Sukuk Focus - May 2010

SUKUK FOCUSMay 2010

T +603 7628 1000 / +603 2299 1000F +603 7620 8251 E [email protected]

Welcome to our new look! As you can see, the Islamic Finance

Bulletin has been given a face-lift, both graphically and editorially. The idea had germinated amid an increasing sense that it was “time for a

change” - for the bulletin to get a newer, more contemporary look; especially when RAM is celebrating its 20th anniversary this year. While we

had been open to the prospect, we had strongly felt that a change of such significance should extend beyond the cover and be built around the

information needs and preferences of our readers.

The redesigned cover features fresh, crisp and clean lines - with a new tagline, Sukuk Focus; this differentiates us from other Islamic finance

publications in the market. Inside the bulletin, the editorial content has also been rearranged, reflecting the way readers prefer information to be

presented nowadays.

To start with, Sukuk Focus will tie in with our current theme on sukuk defaults. The landscape of the global sukuk market has indeed changed. A

few years back, sukuk defaults had been virtually unheard of. Today, the

industry has been surprised by a string of defaults, especially those that had earlier been celebrated as being the most innovative. While some

have argued that there is no such thing as a default in Islamic finance due to the profit-sharing and risk-avoidance nature of the transactions, others

are pointing their fingers at the Islamic structures and have begun questioning the Shariah-compliancy of the issuances.

Editorial Contacts:

Islamic Ratings

Zakariya Othman

Head

(603) 7628 1018

[email protected]

Ezza Ibrahim

Manager

(603) 7628 1084

[email protected]

Noor Maliana Mansor

Analyst

(603) 7628 1029

[email protected]

MAY 2010

PUBLISHER’S NOTES

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But is it fair to put the blame on Islamic finance per se? Criticising Islamic finance for sukuk defaults is both simplistic and misleading.

Nonetheless, the virtuous image of Islamic finance has been tarnished

by these high-profile default cases. Hence correcting the perception of sukuk defaults is vital for the market to move forward and grow

further.

On this note, Sukuk Focus’ spotlight will be on the real culprit behind the recent sukuk defaults and the possible impact on the investing

community. We will discuss the fall of the infamous USD3.52 billion Sukuk Ijarah by Nakheel and also take a peek at some cases that are

closer to home. While sukuk default is the main theme of this issue, we will also delve into the subject of setting the risk assessment of

sukuk, with particular focus on debt-based sukuk, and the rating of partnership-based sukuk.

Our new format will also include rating updates and redesigned charts

with a typeface that is more reader-friendly, inclusive of brief narrations. All this is aimed at creating a reading environment that is

both inviting and compelling.

We hope you will like what you see as we are really excited about bringing our new look to you. However, some things have not changed

- the top-quality sukuk information that you have been counting on

from our Islamic Finance Bulletin over the last 7 years, since we were first published in 2003.

TABLE OF CONTENT

Quarterly Sukuk Rating

News…………………………….……….3

The Case of Wrongly

Accused……………………….……….9

Sukuk Defaults – Local

Flavours………………………………11

Setting the Risk Assessment of

Sukuk in Perspective – Focus

on Debt-Based Sukuk…………23

Market Statistics……………..….25

Ringgit Sukuk Market

Report………………….………………30

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Quarterly Sukuk Rating News – 1Q2010

Toyota Capital’s ratings reaffirmed and revised outlook to negative

1. Both long- and short-term ratings of Toyota Capital

Malaysia Sdn Bhd‟s (Toyota Capital or the Company)

RM1 billion Islamic Commercial Papers/Medium-Term

Notes Programme (2008/2015) (Islamic CP/MTN

Programme), was reaffirmed at AAA(s) and P1(s).

2. The ratings of Toyota Capital‟s RM1.2 billion MTN

Programme (2008/2018) and RM400 million MTN

Programme (2005/2012) (collectively, the MTN

Programmes) have also been reaffirmed at AAA(s).

3. At the same time, RAM Ratings has reaffirmed the

P1(s) rating of the Company‟s RM600 million CP

Programme (2004/2011).

4. The rating outlook on all the long-term ratings has

been revised from stable to negative.

The enhanced ratings of Toyota Capital‟s MTN and CP

Programmes reflect the credit strength of the irrevocable and unconditional guarantee extended by Toyota Motor

Finance (Netherlands) BV. Similarly, the ratings of the Islamic CP/MTN Programme are underpinned by a

Purchase Undertaking from Toyota Capital, which is in turn backed by the irrevocable and unconditional guarantee extended by Toyota Netherlands, with the

ultimate credit support stemming from Toyota Motor Corporation of Japan (Toyota Motor or the Group). Hence, the ultimate support from Toyota Motor

enhances the credit profiles of these conventional debt facilities beyond Toyota Capital‟s stand-alone credit strength.

Toyota Motor‟s superior business profile is underscored by its position as one of the world‟s largest vehicle manufacturers, as well as its strong branding.

Nevertheless, the negative rating outlook reflects RAM Ratings‟ concerns over the Group‟s future earnings, arising from the uncertainties surrounding the economic

recovery of Toyota Motor‟s key markets - Japan, the United States and Europe. Editor’s note: On our press release dated 8 March 2010, RAM

Ratings has maintained the negative outlook on the debt and

sukuk ratings of Toyota Capital, after factoring in the potential

impact of the worldwide recall of Toyota vehicles on Toyota

Motor Corporation of Japan.

Golden Crop’s Sukuk Ijarah ratings reaffirmed with a stable outlook

RAM Ratings has reaffirmed the respective AAA, AA1, A1, A2 and BBB1 ratings of Golden Crop Returns Berhad‟s (Golden Crop or the Issuer) Series 1, 2, 3, 4 and 5 Sukuk Al-Ijarah (Sukuk), with a stable outlook.

The reaffirmation is premised on the plantations‟ performance, which has fallen within our expectations,

as well as loan-to-value (LTV) ratios and debt service coverage ratios (DSCRs) that commensurate with their respective ratings. Golden Crop is a bankruptcy-remote,

special-purpose company that had been set up as the financing vehicle for the sale-and-leaseback transaction involving 17 plantations and 5 mills under the purview of entities within the Boustead Holdings Berhad Group.

This transaction‟s strengths include the senior-subordination structure of the Sukuk and its structural

features that support the ratings. These are, however, moderated by the vulnerability of the Plantation Assets‟ performance to the volatile price movements of crude

palm oil (CPO). Nevertheless, RAM Ratings notes that the plantation estates (the Lessees) have been able to meet full and timely payments on their scheduled lease obligations.

Focal Quality’s Sukuk Ijarah ratings reaffirmed

with a stable outlook RAM Ratings has reaffirmed the respective AAA, AA2, A2

and A3 ratings of Class A, Class B, Class C and Class D of Focal Quality Sdn Bhd‟s (Focal Quality) RM190 million Sukuk Ijarah Islamic Debt Securities (Sukuk Ijarah), with a stable outlook. The reaffirmation is premised on

the overall financial performance of the underlying properties, i.e. Ipoh Parade, Seremban Parade and Klang Parade (collectively, the Parades), as well as the

credit support that commensurates with the respective ratings.

Under this Islamic sale-and-leaseback transaction, Focal Quality had been incorporated to acquire the Parades from Lion Ipoh Parade Sdn Bhd (LIP), Lion Klang Parade Sdn Bhd (LKP) and Lion Seremban Parade Sdn Bhd

(LSP) (collectively, the Lessees). Upon the acquisitions, Focal Quality had entered into lease agreements with

the Lessees; the lease payments are used to meet profit

payments on the Sukuk Ijarah while the Sukuk Ijarah

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will be redeemed using proceeds from either: (i) the Parades‟ internally generated funds; (ii) the shareholders of Focal Quality; or (iii) the proceeds from

the disposal of the Parades to the Lessees or in the open market.

During the reviewed period, the performance of Ipoh Parade and Klang Parade had remained commendable, supported by higher average rental rates (ARRs) and

healthy average occupancy rates (AORs). Seremban Parade‟s performance, although better in fiscal 2008, is still below our expectations amid the difficult operating environment and intense competition in the area.

Negative Rating Watch maintained on rating of

Senai Desaru Expressway’s BaIDS RAM Ratings has maintained the Rating Watch, with a

negative outlook, on the AA3 rating of Senai-Desaru Expressway Berhad‟s (SDEB or the Company) RM1.46 billion nominal value Bai’ Bithaman Ajil Islamic Debt Securities (2005/2024) (BaIDS). SDEB is a special-

purpose company incorporated to undertake the design, construction, management, operation and maintenance of a 77-km highway in Johor, known as the Senai-Pasir

Gudang-Desaru Expressway (the Expressway).

The Rating Watch is premised on the delayed

commencement of tolling operations for the Expressway, and the consequent impact on its traffic volume and SDEB‟s future cashflow. Other factors influencing SDEB‟s cashflow include the delayed completion of the

Expressway‟s Package 3, which the Company now expects to wrap up by mid-2010. A protracted delay in the completion of Package 3 and lower-than-expected

growth in traffic volume would have a severe negative impact on SDEB‟s cashflow and debt-servicing ability.

RAM Ratings' Rating Watch highlights a possible change in an issuer's existing debt rating. It focuses on identifiable events such as mergers, acquisitions, regulatory changes and operational developments that

place a rated debt under special surveillance by RAM Ratings. In a broader sense, it covers any event that may result in changes in the risk factors relating to the

repayment of principal and interest. Issues will appear on RAM Ratings' Rating Watch when

some of the above events are expected to or have occurred. Appearance on RAM Ratings' Rating Watch, however, does not inevitably mean that the existing rating will be changed. It only means that a rating is

under evaluation by RAM Ratings and a final affirmation

is expected to be announced. A "positive" outlook indicates that a rating may be raised while a "negative"

outlook indicates that a rating may be lowered. A “developing” outlook refers to those unusual situations in which future events are so unclear that the rating

may potentially be raised or lowered. Editor’s note: On 8 April 2010, the long-term rating of the

BaIDS has been downgraded to C1, while the outlook on the

rating remained negative.

Hubline’s A2/P1 ratings reaffirmed

RAM Ratings has reaffirmed the respective A2 and P1 ratings of Hubline Berhad‟s (Hubline or the Group) RM150 million Murabahah Commercial Papers/Medium-

Term Notes Programme (2005/2012), as well as the A2 rating of its RM70 million Bai Bithaman Ajil Islamic Bonds (2005/2012); both long-term ratings have a

stable outlook. The reaffirmation reflects Hubline‟s fairly resilient operations despite economic vagaries, anchored by the

Group‟s extensive network and niche routes that give it a competitive edge. Meanwhile, the Group‟s commendable liquidity profile is supported by its robust

cash reserves, especially after its recent rights issue. On the other hand, the ratings remain moderated by the

cyclical nature of the shipping industry. The Group is also exposed to volatile bunker costs and hefty capital outlay.

PKNS’s debt facilities A1/P1 ratings reaffirmed

RAM Ratings has reaffirmed the A1/P1 ratings of Perbadanan Kemajuan Negeri Selangor‟s (PKNS or the Agency) RM300 million Murabahah Commercial

Papers/Medium-Term Notes (MCP/MTN) Programme (2004/2011); the long-term rating has a stable outlook. “Despite the subdued property market in 2008 and

1H2009, PKNS managed to record improved property sales; property development projects at choice locations like Shah Alam, Kota Damansara, Kelana Jaya and Bangi

contributed 66% of total revenue last year. The Agency is also in discussions with several parties vis-à-vis Selangor Science Park 2 (“SSP2”), which if materialised,

would add vibrancy and spur further residential and commercial interests in SSP2,” elaborates Shahina Azura Halip, RAM Ratings‟ Head of Real Estate and Construction Ratings, on the rating reaffirmation. “Apart

from the steady stream of progress billings from its various property developments, proceeds from land

sales and income from its privatisation ventures are

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expected to contribute positively towards the Group‟s financial performance over the near term,” she adds.

