M'sian takaful firms ‘outperforming’ Middle East ones

by Habhajan Singh

Malaysian takaful operators have fared better than their Middle East counterparts in terms of returns on equity since 2007 when world economies underwent the global financial crisis stress.

Malaysian takaful companies also came out better than their Gulf Cooperation Council (GCC) counterparts in terms of risk retention, an indication that Malaysia has a more sophisticated operational capability, according to a global study on takaful by Ernst & Young (E&Y).

The study, in E&Y's third annual edition of its World Takaful Report, showed that Malaysian takaful operators also came out better on technical fronts like claims ratio and underwriting income.

On retention, Bank Negara Malaysia's (BNM) Financial Stability and Payment Systems Report 2009 released in March, had noted that the 'consistently high' net retention level of 72.3% for Malaysian general and general takaful business enabled counterparty reinsurance risks to be kept at 'manageable level'.

It added that as a majority of the offshore and foreign reinsurers were reputable and strongly rated companies, it further reduced the extent of counterparty risk during the challenging financial climate in 2009.

Looking at claims ration, the E&Y report said that claims ratio for takaful operators in the GCC - which includes Bahrain, Saudi Arabia, United Arab Emirates (UAE) and Qatar — 'remain significantly higher' than Malaysian takaful operators 'where underwriting practice appears more structured'.

The report also said that underwriting income has consistently contributed to the profitability of the Malaysian operators while the GCC operators traditionally relied on investments.

Among the GCC takaful operators that contributed data to the study's sampling were Bahrain's Takaful International Company and Solidarity Group Holding; Saudi Arabia's Allied Cooperative Insurance Group, Al Ahlia Cooperative Insurance Company and Alahli Takaful Company; UAE's Abu Dhabi National Takaful Company, Dubai Islamic Insurance and Reinsurance Company, Dar Al Takaful; Qatar's Qatar Islamic Insurance Company; and Kuwait's First Takaful Insurance Company, Wethaq Takaful Insurance Company and Gulf Company for Takaful Insurance Malaysia.

Malaysian players involved were CIMB Aviva Takaful Bhd, Hong Leong Tokio Marine Takaful Bhd, Prudential BSN Takaful Bhd, Takaful Ikhlas Sdn Bhd, AIA Takaful International Bhd and Syarikat Takaful Malaysia Bhd. On ROE, the report study showed that both Malaysian and GCC operators were closest in 2007, with GCC operators averaging at 6.2% while Malaysian operators averaged at 5.7%. Before that, GCC players were constantly scoring higher on the ROE score.

However, post-2007 debt debacle and the financial crisis, the Malaysian operators performed better, with an average return of 11.1% in 2008 and 7.6% in 2009, while GCC players were in the negative zone (-5.3% in 2008 and -6.5% in 2009).

When it comes to operating efficiency, the study found that Malaysia has been consistently stronger in its combined ratios to the GCC, 'although the gap is shrinking'. in 2005, Malaysian operators surveyed had averaged at 41.3% to GCC's 130/8%. In 2009, it was Malaysia at 53.3% and GCC at 71.9%.

"Profitability is under unprecedented stress. In the aftermath of the financial crises, takaful operators are coping with depressed capital levels, distressed asset values and difficult capital markets," E&Y said in a statement when the report was released.

(This story appeared in The Malaysian Reserve on 26 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)

Takaful in each region ‘faces unique challenges’

by Habhajan Singh

Takaful in the Gulf Cooperation Council (GCC) and Malaysia are at very different stages of development with each region facing unique challenges, said a global study on takaful by Ernst & Young (E&Y).

The World Takaful Report report, based on a combination of quantitative data and qualitative comments, had made some observations on areas like on efficiency operations, quality of underwritten business and ensuring investment discipline.

On efficiency operations, the report said most takaful operators have yet to achieve critical business volume, despite incurring substantial establishment costs over the years. Also, players have combined ratio is much higher than conventional peers while service quality remains sub optimal for many operators.

It made some recommendations on lowering cost of operation, which included targeting economies of scale and scope through organic and inorganic growth; articulate cost strategy for customer acquisition, servicing and retention; improve loss ratios through changed business mix and better claims management; and consider shared service arrangement for back office operations.

On risk retention, it noted that Malaysian takaful operators, on the average operators cede between 5%-15% of gross premiums to retakaful entities while retaining a larger proportion of business on their books and converting this into better technical results.
"This strategy requires greater underwriting competence and track record (using historical data) to build a quality book," it noted. On the other hand, GCC operators on average cede between 30%-50% of gross premiums to retakaful companies, which reduces their ability to generate potentially positive underwriting results, and that the broking approach causes excessive reliance on investment returns to generate profitability.
On technical results, Malaysian operators' average claims ratio of between 25%-35% is reflective of stronger underwriting discipline and diversified business.
"Strong underwriting results allow operators to benefit from a larger participants pool and ability to re-distribute surplus, generating strong customer c onfidence. Underwriting results account for the majority of overall profitability," it said.

On the GCC front, the higher average claims ratio of between 40%-60% can be improved through stronger underwriting competence.
"As historical data becomes more readily available, operators should strive to build cleaner books of diversified business. Weak technical results have led operators to become heavily reliant upon investment income, that are volatile, to achieve shareholder expectations," the report noted.
The report noted that global takaful contributions grew 29% in 2008 to reach US$5.3 billion (RM16.9 billion) and remain on course to surpass US$8.9 billion (RM28.38 billion) by 2010.
"Strong growth in health takaful in GCC, and family takaful in Malaysia are two noteworthy trends that have delivered growth for many operators. Government safety nets are being reduced providing new opportunities to offer product solutions in these respective business lines," E&Y said in a press release when announcing the report.
Saudi Arabia, with contributions totalling US$2.9 billion in 2008, and Malaysia with US$900 million are the top two takaful markets in the world. Sudan is the most significant market outside of the GCC and South-East Asia, with contributions totalling US$280 million in 2008, it said.

