Maybank Analysis Part II: Risk Exposures

In the first part of this series I looked into Maybank’s profitability. However, profits don’t mean nothing if they’re not accompanied by sound risk management practices. Just ask Citigroup, it made crazy profits when it was all rainbows and butterflies, but destroyed a ton of shareholder value when reality caught up to it. In part 2 of this series, I will look into Maybank’s risk exposures. So grab a cup of coffee and a packet of nasi lemak and let’s get started on them risks.

Credit risk:

Credit risk for a bank mainly relates to the risk of customers defaulting on their loans. We need to look at a bank’s loan write-off rate to tell if it has been managing its credit risk prudently. For the 5-year period of 2008-2012, Maybank had an average loan write-off rate of 0.75%. Public Bank’s average loan write-off rate was 0.34% for the 5-year period of 2008-2012. As at September 30, 2013, Maybank’s ratio of net impaired loans of 1.06% is manageable.

Maybank’s loan write-off rate is acceptable. However, Maybank had a net interest margin of only 2.01% (annualized) for the 6 months ended June 30, 2013. After accounting for the loan write-off rate, Maybank’s asset portfolio would be earning a pretty low rate of return. Sure, if things stay the way it is, Maybank’s asset portfolio should be fine. But what if Malaysia enters a deep recession and loan write-off rates skyrocket? There’s a real possibility that Maybank’s asset portfolio could give back all the profits it made over multiple years. It may be unlikely that Malaysia would enter a deep recession in the foreseeable future, but I only feel comfortable when investing in a company that can handle extremely negative scenarios. To be fair, we can’t pin this on Maybank. It’s the low interest rate environment that contributes to the lacklustre position of Maybank’s asset portfolio.  

Public Bank has been excellent at managing credit risks. The lower loan write-off rates should result in Public Bank being able to build up more profits during the good times and reduce the risk of many years of profits simply being wiped out by loan write-offs during tough times.  Is Public Bank’s asset portfolio great? Hell no! Its net interest margin of 2.02% (annualised) is simply too low to compensate for the risks and still earn a good return over the long-term. But that’s the fault of the low interest rate environment. Some of you may be wondering why I’m kicking up a big fuss over a 0.41% difference in loan write-off rate. Over the long-term, however, it really adds up and it can separate an average bank from a good bank. Just like how adding a slice of cheese to a ramly burger makes something that tastes alright into something awesome.

Liquidity risk:

Maybank has a very solid deposit base. Its loan to customer deposit ratio was 88.24% as at September 30, 2013. Maybank’s loan to customer deposit ratio is low and indicates that it’s in a good position liquidity-wise.

Deposits are generally a more stable source of funds than the debt markets. During tough times, a bank that relies heavily on the debt markets could find itself having trouble raising funds to meet its obligations. Such a bank may be forced to pay very high interest rates to issue new debt securities and may even face insolvency if it can’t raise the necessary funds to meet its obligations.

Maybank also has a lot of cash and investment securities that it can sell to raise liquidity. As at September 30, 2013, Maybank had Ringgit Malaysia (RM) 58.95 billion in cash and RM 107.73 billion in securities. Maybank also has RM 98.63 billion in loans maturing within 1 year. Maybank could survive an extreme scenario where 20% of customer deposits and 70% of deposits from financial institutions are suddenly withdrawn within 1 year as that would only add up to RM 105 billion. On top of surviving such an extreme scenario, Maybank would still be able to cover the sum of RM 14.94 billion in other liabilities and borrowings that mature in 1 year. Overall, I would say that Maybank has very low liquidity risk.

Side note: In investing, it’s good to be paranoid and examine the company’s ability to survive in extremely negative scenarios. Think of risks as lego men lurking around corners, waiting to rob you of your investment capital. That way you would be more careful when assessing risks.

Interest rate risk:

Interest rate risk relates to the risk that the bank’s profitability may be impaired as a result of adverse movements in interest rates. When interest rates rise and interest-bearing liabilities mature or adjust faster than interest-earning assets, profits could suffer for a while as cost of funds might increase more than interest earned on loans. When interest rates fall and interest-earning assets mature or adjust faster than interest-bearing liabilities, profits could suffer for a while as interest earned on loans might fall more than cost of funds.

I think Maybank shouldn’t be in much trouble whichever way interest rates move as its loan portfolio seems to have the flexibility to adjust to changes in interest rates.  As at September 30, 2013, 66.70% of Maybank’s loans are variable rate loans. 29% of Maybank’s total loans are set to mature within one year.

Solvency risk:

Solvency risk relates to the risk of losses causing the bank’s capital ratios to fall below the minimum requirement. This could cause the bank to go bankrupt or be forced to raise additional capital at the expense of wiping out existing shareholders.

