8th International Conference on Islamic Economics and Finance

Sukuk Defaults and Its Implication: A Case Study of Malaysian Capital

Market
Hafizi Ab Majid1
Shahida Shahimi2
Mohd Hafizuddin Syah Bangaan Abdullah3

Sukuk have become increasingly popular as a feasible and viable shariah-

compliant long-term financing instrument. Being the leader in sukuk market,
Malaysia is committed to evolve its financial services sector to serve the needs
of businesses and consumers, as well as to increase its appeal in the regional
and global market shares of selected niches, in particular, the sukuk market.
Sukuk markets around the world are growing to becoming significant sources of
capital even though a series of high profile sukuk defaults in the Gulf
Corporation Countries (GCCs) had tarnished the market's confidence on sukuk.
Malaysia had also recorded several cases of sukuk defaults such as of Johor
Corporation, Ingress Sukuk Berhad, Tracoma Holdings Berhad and Nam Fatt
Corporation Berhad. The issue of sukuk default is very crucial since it affects
the welfare of its stakeholders. Identification of default risk in sukuk is important
for supervision and risk management purposes. Certainty with regard to the
post-default process in sukuk transactions is necessary because the risk for a
default exists in all types of transactions. Even the most prudently structured
products can fail due to circumstances outside investors‟ control. Therefore, this
paper aims to discuss the issue of sukuk default and its implication on Malaysian
capital market. At the same time, it also intends to investigate the implication of
sukuk default on a country‟s reputation, the legal aspect and on the investor‟s
protection. The impact of sukuk default on Malaysian capital market as a hub
for global Islamic finance industry is also discussed comprehensively in this
study. It is hoped that this study will help sukuk issuers and rating agencies for
estimation of credit risk and setting corporate pricing on a risk adjusted return
basis, as well as the regulators in ensuring market stability and efficiency
towards sustainable economic growth.

Keyword: capital market; default; Islamic finance; Malaysia; sukuk rating.

1. Introduction
The sukuk market has grown rapidly over the last few years in terms of size, numbers and
sophistication. Sukuk has become an alternative for conventional bonds and being used in
financing for the last twenty years. It provides sovereign governments and corporations with

1
Lecturer of Finance, School of Management, Faculty of Economics & Management, Universiti Kebangsaan
Malaysia (Corresponding author). Email: [email protected]
2
Senior Lecturer of Islamic Economics, Banking and Finance, School of Economics, Faculty of Economics and
Management, Universiti Kebangsaan Malaysia. Email: [email protected]
3
Lecturer of Finance and Risk Management, School of Management, Faculty of Economics and Management,
Universiti Kebangsaan Malaysia. Email: [email protected]

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

access to the huge and growing Islamic liquidity pool, in addition to the conventional investor
base. However, the series of high profile sukuk defaults in the Gulf Corporation Countries
(GCCs) such as Investment Dar, Saad Group and Dubai World’s Nakheel Sukuk in 2009, as well
as the East Cameron Sukuk (US) have astounded the market’s confidence in the global Islamic
finance industry, provoking a debate on investors’ protection and rights. Although sukuk is
claimed to be more secured than the conventional bonds due to the requirement of physical
assets to underpin deals, sukuk is now asserted to have lost credibility as a feasible and viable
Islamic long-term project financing instrument. In the Malaysian context, despite being a leader
in sukuk market, Malaysia has also recorded cases of sukuk defaults such as of Johor
Corporation, Ingress Sukuk Berhad, Tracoma Holdings Berhad and Nam Fatt Corporation
Berhad. Although sukuk defaults in Malaysia are not widely discussed, the issue raises concern
on the investors’ protection and the survival of Malaysian capital market in the future.
A default occurs due to the breach of any binding obligations under the original terms of
the agreement between the issuer and the sukukholders. Apparently, both contractual parties must
fulfill their obligations under the contract or agreement. The complexity of structure and several
legal issues may be significant on rating process, but from a rating perspective, assessing the risk
of the issuer's inherent credit strength is fundamental to the final rating outcome. In other words,
performance of the sukuk issuer highly affects the final rating on the sukuk itself.
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
guidelines emphasize the difference between sukuk and conventional bonds. These guidelines
indicate that sukuk does not represent a debt owed to the certificate holder by the issuer, sothat
the owners share in the returns and bear the losses. Furthermore, the standards state that the
documentation must explicitly abide shariah (Islamic law) and that a shariah board of the capital
market regulatory body must monitor its implementation.1 Conventional bond default provisions
that are frequently incorporated into sukuk documentation appear to provide investors with an
Islamic instrument that is similar to the conventional bonds. While fatwas2 are procured to
provide comfort that instruments are shariah-compliant, such endorsements are subject to
different interpretations. When fatwas contravene AAOIFI standards, their reliability becomes
tenuous. Even when they may be compliant with a standard, which has been passed with a
narrow majority, a structure may be called into question by the individual judge, who may
subscribe to the strong minority view.
Rating on sukuk reflects the (credit) worthiness and stability of sukuk. By having the
annual rating reviews conducted by the respective rating agencies, sukuk investors are adequately
informed of the issuer’s status and progress. In addition, the rating changes on sukuk may be
significant to the possibility of sukuk default to a certain extent. Generally, sukuk with higher
rating is unlikely to default and vice versa.
This study will discuss on the sukuk defaults in Malaysia and its implication on the
Malaysian capital market with a special reference to the selected cases of Malaysian defaulted
sukuk. This paper will follow qualitative or descriptive research method, related to the issues of
sukuk defaults by selecting a few cases of defaulted sukuk that may affect the Malaysian capital
market.
So far, studies on sukuk defaults are very limited as compared to conventional bond
defaults. Hence, this study contributes to the literature by providing constructive discussion on
sukuk defaults and their implication on Malaysian capital market. This study will benefit the
regulators, investors, industry players and also researchers in this area.