(This story appeared in The Malaysian Reserve on 26 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)

Bar Council calls for ‘third party’ committee

The Malaysian Bar Council, which is opposing a Bank Negara initiative to revamp the motor insurance sector, is calling for the central bank to set up a cross-industry working committee to review feedback from all parties before implementing a scheme that would limit the liability of motor insurers to third party claimants to RM2 million.
The move by Bank Negara is in line with the government's aim of ensuring access for motorists to the mandatory third party bodily injury and death insurance coverage that is reportedly a longstanding grouse of motor insurance underwriters. According to reports, citing central bank data, losses from such third party motor policies are estimated at about RM1 billion annually.
Bank Negara was said to be considering the RM2 million cap but had yet to finalise the capping level. Speaking at a media briefing in Kuala Lumpur yesterday, Bar Council president Ragunath Kesavan said the proposals by Bank Negara, which it outlined to the council in a dialogue on Monday (Apr 19), could not be agreed upon by just conducting dialogues with concerned stakeholders.
"There should be proper, true consultations. There has to be a working committee, and not a one-off dialogues, to look at the issues. It seems to be a huge transformation with very little thoughtthrough process, with minimal consultation and it all seems to lead to one direction, profitability of the insurance companies," he said.

Under the scheme being proposed by Bank Negara, a newco would be established to manage the new scheme with the government holding a majority stake in this new entity.
Ragunath said the formation of the newco would be expensive at the onset as there was a need to set up a nationwide infrastructure and network, which would ultimately be paid for by the tax payers.
"What we're saying is to look (and make) use of the current system (in place). The cost of setting up a parallel system will be very high. The solution is to maintain the current system, no caps, and look at where the losses are (occuring) and address those issues.
"If it's inevitable that there is a need to increase premiums, then do it gradually. The tariffs have not been increased since 1978. What has the regulator being doing for the last 30 years? What about periodical reviews? Why hasn't it been done? You don't need a 300% increase in premium, you can do (an annual) 10% increase over the next four years, or look at the comprehensive sector and use it to subsidise the poorer sector," he added.

Asked whether the Bar Council could get Bank Negara to backtrack, Ragunath said, "It's an uphill battle. I don't think it's going to be easy. The only way to resolve this is if there's a public outcry. We need the support of the public otherwise it's an extremely uphill battle."
"We're commited to working with the various indsutry groups, hosting road shows, spoken to members of Parliament and we want to escalate awareness of this issue. We want public participation of this issue. We're committed to ensure that the public interest is protected.
"We can only do what it's right. We will keep pushing and maintain our campaign. It's about time to have transparency in the industry and such issues need to be looked at. We don't this to be a burden to the people. That's the crux of what we're trying to say," he added.

(The Malaysian Reserve, Jan 24, 2010, Page 1)

Affin eyes Islamic finance foray

Affin Bank Bhd will work with its parent company to convert PT Ina Perdana into a syariah bank once the purchase of the Indonesian lender is concluded, as the group expands into the populous Muslim country, reports Business Times.
"Our holding company is looking at it, it will acquire the bank and then we will work together to convert it into an Islamic bank. It is now a conventional lender," Affin Bank managing director Datuk Zulkiflee Abbas Abdul Hamid told the business section of NST in an interview in Kuala Lumpur.

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The legal and financial due diligence have been done recently.
Affin Holdings Bhd, the bank's parent, in January said it was granted the regulatory approval to start negotiating for a controlling stake in PT Bank Ina Perdana, making Indonesia its first overseas venture.
The group's deputy chairman Tan Sri Lodin Wok Kamaruddin told reporters this month that he hopes the purchase will be concluded by the third quarter this year.
PT Bank Ina Perdana is a tiny lender in Indonesia's fragmented market, which has 121 commercial banks. It operates about 20 branches, most of them in Jakarta.
Despite its small size, Zulkiflee said the bank is profitable with relatively low non-performing loans. Most of PT Bank Ina Perdana's business comes from consumer banking, like car loans, while business banking only takes up a small portion of its portfolio.
The purchase will give Affin Holdings a toehold in Indonesia, and it will slowly grow from there, he added.
"We are of the view that, if we want to go (into Indonesia), this is the time for us to go. There are not too many Islamic banks in Indonesia considering its big population. Islamic finance is still in the early stage of development as compared to Malaysia, so there is vast potential for growth," he said.
With a population of 230 million and a fast growing economy, Indonesian banks have been a highly sought after asset. Global banks in the likes of HSBC plc, have all scrambled to get a slice of the market there.
Malayan Banking Bhd, Malaysia's top lender, had paid hefty premiums to buy Bank Internasional Indonesia two years ago, while CIMB Group Holdings Bhd also has a major presence there through CIMB Niaga. RHB Capital Bhd recently bought into PT Bank Mestika Dharma.
Indonesia aside, Zulkiflee said Affin is not eyeing expansion into other countries yet, and it wants to strengthen its operations back home for now.
"True, people say that the Malaysian market is saturated, but we think there are still pockets of opportunity. The big banks probably must go out, otherwise not sexy. But for us, I don't think we should follow them yet."
He said although the net interest margin (NIM) has been narrowing for Malaysian banks over the years, it is still decent at around 2 per cent to 2.5 per cent. Affin Bank's NIM stood at 2.57 per cent last year, improving slightly from 2.46 per cent in 2008.
This year, Affin Bank will hire more sales people to help grow loans by the targeted 13 per cent to 15 per cent. It is eyeing a deposit growth of 10 per cent this year.
Affin Bank will also beef up the branches to let every walk-in customer feel like a premier guest, no matter how much a customer is banking with it. It plans to put more branches within the city and create some flagship outlets in certain locations, overall adding between five and 10 more to the existing 90 branches.
The bank, which has significantly expanded its business banking in the past two to three years, also wants to increase the number of business centres to cover all the major cities.
Last year, the bank's profit after tax fell 4.1 per cent to RM317.8 million, even as operating profit was 17 per cent higher at RM614.1 million.
"Our business has grown. The profit after tax was lower because we had a lot more (loan) recoveries in the previous year," Zulkiflee explained. Loans grew at 12.7 per cent last year, slightly slower than the 15.8 per cent growth in the previous year.
Net NPL has fallen to 2.36 per cent, from 3.22 per cent at the end in 2008. Its return on equity (ROE), which measures how efficient profits are being reinvested, came in at 11.4 per cent.
This year, he said, the bank is targeting a ROE of 12 per cent to 13 per cent.

