MALAYSIA’S sukuk issuance volume surged almost 68% year-on-year in 2007, charting an all-time high of about RM39.6bil of proceeds from 53 issues. This accounted for 64% of total funds raised from the domestic bond market last year.

A large portion of the proceeds had been used to finance a slew of listed companies’ privatisation exercises and leveraged buy-out schemes – the dominant theme of the Malaysian corporate scene in 2007.

The big boy’s club

Sectorial-wise, the telecommunications sector was the industry leader in 2007, with RM18.4bil of sukuk proceeds raised from 5 issues, accounting for about 46% of the sukuk market.

This is not surprising given that the largest sukuk transaction last year was valued at RM15bil, issued by Binariang GSM Sdn Bhd. The sukuk proceeds had been used to refinance an equivalent bridging loan of RM20bil, which had been initially taken up to fund the buy-out of Malaysia’s leading cellular company, Maxis Communications Bhd.

The remaining outstanding amount under the bridging loan is to be refinanced through a syndicated term loan of up to US$1.5bil.

Binariang’s sukuk programme is not only Malaysia’s largest-ever issuance of Islamic securities; it is also the country’s largest corporate bond issue to date.

It is also reportedly one of the largest Asian (ex-Japan) corporate bond issues. This facility is made up of a RM19bil medium-term notes programme and a RM2bil commercial papers programme (collectively known as the senior sukuk), as well as cumulative non-convertible Islamic Junior sukuk of up to an aggregate nominal value of Ringgit Malaysia equivalent of US$900mil (junior sukuk).

Both the senior and junior sukuk had been issued under the syariah-based principle of musharakah, which is becoming an increasingly popular mode of raising sukuk in the Malaysian bond market.

Another sizeable transaction last year was a RM7.9bil sukuk issue, also by a special funding conduit, Nucleus Avenue (M) Bhd.

Nucleus was incorporated as the funding vehicle for MMC Corp Bhd’s leveraged buy-out of its 22%-held associate, Malakoff Bhd. The latter, an investment-holding company with interests primarily in the power-generation sector, had subsequently been de-listed.

The proceeds from the sukuk had been utilised to partially meet Malakoff’s RM9.3bil price tag, as well as to retire its existing RM1.9bil of debts.

Nucleus’ sukuk programme entails a combination of a RM600mil commercial papers/medium-term notes programme and a RM5.6bil medium-term notes programme (also collectively known as the Senior sukuk) and a RM1.7bil cumulative non-convertible Islamic sukuk (junior sukuk).

Both the senior and junior sukuk had also been issued under the musharakah principle.

Elsewhere, the RM3.6bil sukuk musharakah by the operator of the North-South Expressway, i.e. Projek Lebuhraya Utara-Selatan Bhd (or PLUS, as it is more commonly known), accounted for most of the sukuk originating from the toll-road sector in 2007.

This represents part of PLUS’s debt-replacement exercise for its RM5.1bil Bai Bithaman Ajil Islamic Debt Securities, of which RM3.55bil of nominal value remained outstanding then.

The debt-swap exercise has been designed to enable PLUS’s holding company, PLUS Expressways Bhd, to maintain its syariah-compliant status under the Dow Jones Islamic Market Index.

As one of the key requirements of this international index, PEB is obligated to keep its ratio of total non-Islamic financing instruments against market capitalisation at below 33%.

In anticipation of PEB raising more non-Islamic financing for its foreign ventures in India and Indonesia, PLUS has embarked on this debt-swap exercise to keep this ratio below the permitted level.

Meanwhile, the RM2.1bil sukuk musharakah of Cagamas MBS Bhd was the single largest sukuk offering under the banking and finance sector last year.

Cagamas MBS is a limited-purpose entity that had been specifically incorporated for the purpose of securitising housing loans granted to civil servants, pursuant to the Akta Kumpulanwang Pinjaman Perumahan, or the Housing Loans Fund Act 1971.

This is Cagamas MBS’s second sukuk issue backed by the (Islamic) home loans of public-sector employees.

About credit strength

In 2007, RAM Ratings published the ratings of 25 new corporate sukuk programmes, with an aggregate value of approximately RM57.1bil; about 60% or RM34.4bil of this had already been issued as at the end of last year. This made up close to 90% of the entire market’s RM39.6bil of sukuk issued in 2007.

In terms of credit risk, the AA3 rating bracket had the highest density vis-à-vis RAM Ratings’ sukuk portfolio, skewed by the year’s 2 largest sukuk programmes.

Nucleus’ senior sukuk had been rated AA3/P1 while its junior sukuk had been assigned a long-term rating of A2.

Binariang’s Senior and junior sukuk had similarly been accorded respective AA3/P1 and A2 ratings. All the long-term ratings have a stable outlook.

Meanwhile, the AAA rating bracket encompassed highly rated sukuk issues from PLUS, Cagamas MBS and Hijrah Pertama Bhd (a special-purpose vehicle that is wholly owned by Telekom Malaysia Bhd).

Zooming in on market novelties

The sukuk programmes of both Nucleus and Binariang depict extensive structuring efforts and innovation, and portray similar traits.

As the cornerstone of the issuers’ capital structure, both sukuk programmes represent well thought-out hybrids – debt instruments with equity-like features.

The junior sukuk’s equity-like traits include its long-dated nature (i.e. 50 years), with a 10-year non-call period and a mandatory replacement-capital provision upon the optional redemption or maturity of the junior tranche, deferrable profit distributions (both optional and mandatory), loss absorption vis-à-vis priority of cash flow application and a deeply subordinated right to claim in the event of insolvency.

The replacement-capital provision commits the issuers to only redeeming the junior sukuk via proceeds from the issuance of replacement capital, i.e. securities with obligations that either rank pari passu with or below the Junior sukuk, rather than drawing on its cash coffers or refinancing it with more debt.

Additional comfort is also derived from the more stringent requirement for the replacement capital to possess similar or less superior terms and conditions as those of the junior sukuk.

Best of Both Worlds

The essence of the sukuk hybrid is achieving concurrent treatment as equity for risk-rating purposes, and as debt for tax purposes.

The junior sukuk issues of Binariang and Nucleus possess strong equity characteristics, thus allowing us to afford equity credit, i.e. they are regarded as equity for credit-rating purposes, instantly providing support to the credit rating of the Senior Sukuk.

In both instances, the Junior Sukuk has been rated 2 notches below the corporate (or senior) credit ratings of the issuers, reflecting their deeply subordinated position as well as equity-like traits.

For further information on RAM Ratings’ treatment of hybrid securities, please refer to our methodology paper, Equity credit for corporate hybrid securities.

As the junior sukuk had also been structured as a liability, the profit payments are tax-deductible.

Leading the Pack

In a year of several large and well-executed transactions, the sukuk programmes by Nucleus and Binariang stand out in terms of breaking new ground.

Moreover, they may have well crafted a new blueprint for tackling buy-side concerns, making hybrid sukuk a welcome addition to the Malaysian sukuk market.

(Source: The STAR Online)