RHB FIC Credit Brief - Cagamas Bhd 17/02/16

17 February 2016

Credit Brief

Cagamas Bhd

Strategically Important National Mortgage Corporation

Key Credit Highlights:

¨        Strategically important with strong shareholders. Cagamas is owned by Bank Negara Malaysia (“BNM”) and other local financial institutions (Figure 1), and serves an essential role as the liquidity facilitator to the financial sector as well as one of the largest PDS issuers in the country. The strategic role and quasi-government status of Cagamas enables the national mortgage corporation to command top AAA rating on the national-scale, while holding a global rating on par with the Malaysia sovereign (A3). The demand for Cagamas bonds are further enhanced by its classification as “High Quality Liquid Assets” under the Liquidity Coverage Ratio requirements for financial institutions.

¨        Healthy asset quality supported by recourse-able loan and direct salary deductions. Cagamas’ asset quality is robust due to the conservative nature of its loan portfolio. About 47% of its lending book comprises of Purchase-With-Recourse (“PWR”) loans where the seller institutions are obligated to substitute loans that fail to meet payments/eligible criteria  (i.e. credit risk is restricted as 90% of loan exposures are to fundamentally strong financial institutions which are mainly rated AA or above) (Chart 3). We view that the increasing proportion of impairment-free PWR loans from 22% of total lending book in 2013, to 47% in 2014, are encouraging and implying a more risk averse underwriting direction during credit downturn cycle, although these have contributed to lower profitability (Chart 2).

Meanwhile, the credit profile on the rest of its 53% loan portfolio are Purchase-Without-Recourse (“PWOR”) loans, where credit risk is mitigated by the non-discretionary direct salary deductions repayment method (i.e. lower non-payment risk). Having said that, the prudent collection method translates into healthy asset quality with the PWOR portfolio registering below-average non-performing loan (“NPL”) ratio of 0.84% as at Dec-14, compared to the banking system average NPL of 1.3% for residential mortgages (Chart 4). While the financial system asset quality may face some headwinds amid high household debt and slowing economic growth, we expect the risk to be manageable at this juncture.

¨        Robust capitalization provides sufficient loan absorption buffers. Cagamas has ample buffers to withstand against additional non-performing loans, on the back of its sturdy capitalization with Common Equity Tier-1 (CET1) of 25% and Risk-Weighted Capital Adequacy Ratio (RWCAR) of 25.7% as at Jun-15, much higher than the banking system average of 12.1% and 15.2% respectively (Chart 5).

¨        Prudent asset liability management mitigates duration, liquidity and refinancing risk. Cagamas matches its cash-inflow to debt repayment profile to eliminate duration, liquidity and refinancing risk. We understand that Cagamas fully hedges its foreign currency position, thus eradicating the exchange-rate fluctuation risk of its foreign currency debt, which accounts for merely 16% of its total funding. The national mortgage corporation has successfully diversified its funding base to other currencies such as CNH, HKD, USD and SGD (Chart 1).

¨        Business diversion could introduce risk. Cagamas’ long term plan to expand into new asset classes, such as SME and infrastructure loans, may change the risk profile, in our opinion.

Merits	Risks
Strategically important with strong shareholders.	Slowing economic growth may moderate system-wide asset quality.
Robust asset quality supported by recourse-able loan and direct salary deduction.	Reliance to wholesale funding.
Sturdy capitalization provides sufficient loan absorption buffer. Prudent asset-liability management.	Business diversification may change the risk profile.