Maybank has pretty strong capital ratios. As at September 30, 2013, Maybank has CET 1 capital ratio, tier 1 capital ratio and total capital ratio of 10.734%, 12.585% and 15.203% respectively. The minimum capital adequacy requirements that will take effect on January 1, 2015 is 4.5%, 6.0% and 8.0% for CET 1 capital ratio, tier 1 capital ratio and total capital ratio respectively. Even the CET 1 capital ratio which has the smallest buffer is 6.234% above the minimum requirement. Unless Malaysia experience some severe recession, Maybank should have enough capital to absorb losses and remain as one of Malaysia’s most stable banks.

Conclusion:

I think Maybank has managed most of its risks well and should be safe as a long-term investment if bought at a reasonable price unless something extremely negative happens like a deep recession, nasi lemak getting banned or investors start taking stock tips from sex bloggers. I don’t really like Maybank’s asset portfolio as there’s a risk that it could deliver underwhelming returns over the long-term. However, if you include Maybank’s other income sources, I guess it earns decent returns on capital.

This concludes the series, and I just want to say that it was really awesome writing for intellecpoint. I hope you enjoyed this series and that you can find the time to visit my blog every now and then. Thank you for reading and may you always sustain good returns on your portfolio. Take care.

About me: Hi, my name is Justin Teo and I run the Greedy Dragon Investment blog which discusses my stock picks, opinions on the business world and value investing principles. I passed the level 1 CFA exam and graduated from Monash with a degree in banking mid this year. I may be young and do not have any professional experience, but I’ve been investing for a few years now and I think I’m pretty good at analysing companies. But don’t take my word for it, judge me by my analysis. I’m currently willingly unemployed as I plan to work on my project portfolio for track record purposes and just chill for the rest of the year.   

Disclaimer: I’m not encouraging anyone to follow my opinions. I’m not a professional wealth manager. I may make errors in my calculations and analysis. I may choose not to follow conventional ways of calculating certain figures and they may differ significantly from the actual figures you may get using conventional formulas. Whatever investment decisions you make should be based on your own independent judgement. I will not be responsible for any of your losses.    

Side note:  Some if not all of the figures in this article are calculated by myself and may differ from the actual figures that you may get using conventional formulas. Please let me know if you’re interested in how I calculate any of the figures in this article.

Analysis of Maybank Part I: Business Performance

This is a guest article and the opinion is strictly from the author.

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I love the banking sector as long-term success really hinges on management’s ability to both effectively allocate funds to generate a decent return as well as manage risks prudently. In this series, I will be analysing Maybank to see if it would make a good long-term investment. Part I of this series will cover Maybank’s business performance while part II will look into Maybank’s risk exposures and valuation. Is Maybank the addictive nasi lemak kukus that people line up 20 minutes for or the 2-day old basi nasi lemak? Let’s find out.

Maybank achieved returns on average assets (ROA) and returns on average equity (ROE) of 1.23% and 14.11% respectively for the 6 months ended June 30, 2013 as compared to Public Bank which achieved ROA and ROE of 1.42% and 20.95% respectively for the same period. Maybank will be benchmarked against Public Bank as Teh Hong Piow just has the secret recipe for making an awesome bank. There are 2 main reasons why I think Public Bank has a higher ROE than Maybank:

1)     Public Bank is more financially leveraged than Maybank as evidenced by its lower capital ratios. As at June 30, 2013, Publick Bank’s tier 1 and total capital ratios was at 10.823% and 13.196% respectively while Maybank’s was at 12.152% and 14.763%  respectively. While higher financial leverage may result in higher ROE, it can also make the company more exposed to insolvency risk.

2) Public Bank has a significantly lower operating cost structure than Maybank. Public Bank had an efficiency ratio of 0.42 while Maybank had an efficiency ratio of 0.58 for the 6 months ended June 30, 2013. The efficiency ratio can be thought of as the number of cents in operating expenses incurred to earn each Ringgit (before taxes). In Public Bank’s case, it has to spend around RM 0.42 cents in operating expenses to earn RM 1. I heard rumours of how Public Bank has the traditional Chinese businessman kiam siap (penny pinching) style of management which is really awesome if you’re a shareholder. I know that my main man Warren Buffett digs a culture of frugality, especially in a commoditized business such as banking.

Maybank’s net interest margin is line with that of Public Bank. Public Bank had a net interest margin of 2.02% while Maybank had a net interest margin of 2.01% for the 6 months ended June 30, 2013. While Public Bank earns a higher yield on its loan portfolio and investments, Maybank has a lower cost of funds.  Maybank’s cost of funds was 1.47% while Public Bank’s cost of funds was 2.19% for the 6 months ended June 30, 2013. Maybank’s and Public Bank’s yield on average earning assets was 3.35% and 4.11% respectively for the 6 months ended June 30, 2013. All said and done, I prefer Maybank’ position as a lower cost of funds is a straightforward advantage while a higher yield could result in a higher charge-off rate. I will look into the charge-off rates of both banks in part II of this series as it relates to their ability to manage credit risk.

