiliates do not have a proprietary

position in the securities recommended in this report as of 31 Jan 2017.

2. DBS Bank Ltd does not market make in equity securities of the issuer(s) or company(ies) mentioned in this Research Report.

Compensation foCompensation foCompensation foCompensation for investment banking services: r investment banking services: r investment banking services: r investment banking services:

3. DBS Bank Ltd, DBSVS, their subsidiaries and/or other affiliates of DBSVUSA, within the next 3 months, will receive or intend to seek

compensation for investment banking services from Maybank as of 1 Jan 2017.

4. DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a

manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further

information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document

should contact DBSVUSA exclusively.

Disclosure of previous investment recommendation produced:Disclosure of previous investment recommendation produced:Disclosure of previous investment recommendation produced:Disclosure of previous investment recommendation produced:

5. DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd (''DBSVS''), their subsidiaries and/or other affiliates may have published other

investment recommendations in respect of the same securities / instruments recommended in this research report during the preceding 12

months. Please contact the primary analyst listed in the first page of this report to view previous investment recommendations published by

DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd (''DBSVS''), their subsidiaries and/or other affiliates in the preceding 12 months.

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GeneralGeneralGeneralGeneral This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

AustraliaAustraliaAustraliaAustralia This report is being distributed in Australia by DBS Bank Ltd. (“DBS”) or DBS Vickers Securities (Singapore) Pte Ltd (“DBSVS”), both of which are exempted from the requirement to hold an Australian Financial Services Licence under the Corporation Act 2001 (“CA”) in respect of financial services provided to the recipients. Both DBS and DBSVS are regulated by the Monetary Authority of Singapore under the laws of Singapore, which differ from Australian laws. Distribution of this report is intended only for “wholesale investors” within the meaning of the CA.

Hong KongHong KongHong KongHong Kong This report is being distributed in Hong Kong by or on behalf of, and is attributable to DBS Vickers (Hong Kong) Limited which is licensed and regulated by the Hong Kong Securities and Futures Commission and/or by DBS Bank (Hong Kong) Limited which is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission. Where this publication relates to a research report, unless otherwise stated in the research report(s), DBS Bank (Hong Kong) Limited is not the issuer of the research report(s). This publication including any research report(s) is/are distributed on the express understanding that, whilst the information contained within is believed to be reliable, the information has not been independently verified by DBS Bank (Hong Kong) Limited. This report is intended for distribution in Hong Kong only to professional investors (as defined in the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) and any rules promulgated thereunder.) For any query regarding the materials herein, please contact Paul Yong (CE. No. ASE988) at equityresearch@dbs.com.

IndonesiaIndonesiaIndonesiaIndonesia This report is being distributed in Indonesia by PT DBS Vickers Sekuritas Indonesia.

MalaysiaMalaysiaMalaysiaMalaysia This report is distributed in Malaysia by AllianceDBS Research Sdn Bhd ("ADBSR"). Recipients of this report, received from ADBSR are to contact the undersigned at 603-2604 3333 in respect of any matters arising from or in connection with this report. In addition to the General Disclosure/Disclaimer found at the preceding page, recipients of this report are advised that ADBSR (the preparer of this report), its holding company Alliance Investment Bank Berhad, their respective connected and associated corporations, affiliates, their directors, officers, employees, agents and parties related or associated with any of them may have positions in, and may effect transactions in the securities mentioned herein and may also perform or seek to perform broking, investment banking/corporate advisory and other services for the subject companies. They may also have received compensation and/or seek to obtain compensation for broking, investment banking/corporate advisory and other services from the subject companies.

Wong Ming Tek, Executive Director, ADBSR

Industry Focus

Islamic Banks

Page 64

Singapore This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) or DBSVS (Company Regn No. 198600294G), both of which are Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd and/or DBSVS, may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, DBS Bank Ltd accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact DBS Bank Ltd at 6327 2288 for matters arising from, or in connection with the report.

Thailand This report is being distributed in Thailand by DBS Vickers Securities (Thailand) Co Ltd. Research reports distributed are only intended for institutional clients only and no other person may act upon it.

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