High Court says BBA rebates ‘must be granted’

by Habhajan Singh

Islamic banks 'must grant' a rebate even if the Bai Bithaman Ajil (BBA) contract is silent on the issue when a default occurs, ruled a recent High Court judgment.

The judgment, in four BBA cases heard together by High Court Judge Datuk Rohana Yusuf, brings to the fore an issue that has been a bone of contention for consumers making avail of Islamic home financing as Islamic banks deem rebate, or ibrar as it is known in Arabic, as discretionary. Consumers, on the other hand, would want more certainty in that matter.

"In doing so, the bank should not be allowed to enrich itself with an amount which is not due while at the same time taking cognisance of the customer’s right to redeem his property.

"Therefore where the BBA contract is silent on issue of rebate or the quantum of rebate, by implied term I hold that the bank must grant a rebate and such rebate shall be the amount of unearned profit as practiced by Islamic banks," she wrote in a 29-page judgment dated Jan 28 in Bank Islam Malaysia Bhd v Azhar Bin Osman, and three other cases. She also noted that legal documentations used by Islamic banks in financing should specify a formula for rebate, which at the moment is loosely attached to the principle loan agreement and whose implementation is very much left to bank's discretion.

In the judgment, Rohana touched on the issues of ibrar and the quantum that banks can claim in an event of a default, two areas that have seen some debate and discussion from the Shariah perspective.

"If the documents of the banks had in fact specified a formula of rebate or ibrar, it will demystify the intricacies of a BBA transaction. It will be easily understood by the customer who would then not be put in the dark as to what is ibrar and what would be the amount of ibrar he should be receiving," she said.

The judgment seems to suggest that Rohana has taken a different tack from a recent Court of Appeal decision on a bundle of BBA contract cases which originated from the much publicised April 2008 decision by High Court Judge Datuk Abdul Wahab Patail, while maintaining that she is still within the bounds of what constitutes a binding decision from the higher courts.

"This is quite a departure form some of her earlier judgments," said lawyer Mohamad Illiayas Seyed Ibrahim who has dealt extensively in Islamic finance cases.

Ibrar, one of the two issues at the heart of this judgment, means surrendering one’s right of claim over debt either partially or in full, according to the definition from a published document by Bank Negara Malaysia (BNM) which regulates Islamic finance outfits.

Ibrar had been a bone of contention with consumers as banks generally do not give them a specific guarantee that they are entitled to a rebate should their loan end prematurely, either due to early payment or a default.

The path pursued by Rohana, in this judgment, seems to push local Islamic banks to insert the ibrar clause explicitly into their financing documents, thus bringing about certainty to the issue of rebate and also streamlining the practice with what is already approved by BNM's Shariah Advisory Council (SAC).

Rohana ruled that "when an Islamic bank practices granting of rebate on a premature termination, it creates an implied term and legitimate expectation on the part of the customer. Accordingly it is only proper that such expectation and practice be read into the contract."

The central bank's SAC — which has the last say on matters pertaining to Shariah in Islamic finance as further reinforced in newly promulgated central bank regulations — had resolved in 2002 that 'Islamic banking institution may incorporate the clause on undertaking to provide ibra’ to customers who make early settlement in the Islamic financing agreement on the basis of public interest (maslahah)'.

The four cases in this judgement came from two sets of appeal before the Court of Appeal relating to BBA contracts in Islamic banking. The plaintiff in all the four cases was Bank Islam Malaysia Bhd (BIMB) who were represented by Oommen Koshy from Skrine & Co and Aedyla Bokari from Nassir Hafiz Nazri & Rahim.

In the first set involving 12 cases heard together, the Court of Appeal had decided on Aug 26, 2009 [Bank Islam Malaysia Berhad v Lim Kok Hoe & Anor and Other Appeals] that a BBA contract is valid and enforceable, thus reversing an earlier decision of the High Court in Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors.

The Taman Ihsan Jaya case made headlines when Abdul Wahab had ruled that the widely used BBA contracts were contrary to Malaysia’s Islamic banking regulations. The Malaysian Reserve first broke that story on Sept 8, 2008.

(This story appeared in The Malaysian Reserve on 19 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)

Bai Bithaman Ajil contract challenged by High Court

By Habhajan Singh

The practice of Islamic banks making a claim for the full sale price in an event of a default of a home financing based on Bai Bithaman Ajil (BBA) contract has been challenged in a recent decision of the High Court.

In a collective judgment for four BBA cases, High Court Judge Datuk Rohana Yusuf (picture) noted the arguments by Bank Islam Malaysia Bhd (BIMB), the plaintiff in all four cases, is that a BBA contract gives the bank a legal right to claim for the full sale price as stipulated in the property sale agreement (PSA).

In her judgment, Rohana noted that the bank's first argument is that the court should honour and enforce the clear written terms of the contract and should not interfere with the intention of parties by imputing any other term. Since parties had agreed as to the amount of sale price as stipulated in the PSA, the defendant is under a legal obligation to pay the full sale price, irrespective of when a breach occurs.