Lafarge Malayan Cement’s Islamic debt facility long-term rating upgraded from A1 to AA2 with

stable outlook RAM Ratings has upgraded the long-term rating of Lafarge Malayan Cement Berhad‟s (LMCB or the Group)

RM350 million Al-Murabahah Commercial Papers/Medium-Term Notes (2003/2010) (CP/MTN), from A1 to AA2; the rating has a stable outlook. At the

same time, the short-term rating of the CP/MTN has been reaffirmed at P1.

LMCB is primarily an investment-holding company; its subsidiaries are involved in the manufacture and sale of clinker, cement, aggregates and ready-mixed concrete, as well as the distribution and trading of cement and

other building materials. The rating upgrade is premised on LMCB‟s resilient and

consistently improving financial performance, sturdy balance sheet and robust debt coverage. The Group‟s strong credit profile is also underpinned by its position

as Malaysia‟s largest integrated cement manufacturer, with access to international markets and favourable corporate lineage as part of the larger Lafarge SA, which

affords it access to international distribution networks

and global expertise. This also represents an additional take-up source for LMCB‟s cement – the Group is the largest exporter in Malaysia. Meanwhile, the

liberalisation of cement prices in 2008 has also allowed LMCB better flexibility in its pricing mechanism.

The AA3/P1 ratings of Gamuda’s Islamic securities reaffirmed

RAM Ratings has reaffirmed the respective long- and short-term ratings of AA3 and P1 for Gamuda Berhad‟s (Gamuda or the Group) RM800 million Islamic Medium-

Term Notes Programme and RM100 million Islamic Commercial Papers Programme; the long-term rating has a stable outlook. Gamuda and its subsidiaries are

principally involved in civil engineering and construction, property development, tolling operations and the operation and maintenance of water-treatment plants.

The reaffirmation of the ratings is premised on Gamuda‟s established standing within the construction industry, both locally and overseas.

As at end-July 2009, the Group‟s outstanding construction order book stayed healthy at RM6 billion,

which will see Gamuda through the medium term. “With the anticipated pick-up in the local construction sector this year and the planned infrastructure projects in

certain Middle Eastern countries, Gamuda is well poised to secure some of these jobs, underscored by its strong operating track record and sound financial profile,”

opines Shahina Azura Halip, RAM Ratings‟ Head of Real Estate and Construction Ratings. Backed by its prominent position as a property developer, Gamuda also enjoys contributions from its established township

projects, as well as stable dividend income from its mature concession assets such as Syarikat Pengeluar Air Sungai Selangor Sdn Bhd (SPLASH) and Lingkaran Trans

Kota Sdn Bhd (Litrak); the latter will help buffer the cyclical nature of the construction and property sectors. However, we note that SPLASH may be sold under the

ongoing restructuring of the Malaysian water industry; RAM Ratings will closely monitor the relevant developments on this front.

On the other hand, the ratings are moderated by the execution risk vis-à-vis the electrified double-track railway project, the risks and uncertainties in relation to

the Group‟s foreign ventures, the cyclical nature of the construction and property industries, expectations of a higher gearing ratio and the regulatory risk faced by its

concession assets.

The AA3(bg)/P1(bg) ratings of BBN Development’s

Islamic debt facility reaffirmed RAM Ratings has reaffirmed the respective long- and

short-term ratings of BBN Development Sdn Bhd‟s (BBND or the Group) RM86 million Bank-Guaranteed Murabahah Medium-Term Notes/Commercial Papers

Programme (2004/2011) (MMTN/MCP), at AA3(bg) and P1(bg); the long-term rating has a stable outlook. The ratings reflect the unconditional and irrevocable

guarantee extended by AmInvestment Bank Berhad (AmInvestment), the financial institution ratings of which were reaffirmed by RAM Ratings at AA3/P1 in

November 2009. Under this structure, all risks associated with the MMTN/MCP are expected to be absorbed by AmInvestment. The bank guarantee also

enhances the credit profile of the debt facility beyond BBND‟s inherent or stand-alone credit risk.

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An AA3/P1 corporate credit ratings assigned to Saudi-based Dar Al-Arkan Real Estate Development Company

RAM Ratings has assigned respective long- and short-term corporate credit ratings of AA3 and P1 to Dar Al-

Arkan Real Estate Development Company (Dar Al-Arkan or the Group); the long-term rating has a stable outlook. Dar Al-Arkan is a property developer based in the

Kingdom of Saudi Arabia. The ratings reflect Dar Al-Arkan‟s strong market position within the Saudi Arabian property sector. Between 2002

and 2008, the Group had completed about 13 residential projects in the kingdom‟s key cities of Riyadh, Makkah, Jeddah, Medinah and Yanbu. The Group had also

consistently sold more than 1,000 acres of land each year between 2006 and 2008, and an average of 1,100 units of residential properties per annum. Dar Al-Arkan

is currently one of the largest property developers in the kingdom, and is also the largest developer listed on the Saudi Stock Exchange (in terms of revenue and assets). The Group‟s strong market position augurs well for its

future projects. Meanwhile, prospects for Saudi Arabia‟s property sector

remain bright, underpinned by steady population growth and healthy demographics, the kingdom‟s economic

growth (and consequently higher per capita income),

and the potential introduction of mortgage laws. Driven by the healthy demand for properties in Saudi Arabia, the Group posted double-digit revenue growth

between fiscal 2006 and 2008, with robust margins on operating profit before depreciation, interest and tax (OPBDIT) of 40% to 50% in the last 5 years. Moving

forward, Dar Al-Arkan‟s large tracts of land in Riyadh, Jeddah, Dammam, Medinah and Makkah – which carried a net book value of SR14.95 billion as at end-September

2009 – will sustain it over the longer term. These cities are a hive of economic activity, being the kingdom‟s capital and financial hubs, the gateway and home to the world‟s holiest sites for the Muslim population, and the

industrial heart of Saudi oil fields. The ratings are, however, moderated by Dar Al-Arkan‟s

exposure to the inherently cyclical nature of the property sector, given the Group‟s lack of business diversity. Any slowdown in Saudi Arabia‟s economy or

property sector is expected to have an adverse impact on the Group‟s financial performance, although RAM Ratings notes the strong fundamentals of the property sector over the intermediate term. That said, Dar Al-

Arkan still faces geographical-concentration risk because

its activities are based entirely in Saudi Arabia. In addition, the kingdom is exposed to geopolitical risks

that affect countries within the Gulf region; while we note that Saudi Arabia has remained relatively sheltered from such geopolitical upheavals to date, the threat of

war and/or terrorism on its shores cannot be discounted. Meanwhile, Dar Al-Arkan shoulders a hefty debt burden,

compounded by a lumpy debt-maturity profile.

An AA1/P1 ratings assigned to CIMB Group Holdings’ CP and MTN Programmes RAM Ratings has assigned respective long- and short-

term ratings of AA1 and P1 to CIMB Group Holdings Berhad‟s (CIMB Group Holdings or the Company) RM6.0 billion Conventional and Islamic Commercial Papers and

Medium-Term Notes Programmes (the CP and MTN Programmes). The long-term rating has a stable outlook.

The CP and MTN Programmes entail 4 issues: an up to RM6.0 billion Conventional Commercial Papers Programme (2007/2014), an up to RM6.0 billion

Conventional Medium-Term Notes Programme (2007/2037), an up to RM6.0 billion Islamic Commercial Papers Programme (2008/2015) and an up to RM6.0

billion Islamic Medium-Term Notes Programme (2008/2038) - with a combined limit of RM6.0 billion.

RAM Ratings had, on 4 March 2010, assigned the corporate credit rating of AA1/P1 to the Company and the long-term rating of AA3 to its RM3.0 billion Subordinated Notes (2009/2074). The long-term ratings

carry a stable outlook.

Wah Seong fully redeems RM200 million Islamic debt facility

RAM Ratings has received confirmation that Wah Seong Corporation Berhad (“Wah Seong”) has fully redeemed and cancelled its RM200 million Murabahah and Ijarah Commercial Papers/Medium-Term Notes Programme

(2004/2011). As such, RAM Ratings no longer has any rating obligation on the said debt facility, and the AA3/P1 ratings are no longer applicable.

Binariang GSM partially redeems senior sukuk

RAM Ratings has received confirmation that Binariang GSM Sdn Bhd (BGSM) partially redeemed RM3.77 billion of its Senior Sukuk and prepaid USD1.10 billion of its

USD-denominated term loan on 25 February 2010,

pursuant to the requirements of the Senior Sukuk Trust

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Deed dated 18 December 2007 and the USD Term Loan Facility Agreement dated 19 December 2007.

BGSM‟s Islamic securities consist of a RM19 billion Islamic Medium-Term Notes Programme (rated AA3, with a stable outlook) and a RM2 billion Islamic Commercial

Papers Programme (rated P1) (collectively referred to as the Senior Sukuk). In addition, BGSM also has a Ringgit Malaysia equivalent of USD900 million Cumulative Non-Convertible Islamic Junior Sukuk (rated A2, with a stable

outlook). BGSM is an investment-holding company that is involved

in the Malaysian and Indian cellular telecommunication markets via its wholly owned subsidiary, Maxis Communications Bhd.

Muhibbah Engineering cancels Islamic CP/MTN, makes variations on proposed sukuk

RAM Ratings has received confirmation from OCBC Bank (Malaysia) Berhad - the facility agent for Muhibbah

Engineering (M) Berhad‟s (Muhibbah or the Group) RM400 million Mudharabah Commercial Papers/Medium-Term Notes (2008/2015) (Islamic CP/MTN) - that the

Group has cancelled its debt facility. There had been no outstanding Islamic CP/MTN prior to the cancellation. As such, the A1/P1 ratings of the Islamic CP/MTN are no

longer applicable.

Meanwhile, Muhibbah is in the process of making variations to the terms and structure of its proposed

RM130 million Mudharabah Bonds with Detachable Warrants of up to 5 years. We highlight that the A1 rating of the proposed bonds may be changed, pending

our review of the relevant documentation on these variations. RAM Ratings will make the appropriate announcement once these variations have been finalised.

Suncity cancels RM250 million debt facility upon

maturity; RAM Ratings maintains surveillance on remaining debt instruments

Sunway City Berhad‟s (Suncity) RM250 million Commercial Papers/Medium-Term Notes Programme (2002/2009) matured on 10 December 2009 and has been cancelled; there was no outstanding CP or MTN as

of the same date. Following this, RAM Ratings no longer has any rating obligation on the debt facility, and the A2/P2 ratings are no longer applicable.

On the other hand, RAM Ratings will maintain surveillance on the following:

i. The enhanced AAA(bg) rating of Series 1 and 3 of

Suncity‟s RM250 million Redeemable Bank-

Guaranteed Serial Bonds (2007/2010) (BG Bonds), and the AA2(bg) rating of Series 2 and 4 of the BG Bonds; the long-term ratings have a

stable outlook. The enhanced ratings reflect the unconditional and irrevocable guarantees extended by OCBC Bank (Malaysia) Berhad to Series 1 and 3, and by RHB Bank Berhad to Series 2 and 4 of

the BG Bonds. ii. The A2/P2 ratings of Suncity‟s RM500 million

Murabahah Commercial Papers/Medium-Term

Notes Programme (2007/2022); the long-term rating has a stable outlook.