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The remainder of this paper is organized as follows; Section 2 deliberates on the sukuk
insights. Section 3 outlines the research design. Section 4 discusses the sukuk development in
Malaysia and provides an evidence of sukuk defaults. Section 5 presents the analysis and
discussion of sukuk defaults and its implication on Malaysian capital market and finally section 6
concludes.

2. Sukuk Insights
2.1 Sukuk concept

Sukuk are among the financial instruments for raising funds and are vital vehicles for resource
mobilization, whether in the public or private sector (Mohd Hafizuddin et al., 2010). According
to AAOIFI (2002), sukuk refer to investment products and can be defined as “certificates of
equal value representing undivided shares in ownership of tangible assets, usufructs and services
or (in the ownership of) the assets of particular projects or special investment activity”. As a
certificate, sukuk is documented the undivided pro-rated ownership of underlying assets and the
sak (singular of sukuk) is freely traded at par, premium or discount (Securities Commission of
Malaysia (SC), 2010). Based on both definitions, sukuk can be further defined as commercial
papers that provide an investor with ownership in an underlying asset. It is an asset-backed trust
certificate evidencing ownership of an asset or its usufruct. It has a stable income and complies
with the principle of shariah. Unlike conventional bonds, sukuk need to have an underlying
tangible asset transaction, either in ownership or master lease agreement.
In economic terms, there are three common types of sukuk; namely fixed-income sukuk;
asset-backed sukuk (ABS); and hybrid sukuk (Zawya, 2009). Sukuk can be of many types
depending on Islamic contracts or principles of financing and trades used in the structuring
process. AAOIFI has issued standards as guidelines for 14 different types of sukuk, which can be
classified as tradable and non-tradable, development and industrial project financing. However,
the most common principles used in sukuk structuring are mudharabah,3 musharakah,4
murabahah,5 ijarah,6 BBA,7 salam8 and istisna‟.9
So far, among all the available structures, sukuk BBA and sukuk murabahah are the two
sukuk with the highest default cases in Malaysia. In fact, sukuk BBA was the sukuk with the most
issuance in Malaysia in 2004, before the Malaysian sukuk market got dominated by musyarakah
sukuk beginning 2006. Sukuk BBA is a financial certificate based on BBA contract as evidence of
ownership right of the investors on the underlying assets (Ab Ghani, 2006). This sukuk is not
similar to bond because the latter represents debt obligation of the issuer. It is created to service
the need for working capital or to re-finance existing debt, normally to be used in the
transportation sector, especially in the shipping and aircraft sectors, real estate, construction, and
also in the petrochemical projects.
In BBA structure, payment is deferred and final price should be contractually agreed and
known to both parties, the time and mode of payment should be ascertained and there is no
requirement to state the cost price and amount of mark-up. The issuer of this sukuk has the right
to get fund from the investors, meanwhile the investors have right to resale the sukuk to another
party to gain additional profit. If the real value of sukuk BBA is not suitable with the previous
contract, the investors have the right to object and return it to the initial issuer.

