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THE grand plan to create Malaysia's biggest bank may be dead in the water - no thanks to lax loan provisioning at Malaysia Building Society Bhd (MBSB) that has surfaced during a three-month due diligence exercise.
The proposal to merge MBSB with CIMB Group and RHB Capital was supposed to result in South-east Asia's fourth biggest lender via a three-way "mega" union.
MBSB's provisioning policy for bad debts may be problematic as it could require considerable capital to realign its loan portfolio for the merger, an outcome deemed unsavoury for a S$27 billion ambitious merger plan largely predicated on deriving cost-saving synergies.
"Harmonising MBSB's standards to industry practice will see the capital base suffer a humongous hit. This possibility has scared everyone," said a source close to the deal.
The deal is expected to be called off this week following the banks' board meeting on Wednesday.
"The merger is going to be very hard to justify, particularly at a time of scarce capital and the weak macro environment," the source added.
As an exempt-finance firm, MBSB provides financing without a banking licence and hence has some leeway in adopting relatively less-stringent standards. For example, banks are generally more conservative in terms of provisioning for soured loans: they provide up to 100 per cent after a certain time and write back as they recover. On the other hand, an insider said MBSB provides for these loans on historical recovery rates and writes back or provides more when necessary.
This could pose unacceptable risks to the merger parties as more loans turn sour on the back of an uncertain macro backdrop. "Imagine the potential risks sitting in the books. This (MBSB) was the entity that was supposed to create the cost synergy for the merger. If that thesis for the merger is no longer apparent, then the merger is not valid," he added.
MBSB, which counts Malaysia's civil servants as its main customers, has long wrestled with the stigma of hefty soured loans; its current NPL (non-performing loan) ratio of some 5 per cent is more than double the banking sector's average but nevertheless marks a stark improvement from a whopping 40 per cent eight years ago, much of that related to legacy mortgage accounts.
Since 2009, a new management has tried to tackle this NPL issue with some success but that clearly remains a work in progress. While some of these loans have been written off, there are others that have yet to be provided for.
"It is hard to justify suffering a big capital hit at a time when the macro environment is looking questionable. It is just not the right or prudent thing to march ahead with the merger," said an industry analyst.
Signs that the deal, which would create an entity with some S$240 billion in total assets and touted to create a formidable and the world's largest Islamic bank, was on the brink of falling apart surfaced in mid-December last year following the findings of the due diligence work.
Should the deal be scuppered, it won't be the first time CIMB and RHB have failed to execute a merger; they last tried three years ago.
The deal's flop would be a major blow for the country's banking consolidation cheerleader, Bank Negara Malaysia, and more so for CIMB, the deal's biggest proponent led by its chairman Nazir Razak.
Mr Nazir, the youngest brother of Malaysian Prime Minister Najib Razak, who last year relinquished his chief executive position in CIMB after 15 years and swooped into the chairman's seat, has long aspired to elevate the lender to the top spot in the country's banking sector and pip rival Maybank. But evidently, not at all costs.
"This is not an ego trip. Everyone needs to stay focused on whether the deal will create value," said a senior banker.
News that the deal - which had raised hopes of further bank mergers - was faltering did not disappoint many, and in fact brought relief in some quarters.
CIMB's share price, which was weighed down by merger worries since the deal was announced in July last year, staged a stealthy rise of 14 per cent to RM5.92 on Tuesday.
In a stock exchange filing, CIMB said that the parties were still in discussions on the proposed merger and added that it would make an announcement should there be any material developments.
Could the deal still be salvaged?
"The potential reputational damage does not justify pushing and reworking the deal," added the source.