RAM Ratings sees no significant credit impact from revocation of Pharmaniaga’s manufacturing licence

RAM Ratings views that the recently announced revocation of Pharmaniaga Manufacturing Berhad‟s

(“Pharma Manufacturing”) manufacturing licence - effective 1 March 2010 - due to non-compliance issues does not have a significant impact on Pharmaniaga

Berhad‟s (“Pharmaniaga” or “the Group”) credit profile at this juncture. Pharmaniaga‟s RM60 million Islamic Medium-Term Notes Programme (2005/2010) and RM40

million Islamic Commercial Papers Programme

(2005/2012) are currently rated AA2(s) (stable outlook) and P1, respectively. To recap, Pharma Manufacturing is a wholly owned subsidiary and manufacturing arm of

Pharmaniaga. The revocation of Pharma Manufacturing‟s licence follows a routine audit by the Ministry of Health‟s Pharmaceutical Services Division (“PSD”).

We believe that the revocation of the manufacturing licence does not affect Pharmaniaga‟s ability to carry out its obligations under its concession agreement with the

Government of Malaysia - for the purchase, storage and distribution of certain pharmaceutical and medical products to government hospitals. Although

Pharmaniaga‟s manufacturing division supplies about 10%-15% of its concession-related requirements, we opine that the Group will be able to procure the needful

from its other suppliers. Nonetheless, given that the manufacturing arm contributes about 10% and 20% of Pharmaniaga‟s

revenue and operating profits, respectively, we expect the revocation of the licence to have some impact on the Group‟s financial performance. Based on RAM Ratings‟

projections, however, Pharmaniaga‟s financial metrics

would still meet the threshold for its current issue ratings should the Group manage to have its licence

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reinstated in the near future. In this regard, we understand that the management is currently addressing the issues highlighted by the PSD. Thus far, the

management has reported that they expect these issues to be rectified within a relatively short time. RAM Ratings is closely monitoring the developments vis-à-vis

Pharmaniaga, and will make an appropriate announcement in due course.

RAM Ratings monitoring impact of global recalls on Toyota Motor Japan, maintains negative outlook on Toyota Capital

RAM Ratings has maintained the negative outlook on the debt ratings of Toyota Capital Malaysia Sdn Bhd (Toyota

Capital or the Company), after factoring in the potential impact of the worldwide recall of Toyota vehicles on Toyota Motor Corporation of Japan (Toyota Motor Japan

or the Group), i.e. the ultimate shareholder of Toyota Capital. RAM Ratings had first placed Toyota Capital‟s debt

ratings on negative outlook on 28 January 2010, premised on our concerns over Toyota Motor Japan‟s future earnings due to the uncertainties surrounding the

economic recovery of its key markets - Japan, the United States and Europe. The recent recalls of an

estimated 8.5 million Toyota cars have shaken

consumers‟ perception of Toyota Motor Japan as a quality vehicle producer. As a result, RAM Ratings expects the Group to incur a hefty cost for the recall and envisage a fall in demand for Toyota vehicles, especially

in the American market, hence delaying its turnaround efforts in FYE 31 March 2010.

Despite the recalls, we believe that Toyota Motor Japan has the financial muscle to weather this tough period, underscored by its strong balance sheet. As at end-

March 2009, the Group‟s automotive division registered a net gearing ratio of a mere 0.01 times. At the same time, its financial-services division, which provides

financing to Toyota vehicle purchasers, maintained a healthy net non-performing-loan ratio of 0.54%. RAM Ratings will continue monitoring the impact of the

global recalls on Toyota Motor Japan. Should the Group be able to exhibit sustainable improvement in its earnings over the next few quarters, the outlook could

be reverted to stable. Otherwise, there would be further downward pressure on the ratings of Toyota Capital‟s debt instruments.

Toyota Capital‟s RM1 billion Islamic Commercial Papers/Medium-Term Notes Programme (CP/MTN) (2008/2015) currently carries AAA(s)/P1(s) ratings.

Meanwhile, the Company‟s RM1.2 billion MTN Programme (2008/2018) and RM400 million MTN Programme (2005/2012) are both rated AAA(s) while its

RM600 million CP Programme (2004/2011) is rated P1(s). The enhanced debt ratings of Toyota Capital

reflect the guarantee that ultimately stems from Toyota

Motor Japan, which enhances the credit profiles of the debt facilities beyond the Company‟s stand-alone credit strength.

Note: For further update, please refer to our press releases at www.ram.com.my

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The Case of Wrongly Accused

t the peak of the global credit crisis, Islamic

finance had been lauded as the saviour in the face of the setbacks suffered by the conventional

markets. Lack of exposure to some of the more risky markets where investors had fallen foul in the past had

rendered Islamic finance attractive. Therefore, market players had perceived Islamic finance as a safe haven amid the global credit crisis.

However, the impression had been short-lived. Investors had been taken aback when the issuers of award-

winning sukuk such as the East Cameron Gas Sukuk, Investment Dar and the Golden Belt Sukuk had defaulted. The near-default of the Nakheel Sukuk had added salt to the wound. Thanks to Abu Dhabi‟s last-

minute rescue, the looming default had been avoided. The market, meanwhile, had been quick to point the

finger at Islamic finance as the reason for the debacle. However, there is an urgent need to correct this misperception. First of all, it is fundamentally wrong to

say that Islamic financial instruments such as sukuk cannot fall into default just because Islamic finance is all about ethical and moral finance.

What investors need to understand is that, like other financial tools, these instruments are also exposed to elements such as credit risk. Imagine that Mr A bought a

house through a conventional home-financing scheme while Mr B opted for Islamic financing. While Mr B diligently paid his monthly repayments, Mr A was

remiss. After some time, Mr A defaulted on his housing loan because of his failure to meet the monthly repayments. So, was the default triggered by the type and structure of financing, i.e. conventional vs Islamic,

or was it because of Mr A‟s creditworthiness? The same applies to the unfortunate sukuk that had

gone bad. Most, if not all, of the time, sukuk defaults are a result of credit issues rather than structural or Shariah concerns.

The epic of the fall The global economic crisis had also given rise to the first

sukuk default in the Middle East, i.e. Investment Dar and Saad‟s Golden Belt, followed by the Nakheel‟s almost-defaulted USD3.52 billion Sukuk Ijarah. The

following section will delve deeper into the mechanism behind the Nakheel sukuk.

For a start, Nakheel Sukuk is mired in a tangled web of

state-owned companies, which adds to the complexity of the sukuk issue. The Dubai government wholly owns Dubai World, which in turn holds 100% of Nakheel World

LLC. Nakheel World LLC is further divided into 3 smaller holdings companies: Nakheel Holdings 1 LLC (“NH1”), Nakheel Holdings 2 LLC (“NH2”) and Nakheel Holdings 3

LLC (“NH3”). Each of these owns 33% of Nakheel PJSC. A special-purpose vehicle known as Nakheel Development Limited (“NDL”) had been established to

issue sukuk certificates to investors in return for their capital contributions.

NDL had then used the funds to buy 2 leasehold assets from NH1. The assets comprised 2 strips of land - valued at USD4.2 billion in 2006 - in the Dubai Waterfront area.

NDL, now the owner of the land, had leased it to NH2 for a period of 3 years. The lease payments received from NH2 would be

reflected in the periodic distributions on the sukuk. Half of the lease amount would be paid to the sukuk holders through Nakheel while the remainder would be deferred

until maturity. NH2 also promised to buy the land from

NDL upon the maturity of the lease or in the case of a default. The whole transaction had been guaranteed by

Dubai World, NH1, NH2 and NH3. There had also been additional protection for the sukuk holders in the form of a pledge vis-à-vis 18.89% of

unlisted Nakheel stock and a mortgage over the underlying assets. From the structure itself, it is clear that the sukuk complies with the Shariah requirement to

have real underlying assets from which revenue can be generated and shared with the sukuk holders. All in all, the Nakheel sukuk had been structured in accordance

with the Shariah guidelines. However, when the global financial turbulence hit the Gulf countries, investors had started losing confidence in

the market. Private investments in commercial and residential estates had dried up, particularly in Dubai - leading to a sharp plunge in property prices. Dubai

property prices reportedly shrank 20% to 30% within 6 months; by the end of 2009, prices had plummeted almost 60%. Most of the much-hyped developments in

Dubai had been either put on hold or shelved, including the Palm Jebel Ali and Dubai Waterfront developments.

The crisis had also contributed to the failure of key

businesses, a decline in consumer wealth estimated at

A

10

trillions of US dollars, substantial financial commitments incurred by governments, and a significant deceleration in economic activity. Dubai World, with USD59 billion of

liabilities, had subsequently sought a “standstill” agreement from its creditors; its debts had included Nakheel‟s USD3.52 billion Sukuk Ijarah, due on 14

December 2009.

Who is to blame? While the Ijarah structure complies with the Shariah ruling of leasing real assets in return for revenue, the 2 idle strips of land had not generated any income for NH2

to honour its lease payments. Instead, NH2 had had to utilise other funding sources to pay for the lease. Therefore, when the property bubble burst, NH2 and

ultimately Dubai World had struggled to meet the lease obligations; failure to do so would render the sukuk non-performing.

Secondly, the underlying assets comprise 2 plots of land in Dubai that, in fact, are merely empty strips of desert land adjacent to the proposed Palm Jebel Ali and Dubai

Waterfront developments. The land was valued at USD4.2 billion based on the development that were to be constructed on it. The underlying assets had been

valued over a proposed development that would propel the value of the surrounding area. Essentially, the underlying assets are of little value until and unless

Nakheel Properties completes the proposed developments there. With the nearby developments having been shelved, the value of these 2 strips of desert land backing the Nakheel Sukuk Ijarah has also

dwindled to almost nothing. So, what is there for the sukuk holders to claim?

The assets fulfilled Shariah compliance in form but lacked substance. Although there is a mortgage over the land, it is uncertain how this may be enforced under

Dubai law as investors cannot have access to assets owned by the government. On top of that, even though Dubai World is a government-owned entity, the offering circular explicitly states that the Dubai government will

not guarantee any debt or other liability of Dubai World. There are many uncertainties surrounding the course of

action that investors may pursue on the various guarantees and collateral vis-à-vis the Nakheel sukuk‟s structure. In this regard, they seem to provide investors

with some comfort on more than just the unsecured pledges of Nakheel and Dubai World. Then again, there

is much doubt on whether the guarantees and collateral will end up being legally enforceable.

Case dismissed For the most part, the Nakheel sukuk had been a

casualty of over-optimism in the Dubai property market. The entire issuance had been based on the assumption of a value for the underlying assets, assuming the

projects in the vicinity would be built within the next few years. Some have questioned Shariah supervision over the defaulted sukuk. But is Shariah supervision really an issue? Shariah risk has never been a factor in the fall of

the Nakheel sukuk; instead, it has been more about the ability of Nakheel to repay its sukuk holders (which in turn depends on NH2 meeting the lease payments) and

Dubai World‟s ability in honouring its guarantee on the sukuk.

The sukuk defaults are not similar to the defaults of the collateralized debt obligations and mortage-backed obligations in the sub-prime mortgage crisis, where problems had been magnified by additional derivatives

written against the underlying loans. This is a relatively straightforward problem of excessive leverage and the failure of the underlying assets to generate sufficient

cashflow to repay the debts, but somewhat complicated by its connection with a sovereign government. The cause of Dubai World‟s crisis is not Islamic finance, but

over-leveraging. The default is more a consequence of the economic difficulties in the Middle East, rather than flaws in sukuk and Islamic finance per se.

Conclusion Sukuk are understood to be safer than conventional

bonds as they theoretically transfer ownership of the underlying assets to the sukuk holders, who in turn will earn a return on holding that asset. This is regarded as

protection for the sukuk holders in case of default. Even if the issuer defaults or goes bankrupt, investors should be in a good position to recover much of their contributions. Therefore, providing asset security or

corporate guarantees to investors is a legal issue that affects both conventional and sukuk structures. It is therefore not a question of Islamic versus conventional

finance. And with that, case dismissed.