Maybank has done well in terms of growing its deposit base. Maybank experienced customer deposit growth of 7.30% over the 6 month period ended June 30, 2013. Maybank also grew customer deposits at a compounded annual rate of 11.28% for the 6-year period of 2007-2012. Deposits are a much more stable source of funds to expand the loan and/or securities portfolios. Banks that rely heavily on debt securities to fund their operations face the risk of not being able to meet their obligations during tough periods when liquidity dries up in the money and capital markets. We’ll look at Maybank’s liquidity risk in part II of this series.

While not great, Maybank’s ROE of 14.11% is still respectable. Charlie Munger (Warren Buffett’s badass partner) once said: “Over the long term, it's hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you're not going to make much different than a six percent return - even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result.” If Maybank is able to sustain a ROE of 14.11% over the long-term, I think an investor would do very well holding on to the stock.

If we go back to the nasi lemak metaphor, we can establish that both Maybank and Public Bank are decent tasting (Public Bank tastes better but not by a huge margin). Not worth lining up in the rain for, but definitely something I won’t mind eating once every week. However, just because something tastes alright doesn’t mean it won’t give you the runs, you need to make sure the ingredients used are not of inferior quality. Join me in part II of this series where I will look into the risk exposures of Maybank to find out if the stock is a sound long-term investment. Thank you for reading and I hope you can find the time to pay the Greedy Dragon Investment blog a visit. Take care.

About me: Hi, my name is Justin Teo and I run the Greedy Dragon Investment blog which discusses my stock picks, opinions on the business world and value investing principles. I passed the level 1 CFA exam and graduated from Monash with a degree in banking mid this year. I may be young and do not have any professional experience, but I’ve been investing for a few years now and I think I’m pretty good at analysing companies. But don’t take my word for it, judge me by my analysis. I’m currently willingly unemployed as I plan to work on my project portfolio for track record purposes and just chill for the rest of the year.   

Disclaimer: I’m not encouraging anyone to follow my opinions. I’m not a professional wealth manager. I may make errors in my calculations and analysis. I may choose not to follow conventional ways of calculating certain figures and they may differ significantly from the actual figures you may get using conventional formulas. Whatever investment decisions you make should be based on your own independent judgement. I will not be responsible for any of your losses.    

Side note:  Some if not all of the figures in this article are calculated by myself and may differ from the actual figures that you may get using conventional formulas. Please let me know if you’re interested in how I calculate any of the figures in this article.

So which bank goes through the harder way to earn your money?

A strong banking system is set up to act as a good lubricant to the economy. What are their main functions? By either providing services and loans for you to buy your properties, motor vehicles, business loans etc. On the other hand, if you have excess funds, their will provide avenue for you to put your deposits with them and using those funds, the banks will be the intermediary to re-lend to those who needs them. These are the basic functions of a bank, but of course from those, later on merchant banks, treasuries, remittance services etc are created. If left to these few core things done well, the growth of an economy will be much smoother to manage be it for running of a business or for ownership of a better home or motor vehicles.

However along the way, banks (as always) became very greedy and they think that they can make more money from you through other means - where it is less risky. How? They start to charge you fees for all kinds of things. They charge unnecessary high fees for late repayment. They charge high fees for overseas remittance. They also charge exorbitant fees for some basic banking functions like remittance, confirmation, trade finance etc. All those fees are categorised under the category of non-interest income in the bank's income statement.

As you can see, banks main income comes from interest income and non-interest income (fee income), and you can add on another category to Islamic Banking Income for Malaysian banks. Interest income has largely elements of risks although it can be fully secured as in the lending for your homes, while non-interest income are most of the cases non or less-risky for example they are charging you for doing a Telegraphic Transfer, Treasuries, audit confirmation, changing of signatories etc. And of course Investment Banking fees are categorised under non-interest income.

Over here, we want to see which bank is the one which concentrates on providing more basic functions of a bank (i.e. lending etc) and doing less thinking of how to charge you fees only. Let's look at a comparison of three banks in Malaysia: Public Bank, Maybank and Hong Leong Bank. (I did not include CIMB as over the last 10 years they have acquired Southern and BCB, hence it may not be that accurate)

Comparison of three banks: Public, Maybank and Hong Leong

I took a 10 year view to look at the behavior of these banks to be able to know what kind of actions and perspectives they have taken on. If you look at the comparison, Public Bank is the one which concentrates on more loans and lesser fee income. The ratio of net interest income to fee income was in fact increased from 3.49x in 2001 to 4.45x in 2011. Over the period of 2001 - 2011, net interest income increased 163% which means that they have increased their loans and advances substantially.

If you look at Maybank, the Net Interest Income growth over the 10 years was 79% while non-interest income in fact grew more, by 215%. As a result of that ratio of net interest income to fee income dropped from 3.07x to 1.75x.

Hong Leong Bank was even worse. Their net interest income only grew by 35%, while fee income grew by a much whopping 210%. Hence, I am wondering whether they are more interested to make fee income or loans?

Err...from here, can you guess which bank would assumingly be taking more risk to make your hard-earned money?

Although this is a much simplistic way to explain how a bank functions as it can be much more complex, the writer feels that it is high time that Bank Negara looks at regulating banks charges  especially in this age of exorbitant fee income.