This article first appeared in The Edge Malaysia Weekly on March 18, 2024 - March 24, 2024

CTOS Digital Bhd told reporters that it was “business as usual”, but the credit reporting agency’s business model had clearly been thrust into the spotlight, pending the outcome of its appeal against the High Court ruling that went against its wholly-owned subsidiary in favour of a businesswoman who had sued it for negligence and breach of fiduciary duty.

Public opinion on the company’s business model has been rife on and off social media, with people divided over many issues, ranging from whether CTOS should be allowed to generate individual credit scores to whether the group should take responsibility for the accuracy of the data generated.

CTOS announced on March 11 that the High Court had decided in favour of Suriati Mohd Yusuf over her claims of negligence and breach of fiduciary duty as well as for defamation that she had brought against CTOS Data Systems Sdn Bhd (CDS).

It was not the first defamation case CTOS had lost but the Suriati case was the first where the judge had touched on whether it had legal grounds to formulate credit scores under the Credit Reporting Agencies Act 2010 (CRA Act) (see “Tracking CTOS’ past legal suits and brushes with defamation” on Page 61). The judge said the CRA Act only gives the company the power to collect, record, hold, store and disseminate the information received to its subscribers.

The CRA Act is silent on the provision of credit score.

The judgment came as a surprise to CTOS, which had won 12 defamation cases. It has since filed an appeal with the Court of Appeal against the decision of the High Court and has emphasised in its communications with the media and investors that the High Court “merely made an incidental observation as regards to the provision of credit score services by CTOS”.

“In the meeting [with regulators], CTOS provided an update on the matter [including its appeal against the decision of the High Court] and informed that based on external counsel’s advice, there wasn’t any declaration or injunction that prohibited CTOS from continuing to provide credit scores. The regulators did not affirm or deny CTOS’ right to provide credit scores as part of its credit reporting business,” says the group in a reply to The Edge when asked if the regulators affirmed CTOS’ right to provide credit scores following its meeting with the regulators that took place on March 12.

Meanwhile, CTOS tells The Edge that the credit rating agency does carry out verification of its data in accordance with the CRA Act.

“CTOS respectfully disagrees with the manner in which the Court had characterised the legal position of CTOS, especially since CTOS was not given an opportunity to explain the requirement of the regulatory framework put in place by the CRA Act, and its full compliance with the same,” it adds.

“As a regulated credit reporting agency, CTOS is obligated under the CRA Act to ensure data accuracy. Periodic compliance audit reviews are conducted by CTOS’ Internal Audit, an independent department that reports directly to the Audit & Risk Committee and the board. Subsequently, a yearly audit is also conducted by the CRA Registrar Office, Ministry of Finance, of which data accuracy is one of the key areas audited.”

The issue of data accuracy was raised in the suit as Suriati had alleged that CTOS included inaccurate information, pertaining to a trade reference submitted by telecommunications service provider WEBE, and had given her a low credit score that led to a loss of confidence by financial institutions, and she was unable to obtain a car loan.

CTOS explained in a Bursa announcement dated March 14 that the low credit score was calculated from a combination of information in CDS’ database and CCRIS pertaining to the individual’s payment history, amounts owed, length of credit history, credit mix and new credit.

“Since the plaintiff only maintained a credit facility with only one bank, there was insufficient credit behaviour. This was one of the factors on which the score algorithm analysis was based,” said the group.

The ability of an individual to obtain credit from financial institutions depends largely on the credit rating of that individual which, more often than not, requires that the individual prove himself as a credible paymaster based on the past track record of other credit obligations.

However, for those with little or no history of credit, credit scores are usually low on account of “insufficient credit behaviour”.

Some observers have argued that the lack of credit record or one’s old financial records to be flawed indicators in determining the creditworthiness of an individual, one that may not accurately reflect an individual’s current ability to repay loans.

In the same announcement, CTOS reiterated that the court judgment against CDS did not prevent it from continuing its credit reporting operations, particularly providing credit scores in its credit reports. When fielding questions from the media last week, CEO Erick Hamburger said it was business as usual at CTOS.

Not everyone is as certain. One question that still hangs in the balance now is whether the risk for CTOS’ business model will increase following an unfavourable legal judgment.

Some see potential bumps in the road ahead for CTOS even though there is currently no injunction against its ability to continue providing its credit scoring services.

“If they were to lose at the CoA and found to be negligent, I think there will likely be a lot of changes in processes that will be required to enhance their verification process. That could cost them a lot of money,” says an analyst who covers the stock.

What is harder to quantify is the potential opening of the floodgates that could lead to other lawsuits.

On talk of a class action suit being mooted, CTOS says it has not been informed of any such suit and adds that in any event, it is “confident in the legality of its credit score reports and will be able to defend itself against any flux of action challenging the same”.

Hamburger has disclosed that credit scoring makes up only 15% of the group’s revenue (see accompanying story on where the rest of the revenue is derived from).

Furthermore, CTOS tells The Edge in its written replies that the company does have insurance against such litigation as a risk mitigation measure. This implies that the financial impact from such suits can be contained.