11

Sukuk Defaults – Local Flavours

tanding true to Islamic teachings and virtues,

sukuk are perceived to be ethically and morally protected from turning bad. However, when sukuk

defaults had been scrutinised by market practitioners

and academicians, concerns had been raised on the reliability of their structures and Shariah supervision. This has created the perception that sukuk may not be any safer than conventional bonds in terms of investor

protection and the treatment of defaults. From a rating perspective, it is very important to

evaluate how sukuk would behave in the case of default. This can be done by ascertaining the salient features of the sukuk; specifically, whether the issue is asset-based

or asset-backed. From there, investors will know their position and protection if the sukuk turned bad. In most asset-based sukuk, the asset is merely used to structure the transaction and not transferred to the investors per

se. The sukuk investors therefore become unsecured creditors via a purchase undertaking that requires the issuer to repurchase the assets in the case of default.

In the case of asset-backed sukuk, the assets sold to the special-purpose vehicle (“SPV”) are used to support the

sukuk and the investors have recourse to this asset, i.e. the sale to the SPV protects them from the claims of the issuer's other creditors.

However, it is also important to note that investors‟

protection varies depending on the Shariah structure adopted; a sukuk transaction may not only be based on one Shariah contract, but could comprise several

Shariah contracts in a single issuance. The more common sukuk structures include Bai Bithaman Ajil, Murabahah, Musharakah, Mudharabah and Ijarah.

Local sukuk defaults Unlike the high-profile default cases in the Middle East,

Malaysia‟s sukuk defaults have received less criticism and scrutiny from global industry players. This may be due to our robust supervisory structure, established

governance and disclosure standards, and the highly developed legal framework and court system which provide the necessary protection and comfort to investors.

According to the latest statistics by the

Securities Commission of Malaysia (“SC”), the default rate for Malaysian sukuk only

came up to a relatively low 0.46% last year1.

1 Speech by YBhg Tan Sri Zarinah Anwar, Chairman of SC,

at the SC’s Annual Report 2009 Press Conference.

S

12

Table 1: Malaysian defaulted sukuk

Date of

Issuance

Initial

Rating

Issuer Type of Sukuk Amount

(RM mil)

Rating

Agency

Date of

Default*

Final

Rating

17 Apr 1997* A2 Hualon Corporation (M) Sdn Bhd

Bai Bithaman Ajil Islamic Debt Securities (“BaIDS”)

150 RAM Ratings

21 Nov 2003 D

25 Jan 1999* BBB3 Johor Corporation Murabahah Islamic Debt Securities

500 RAM Ratings

27 June 2002 D

21 Sept 2000* AID/ MARC-2ID Europlus Corporation Sdn Bhd

BaIDS 250 MARC 10 Mar 2006 DID

11 Dec 2000 BBB3 Moccis Trading Sdn Bhd BaIDS 50 RAM Ratings

3 June 2003 D

22 Feb 2001* AID Maxisegar Sdn Bhd BaIDS 300 MARC 10 Mar 2006 DID

24 July 2003 MARC-3ID Perspektif Perkasa Sdn Bhd Murabahah Underwritten Notes Issuance Facility (“MUNIF”)

188 MARC 10 Mar 2006 DID

19 Sept 2003 MARC-3ID Stenta Films (M) Sdn Bhd MUNIF 90 MARC 20 Sept 2007 DID

28 Nov 2003 AAID Malaysian Merchant Marine Berhad

BaIDS 120 MARC 2 Apr 2010 DID

30 Dec 2003 AID/ MARC-2ID Evermaster Berhad BaIDS & Murabahah Multi-Option Notes Issuance Facility

50 &

40

MARC 31 Dec 2008 DID

1 Apr 2004 A+ID/ MARC-1ID

Pesaka Astana (M) Sdn Bhd

BaIDS 200 MARC 30 Sept 2005 DID

9 July 2004 A+ID Ingress Sukuk Berhad Sukuk Ijarah 160 MARC 13 July 2009 DIS

7 Oct 2004 AID/ MARC-2ID Oilcorp Berhad Murabahah IMTN/ MUNIF

70 MARC 7 Oct 2009 DID

19 Oct 2004 A3/P2 BSA International Berhad Murabahah CP/ MTN 150 RAM Ratings

28 May 2008 D

4 Nov 2004* AID/ MARC-2ID Jana Niaga Sdn Bhd MUNIF 100 MARC 15 Nov 2007 DID

12 Nov 2004 A2/ P2 The Royal Mint of Malaysia Sdn Bhd

Murabahah Multi-Option Notes Issuance Facility

55 RAM Ratings

8 June 2007 D

15 Dec 2004 AAID PSSB Ship Management Sdn Bhd

BaIDS 40 MARC 15 Dec 2009 DID

28 Jan 2005 AID Tracoma Holdings Berhad BaIDS 100 MARC 29 Jan 2009 DID

8 Mar 2005 MARC-2ID M-Trex Corporation Sdn Mhd

Murabahah ICP 60 MARC 21 May 2009 DID

29 Apr 2005 A1(s)/ P1(s) Oxbridge Height Sdn Bhd Murabahah IMTN/ MUNIF

104/

50

RAM Ratings

6 Apr 2009 D

26 Sept 2005 AID Englotechs Holding Bhd Murabahah MTN 50 MARC 27 Mar 2009 DID

28 Oct 2005 A2 Memory Tech Sdn Bhd BaIDS 320 RAM Ratings

7 June 2007 D

31 Jan 2006 A+ID/ MARC-1ID

Nam Fatt Corporation Berhad

Murabahah ICP/ IMTN

250 MARC 6 Apr 2010 DID

13 Apr 2007 MARC-1ID Straight A's Portfolio Sdn Bhd

MUNIF 200 MARC 11 Dec 2009 DID

17 May 2007 A+ID Malaysian International Tuna Port Sdn Bhd

BaIDS 240 MARC 18 Nov 2009 DID

* Date of issuance is based from press releases on rating agencies‟ website/ internal database. Sources: RAM Ratings, MARC, SC

13

The following are some local sukuk default cases:

Memory Tech Sdn Bhd - RM320 million Bai Bithaman Ajil Islamic Debt Securities

BBA had been a popular Shariah contract for sukuk when the Islamic capital market was first developed in Malaysia. Due to some of the controversial elements

embedded in the structure, however, it is only accepted in the Malaysian market. Under the BBA structure, eligible sukuk investors will first purchase (from the issuer) the underlying assets at an agreed purchase

price. The assets must be certified as Shariah-compliant and of sufficient value, as per the pricing guidelines of the SC‟s Shariah Advisory Council. The assets will

subsequently be sold back to the issuer at cost plus a profit on deferred payment. Therefore, sukuk using the BBA contract will be used to securitise Shariah-

compliant assets (either tangible assets or receivables); it adds value to the debt facility, in terms of credibility and liquidity.

Memory Tech Sdn Bhd (“Memory Tech”) is a wholly

owned subsidiary of Megan Media Holdings Berhad (“MMHB”). MMHB is the largest contract-manufacturer for optical data-storage media, e.g. recordable compact

discs (better known as CD-Rs) and recordable digital versatile discs (more popularly termed as DVD-Rs), in South-East Asia. MMHB‟s ability to cater to its clients‟

specific needs and its reputation as a reliable

manufacturer have earned it a prominent base of global clients. Additionally, its location away from Taiwan (where more than 60% of the world‟s CD-Rs and DVD-

Rs are produced) is viewed favourably by original-equipment manufacturers, as this reduces their exposure to single-country risk vis-à-vis supply. Memory

Tech‟s BaIDS had been fully backed by a corporate guarantee from MMHB. As such, the rating had essentially

mirrored the strength of MMHB‟s business and financial profiles. RAM Ratings had assigned an initial long-term

rating of A2 to Memory Tech‟s RM320 million BaIDS (2005/2012), with a stable outlook, in October 2005.In early 2006, MMHB began showing signs of financial distress due to its burgeoning debt load as a result of

aggressive capital spending. The additional borrowings, which had been mainly used to pay deposits on purchases of new machinery and as working capital, had

also augmented its ratio of total debt against earnings before interest, tax, depreciation and amortisation. The significant increase in MMHB‟s debt burden had resulted

in its non-compliance with 2 of the financial covenants in the BaIDS‟s original trust deed. Furthermore, Memory Tech and another subsidiary of MMHB in Singapore had failed to repay their trade facilities amounting to

RM47.36 million, which fell due on 27 April 2007. Based on the terms of the trust deed, this default on the trade facilities had constituted a cross-default on the BaIDS.

According to MMHB‟s management, the inability of the subsidiaries to meet their debt obligations had been primarily due to a liquidity crunch arising from slow

collections from trade debtors. These trade receivables had mainly stemmed from MMHB‟s trading business,

which had increased since RAM Ratings‟ review in November 2006. After a series of downgrades, Memory

Tech‟s RM320 million BaIDS had eventually ended up with a D rating.

14

Chart 1: Key transaction information and rating history of Memory Tech’s RM320 million BaIDS

Key Transaction Information

Issuer Memory Tech Sdn Bhd

Instrument RM320 million BaIDS

Issuance Date 28 October 2005

Islamic Contracts Bai Bithaman Ajil and Hibah

Underlying Asset Compact disc recordables (CD-

Rs)/ digital versatile disc

recordables (DVD-Rs)

production system custom-

made MTL-2LC (comprises a

system of machinery used in the

production of CD-Rs or DVD-Rs,

including plastic injection, dye

coating, sputtering, spin coating

and bonding)

Facility Agent Citibank Berhad

Shariah Advisor Dr Mohd Daud Bakar

Financial Advisor BinaFikir Sdn Bhd

Purpose of Issue Proceeds from the BaIDS had

been utilised for the following

purposes:

i) Repay amount due to

holding company, MMHB

ii) Refinance trade facilities

iii) Refinance bank borrowings

iv) Refinance hire-purchase

facilities

v) Finance acquisition of a

factory lot and renovation

Any remaining balance

after meeting items (i) to

(v) above could be used

as the Issuer‟s working

capital

Legal Counsel i) Adnan, Sundra & Low

ii) Lee Hishamuddin Allen &

Gledhill (only confined to

the proposed BBA Serial

Bonds restructuring)

Trustee Mayban Trustees Berhad

Initial Rating A2 by RAM Ratings

Rating History – Memory Tech Sdn Bhd

11 October 2005 Assigned a long-term rating of A2, with a stable outlook. The BaIDS carry a corporate guarantee from MMHB

25 July 2006

Rating outlook revised from stable to negative. The negative outlook reflects RAM Ratings’ concerns about MMHB’s rising debts to support its capital spending, and the prevailing industry depression.

2 October 2006

Reaffirmed A2 rating, maintained negative outlook. The negative outlook on the rating reflects RAM Ratings’ concerns about the Group’s rising debts to support its capital spending and the substantially volatile nature of the industry.

9 May 2007

Rating downgraded to C3; negative outlook maintained. This was premised upon the failure of Memory Tech and MJC (Singapore) Pte Ltd (another wholly owned subsidiary of MMHB) to repay their trade facilities amounting to RM47.36 million, which fell due on 27 April 2007. Based on the terms of the trust deed, this default on the trade facilities constituted a cross-default on the BaIDS. As a guarantor for the BaIDS, MMHB had 30 days to remedy this breach.

7 June 2007

Rating downgraded from C3 (negative outlook) to D, following the failure of Memory Tech and MJC (Singapore) Pte Ltd to repay their trade facilities. On 30 May 2007, the trustee, acting on the instructions of the BaIDS holders, declared that an event of default had occurred on the BaIDS. Based on Clause 9.1 of the Trust Deed, the BaIDS had then become immediately due and payable. On 5 June 2007, MMHB (as the guarantor for the BaIDS) had also been served a notice of demand by the trustee for the payment of RM436.11 million (comprising RM320 million and RM116.11 million for the Primary and Secondary Notes of the BaIDS, respectively) by 6 June 2007. MMHB, however, had failed to meet the payment on the due date.