Second, by virtue of the doctrine of stare decisis, the court is bound by the decision of the Court of Appeal in Lim Kok Hoe which, according to Oommen, upheld and acknowledged the obligation to pay the full sale price under the PSA.

"After a careful scrutiny of the cases I find that none of the decisions has established the ratio decidendi suggested," she wrote. Stare decisis literally means "to stand by things decided" and is a legal maxim which underlay the basis of the doctrine of binding precedent, with the lower courts having to abide by former precedent by higher courts.

Ratio decidendi of a case can be defined as the principle of law on which the court reaches its decision. On the point of lack of binding precedent, some lawyers contacted by The Malaysian Reserve believe that the argument is not on solid grounds and is open for challenge. In her judgment, Rohana said that there are 'no binding precedent by the Superior Court for me to follow to enforce the sale price under the PSA at all costs'.

"In fact to my mind, it is apparent from Lim Kok Hoe’s decision that the reference made by the Court of Appeal to all these cases is to reinforce its decision in upholding the validity and enforceability of BBA contracts."

This is clear at page 39 of the judgment when the Court of Appeal states that "it is clear that the validity and enforceability of BBA contract had been ruled by the Superior Courts".

"Hence applying the doctrine of stare decisive, it is binding on Court of Appeal in Lim Kok Hoe to follow the Superior Court. I am not able to find any affirmation on the quantum to be enforced in a BBA contract by the Superior Court," she wrote.

Bank Islam Malaysia Berhad v Lim Kok Hoe & Anor and Other Appeals was decided by the Court of Appeal on Aug 26, 2009, reversing an earlier decision of the High Court in Arab-Malaysian Finance Bhd v Taman Ihsan Jaya Sdn Bhd & Ors.

"I must vehemently stress that the purpose of this proceeding is to deal with what would be considered fair and equitable in the circumstances and to lay emphasis on what would be the better and appropriate approach in dealing with the plaintiff’s quantum with particular reference to the manner of its determination while being mindful of the parties’ position," she wrote.

(This story appeared in The Malaysian Reserve on 19 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)

Dubai World to offer 1% interest on restructured loans

Dubai World, the state-owned holding company restructuring US$24.8 billion (RM79.17 billion) of debt, is offering to pay creditors 1% interest on new loans as part of a restructuring plan, according to a banker familiar with the plan, reports Bloomberg.

Banks are reluctant to accept the new rate presented on March 25 as it is lower than the market rate of about 5% and would force Dubai World’s creditors to book impairment provisions, two bankers said, declining to be identified because the talks are private. Provisions could vary from 5% to 20% of the loan value depending on how the transaction is structured, they said. Reuters reported the 1% interest rate on the new loans earlier yesterday. A spokesman for Dubai World declined to comment. He repeated comments made by Dubai World chief restructuring officer Aidan Birkett in March that the company did not expect the fundamentals of the restructuring proposal to change and that the negotiations could take months.

Malaysia’s Senai-Desaru to Restructure Islamic Bonds

Malaysia’s Senai-Desaru Expressway Bhd plans to restructure RM1.46 billion (US$457 million) of Shariah-compliant bonds to avoid becoming the country’s biggest Islamic-debt defaulter in more than two years. The toll-road operator may seek to reschedule repayments or refinance, Chief Executive Officer Mustaza Salim said in an interview yesterday in Kuala Lumpur, reports Bloomberg (April 16, 2010).

RAM Holdings Bhd., one of two credit-rating agencies in Malaysia, cut the company’s long- term rating last week to C1 from AA3, citing a “high likelihood of default” when its first principal payment falls due in December 2011. The company is seeking to avoid the country’s biggest sukuk failure since a 2 billion ringgit default by Sistem Lingkaran Lebuhraya Kajang Sdn Bhd in August 2007, the rating company’s data shows. RAM’s report said traffic on the highway, which opened in Malaysia’s southern state of Johor in October 2009, is less than 10 percent of what was projected, it adfded.

"Their traffic volumes are low due to delays in the completion of the highway,” which undermines the company’s ability to generate cash, Yean Ni Ven, a RAM analyst based in Kuala Lumpur told the newswire.

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Senai-Desaru’s June 2015 and December 2020 bonds haven’t traded since 2007, according to Ambank Bhd. in Kuala Lumpur, which said the notes would yield 39 percent and 44 percent, respectively. When last traded in 2007, they yielded 5.91 percent and 6.9 percent, Ambank said.
Senai-Desaru sold the sukuk maturing in six to 15 years in 2005 to help fund a 77-kilometer toll highway, the third-longest in the country after the 848-kilometer North-South Highway and the 169-kilometer East Coast link.
The company will present an initial restructuring proposal to bondholders this month with a final plan to be ready by the end of May, CEO Mustaza said. “At the moment, it’s still too early to talk about details,” he said.
Traffic volume on the expressway has “improved,” Mustaza said, without elaborating. Senai-Desaru is a privately run company 70 percent owned by Rancak Bistari Sdn., with the rest held by YPJ Holdings Bhd.
Shariah-compliant bonds follow Islamic principles, which forbid the payment of interest and stipulate agreements be based on the transfer of goods or services. In Senai-Desaru’s case, the contract is backed by revenue from the toll roads.
Bond Defaults
Islamic bond defaults in Malaysia reached 176 million ringgit in the first four months of this year, 65 percent of the total in 2009 when the country suffered its first recession in a decade. Malaysian Merchant Marine Bhd. and Evermaster Group Bhd. were among the domestic companies that defaulted on Islamic debt this year, stock exchange filings showed.
This won’t deter interest in Shariah-compliant finance, said Badlisyah Abdul Ghani, head of Islamic-banking operations at CIMB Group Holdings Bhd., last year’s top global underwriter for Islamic bonds or sukuks. Global Islamic bond sales may climb 24 percent this year from $20.2 billion in 2009 as the global economy recovers, Kuala Lumpur-based Badlisyah said.
The world’s biggest sukuk defaulter in the past year is Saad Trading, Contracting & Financial Services Co., owned by Saudi billionaire Maan al-Sanea and his family, which missed payments on its $650 million Islamic bonds in November.
“Islamic debt default is a credit issue,” said Zakariya Othman, head of Islamic finance at RAM in Kuala Lumpur. “It’s got nothing to do with the structure. You can’t say, for example, when someone defaults on his mortgage that it’s because of the structure of the loan.”
The toll-road operator issued the bonds in December 2005, which have maturities ranging from six years to 18.5 years, with an annual profit-sharing rate of 3.5 percent.
Kuala Lumpur-listed builder Ranhill Bhd. holds convertible bonds in the toll-road operator that could be exchanged into shares equivalent to a 50 percent stake, according to Senai- Desaru’s bond prospectus. Ranhill’s Chief Financial Officer Amran Awaluddin wasn’t immediately available to comment.
Senai-Desaru holds the concession to operate the 77- kilometer highway for 33 years. It is the third-longest highway project awarded by the Malaysian government, according to the company’s Web site.

