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The Black Swan Hidden in RCE CAPITAL (RCECAP)

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I never really expected this day to come, or for me to do it in such circumstances (I would have preferred selling it for much more). However, over the last week, I cleared my entire position in RCECAP.

Normally, I wouldn’t be inclined to explain to the public why I did so, however, as I had written the article below, i felt morally obligated to do so.

Lets Talk About RCE CAPITAL

Make no mistake, the management is great. I am personally very happy with how the company is managed.

Investor Relations is very forthcoming and easy to speak with. In addition, the Credit Culture facility (now cancelled) gave me a peek in terms of their thought process when it comes to how they consider risk/reward for each loan.

A 10% credit facility to a company giving out personal loans at 11% in Singapore. What a deal!

This is incredibly attractive, since the risk-free rate in SG is like 1.5-2%, while Malaysia’s is like 4%. In addition, RCE makes roughly 6.5% net on their loan books (second highest in Malaysia, the first is Elk-Desa), 10% would be unbelievable.

And due to the sheer impossibility of having impairments of less than 1% doing personal loans, it seemed extremely likely that RCECAP would have been able to takeover the entire company for a song when they inevitably failed to meet the interest payments in full.

If RCE’s impairment rates for its Malaysian books is comparable as a benchmark (its not), RCE would end up owning both an SGD loan book paying out 6.5% net, AND a SG Personal Loan company.

Pretty decent deal. No surprise it didn't work out, you'd have to be a fool of the highest degree to take the other end of that deal.

Its not the kind of a mindset you want in a venture capitalist, but definitely one you want in an financial institution.

The Black Swan

Despite waxing lyrical about the company in my previous company and in the paragraph above, I still sold my position as the fundamentals have changes somewhat last Saturday.

In my opinion, the real risk that lies in RCE Capital was in the political aspect, and this was one aspect I have always tracked very closely, along with the civil servant loan market.

It was last Saturday when something caught my attention.

8/6/2019 (THE STAR) - Civil servants spend more than half of salaries on repaying debts

8/6/2019 (THE STAR) - What is Angkasa

8/6/2018 (THE STAR) - Syndicated loan scam 

13/5/2018 (THE STAR) - Be wary of Angkasa loan offer, civil servants told

In just one day, 3 unflattering articles on co-operative loans appeared on “The Star” (and I also found an unflattering article written in May). Nothing about what they said is unknown.

Chances are, you only went for a Koperasi's loan because you can’t get one from Bank Rakyat or MBSB, and so there is almost no way that you would get a full payout. A 20-30% haircut is normal and stated in the contracts.

However, like the process of making sausages or industrial farming, its one of those uglier things that people don’t talk about.

To make it so public felt a little like the ground moving. Especially since “One particular prominent Malaysian cooperative” sounded like “Yayasan Dewan Perniagaan Melayu Perlis Berhad” which is funded by RCECAP. They are the biggest Koperasi after all.

Just 4 days later this appears.

13/6/2019 (THE STAR) - Probe on loan scam, co-operative commission acts

I cleared the rest on that day.

Why does this matter?

One of the things I always tried to find out, was who owns these Koperasi's.  However, it had proven quite difficult.

The thing one should note is, these Koperasi's, if active with good volume, are an incredibly lucrative businesses.

Their job is just to take a commission for each loan given, with no skin in game since they don’t hold the loan book.

Often, it’s the financial companies backing them, like RCECAP that is even doing the sales and credit vetting.

They are wholly disposable if not for their ANGKASA codes (which are needed to do direct salary deduction). And RCECAP or the other financial companies are essentially just renting the codes.

I had previously naively assumed that it was run like a typical ko-operasi/savings & loan, where depositors have shares equal to the amount deposited. However, recently, I’ve learnt from my ex-banker friend, that this is not really the case.

For cooperatives, there are about 800 licenses, and only about 30 are significant business. Back in the day, the government used to give out a Koperasi license/ANGKASA code to UMNO Division heads, and it was (and still is) a good source of income for the party.

And “Yayasan Dewan Perniagaan Melayu Perlis Berhad” the biggest one which is funded by RCECAP, is apparently owned by Dato' Sri Dr. Shahidan bin Kassim (I don’t have proof), the UMNO warlord who was accused of child molestation, but was ultimately given a discharge not amounting to an acquittal by the Kangar Sessions Court for the allegation of molesting of an underage girl after the victim retracted her report, for one reason or another.

In addition, my friends in MOF have also indicated to me that the government being unhappy about Koperasi personal loans by civil servants and they are thinking of ways to solve it.

These news feels a little like positioning before the big whacking.

What actions could the government take?

Well, so what actions could the government take to reduce the loans?

The more common ones are as follows and was done in 2014.

1. Decrease the personal loan length from 10 years to say 5 or less.
2. Lower the proportion of civil servants’ personal loans, in the loan portfolio of banks, making it harder to loan money or buy Sukuk from companies like RCECAP.
3. Lower the maximum salary deduction / garnishment from 60% to 40% or so.

In 2014, the losses from MBSB and lower profit in RCECAP, is due to these companies in being a bit cheeky and giving out personal loans that have actual lengths that are longer than what was allowed. The plan was to keep it off the system first, and to extend the tenure say 5 years down the line.

However, there was a directive from the top disallowing this method, despite all the loans given out, resulting in the massive impairments. After that lesson, they all started to toe the line.

As the above methods apply to future loans and not current, it would not have any impact on the current loan book unlike 2014 but would affect growth.

However, there is are two other methods, I don’t think too many have considered.

1. Making koperasi’s pay a high lease for the codes, ensuring most koperasi’s shut down.
2. Opening access for these codes to deposit taking financial institutes such as Maybank, CIMB etc. The banks have been lobbying for access for a long time.

Done in combination, especially the second method, would ensure that civil servants get a better rate (since Maybank etc have way cheaper cost of funds, and can accept a higher NIM), and indirectly (this is important as you can’t just take away the codes unless they broke the law) killing off ALL Koperasi’s since they have a cost base and marketing / eyeballs disadvantage.

Given that this is a Pakatan Harapan government, they are incentivized to shut down these Koperasi’s and further cripple UMNO’s source of funding, and to top it off, they can couch it as being it betting a good deal for the civil servants and the people (which it actually is).

Of course as EPF is a majority holding in MBSB and MOF owns Bank Rakyat, its not like there is no cost to it. However, EPF & PNB etc also control and hold CIMB, Maybank etc, its more like a left hand to right hand transaction. 

This changes the dynamics completely.

Conclusion

Given this change in fundamentals, the valuation in RCECAP changes quite significantly. Realistically, there is a good probability that RCECAP is now only worth its current loan book, which pays out 6.5% net.

Well, if I’m only buying the loan book, I’d like a 30-50% discount to book.

These days, with the sheer amount of opportunities globally. For example, Kraft Heinz and Intel is only trading at 6 and 10PE respectively, with earnings yield over Enterprise value something like 11 and 13 times, not a bad price at all.

It has become increasingly difficult for me to justify holding RCECAP, especially with the change in fundamentals.

Sucks to not be able to take that lovely 5 cent dividend though.