15

Tracoma Holdings Berhad - RM100 million Bai Bithaman Ajil Islamic Debt Securities

Tracoma Holdings Berhad (“Tracoma”) is a an investment-holding company with a paid-up capital of RM48 million2. It is involved in the manufacturing and supply of automotive parts and components, the

manufacture and assembly of motor vehicles, and maintenance and engineering services for the shipping as well as oil and gas sectors.

The RM100 million BaIDS had been issued in 2 series of RM50 million each, with tenures of 4 and 5 years.

In November 2004, MARC assigned an initial rating of AID to the issue. This reflected, among others, Tracoma‟s vast experience and good track record as one of the

leading local manufacturers of automotive components and its commendable financials. In October 2006, MARC placed Tracoma‟s RM100 million BaIDS on a negative

outlook, premised on Tracoma‟s delay (in accordance with the terms and conditions of the BaIDS) in depositing the monthly amount in the Profit Service Account (“PSA”) required for the upcoming profit

payments due in January 2007. The balance in the PSA stood at RM347,726 as at 26

September 2006, representing a shortfall of RM1.4 million compared to the minimum requirement of RM1.8 million. Nevertheless, Tracoma could utilise the funds in

the Finance Service Reserve Account (“FSRA”) to make up for the shortfall in the PSA, to service the RM3.7 million of profit payments due in January 2007. As at 26 September 2006, the balance in the FSRA stood at

RM3.89 million. Under the Trust Deed, Tracoma was required to replenish the amount utilised within 14 days vis-a-vis the drawdown on the FSRA. On 29 January

2007, MARC received confirmation from Pacific Trustees Berhad that Tracoma had successfully redeemed the Secondary Notes of the BaIDS, due on 26 January 2007.

A couple of downgrades had been instituted during the annual rating reviews on the BaIDS, due to Tracoma‟s tight liquidity position and limited financial flexibility,

exacerbated by its weaker-than-expected cashflow. In late January 2009, MARC downgraded the

rating of the BaIDS to DID due to Tracoma‟s failure to redeem its first RM50 million series based on the original scheduled maturity date of 28 January 2009, as

confirmed by the trustee. The missed payment had been

2 Tracoma’s Annual Report 2008, from Bursa Malaysia website

treated as an indication that the company was facing financial distress.

Chart 2: Key transaction information and rating history of Tracoma’s RM100 million BaIDS

Key Transaction Information

Issuer/Lessor Tracoma Holdings Berhad

Instrument RM100 million BaIDS

Issuance Date 28 January 2005

Islamic Contract Bai Bithaman Ajil

Principal Advisor/

Lead Arranger

Affin Investment Bank Berhad

(previously known as Affin

Merchant Bank Berhad)

Shariah Advisor Dr Mohd Daud Bakar

Purpose of Issue Proceeds from the BaIDS had

been utilised for the following

purposes:

i) RM36.3 million to part-

finance its subscription

for shares in PT Tracoma

Motors.

ii) RM5.0 million to finance

the acquisition of land

and building by PT

Tracoma Nusantara.

iii) RM12.0 million to finance

the construction of a new

plant.

iv) RM22.0 million to repay

bank borrowings or other

financial obligations the

issuer and its subsidiaries

(“Tracoma Group”).

v) RM3.8 million to pre-fund

the FSRA.

vi) RM20.4 million to meet

the Tracoma Group‟s

working-capital

requirements. For

avoidance of doubt,

should the use of any

amount for non–working-

capital purposes

marginally exceed the

allocated sum, then the

16

amount allocated as

working capital should be

reduced accordingly. In

such an event, the

amount allocated for

non-working-capital

purposes should be

adjusted accordingly

vii) RM0.5 million to finance

the costs and expenses in

relation to the BaIDS.

Legal Counsel Zul Rafique & Partners

Facility Agent Affin Investment Bank Berhad

Trustee Pacific Trustee Berhad

Initial Rating AID by MARC

Rating History – Tracoma Holdings Berhad

29 November 2004

A long-term rating of AID was assigned based on Tracoma’s vast experience and good track record as one of the leading local automotive component manufacturer and its commendable financial results.

7 April 2006

Reaffirmed the long-term rating of AID, with developing outlook pending resolution of its earlier joint venture with Proton in Indonesia.

3 October 2006

Placed on negative outlook, premised on Tracoma’s delay (in accordance with the Terms and Conditions of the BaIDS) to deposit the monthly built up in the Profit Service Account (PSA) required for the upcoming profit payments due in January 2007.

26 February 2007

Downgraded the long-term rating to BBB+ID and maintained the negative outlook. Underpinned by the current negative domestic automotive industry outlook reflecting weak industry fundamentals which MARC believes will have an adverse impact on Tracoma’s future operating and financial performance

25 July 2008

Reaffirmed the BBB+ID rating (negative outlook). The MARCWatch Negative placement reflects heightened concerns about Tracoma’s ability to make a RM25 million scheduled payment into the principal service reserve account (PSRA) on July 28, 2008, which represents the first of six scheduled monthly payments to build up the PSRA for the redemption of the first series of the BaIDS amounting to RM50 million maturing on January 28, 2009. Thereafter, Tracoma is required to make five monthly payments of RM5 million each.

31 July 2008

Downgraded the long-term rating to BB+ID, maintained the negative outlook. The downgrade reflects the company’s tight liquidity position and limited financial flexibility, exacerbated by weaker-than-expected cash flow generation as indicated by Tracoma’s failure to make a scheduled RM5 million payment into the PSRA on July 28, 2008 in accordance with the revised schedule of build-up payments.

30 October 2008

Downgraded the long-term rating to BID, maintained the negative outlook. The downgrade heightened concerns over Tracoma’s ability to redeem its first BaIDS series maturing on January 28, 2009 amounting to RM50 million.

23 January 2009 Downgraded the long-term rating to CID, maintained the negative outlook to reflect our expectation that no payment will be made on its first BaIDS series.

23 January 2009

Downgraded the long-term rating to DID to reflect reflects Tracoma’s failure to redeem its first BaIDS series and considered the missed payment as an indication that the company is facing financial distress.

17

Oxbridge Height Sdn Bhd - RM50 million Murabahah Underwritten Notes Issuance Facility and up to RM104 million Islamic Medium-Term Notes Facility

The Murabahah Underwritten Notes Issuance Facility

(“MUNIF”) is a short-term note while the Islamic Medium-Term Notes (“IMTN”) is a medium-term note. The MUNIF/IMTN had adopted the underlying Shariah

principle of Murabahah, i.e. an agreement that refers to a sale and purchase transaction for the financing of an asset on a deferred-payment basis, with a pre-agreed payment period and mark-up. The selling price of the

assets will include a profit margin. Oxbridge Height Sdn Bhd (“Oxbridge”) is a single-

purpose company set up to undertake the development of Jaya Putra Perdana (“JPP”) in Tebrau, Johor. Oxbridge is a subsidiary of Renewed Development Sdn Bhd, a

Johor-based property developer. JPP is located approximately 15 km to the north of Johor Bahru city centre and is surrounded by more established developments such as Taman Mount Austin and Taman

Daya. To facilitate the issuance, Tradewinds Corporation

Berhad (“Tradewinds”) - as the beneficial land owner – had voluntarily granted the identified assets to Oxbridge as a gift (hibah) for no consideration. The sukuk

investors had then acquired the assets from Oxbridge at the purchase price. Thereafter, the sukuk investors had sold back the assets to Oxbridge at a price comprising the original purchase price and a profit margin, at a pre-

agreed rate and on a deferred-payment basis. Once the sale and purchase transactions had been executed, Oxbridge had subsequently given back the assets to

Tradewinds, based on the concept of hibah. Oxbridge‟s obligation to pay had been evidenced through the issuance of the negotiable and non-profit-bearing

promissory notes (“MUNIF Notes” or “IMTNs”) under the MUNIF and IMTN Facility, which it would redeem on the respective maturity dates. The issuance of the MUNIF Notes and IMTNs had been backed by various securities,

such as a first fixed legal third-party charge over the identified land parcels (equivalent to 418.64 acres) and legal assignment of 20% of the proceeds from the sale

of units under the JPP development. In April 2005, RAM Ratings had accorded an initial long-

term rating of A1(s) (with a stable outlook) to the IMTN Facility of up to RM104

million, and a short-term rating of P1(s) to the MUNIF of up to RM50 million. However, Oxbridge‟s business and

financial profiles had weakened in late 2008, as a result

of the delayed land sale, deferred property launches in the last few years, reduced launches, sale cancellations,

construction hold-ups and increased construction costs - thus triggering an event of default. Chart 3: Key transaction information and rating

history of Oxbridge’s RM50 million MUNIF and RM104 million IMTN

Key Transaction Information

Issuer Oxbridge Height Sdn Bhd

Instrument RM50 million MUNIF and up to

RM104 million IMTN

Issuance Date 29 April 2005

Islamic Contracts Murabahah and Hibah

Underlying Assets Identified project land

Principal

Advisor/Lead

Arranger/Facility

Agent

Amanah Short Deposits Berhad

Joint Arranger OSK Securities Berhad

Shariah Advisor Dr Mohd Daud Bakar

Purpose of Issue Proceeds from the MUNIF had

been utilised for the following

purposes:

i) Direct payment of fees

and expenses relating to

the issuance.

ii) To finance the

construction,

development and

operating costs and

expenses relating to JPP,

Oxbridge‟s mixed-

development project

developed in Mukim

Tebrau Daerah Johor

Bahru, Johor.

However, proceeds from the

IMTN had been utilised for the

following purposes:

i) To part-finance the

acquisition of the land

development rights from

18

the beneficial land owner.

ii) To deposit into the FSRA

4.0% of each IMTN

issued

Legal Counsel Messrs Raslan Loong

Trustee AmTrustees Berhad

Initial Ratings A1(s)/ P1(s) by RAM Ratings

12 April 2005

A long-term rating of A1(s) with a stable outlook was assigned to proposed IMTN of up RM104 million. Simultaneously, a short-term rating of P1(s) was assigned to proposed MUNIF of up to RM50 million.

11 November 2005

Reaffirmed the long-term rating of A1(s) with a stable outlook IMTN facility of up RM104 million. At the same time, a short-term rating of P1(s) was reaffirmed to MUNIF facility of up to RM50 million.

18 March 2008

Reaffirmed the enhanced long- and short-term rating, and maintained the negative outlook. The negative outlook reflects Oxbridge’s weakened fundamentals following its deferred and reduced launches.

18 February 2009 Maintained the Rating Watch (with a negative outlook) on the A1(s)/P1(s) ratings of Oxbridge’s IMTN/MUNIF.

5 November 2008

Reaffirmed the enhanced long- and short-term rating, and maintained the negative outlook It premised on the delays in the proposed sale of about 600 acres of land under its sister company, Hartaplus Realty Sdn Bhd, for RM260 million - expected to complete by 3Q 2008; part of the proceeds is to be channelled to Oxbridge to meet its working-capital requirements.

Rating History – Oxbridge Height Sdn Bhd

12 March 2009

Downgraded the ratings of Oxbridge’s IMTN/MUNIF, from A1(s)/P1(s) to BB1/NP. The rating downgrade reflects the significant deterioration in Oxbridge’s business and financial profiles as a result of the delayed land sale, deferred property launches in the last few years, reduced launches, sales cancellation, construction hold-ups and increased construction costs.