Economist: Sukuk it up

There was a time when proponents of Islamic finance sniffed opportunity in the crisis. The problems of speculative, casino-like Western banks contrasted nicely with the emphasis that sharia-compliant finance places on an ethical, risk-sharing approach. But risk-sharing looks much less appealing when issuers are defaulting, writes The Economist (Apr 15th 2010, print edition).

The report said that Dubai’s debt problems badly shook investors in sukuk, a type of Islamic bond, issued by Nakheel, a troubled property developer.

Although a restructuring deal announced last month should ensure that Nakheel’s bondholders will now be paid back on schedule, the saga is bound to have damaged confidence. Three other sukuk issuers have defaulted in recent months: East Cameron Partners, an American oil and gas producer; Investment Dar, a Kuwaiti investment firm; and Saad Group, a Saudi conglomerate, it said.

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Islamic finance’s fans insist that this does not represent a crisis. They say that the individual issuers are at fault, not the products. Dubai’s state-backed firms ran up too much debt. East Cameron was a poor credit risk from the start, with a CCC+ rating at the time the bond was issued. Investment Dar was too reliant on short-term debt, they argue, and the Saad Group is at the centre of fraud allegations.

Even so, the prospect of losses has forced creditors to think about some of the uncertainties surrounding Islamic default. One issue is enforceability: many sukuk contracts are governed by English law but refer to assets located in the Gulf. Another is the spectre of “sharia risk”. Investment Dar is wrangling over the repayment of a separate type of debt to Blom Bank, a Lebanese bank, on the grounds that the transaction was not sharia-compliant; an English court surprised many by ruling that the firm had an “arguable case”.

Lawyers point out that these problems are, again, not unique to Islamic finance. Enforceability is an issue in any cross-border transaction. The objection that a counterparty lacks the legal capacity to do a deal is not unknown in conventional finance (though defining what is sharia-compliant is a tricky task).

Much more damaging is widespread confusion among sukuk investors about the sorts of risks they were really taking on. A sukuk is structured to avoid the Islamic prohibition on interest payments. It manages this by paying bondholders with the cashflows generated by specific assets, which are put into a special-purpose vehicle (SPV) as part of the deal. Many seem to have thought that the bonds were “asset-backed”, giving them a claim on the assets in the event of a default. Most sukuk, however, are “asset-based”, handing investors ownership of the cashflows but not of the assets themselves. “Many sukuk holders have a perception that they hold a security that is collateralised,” says Anouar Hassoune of Moody’s, a rating agency. “In 90% of cases, that is incorrect.”

A bit more scrutiny could have helped investors work this out for themselves. If assets are not really being sold to the SPV, they do not move off the issuer’s balance-sheet. But lenders will demand greater clarity in future, which points to a bigger problem for Islamic finance than any source of legal uncertainty: it is likely to get more expensive.

The bulk of the sukuk issued so far have not been rated. International investors, at least, are unlikely to stand for that in future, which will make life dearer for issuers that are below investment grade. The illiquidity of the sukuk market will probably incur a greater premium in future. Investors in occasional asset-backed deals will be more focused on where the assets are physically located. Holders of more common, asset-based sukuk are likely to demand a bigger excess spread between the cash flowing into the SPV and the cash flowing out of it to them: the bigger this “reserve account”, the greater the buffer protecting investors. Risk is central to Islamic finance. Now it is going to get properly priced.

EU woes laughable: Islamic finance chief

BRUSSELS: Muslim nations are “laughing” at European efforts to grapple with a debilitating debt crisis in Greece, which has serious ramifications for the world’s biggest open market, the head of the World Islamic Economic Forum has said.
Former Malaysian deputy prime minister Tun Musa Hitam spoke to AFP in Brussels as European Union plans for a backstop bailout enabling Athens to refinance tens of billions of euros of debt repayments and budget commitments were being thrashed out among eurozone officials.
“Seen from the east, from developing countries, we’re laughing because they’re not doing what they taught us,” Tun Musa said of the EU’s decision to protect Greece rather than sending Athens to the International Monetary Fund.
“You find that a European nation has adopted anything but good practice, which has resulted in a disaster (and) now the name and the prestige of the European Union is at stake, but more importantly, its economies,” he added.
“The normal way of resolving these issues is to go to the IMF. Developing countries do that, but not the EU.
“It’s yes, no, maybe every day,” he said.