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2.2 Selected sukuk structures in Malaysian capital market

The Malaysian sukuk market took off in 1990 with the world’s first sukuk issuance by Shell
MDS. Since 2006, global demand for Malaysian sukuk has been increasing and the issuances are
based on the globally accepted contracts of mudharabah, ijarah and musharakah. Since then, the
market has expanded, not only in term of size but also sophistication that shows structures based
on ijarah, musharakah and murabahah are now common in practice.
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. Based on this
structure, the sukuk holders own equal shares on the underlying asset (or its usufruct). Basically,
the sukuk holders hold the right to own the asset and collect the rental payment or dispose the
sukuk at any time (Noor Inayah et al, 2011). Again, these rights depend on the structure of ijarah
whether asset-backed sukuk ijarah or asset-based sukuk ijarah. Asset-backed sukuk allows the
holders to liquidate the underlying asset in the event of default to recover most of their
investments (Noor Inayah et al, 2011). On the other hand, asset-based sukuk only represent
beneficial ownership on the underlying asset and it restricted the holders’ right in the event of
default. Figure 1 shows the common structure of sukuk ijarah, which involves three parties i.e.
originator, special purpose vehicle and the sukuk investors.

Source: Abstracted from Wilson (2008).

Figure 1: Basic Structure of Sukuk Ijarah

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Steps in Sukuk Ijarah transaction

(1) The originator sells certain assets to special purpose vehicle (SPV) at an
agreed pre-determined purchase price.
(2) – (3) SPV will raise funds to finance the purchase of the assets through the
issuance of sukuk and sell to investors.
(4) A lease agreement is signed between SPV and the originator for a fixed
period of time, where the obligator leases back the assets to lessee.
(5) – (6) SPV receives periodic rentals from the originator. These are distributed
among the investors i.e. the sukuk holders.
(7) – (8) At maturity, the SPV sells the assets back to the seller at a predetermined
value. This proceed will be used to reimburse the certificate holder at issue
price.

Meanwhile, the concept of murabahah has been used to develop an innovative Islamic
finance contract, including sukuk. Murabahah refers to the sale of goods at certain price that
comprised the purchase price and profit margin agreed by contractual parties. Thus, sukuk
murabahah refers to the certificates of equal value issued for the purpose of financing the
purchase of goods through murabahah. By doing so, the investors of the sukuk holders are the
legal owner of the murabahah commodity. The issuer of the certificate is the seller of the
murabahah commodity, the subscribers are the buyers of that commodity, and the realised funds
are the purchasing cost of the commodity. The certificate holders own the murabahah
commodity and are entitled to its final sale price upon the re-sale of the commodity. Murabahah
sukuk have, however, become popular in Malaysian capital market due to a more liberal
interpretation of fiqh by Malaysian jurists permitting sale of debt (bai-al-dayn) at a negotiated
price. Common structure of sukuk murabahah is shown in Figure 2.

Figure 2: Sukuk Murabahah Structure

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

Steps in Sukuk Murabahah transaction

1 A master agreement is signed between the SPV and the borrower

2 SPV issues sukuk to the investor and received sukuk proceed
3a & 3b SPV buys commodity on spot basis from commodity supplier
4a & 4b SPV sells the commodity to the borrower at the spot price plus profit margin,
payable on instalments over an agreed period of time.
5a & 5b The borrower sells the commodity to the commodity buyer on the spot basis.
6 The investors receive the final sale and profits.