6 April 2009

Downgraded the ratings of Oxbridge’s IMTN/MUNIF, from BB1/NP to D. The rating actions are premised on confirmation from MIDF Amanah Investment Bank Berhad’s announcement through the FAST that Oxbridge had failed to redeem the RM10 million Islamic Commercial Paper under its MUNIF, which fell due on 3 April 2009. Under Clause 12.1A(vii) of the Trust Deed for the IMTN facility, any other indebtedness that becomes due or capable of being declared due before its stated maturity will trigger a cross-default and constitutes an event of default. RAM Ratings understands that the IMTN/MUNIF holders have not declared an event of default, premised on Oxbridge’s plans to restructure the debt facility.

19

Oilcorp Berhad - RM70 million Murabahah Underwritten Notes Issuance/Islamic Medium-Term Notes Facility

Oilcorp Berhad (“Oilcorp”) is an investment-holding

company; its subsidiaries are involved in 3 core businesses: oil and gas; special projects, hotel, resort operation and property investment; and deep-sea

fishing. In September 2004, MARC had assigned initial ratings of MARC-2ID/AID to Oilcorp‟s RM70.0 million MUNIF/IMTN, premised on its strong historical profit performance and low gearing levels. However, this was

moderated by the sustainability of Oilcorp‟s revenue and profits after FY 2005, given that the company‟s existing contracts were expected to be fully completed in FY

2004 and FY 2005. In 2006, the ratings were reaffirmed at MARC-2ID/AID.

However, a year later, the long-term rating was downgraded to A-ID, its short-term rating maintained at MARC-2ID, underpinned by the Group‟s weakened financial profile, particularly the persistent deficit in net

cashflow from operations due to higher receivables arising from longer payment terms, its cashflow‟s sensitivity to reductions in revenue and heftier

operating costs, and the need for additional borrowing to support its core business activities: engineering, procurement and construction; property investment;

and fisheries. MARC had also been concerned about the deficit in Oilcorp‟s cashflow arising from hefty receivables and lofty borrowings for its project, which had outstripped the accumulation of its retained

earnings. In March 2008, MARC placed the ratings on MARCWatch

with a developing outlook, following Oilcorp‟s announcement - dated 20 May 2008 - to Bursa Malaysia that its annual audited accounts for the year ended 31

December 2007 would be amended due to a disagreement between the management and its auditors, Messrs Baker Tilly Monteiro Heng, on the accounting treatment relating to a RM110 million long-

term contract. About 4 months later, MARC revised the outlook from developing to negative, due to a prolonged dispute that would affect Oilcorp‟s access to capital and

which could result in its potential exposure to disciplinary action by the regulators.

Due to further deterioration in the company‟s liquidity position, the ratings were

downgraded to MARC-4ID/BBID, while maintaining the MARCWatch Negative. This was because Oilcorp had

failed to deposit RM10 million into the facility‟s sinking

fund account, which would fall due on 7 September 2009, and represented the balance of an upcoming

RM20 million redemption due on 7 October 2009 (i.e. the October redemption). Further rating downgraded had occurred due to the expectation of an imminent

default on the October redemption, in addition to Oilcop‟s failure to pay profit on a loan under a CLO programme. The missed profit payment could lead to

the declaration of an event of default on the sukuk programme. The sukuk fell into default and was rated DID in October

2009, following Oilcorp‟s failure to meet its RM20 million principal repayment based on its original scheduled redemption.

Chart 4: Key transaction information and rating history of Oilcorp’s RM70 million MUNIF/IMTN

Key Transaction Information

Issuer Oilcorp Berhad

Instrument RM70 million MUNIF/ IMTN

Issuance Date 7 October 2004

Islamic Contract Murabahah

Principal Advisor/ Lead

Arranger

MIDF Amanah Investment Berhad

(formerly known Amanah Short

Deposits Berhad)

Shariah Advisor Dr Mohd Daud Bakar

Purpose of Issue

Proceeds from the MUNIF/ IMTN had

been utilised for the following

purposes:

i) To refinance and repay the

existing loan facilities of Oilcorp

and its subsidiaries (“the

Group”).

ii) As the capital expenditure of

Oilcorp.

Legal Counsel Raslan Loong Advocates & Solicitors

Facility Agent MIDF Amanah Investment Berhad

Trustee OSK Trustees Berhad (formerly known

as OSK-Signet Trustees Berhad)

Initial Ratings MARC-2ID/AID by MARC

20

Ingress Sukuk Berhad - RM160 million Sukuk Ijarah

Ingress Sukuk Berhad (“ISB”) had been incorporated by its holding company, Ingress Corporation Berhad

(“Ingress”), as a special-purpose vehicle to facilitate the execution of the sale and leaseback of Ingress‟ identified assets for the Sukuk Ijarah issuance.

Ijarah is a manfa’ah (usufruct) type of contract, where the owner leases out an asset to a client, at an agreed rental fee and pre-determined lease period, as per the

„aqd (contract). Normally, the ownership of the leased asset remains in the hands of the lessor. As per the structure, the sukuk holders possess undivided

proportionate beneficial ownership of the assets and the rights, titles, interests and benefits under all the transaction documents. In addition, a purchase and sale

undertaking is exercisable by both Ingress and ISB for the redemption of the sukuk upon the maturity of the issuance, or upon the occurrence of a dissolution event or an event of default vis-à-vis repaying any outstanding

balance. In June 2004, MARC assigned an initial rating of A+IS to

ISB‟s proposed RM160.0 million Sukuk Ijarah. The rating reflected Ingress‟ track record as one of the leading local automotive-component manufacturers, with a diversified

customer profile and geographical distribution; and its

above-average financial results, characterised by its favourable operating margins. Moderating factors included the vulnerability of the automotive industry and

the manufacturing sector to economic swings and increasing competition arising from trade liberalisation.

In July 2007, MARC placed the rating on MARCWatch Developing, following confirmation from CIMB Trustee Berhad that a breach in the debt-to-equity ratio had

occurred based on Ingress‟ audited accounts for the financial year ended 31 January 2007. At the end of the year, MARC lowered ISB‟s rating to AIS, with a stable outlook.

In April 2008, MARC revised the outlook to MARCWatch developing, following ISB‟ announcement (dated 10 April

2008) to Bursa Malaysia in response to a notice by CIMB Trustee Berhad for non-compliance of financial covenants under the sukuk issuance. According to the Ijarah Agreement, ISB was required to rectify its non-

compliance of the covenants within 3 months from the date of the notice. Three months later, MARC maintained the MARCWatch developing following an extension of the

remedy period given to ISB until 26 July 2008 - to resolve the breach of certain financial covenants under

the Ijarah Agreement. However, ISBhad failed to rectify

the breaches and also failed to conclude a refinancing

14 September 2004 The MARC-2ID/AID ratings were assigned.

17 February 2006 Reaffirmed the MARC-2ID/AID ratings.

7 February 2007

Downgraded the long-term rating from AID to A-ID, and short term rating reaffirmed at MARC-2ID with stable outlook. The rating downgrade is underpinned by the Group’s weakened financial profile, in particular the continuous deficit in net cash flow from operations due to higher receivables arising from longer milestone in payment terms, sensitive cash flow towards reduction in revenue and operating costs, and the need of additional debt leverage going forward to support its business activities.

14 March 2008 Reaffirmed the ratings of MARC-2ID/A-ID

31 October 2008 Maintained its rating at MARCWatch negative.

22 May 2008

Placed on MARCWatch developing following Oilcorp’s announcement dated 20 May 2008 to Bursa Malaysia that its annual audited accounts for the year ended 31 December 2007 will be amended due to a disagreement between management and its auditors.

30 July 2008

Revised its MARCWatch status to negative, concerned that a prolonged dispute would affect Oilcorp’s access to capital and may result in potential exposure to disciplinary action by the regulators.

20 February 2009 Continue to maintain its rating at MARCWatch negative due to a protracted delay in releasing audited accounts for the FY2007.

5 June 2009 Continued MARCWatch negative placement highlights Oilcorp’s thin liquidity cushion relative to its significant upcoming debt maturity in October 2009.

11 September 2009

Downgraded the ratings to MARC-4ID/BBID, and maintained MARCWatch negative due to the company’s liquidity position which had deteriorated further, and incorporated Oilcorp’s increasingly limited options to stabilise its credit profile. Oilcorp failed to deposit RM10 million into the facility’s sinking fund account.

30 September 2009

Downgraded the ratings to MARC-4ID/CID and maintained MARCWatch negative in expectation of imminent default by Oilcorp on its upcoming redemption of its MUNIF/IMTN on October 7, 2009 under the facility’s original redemption schedule.

7 October 2009 Downgraded DID on missed principal payment.

Rating History – Oilcorp Berhad

21

scheme in relation to the sukuk. MARC had thus revised the MARCWatch to negative.

After a couple of downgrades due to ISB‟s deteriorating liquidity position, MARC had eventually downgraded the rating to BB-IS, but retained the MARCWatch Negative.

ISB had failed to make a RM25 million payment into the Ijarah Service Rental Account (“ISRA”) by the deadline of 9 April 2009. On 6 July 2009, MARC lowered the rating to CIS and maintained the MARCWatch Negative.

The rating action was based on ISB‟s decision to postpone RM45.0 million of the RM50.0 million payment on the first tranche of the sukuk, which would become

due on 9 July 2009. On 13 July 2009, ISB defaulted on its RM160 million

Sukuk Ijarah; MARC downgraded the rating from CIS to DIS, even though ISB had confirmed that it had made a partial payment of RM5 million on 9 July 2009, in line with its earlier agreement with the sukuk holders. The

payment date of the remaining RM45 million - due on 9 July 2009 – had been deferred to 9 January 2010 (with the agreement of the majority of the sukuk holders), to

allow the Group to complete its group-wide restructuring plan.

Chart 5: Key transaction information and rating history of ISB’s RM160 million Sukuk Ijarah

Key Transaction Information

Issuer Ingress Sukuk Berhad

Instrument RM160 million Sukuk Ijarah

Issuance Date 9 July 2004

Islamic Contract Ijarah

Principal Advisor/Lead

Arranger/Facility

Agent

HSBC Bank Malaysia Berhad

(“HSBC”)

Service Agent/Lessee Ingress Corporation Berhad

Lessor Ingress Sukuk Berhad

Shariah Advisor Dr Mohd Daud Bakar

Purpose of Issue Proceeds from the Sukuk

Ijarah had been utilised for

the following purposes:

i) Direct payment of fees

and expenses relating

to the issuance of the

facility to relevant

parties, based on the

invoices or such other

documentary evidence

satisfactory to the

arrangers.

ii) To finance the

construction,

development and

operating costs and

expenses relating to

JPP, Oxbridge‟s mixed-

development project to

be developed in Mukim

Tebrau Daerah Johor

Bahru, Johor Darul

Takzim.

Legal Counsels

i) Mohamed Ismail & Co,

counsel for the Principal

Advisor/Lead Arranger.

ii) Azmi & Associates,

counsel for Ingress.

Trustees

i) ISB as the initial trustee

ii) Bumiputra-Commerce

Trustee Berhad as co-

trustee

Initial Rating A+IS by MARC

8 June 2004 A long-term rating of AIS was assigned.

8 December 2005 Reaffirmed the long-term rating of AIS.

12 October 2006 Reaffirmed the long-term rating of AIS

with stable outlook.

30 October 2007 Maintained A+IS rating with developing outlook,

31 July 2007

Placed its A+IS rating on MARCWatch Developing, followed confirmation from CIMB Trustee Berhad that a breach in the Debt to Equity Ratio had occurred based on Ingress’ audited accounts for the FY2007.

Rating History – Ingress Sukuk Berhad

22

As clearly highlighted in the preceding cases, the reasons behind the defaults have nothing to do with the Shariah structure. Rather, they were related to the

impact from adverse market conditions and economic situation that had led to financial distress. Nevertheless, it is worth noting that sukuk investors had been

adequately informed of the issuers‟ status and progress via the annual rating reviews conducted by the respective rating agencies.