Tun Musa was speaking before eurozone finance ministers agreed last Sunday to pump some 30 billion euros (41 billion dollars) into Greece’s coffers this year if necessary — at below-market rates of around five per cent interest.
But in the aftermath of the accord doubts have emerged as to the readiness and scale of the financial aid, with a series of political hurdles still to be crossed before these monies can ever be handed over.
And within no time, new nationwide strikes had pushed Greek borrowing rates back through the pain barrier.
With parallel EU negotiations with the IMF under way on its involvement, and 15 billion euros of loans anticipated in 2010 from Washington, Tun Musa maintained that the Western system where “anything goes in terms of lending and conduct” lay behind the Greek fiscal disaster.
The missing ingredients of “responsibility, transparency and accountability,” glaringly absent throughout fraudulent Greek reporting to the EU, were instead to be found in Islamic finance, he argued.
“The methodology of Islamic banking will become more acceptable, even without being in Islam,” he said.
He cited a surge in the numbers of specialist economic religious ulama, who re-interpret Sharia law for expansion throughout non-Islamic territories.
Sharia prohibits interest on money and re-distributes added value based on goods not paper.
Ironically, Moody’s Investors Service said earlier this month that the Islamic finance industry had a market potential of at least 5.0 trillion dollars — more than five times its actual 2009 value.

Motor insurance needs an overhaul

By Habhajan Singh

[The Malaysian Reserve on June 15, 2009]

Motor insurance in Malaysia requires a serious overhaul, with the perennially unprofitable third party coverage demanding a separate treatment altogether, says a senior industry executive.

The issue has come to a boil for general insurers and takaful providers active in the motoring sector, with most of them now no longer providing third party motor insurance coverage due to the high claims ratio.

"I'm proposing a rethink of our Road Transport Act 1987 and a review of the motor insurance policy. A new government agency should be set up to handle at least the Act cover, while redesigned insurance policies should only cover one's own damage, leaving third party claims to the agency. An industry pool could provide base underwriting," said Datuk Syed Moheeb Syed Kamarulzaman, the newly appointed chairman of the Malaysian Takaful Association (MTA).

Under this proposal, a new industry pool would be setup to manage third party made compulsory by the Act, commonly referred to as the Act cover.

Here, Syed Moheeb proposes that each vehicle licensed holder should contribute individually to the pool. Currently, third party insurance is pegged to the vehicle, irrespective of the number of drivers nor the name it is insured under. A family car may be insured under the head of the family, when in fact it could be driven by all children. This could result in a situation of inadequate premium against the risks exposed.

The suggestion by the seasoned insurer is for everyone with a valid licence to bear a portion of the risk.
"When you pay for your motor licence, a portion automatically goes to cover third party claims. This way, the third party risk is automatically handled by the new pool," said Syed Moheeb who is also the president and chief executive officer of Takaful Ikhlas Sdn Bhd.

This would also mean insurers and takaful operators will only provide coverage for claims other than those mandated under the Act.
The pool could replace the Malaysian Motor Insurance Pool (MMIP), a high-risk insurance pool run collectively by the industry under orders from the regulators, which acts as the insurer of last resort.
Under the present set-up, when a vehicle owner is unable to get any insurer to provide him liability cover for third party, MMIP would step in to provide the cover, at a rate higher than what insurers are allowed to charge. Industry players have been lobbying for years to change the tariff-driven premium structure for motor insurance, claiming that providing coverage mandatory under the Act is almost a sure loss-making proposition.
The move has not yielded results thus far, industry executives said.
"So far, we have been looking at tweaking insurance premiums rather than changing the whole structure. Perenially, we have a problem of inadequate premiums to pay for the increasing third party claims.
"This year, several insurers have found it difficult to continue writing third party risks. So, if we want different results, we need to do things differently. We need to reengineer. This suggestion, if it happens, will be headed by a new body supported by the government," said Syed Moheeb.
Syed Moheeb, a seasoned insurer with experience in reinsurance, was involved some years ago when the general insurance association, Persatuan Insurans Am Malaysia (Piam), was actively discussing with Bank Negara Malaysia (BNM) suggested changes to the motor insurance premium tariffs.
In the meantime, industry executives said writing third party motor cover had become more and more untenable from the profit standpoint, forcing players to steer clear of the segment.

On May 27, The Malaysian Reserve reported that insurance companies are no longer willing to provide third party motor insurance under their banner, thus sending their customers to the highrisk insurance pool instead.
On June 1, this newspaper also reported that Pacific & Orient Insurance Co Bhd (P&O Insurance), one of the local top guns in motor insurance, was set to pull out completely from the third party motor insurance segment, following the trend of other insurance providers in Malaysia who have stayed clear of the sector.
The general insurer, a subsidiary of listed Pacific & Orient Bhd (P&O), was second only to Kurnia Insurans (M) Bhd for underwriting third party motor insurance covers in 2008.

From latest figures released, Piam said combined loss ratios for the motor insurance business in 2007 and 2008 stood at 114% and 115% respectively. It said insurers have also expressed their concerns over the rapidly increasing claims pay-outs especially for third party bodily injury claims. The claims ratio for third party bodily injury claims skyrocketed to 262% in 2007 and 288% in 2008, it added.
Industry sources estimate that the standalone motor 'Act' insurance, which is the portion compulsory for all motorists, has generated gross premiums of close to RM600 million last year, with Kurnia Insurans and P&O Insurance conducting close to half of the industry's total.
The motor 'Act' insurance policy provides protection against death and injury to third parties. The third party motor insurance also provides protection against other legal liabilities such as damage to the property of a third party (usually somebody else's car or motorcycle or a neighbour's gate) and certain specified legal costs.
Under the third party cover, a policyholder may opt to include protection for loss or damage to his own vehicle due to fire or theft only.

