Affin’s PErplexing plan

Affin Bank Bhd is planning to get into private equity (PE), but unlike other banks in PE that provide advisory services or financing, it is taking a different route.

Affin Bank’s plan is to go directly into this business.

Affin Bank’s president and group chief executive officer Datuk Wan Razly Abdullah Wan Ali has told the media that it has received Bank Negara Malaysia’s approval and is now in applying to the Securities Commission for a PE licence.

Not only that, Wan Razly said the bank was also assessing the possibility of venturing into private credit, bitcoin lending and microfinancing.

Wan Razly and team seem set on differentiating the bank.

The PE business, he believes, is complementary to investment banking, noting that the bank had come across “many attractive investment opportunities” but could not participate as it didn’t have a PE licence. He also sees PE as another wholesale banking pillar.

While all banks have been pushing to raise their non-interest income, the PE business is a rare move.

The business model of a bank has structural differences with a PE firm. The differences include capital structures, incentives for professionals, investment time horizons and risk appetite.

Banks use their main source of capital, namely deposits, by lending them out and earning interest on that. But banks have been striving to raise their fee based income, which is what investment banking is all about.

PE, however, is a different ball game. Culturally, PE firms are quite different.

Professionals working in PE are driven by what they call the “carry”, essentially a profit share that they are entitled to when an investment bears fruit. Banks would be hard pressed to reward their employees that way.

PE investments have long gestation periods, sometimes locking up capital for 10 years and even then, not all investments work out.

Malaysia’s big banks such as Maybank, CIMB and RHB have in the past delved into PE, but these did not turn out to be successful ventures, otherwise we would have heard about the big profits that those banks earned from their PE divisions in the past. Those banks have since wound down their PE businesses.

As one seasoned PE player puts it: “Most banks do not succeed when they go into direct PE and the ones that do tend to lose their teams as it’s far more attractive for a successful team to go and raise their own fund.

“Banks are better off intermediating between their private wealth clients and a portfolio of best of breed PE fund managers.

“To go straight into direct PE investing is not an easy exercise at all as the culture of banking versus that of private equity is very different,” he quips.

Other less apparent issues could crop up – can the bank continue to lend to a company which is the main competitor of a company that the bank’s PE fund has invested in?

Also a public listed bank has to keep answering to shareholders, regulators and other stakeholders on a quarterly basis. A privately owned PE firm typically only answers to its long term limited partners (typically pension funds).

If Affin Bank runs the PE firm using only other people’s money, then its capital would not be exposed to the long gestation period of the investments being made. But that would also not give it the home run returns that PE is all about, so why do this business in the first place?

Perhaps to earn fees from running the business. Like how banks also have asset management arms that manage the money of wealthy people. Even that business is being disrupted.

In its heyday, the asset management business created its own investment products and sold them to a ready base of clients of the bank, earning the banks’ some nice fat fees.

Today, banks are focused on wealth management, giving the clients everything they need, including investment products.

But rather than their own in-house products, banks are realising that they need to bring the best-of-breed global investment products to their clients, instead of stuffing them with in-house ones.

So if a bank wishes to give its high net worth clients exposure to PE, why not figure out a way where they could get some exposure to the global big boys of PE, rather than trying to start their own PE fund.

The lack of a track record would put it in a hard position to attract investors (the limited partners in PE lingo).

In the end, a bank’s best way for any PE forays would be to continue playing the supporting role – be the banker to the PE firm and its investee companies. Advise on their exits, provide financing, manage their cash and foreign exchange needs and advise on acquisitions.

Meanwhile, Wan Razly’s plan for Affin Bank to venture into private credit, bitcoin lending and microfinancing is even more astonishing.

Recall that private credit first reared its head after the 2008 global financial crisis (GFC).

It is said to fill a gap of providing loans to companies that cannot secure traditional banking loans. It is the result of the aftermath of the GFC when new regulation required banks to shore up capital, tighten risk management and de-leverage.

Private credit is essentially the provision of loans by non-bank companies and are subject to looser regulation. So it’s almost ironic that some banks now want to get into private credit.

That has happened in the United States but only in rare instances and in some novel structures. JPMorgan Chase & Co reportedly is making a bold move into private credit, building a dedicated team within the bank for this business and using the bank’s own capital to lend.

It is left to be seen how that will work out for that bank.

As for bitcoin lending, which entails taking bitcoins as collateral for loans or facilitating the lending of bitcoins for a yield, the inherent risks or challenges include the volatility of the cryptocurrency, the additional work that needs to be done to vet through for financial crime, the complexities of custodian services and cybersecurity vulnerabilities.

Microfinancing, meanwhile, has been tried by at least one large bank in Malaysia but without much success, again due to structural issues.

Perhaps Affin Bank will figure out how to manoeuvre through all these challenges and in due time reap the benefits of boosting their non-interest income from these new-fangled businesses.

In Malaysia’s context, one of the most prominent bankers to push the envelope when it came to investment banking must be Tan Sri Nazir Razak, who aggressively pushed the boundaries to transform CIMB Group from a small, domestic merchant bank into an Asean banking powerhouse.

Could Wan Razly be looking to become today’s most innovative banker?