Law and Order Like the Middle East, Malaysia has also had its fair share

of defaulted sukuk, albeit with a lower issuance value. Nonetheless, what have protected Malaysia from the negative limelight are the tight regulations and laws that

bind the sukuk market. Both sukuk and conventional bonds are governed by similar standards, guidelines and laws that issuers have to abide by. Sukuk are therefore

considered as financial obligations, whereby the investors are recognised as creditors and rank equally with other conventional creditors. This provides some level of comfort to investors, knowing that they are

adequately protected in any unfavourable event. Malaysia conforms to consistent and clear investors protection whereby the investors are well aware of their

position and options. While the investor protection are very much intact and market-tested, the legal and recovery process are also in order.

Apart from being well-regulated by various standards and guidelines, Malaysia is also the only country that makes it compulsory for all tradable corporate debt

securities to be rated - to enhance investors‟ confidence and assist in the investment decision-making process.

Another distinguishing factor for the Malaysian sukuk market is the establishment of a centralised, national-level Shariah supervisory board, which ensures that

every sukuk issued in Malaysia fully complies with the Shariah. All these factors provide sufficient protection to investors in the sukuk and conventional bond markets.

Rating History – Ingress Sukuk Berhad

28 December 2007

Lowered the rating to AIS (stable outlook). The downgraded rating reflects Ingress’ deteriorating profitability and the breach of its debt-to-equity covenant, resulting from additional debt assumed to fund its substantial capital expenditure in respect of its Thailand operations.

11 July 2008 Maintained A+IS rating with developing outlook,

25 February 2009

Downgraded to A-IS with negative outlook, incorporated the deteriorating liquidity position and declining profitability of Ingress and continuing existing non-compliance with certain financial covenants.

11 April 2008

Placed MARCWatch developing, following Ingress’ announcement dated April 10, 2008 to Bursa Malaysia in response to a notice by CIMB Trustee Berhad for non-compliance of financial covenants under the sukuk issuance.

28 July 2008

Revised its MARCWatch placement to negative outlook following Ingress’ failure to rectify the breach in certain financial covenants under the Ijarah Agreement.

31 March 2009

Downgraded to BBB-IS rating with negative outlook due to Ingress’ insufficient liquidity resources as well as the lack of positive developments with regard to its refinancing initiatives and asset disposals vis-à-vis its upcoming scheduled RM50 million sukuk redemption in 9 July 2009.

10 April 2009

Lowered its rating to BB-IS, maintained negative outlook. ISB has failed to make a RM25 million payment into the Ijarah Service Rental Account within the required deadline.

6 July 2009

Downgraded to CIS, with negative outlook, based on ISB’s decision to postpone RM45.0 million of the RM50.0 million upcoming first tranche sukuk payment.

13 July 2009 Downgraded to DIS, on missed principal payment.

23

Setting the Risk Assessment of Sukuk in Perspective ~ Focus on Debt-Based Sukuk

In essence, a credit rating reflects a rating agency’s opinion of the creditworthiness of a

particular debt security or obligation. However, with the proliferation of sukuk, public and private commentaries seem to suggest that the credit ratings assigned to sukuk also imply that the bonds

are Shariah-compliant from the rating agencies’ viewpoint. This is a misconception about the

roles and functions of ratings and credit rating agencies. Basically, credit ratings relate only to credit risks and, therefore, have no bearing on the issue of compliance with Shariah principles.

The Misconception Ratings have been used in a wide range of functions,

becoming tools employed by issuers, investors, intermediaries, securities analysts, regulators, counterparties to financial and commercial contracts, among others. Each user group has its specific purpose

and objective. For example, issuers seek credit ratings because of market or regulatory demands; as such, issuers would like higher ratings and greater control

over the rating process. Parties on the buy side, such as insurance companies and pension funds, use ratings to

satisfy certain requirements of their portfolios and as

governance guidelines; they therefore would prefer stable ratings and tend to frown upon rating changes. There is, of course, the incorporation of ratings as a regulatory tool in terms of banks and insurance

companies, among others. Given the multiple roles, it is not surprising that ratings

have been subjected to varied interpretations, perhaps at times incompatible with the stated purpose of ratings. A possible case in point is the common

misconception that the credit ratings assigned by rating agencies to sukuk also mean their seal of approval that the securities are Shariah-compliant. This is certainly not among the intended roles and functions of ratings

and rating agencies. Credit ratings relate only to credit risks and, therefore,

have no bearing on the issue of

compliance with Shariah principles. In Malaysia, the Securities Commission (“SC”) –

as the regulatory body for the capital market - has the task of ascertaining the conformity of an Islamic

instrument to Shariah principles and, finally, approving the instrument as indeed being Shariah-compliant.

The principles and concepts that are approved for the issuance of sukuk are set out in the SC‟s Guidelines on the Offering of Islamic Securities (“IS Guidelines”). The

IS Guidelines cover different aspects, including the need to seek SC‟s approval for an issuance of sukuk; the persons who are eligible to act as principal advisors for different types of proposals; the documents and

information required to be submitted; the persons who are eligible to be issuers; other requirements such as the appointment of Shariah advisors, rating,

underwriting and disclosure requirements; the mode of issue and the utilisation of proceeds; and the time frame for approval from the SC.

Practically, the fundamental Shariah principles and concepts that underpin the instruments would need to have been pre-determined and, where necessary,

verified by the relevant Shariah councils as these aspects would determine the structures, mechanisms and salient terms of the instruments to be subjected to

credit ratings. In fact, these regulatory-approved principles or concepts determine the names or types of sukuk that are in the market today.

24

Figure 1: Issuance of Bai' Bithaman Ajil Islamic Debt Securities (“BaIDS”) - schematic presentation

Origination of Debt–Based Sukuk

In most instances, sukuk in the Malaysian debt market

are raised pursuant to a contract of sale3; the most

common are those based on the principles of Bai

Bithaman Ajil (“BBA”) and Bai Murabahah

(“Murabahah”). As may be seen from the schematic

presentation above (Figure 1), the sale contract entered

into between the Issuer and the Seller4 consequently

results in an 'IOU' on the part of the Issuer. The Issuer

then undertakes an Islamic bond issue, matching the

indebtedness which has arisen from the BBA transaction.

The bonds indicate the Issuer's obligation to pay their

face value5 and the right of the sukukholders to receive

payments. As one may appreciate, the subsequent issue

now would be the credit risk of the Issuer.

An issue rating for a debt-based sukuk is RAM Ratings‟

opinions on the creditworthiness of a particular debt-

based sukuk. It reflects the overall capacity and

willingness of an issuer to meet the financial obligations

on a particular debt-based sukuk on a full and timely

basis, taking into account its expressed terms and

conditions. RAM Ratings‟ sukuk ratings are, however,

not a measure of compliance with Shariah principles or

the role, formation, practices, legitimacy and soundness

of the Shariah advisors‟ recommendations and decisions.

3 Contract of sale is the main contract of exchange in Islamic

commercial law. 4 The role of Primary Subscriber is typically performed by the

Arranger. 5 The face value of the Islamic bonds is equivalent to the total

Selling Price, made up of the original purchase price plus the profit margin.

Rating Framework of Debt-Based Sukuk in

Brief

RAM Ratings‟ ratings are arrived at through a rigorous

and judicious process that tends to favour long-term

considerations and rating stability over transitory

conditions. The assessment of creditworthiness and the

ultimate assignment of a rating depend on various

factors, taken in aggregate.

In the appraisal of sukuk, our rating methodology

incorporates vigorous scrutiny of the pertinent aspects

of the bond structure which affirm the instrument as an Islamic investment. This is to ensure that any ensuing

risks and implications that may affect the credit risk profile of the sukuk have been taken into consideration. Factors assessed include the underlying principles or

concepts, the form and structure of the proposed instrument (including any embedded credit enhancements), as well as the process, mechanism and

documentation. Over and above these factors, our ratings for sukuk are also based on the analysis of macro-economic data, industry- and company-specific

elements that may affect the company's operating environment, the robustness of its projected cashflow and key financial parameters, as well as the management‟s goals and strategies, corporate

philosophy and succession plans.

To meet the payment obligation arising out of the

BBA contract, the Issuer issues sukuk (BaIDS)

equivalent to the total Selling Price. The BaIDS confirms the

right of the holder to payment of the sale price.

Seller (role typically assumed by the Primary Subscriber(s)) and Issuer identify asset for

purpose of buying and selling (i.e. a sale contract) under

the principles of BBA.

On bought-deal basis, the Primary Subscriber(s)

purchases the asset with cash, at the Purchase Price.

The same asset will then be resold to the Issuer by the

Primary Subscriber(s) at the Selling Price (Purchase Price +

Profit Margin) on deferred payment sale (BBA).

25

Market Statistics

Malaysian Islamic Capital Market

Malaysian Rated Corporate Sukuk Market

League Table of Lead Managers as at 31 March 2010

RM Million %

CIMB Investment Bank Berhad 600 71.4%

Maybank Investment Bank Berhad 240 28.6%

840 100%

The value of consortium issues have been equally divided by the number of lead managers of a consortium

Source : RAM Ratings/ FAST

The latest sukuk issuance arranged by these arrangers are Naim Holdings Berhad (Sukuk Murabahah/ Musharakah of RM600m) and Haluan Gigih Sdn Bhd (Sukuk Musharakah of RM240m) respectively.

26

Market Statistics

Malaysian Islamic Capital Market

As at end-February 2010, the total sovereign, near-sovereign and corporate bonds and sukuk issued amounted to RM13.27

billion.

Corporate bonds and sukuk only contributed about 9% of the total bond market share.

For the month of February, new issues of debt securities in the capital market was lower at RM4.4 billion (January 2010:

RM8.9 billion). The bulk of the issuance was from the public sector i.e. gross issuance of RM3.5 billion from a 5.5 year Malaysian Government Securities (MGS).

Issued Sovereign & Corporate Bonds Gross figures ( not inclusive of redemptions)

RM Million As end Feb Instruments 2006 2007 2008 2009 2010

Malaysian Government Securities 26,830.0 43,187.4

44,618.5 61,295.0

9,065.0

Khazanah Bonds 2,000.0 524.4

- -

-

Government Investment Issues 9,500.0 10,000.1

16,500.0 28,500.0

3,000.0

Malaysia Savings Bonds - -

1,483.1 7,000.0

-

Cagamas Bonds 6,950.0 1,750.0

541.0 -

-

Total Sovereign & Near-Sovereign (1) 45,280.0 55,461.8

63,142.6 96,795.0 12,065.0

Straight Bonds 8,667.1 7,008.4

17,477.4 10,847.0

-

Bonds with warrants - -

- -

-

Convertible Bonds 155.8 30.8

846.9 612.0

42.0

Islamic Bonds 4,780.6 12,127.0

7,467.5 3,785.0

-

Asset Backed Bonds * 1,545.9 4,005.0

1,300.0 97.0

100.0

Medium Term Notes * 16,587.5 41,766.0

26,068.0 43,234.0

1,064.0

Total Corporate Issues (2) 31,736.9 64,937.2

53,159.9 58,575.0 1,206.0

Total Bonds Issued (1 + 2) 77,016.9 120,399.0

116,302.4 155,370.0 13,271.0

Proportion of Total Bonds Issued (%): Sovereign & Near Sovereign 58.8 46.1 54.3 62.3 90.9 Corporate Issues 41.2 53.9 45.7 37.7 9.1

Note: * Includes Islamic issues - no breakdown available Source: BNM

27

Market Statistics

Market Statistics

Malaysian Islamic Capital Market

Outstanding Bonds (RM Million)