(This story appeared in The Malaysian Reserve on June 15, 2009. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur)

Shariah-compliant equity-based financing needed for Islamic home loans

Islamic home loan consumers stand to lose out to those using conventional equivalents in the event of a default/early settlement and the adoption of Shariah-compliant equity-based financing could be the solution, said an economist from International Islamic University Malaysia (IIUM).
Due to the structure of the Islamic home financing system, in comparison with the conventional equivalent, consumers of such products were at a disadvantage, said Dr Ahamed Kameel Mydin Meera, an associate professor at IIUM department of business administration, kulliyyah of economics and management sciences.
"It's not the problem of Islamic loan concepts like bai bithaman ajil (BBA) but in the way it's implemented in the present monetary system makes it problematic. If you take Islamic financing, in the case of defaults, you will owe more," he said in presentation at the contemporary issues in Islamic home, personal and auto finance conference in Kuala Lumpur last Friday.
Ahamed Kameel had earlier shown that his calculations indicated that, when compared to standard conventional home financing products, users of Islamic home loans stood to pay much more if they defaulted or settled earlier than the previously agreed upon repayment tenure.
"Early settlements are common. Studies have shown that people move from a home to another home within ten years due to a variety of factors. This will mean that you'd want to sell up the house and move on to another one. Those taking Islamic financing, again, will be at a disadvantage because you will owe more than those taking conventional financing," he said.
As a result of the global financial crisis, more and more people are expected to default on their mortgage.
"If you can get hold of banking statistics, I'm sure you can observe this. The statistics will show that more and more people will default simply because there's less money circulating. This is why we need to have some solutions in place before you see a lot of people out there frustrated by the end of the year," he said.

Speaking to reporters later, Ahamed Kameel posed the question if the defaults in Islamic home financing rise gradually.
"The defaults will be both for Islamic and conventional because of the macro-economic system that is imposing on customers. But the issue is those who default on the Islamic system will tend to owe more. The Islamic system is a safe contract, this means that profit is capitalised upfront.
Even if you pay back, say for a 20 year loan, after ten years, the profit for the remaining ten years is still due.
"But, for conventional, the loan balance is always lower than original loan taken because you don't need to pay interest for the remaining ten years," he said.
Asked whether there were already existing guidelines to protect Islamic home financing consumers, Ahamed Kameel said: "Right now, as you know, there are a few cases in the courts and similar things will happen. That is the reason why we're holding this conference, to come out with proper, standard procedures to solve these kinds of issues.
"How to make Islamic home financing attractive then? You need to make it more equitybased. The musharakah mutanaqisah is a very promising alternative but you have to make it exactly as it is, which means you use a rental rate rather than an interest rate. I believe this is the way to go."

(This story appeared in The Malaysian Reserve on 5 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)

Islamic finance players urged to explore equity-based financing

Islamic finance players should explore opportunities in equity-based financing in making the industry more attractive. Making this call, Bank Negara Malaysia's assistant governor Datuk Muhammad Ibrahim (picture) said through equity-based financing, industry players could move away from mimicking conventional products and operate truly on Shariah compliance.
He said in terms of risk assessment, such transactions will necessary inject greater market discipline among industry players.
"This business model is premised on a few fundamental assumptions. The bank and its staff will have to be good at risk assessment, due diligence, assets valuation, good at project financing and management, a good landlord, skilful in project monitoring and have the necessary expertise on specific areas such as construction, agriculture and manufacturing," he said.
He was speaking at the opening ceremony of a conference in Kuala Lumpur on Friday on contemporary issues in Islamic home, personal and auto financing.

Muhammad said the shift from asset-based financing to equity-based financing however did not mean Islamic banks would operate without any risks.
Islamic banking should be the conduit for the financing model if the business climate is good. If the environment in certain sectors decline significantly, it could adversely impact Islamic finance, he said.
Muhammad also said a shift from debt-based financing to equity-based financial system would not necessarily lead to a better equitable outcome to society. If it is not properly implemented, it could cause uneven benefits to various stakeholders, he explained.
Equity-based financing in Islamic model is based on the sharing of business risks, as well as rewards by the bank and its client. Both parties would have to contribute for the basic ingredients of a business venture such as capital, management, know-how, labour, and other related professional attributes.
Profits are distributed based on an agreed-profit distribution ratio while losses are prorated to each party’s capital participation. Equity financing is cemented by entering in either one of two contracts, namely a partnership contract and a trust financing contract. — Bernama

(The Malaysian Reserve, 5 April, 2010)

Danajamin: The new kid on the block

Comment: Habhajan Singh

There is discontent among investment bankers when you talk about Danajamin Nasional Bhd. The new kid on the block, they argue, is competing head-on with them.
Instead of boosting the capacity of corporations with a slightly less than desirable financial position to enter the bond market, the financial guarantee insurer is in the fray to capture a slice of the business, themselves.
Investment bankers complaint that Danajamin is talking to corporations with enough financial firepower to go into the bond market unaided. In other words, they claim the new outfit is literraly sweeping clients from under their feet. This was evident looking at Danajamin's first client since it was established on May 15, 2009, with the aim of introducing financial-guarantee insurance, touted as a unique form of credit enhancement for private debt securities in the Malaysian bond market.
Without any fanfare, but a mere press release, Danajamin a fortnight ago revealed that its first credit enhanced debt guarantee went to Kencana Petroleum Bhd for a RM250 million sukuk issuance. Under the agreement, Danajamin will provide an al-kafalah guarantee for Kencana’s seven-year sukuk mudharabah medium term note programme.
The Danajamin backing gave Kencana issue a AAA rating. Anyone with Danajamin's backing would get that. You could hear some investment bankers screaming. How did public-listed Kencana find its way into Dajamanin's list? Surely, they argued, Kencana is able enough to enter the bond market on its steam, or make avail of the other avenues for raising funds.