2.3 Credit risk and rating

In the case of credit (default) risk, there is always a probability that a corporate borrower will not
be able to meet its contractual obligations and may renege from paying the principal and the
profit due. Even for the typical high-grade borrower, this risk still exists even though it may be
very small, perhaps 1/10 of 1 percent per year. Although this type of risk does not seem large, it
is in fact highly significant, and can increase quickly with little warning. Furthermore, margins in
corporate lending are very tight, and even small miscalculations of credit risk can undermine the
profitability of lending. Unexpected realizations of the risk have destabilized, de-capitalized, and
destroyed many international corporate institutions.
In Malaysia, all debt securities including sukuk issues are required to be accompanied by
a credit rating at all times. A credit rating is a mechanism through which an independent third
party, i.e. the credit rating agency (CRA),10 makes an assessment on the likelihood of a corporate
issuer’s default on its debt repayments. It focuses on a specific debt instrument and not the
overall creditworthiness or financial standing of the corporate issuer. A rating will take into
consideration various enhancement tools like guarantees, sinking funds, letters of credit or any
other mechanism devised to reduce the default risk of specific issues. Thus, a corporate may be
assigned different rating categories for different debt issues across time (RAM Ratings, 2010).
However, rating is not a recommendation to purchase, sell or hold a security’s market price or its
suitability for a particular investment, nor does it involve any audit by the rating agency (RAM
Ratings, 2010).
Malaysia is one of the first few countries in the world to require the recognition of CRAs
for the purpose of rating a bond or sukuk issue. This is in recognition of their vital role in
evaluating the probability of default of sukuk issue, and the importance investors place on ratings
for their investment decisions. CRAs are required to be recognized by the SC for the purpose of
rating debt or sukuk issues in Malaysia, pursuant to the Guidelines on Recognition of Credit
Rating Agencies by the Securities Commission for the Purpose of Rating Bond Issues.

2.4 Rating performance and sukuk defaults

Bandyopadhyay (2006) reports that as the credit quality worsens i.e. decline in the rating grades,
the probability of default (PD) increases. Furthermore, the PD jumps sharply as soon as the
rating move from investment to non-investment grades (i.e., from BBB rating to BB) and that
justifies the reason for a study on the rating performance and sukuk defaults. He also observes
that rating stability declines as the credit quality worsens. The higher risk in the bottom grades

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(mainly non-investment grades) calls for developing a corporate default predictor model that
would better capture the firm’s characteristics and could give an early warning signal of
corporate distress. This issue is very relevant and significant not only for conventional corporate
bond, but also for sukuk. Furthermore, in the wake of a series of high profile sukuk defaults in the
GCCs, such as Investment Dar, Saad Group and Dubai World’s Nakheel Sukuk in 2009, sukuk
are alleged to have lost credibility as feasible and viable Islamic long-term project financing
instrument (Raja Teh Maimunah, 2010).

3. Research Design
This paper will follow qualitative or descriptive research method, related to the growing issues of
sukuk defaults by focusing on the development of theory through a case study approach
(Eisenhardt, 1989; Yin, 1994). The ultimate objective of the study is to provide an understanding
on the default cases and its implication on capital market. The general discussion on Malaysian
defaulted sukuk will cover the period of 1997 to 2010 (14 years).
This paper will discuss on the selected defaulted sukuk cases. For this purpose, a
Murabahah Islamic Debt Securities issued by Johor Corporation, Sukuk Ijarah issued by Ingress
Sukuk Berhad and Murabahah ICP/IMTN issued by Nam Fatt Corporation Berhad will be
discussed in the context of Malaysian capital market. Sources of data include observation,
documents and texts (i.e. archival research), specifically from the SC, RAM Ratings and MARC,
and authors’ analysis on the subject matter.
Written data sources include published and unpublished documents, company reports,
reports, newspaper articles and others. The information on defaulted and solvent firms is
collected from Malaysia Rating Corporation Berhad’s (MARC) annual or monthly ratings of
middle to short-term corporate sukuk issued by companies from 2000 until 2010, which later turn
out to be defaulted. The financial information of these companies over the period is obtained
from the MARC and Rating Agency Malaysia (RAM) databases, as well as Securities
Commission’s website.

4. Overview of Sukuk in Malaysia

4.1 Sukuk development

Malaysia has emerged as leader in sukuk market since the first corporate sukuk issuance in 1990
by Shell MDS Sdn. Bhd. This is due to the consistent growth in the issuance of sukuk, increase in
the level of knowledge and numbers of expertise amongst market players and progressive
development of the Malaysian legal framework. This situation makes Malaysia the world’s
largest sukuk issuer with more than 60% of outstanding global sukuk (as at end of 2009). From
total sukuk issued globally, 66.8% with a value of USD 67,872 million were issued in Malaysian
market, as illustrated in Table 1. As at end June 2010, local currency sukuk market stood at a
whopping USD76.4 billion or 35.5% of total bond market outstanding. This is attributable to
various factors including well-executed policies, facilitative regulatory environment, increasing
numbers and sophistication of intermediaries that continue to push the frontiers in terms of
product innovation as well as the existence of a complete, matured and well established Islamic
financial system.