Source: Bank Negara Malaysia Conventional Islamic Conventional Islamic Conventional Islamic

Asset Backed Securities 11,028 6,169 9,781 5,921 96,554 5,839

Asset Backed Securities (Commercial Papers) - - - - - -

Asset Backed Securities (MTN/IMTN) 1,562 - 2,023 - 1,990 -

Bonds 60,991 71,822 61,641 71,462 61,793 72,280

Medium Term Notes 28,209 67,668 39,979 88,350 41,003 84,361

Commercial Papers 3,827 5,308 3,932 3,723 3,328 3,959

Commercial Papers-CPN 4,850 580 300 307 200 300

Loan Notes 857 - 17 - 17 -

Loan Stocks 8,899 - 8,695 58 8,269 58

Total Corporate Issues 120,223 151,546 126,368 169,820 213,154 166,796

Aggregate Corporate Issues 271,770 296,187 379,951

Bank Negara Bills/Negotiable Notes - - - - - -

Bank Negara Monetary Notes-CB - - - - - -

Bank Negara Monetary Notes-DB/IDB/IDM 30,700 7,300 21,600 8,000 25,650 6,400

Bank Negara Monetary Notes-IPB - 1,000 - - - -

Bank Negara Monetary Notes-NF 3,000 - - - - -

Cagamas Bonds 3,435 - 1,805 - 980 -

Cagamas Notes - - - - - -

Cagamas Notes-CPN - - - - - -

Danaharta Bonds - - - - - -

Danamodal Bonds - - - - - -

Khazanah Bonds 1,000 3,350 1,000 1,000 1,000 -

Government Investment Issues - 42,500 - 66,000 - 69,000

Islamic Cagamas Papers - 2,925 - 1,465 - 725

Sukuk Bank Negara Malaysia Ijarah - 400 - 400 - 400

Malaysian Government Securities 211,801 - 240,770 - 253,270 -

Malaysian Government Securities Callable 2,000 - 1,500 - 1,500 -

Malaysian Treasury Bills 2,320 2,000 2,320 2,000 2,320 2,000

Total Sovereign & Near – Sovereign Issues 254,256 59,475 268,995 78,865 284,720 78,525

Total Debt Securities 374,480 211,021 395,363 248,685 497,875 245,321

AGGREGATE 585,501 644,048 743,196

As at end 2009As at end 2008 As at end March 2010

Sukuk outstanding as the end of March 2010 amounted to RM245.3 billion compared with RM248.7 billion as at end- 2009.

The percentage of outstanding sukuk to total outstanding corporate bonds decreased from 39% in 2009 to 33% at the end

of March 2010.

28

Market Statistics

Malaysian Islamic Capital Market

Diversified holdings4% Financial services

6%Mining & petroleum

2% Plantation & agriculture

9%

Consumer products1%

Industrial products13%

Construction & engineering

4%

Property & real estate

16%

Transportation3%

Trading & services6%

Infrastructure & utilities

24%

Asset-backed securities

11%

Public Finance1%

Corporate Sukuk Market Issued & Rated by Economic Sector as at March 2010 (by number of issues)

Total number of issues = 498Source : RAM Ratings

Diversified holdings10%

Financial services15%

Mining & petroleum1%Plantation &

agriculture1%

Consumer products1%

Industrial products4%

Construction & engineering

2%

Property & real estate

10%

Transportation1%

Trading & services5%

Infrastructure & utilities

46%

Asset-backed securities

4%

Public Finance0%

Corporate Sukuk Market Issued & Rated by Economic Sectoras at March 2010 (by value)

Total value = RM309 billionSource : RAM Ratings

BBA29%

Murabahah34%

Istisna3%Ijarah

20%

Mudharabah2%

Musharakah11%

Bai Al-Dayn1%

Corporate Sukuk Market Issued & Rated by Financing Contract as at March 2010 (by number of issues)

Total number of issues = 498Source : RAM Ratings

BBA22%

Murabahah27%

Istisna6%

Ijarah7%

Mudharabah1%

Musharakah36%

Bai Al-Dayn1%

Corporate Sukuk Market Issued & Rated by Financing Contract as at March 2010 (by value)

Total value = RM309 billionSource : RAM Ratings

As at end of March 2010, majority of the sukuk issued issued in the market were from the infrastructure and utilities sector

which commands 24% of the total issuances. More than half of the total bonds in terms of number of issues and value from this sector were Shariah-compliant.

For the first quarter of 2010, the number of corporate sukuk issued and rated increased by 50% q-o-q to 3 issuances. Nonetheless the sukuk value declined by 97% to RM840 million for the same period.

Sukuk issued in 1Q10 were only those using Murabahah and Musharakah concept but we believe there will be more sukuk

adopting other contracts that will be issued in the 2nd half of 2010.

29

Market Statistics

Market Statistics

Sukuk Rated By RAM Ratings

AAA21.1%

AA35.3%

A33.8%

BBB5.8%

BB1.5%

B2.2%

C0.4%

D0.0%

RAM Ratings-Rated Sukuk (long-term) as at March 2010 (by number of issues)

Total number of issues = 275

Source : RAM Ratings

AAA44.6%

AA39.5%

A13.9%

BBB0.7%

BB0.2%

B1.1%

C0.1% D

0.0%

RAM Ratings-Rated Sukuk (long-term) as at March 2010 (by value)

Total value = RM241 billionSource : RAM Ratings

P146.4%

P232.1%

P37.1%

NP14.3%

RAM Ratings-Rated Sukuk (short-term) as at March 2010 (by number of issues)

Total number of issues = 28Source : RAM Ratings

P189.7%

P27.8%

P30.5% NP

2.0%

RAM Ratings-Rated Sukuk (short-term) as at March 2010 (by value)

Total value = RM17 billionSource : RAM Ratings

The bulk of long-term sukuk rated by RAM Ratings are assigned AA (35%) and AAA (21%) ratings.

30

Ringgit Sukuk Market Report

Sukuk - Total Traded Amount for the Quarter ended 31 March 2010

Sukuk - Total Sukuk Outstanding (RM mil) by Class: 31 March 2010

Sukuk New Facilities created for the Quarter ended 31-Mar-2010

Facility Code Facility Name Instrument Maturity Date Facility Limit

201000002 NAIM RM500.0M IMTN PROGRAMME MTN 18-Mar-25 500,000,000

201000007 HGSB RM240.0M 10YRS IMTN MTN 30-Mar-20 240,000,000

201000003 NAIM RM100.0M ICP PROGRAMME CP 17-Mar-17 100,000,000

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes.

None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn

Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any

security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this

page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides

no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a particular purpose, accuracy, correctness, non-infringement, timeliness, completeness, or that the information is always up-to-date.

31

Ringgit Sukuk Market Report

Top 10 Sukuk Tender Result for the Quarter ending 31-Mar-2010

Stock Name Issue Date

Maturity Date

Actual Issue Successful

Yield Successful

Price

PROFIT-BASED GII 2/2010 30.09.2015 31-Mar-10 30-Sep-15 3500 3.860 99.999

PROFIT-BASED GII 1/2010 15.07.2013 15-Jan-10 15-Jul-13 3000 3.288 99.998

BNMN-IDM 11/2010 182D 23.09.2010 25-Mar-10 23-Sep-10 1000 2.538 98.750

BNMN-IDM 10/2010 91D 17.06.2010 18-Mar-10 17-Jun-10 1000 2.191 99.457

BNMN-IDM 9/2010 63D 13.05.2010 11-Mar-10 13-May-10 1000 2.161 99.628

BNMN-IDM 5/2010 63D 08.04.2010 4-Feb-10 8-Apr-10 1000 2.157 99.629

BNMN-IDM 2/2010 63D 18.03.2010 14-Jan-10 18-Mar-10 1000 1.877 99.677

BNMN-IDM 12/2010 364D 29.03.2011 30-Mar-10 29-Mar-11 500 2.675 97.402

BNMN-IDM 7/2010 63D 29.04.2010 25-Feb-10 29-Apr-10 500 2.082 99.642

BNMN-IDM 4/2010 91D 29.04.2010 28-Jan-10 29-Apr-10 500 1.989 99.506

10 Most Active Bonds Traded between 01-Jan-2010 and 31-Mar-2010

Stock Name Last Traded Price Last Traded

Yield/Discount Total Volume

Traded Last Qtr

PROFIT-BASED GII 1/2010 15.07.2013 99.49 3.45 4786

PROFIT-BASED GII 1/2007 15.03.2010 100.02 2.17 4180

BNMN-IDM 5/2010 63D 08.04.2010 99.91 2.15 2380

MAYBANK 0% 15.05.2018 101.44 4.50 1860

BNMN-IDM 9/2010 63D 13.05.2010 99.69 2.06 1727

PROFIT-BASED GII 3/2009 30.12.2014 102.1 3.42 1500

PROFIT-BASED GII 2/2010 30.09.2015 99.95 3.87 1411

BNMN-IDM 26/2009 63D 04.03.2010 99.93 2.00 1252

BNMN-IDM 4/2010 91D 29.04.2010 99.69 2.05 1150

BNMN-IDM 3/2010 91D 22.04.2010 99.75 2.05 973

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes.

None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn

Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any

security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this

page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides

no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a particular purpose, accuracy, correctness, non-infringement, timeliness, completeness, or that the information is always up-to-date.

32

Ringgit Sukuk Market Report

YTM Curves as at 31 March 2010

5-YEAR YTM Historical Chart (weekly closing, last 6 months)

Tenure LT Islm-

Gov-GII

LT Islm-

Quasi Gov-Khazanah

LT Islm-

Corporate-AAA

LT Islm-

Corporate-AA2

3m 2.25 2.35 2.52 2.92

6m 2.30 2.40 2.81 3.30

1y 2.50 2.60 3.16 3.84

2y 2.98 3.12 3.59 4.32

3y 3.37 3.44 4.00 4.77

5y 3.82 3.94 4.48 5.29

7y 4.02 4.16 4.89 5.74

10y 4.31 4.50 5.33 6.25

15y 4.53 4.75 5.75 6.71

20y 4.74 5.00 6.17 7.17

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes.

None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn

Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any

security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this

page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides

no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a

particular purpose, accuracy, correctness, non-infringement, timeliness, completeness, or that the information is always up-to-date.

33

Ringgit Sukuk Market Report

YTM Spread (5-YEAR GII) as at 31 March 2010 YTM Matrix – Item Spread Principle: Islamic Date: 31 March 2010

Class1 Class2 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 15Y 20Y

Government GII 2.25 2.3 2.5 2.98 3.37 3.82 4.02 4.31 4.53 4.74

Quasi Government

Khazanah 0.1 0.1 0.1 0.14 0.07 0.12 0.14 0.19 0.22 0.26

Corporate AAA 0.27 0.51 0.66 0.61 0.63 0.66 0.87 1.02 1.22 1.43

Corporate

AA2 0.67 1 1.34 1.34 1.4 1.47 1.72 1.94 2.18 2.43

Information on this page is intended solely for the purpose of providing general information on the Ringgit Bond market and is not intended for trading purposes.

None of the information constitutes a solicitation, offer, opinion, or recommendation by Bond Pricing Agency Malaysia Sdn Bhd (formerly Bondweb Malaysia Sdn

Bhd) (“BPAM”) to buy or sell any security, or to provide legal, tax, accounting, or investment advice or services regarding the profitability or suitability of any

security or investment. Investors are advised to consult their professional investment advisors before making any investment decision. Materials provided on this

page are provided on an "as is" basis, and while care has been taken to ensure the accuracy and reliability of the information provided in this page, BPAM provides

no warranties or representations of any kind, either express or implied, including, but not limited to, warranties of title or implied warranties of fitness for a

particular purpose, accuracy, correctness, non-infringement, timeliness, completeness, or that the information is always up-to-date.