The very idea of having Danajamin is to help firms who may have some trouble, on their own, to raise bonds one or two notches below.
While investment bankers are every hungry for deals, they have a point here. Does helping companies like Kencana the very reason for Danajamin's birth?
When releasing the 2009 annual report, Bank Negara Malaysia (BNM) had said that easing of monetary policy was complemented by other measures designed to reach specific sectors of the economy.
"Ensuring continued access to financing was a key policy priority," it said in its press release. Here, it said that BNM and the Government had implemented several measures, including the setting up of several special funds for the small and medium enterprises (SMEs) and the establishment of Danajamin to provide financial guarantees for the issuances of PDS and Sukuk by financially viable companies.
In its own words, Danajamin says that its objective is to provide credit enhancement to financially viable companies to help the companies achieve cost savings on overall funding, facilitate their access to bond market, and stimulate investments in the economy.

How does Danajamin's guarantee work? It provides a guarantee on the bond issuance which is an irrevocable and unconditional promise to pay coupon and principal to the bond investors, on behalf of the issuer, in an event of missed payment or default.
In return, the bond issuer will pay Danajamin a fee for the guarantee provided. Bonds that are guaranteed by Danajamin will automatically be upgraded to AAA, the highest rating for bonds. This will enable the bonds to be issued in the current risk adverse environment.
Neat and tidy. But it does raise a question when they make avail the facility to companies that are financially stronger, an area where bankers prowl. The market will watch closely who will be the next recipient of Danajamin's backing.

(The Malaysian Reserve, 5 April, 2010, Page 2)

Kuwait Finance House embarks on 5-year to strenghten ops plan

By Habhajan Singh

Kuwait Finance House (M) Bhd, which had recently directed a number of its staff to go on leave to pending internal investigations into 'transactions and contractual arrangements that have been undertaken over the years', has embarked on a five-year business plan to strengthen its operations in the country.

KFH Malaysia CEO Jamelah Jamaluddin told reporters yesterday that the plan would allow the Islamic banking unit to enhance its credit quality, lower non-performing financing, strengthen corporate investment banking and equity while looking at opportunities in retail business.

"Our due diligence audit is expected to take at least six weeks," she told a media briefing yesterday, reported Bernama, which acced that the audit aimed to obtain an accurate picture of certain transactions and contractual arrangements that have been undertaken over the years.

On April 29, The Malaysian Reserve reported the KFH Malaysia new boss, who came on board just under two months ago, has directed more than a dozen staff to go on leave pending the internal investigations.

In an email response, Jamelah told The Malaysian Reserve that the bank was "taking a proactive approach and conducting a due diligence status audit, in light of the different and more challenging economic environment". In that email, she added: "This is aimed at obtaining an accurate picture of certain transactions and contractual arrangements that have been undertaken over the years. Some employees have taken leave to help facilitate the exercise and the Bank will be guided by pragmatism and act accordingly as per the recommendations of the audit team conducting the due diligence status audit."

The Monday report also said that in a communication with staff on March 19, it was understood that Jamelah had asked a number of staff, including at least one head of department, to go on leave to enable the Kuwait-based Islamic banking unit to conduct its internal investigations.

In the briefing yesterday, Bernama also quoted her as saying: "We expect to experience modest business growth this year, not more than 10%," she said, adding that it registered 8% growth last year.
She said the bank would adopt KFH Kuwait's business model in order to sustain growth in terms of risk management and take full advantage of opportunities in the region, Bernama added.
On Friday, RAM Ratings said it had met with the senior management of KFH Malaysia to seek further clarification on the matter. The rating agency was made to understand that an "internal reorganisation exercise has been put in place to strengthen the Bank’s credit team and processes, with the intention of improving asset quality."

(This story appeared in The Malaysian Reserve on 2 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)

Ibrahim Hussain buys Beukhen

By Habhajan Singh Ibrahim Hussain, the single biggest shareholder of Modular Techcorp Holdings Bhd which he took private in 2008, recently bought the region's largest debt collection agency, Beukhen International.
Industry sources say that the price tag for the sale was between RM30 million to RM40 million. When contacted, Ibrahim said that the agency, which now has some RM3 billion asset under management, will be transformed from a debt agency to a full-fledged debt acquisition company.
"Essentially, we buy over debts from banks. What this firm is now is very different from what it was just 12 months ago," he told The Malaysian Reserve.
Recently, he said that the agency had bought over some RM1.4 billion debts from financial institutions, which he did not name. When contacted, an owner of another debt collection agency told The Malaysian Reserve that the entry of the new face into the industry shows the keen interest people have in the already 'crowded sector'.
"They are leveraging their banking connections. They see money to be made there," he said. On the local front, some of the larger debt collection outfits, in terms of manpower, are Kudrat & Partners, Zuri Group, PNA Smart Solutions Sdn Bhd, Deblect Sdn Bhd, Global CMC and Galatrack Sdn Bhd.
Beukhen International, which provides receivables management and contact centre outsourcing services with offices in a number of countries including Malaysia, Singapore and Philippines, was founded by Jarnail Singh Gill, one of pioneers on the local debt collection scene. He then moved to New Zealand where he began Flo2Cash Ltd, a provider of payment processing services and solutions.
Check on its Flo2Cash website states that Flo2Cash, 'established in New Zealand in 2003 and is 100% NZ-owned and operated', is a member of the Beukhen International group.
However, it could not confirmed if Ibrahim's scoop of the large debt collection agency also comes with the New Zealand outfit.
Asked why he made the inroads into debt collection, Ibrahim said the recent financial crisis saw the proliferation of debts, bringing with its opportunities.
Information on its website states that Flo2Cash's services enable businesses to streamline their payment processes to improve cash flow and reduce operating expenses. It claims Flo2Cash employs the latest technologies and works with all major banks and credit card issuers to offer 'the greatest variety of payment channels' within New Zealand.
It also provides customers with the means to make payments through a variety of channels, so that bills are 'easily managed and shopping can be done with the full confidence of financial security'. When asked why he made the move on Beukhen International, Ibrahim said: "We see huge debts."
The new owners of Beukhen International will unveil its corporate identity today.

(The Malaysian Reserve, 1 April, 2010)