Is there a risk of customers swapping out of CTOS for other providers?

Some do not think so, given how CTOS is the predominant player in Malaysia commanding more than 70% market share of the credit rating landscape. There are two other players in Malaysia, namely Experian Information Services (Malaysia) Sdn Bhd — in which CTOS holds 26% equity interest — and Credit Bureau Malaysia Sdn Bhd, which is jointly owned by Sunway Holdings Sdn Bhd and Credit Guarantee Corporation Malaysia Bhd.

“Financial institutions and many businesses are quite entrenched in the CTOS system, so it is unlikely that they will switch out,” notes an observer.

Some observers opine that the real threat may not be from conventional rating agencies, but if customers rely on other ways to determine creditworthiness.

Kenanga Research, the only research house to downgrade the stock to “underperform” and lower its target price to RM1.15, believes that the court’s interpretation posts a challenge to the group’s business model.

“We believe the onus is on CTOS to show that the court decision will have no impact on its day-to-day operations and financial performance,” it says in a March 13 note.

To a question on business risk and business model changing, should CTOS fail in its legal appeal, the group tells The Edge that the provision of credit scores has been part and parcel of the credit reporting business in Malaysia since its enforcement in 2014.

“Most of the CRAs in Malaysia provide credit scores as part of their core product and service offerings. CTOS has been advised by its external counsel that the question of whether it can continue to provide such services is a matter for the Registrar under the CRA Act, who has all the necessary power to deal with contraventions of the Act, if any, under Part VI of the Act. The Registrar has not, to date, directed CTOS to cease providing such services, either as a consequence of the judgment of the High Court or otherwise,” it says.

The court judgment resulted in a steep fall in the listed credit rating agency’s share price, plunging 13% in one trading day. The stock closed at RM1.25 on March 12.

At the close of March 15, however, CTOS’ share price had regained some lost ground to close at RM1.35 — just 10 sen below the closing price of RM1.45 last Monday.

Analysts who are still positive on CTOS say the selldown was “overdone” and presents an opportunity for investors to accumulate.

CTOS’ largest shareholder, private equity firm Creador V LP, acquired three million shares on March 12, upping its stake to 19.54%. Abrdn plc, the group’s third-largest shareholder, acquired 29 million shares, bringing its equity interest to 7.91%.

CTOS also saw the emergence of a new substantial shareholder on the back of its share price decline. Kumpulan Wang Persaraan (Diperbadankan) (KWAP) picked up about 36 million shares on the open market last week, raising its stake to 6.11%.

The Employees Provident Fund, CTOS’ second-largest shareholder with an 11.35% stake, however, had not made any changes in its shareholding, according to filings at the time of writing.

According to Bloomberg data, Kenanga Research’s “sell” call is an outlier versus seven “buy” and three “hold” calls, with target prices averaging RM1.69. Maybank Investment Bank Research even upgraded its call on CTOS from “hold” to “buy” while maintaining its target price of RM2.10.

For those who opine that CTOS will weather this episode, the outlook for the group may look attractive to them.

In an interview with Hamburger that takes place before the announcement of the court judgment, he shares that the group’s internal management targets revenue and net profit growth of 38% and 25% respectively in FY2024. The targets are based on the businesses it currently operates and contributions from any potential acquisition will be in addition to those numbers, he says.

While CTOS has a lion’s share of the local market, Hamburger says there are still plenty of opportunities for growth in Malaysia.

“We offer an entire value chain of services, from identifying the customer, preventing fraud, doing analytics and decisioning to disbursement of the loan, et cetera. So, the more services you can provide in that value chain, the more we grow. Our growth will come from offering these services and offering new services,” he adds.

The strategy is the same with its operations overseas, that is, to add more services to the existing portfolio that is being offered in those markets.

In FY2023, CTOS acquired two companies, one in Indonesia and another in the Philippines, which use telecommunications data to determine a customer’s creditworthiness. It also has an associate stake in a listed company in Thailand, Business Online pcl, which provides credit scoring services for businesses.

“It’s about replicating what we have and extending our best practices into other Asean countries,” says Hamburger, adding that if the right opportunities come along, it would look into acquisitions to expand its portfolio.

“Building data and getting access to data is difficult and it takes a long time. Acquisitions are a way to accelerate our penetration into these markets or into these services. There’s nothing concrete now. We are looking.”

He says CTOS’ balance sheet is in a “great position” to take on any acquisitions that could come its way.

“We have a lot of room to grow, so acquisitions are on the radar. If it fits our strategic purpose and accelerates in a profitable way, we will continue to do acquisitions,” he adds.

“I’ll give you an example. We are not in the telco scoring business in Thailand yet. So again, I could look for an acquisition or I could try to do it on my own. If there were somebody [willing to sell], I would prefer to acquire.”

At the online media conference last week, Hamburger said there should be greater clarity on its appeal within three to six months. What is certain is that both CTOS’ fans and detractors will be keeping their eyes peeled and ears open for any developments.

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