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

Table 1: Regional Break-up of the Domestic Sukuk Market

Country Volume (US$ millions) No. of Issues % of Total Value

Asia
Malaysia 67,872 792 66.8
Indonesia 1,923 48 1.9
Pakistan 1,657 31 1.6
Brunei 740 13 0.7
Singapore 99 2 0.1
GCC
Saudi Arabia 7,665 10 7.5
UAE 7,151 10 7.0
Bahrain 1,508 77 1.5
Qatar 137 1 0.1
US, Europe and Africa
US 167 1 0.2
Germany 123 1 0.1
Gambia 0.388 1 0.0
Sudan 12,614 20 12.4
Total 101,656 1,007 100.0

Source: International Islamic Financial Market-IIFM (2009)

Malaysia’s Islamic capital market continues to show vibrant growth as can be seen from
the ever-increasing size and diversity of sukuk offered. This is attributable to various factors
including well-executed policies, facilitative regulatory environment, increasing numbers and
sophistication of intermediaries that continue to push the frontiers in terms of product innovation
as well as the existence of a complete, matured and well-established Islamic financial system.
Figure 3 depicts total outstanding sukuk issued by public and private sectors from 1990 to 2010,
dominated by corporate issuers for the period of 1997-2008, government related entities in 2009,
and sovereign in 2010.

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Source: IFIS & RAM Ratings (2010).

Figure 3: Sukuk Issuance by Type of Issuer in Malaysia (USD mil.)

The corporate debt securities and sukuk market had withstood severe stress during the
1997/1998 Asian financial crisis, and again during the economic slowdown in 2001 following
the collapse of the information technology (IT) bubble in the advanced economies. Notably,
corporations that have funded their long-term capital investments or business expansion projects
with long-term debt securities and sukuk had escaped the negative effects of credit crunches,
interest rate spikes and exchange rate depreciation. This had contributed to the stable
performance of the debt securities and sukuk.
Besides avoiding the risks of currency, maturity and asset-liability mismatches, only debt
securities and sukuk that carry investment-grade ratings from the domestic rating agencies had
been allowed to be issued in the Malaysian market during the early years. Mandatory rating,
together with the requirement for investment-grade ratings (removed as the market matured), had
helped boost investor confidence during the domestic debt securities and sukuk market’s nascent
phase. The market integrity and confidence established during the formative years, which had led
to successful redemptions of debt securities and sukuk upon maturity, had in turn stimulated
confidence in and acceptance of long-tenured corporate debt securities and sukuk, some of which
stretch for over 30 years.

4.2 Evidence of default in capital market

The debt securities and sukuk issued in the Malaysian market are mostly rated from AAA to
BBB, although most issues tend to cluster around the AA category. Table 2 explains total
corporate bond (inclusive of sukuk) defaults in Malaysia, from 1997 to 2009. Note that there had
been no default prior to 1997. By referring to the default rate by no. of issuers (column 5), there
is a significant correlation between no. of issuers and issues (positive value of %). The overall
defaults involve quite a huge amount of money (RM12.9 billion).

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Table 2: Total defaults (1997 – 2009)

Year Total defaulted Default rate Defaults with bank No. of issuer Adjusted
(by no. of guarantees defaults ex-bank default rate
issuers) guarantee (by no. of
issuers)

No. of No. of Amount of (%) No. of No. of (%)

issuers issues rated debt issuers issues
(RM million)
1997 1 1 30 0.6 1 1 - -
1998 16 20 3,820 8.8 11 12 5 2.8
1999 4 5 1,850 2.5 3 3 1 0.6
2000 6 12 1,875 3.6 4 9 2 1.2
2001 4 12 2,757 2.3 - - 4 2.3
2002 - - - - - - - -
2003 3 3 225 1.9 - - 3 1.9
2004 2 2 98 1.1 1 1 1 0.6
2005 6 6 1,182 3.3 1 1 5 2.8
2006 - - - - - - - -
2007 2 2 366 1.0 - - 2 1.0
2008 2 4 300 1.1 - - 2 1.1
2009 3 5 394 1.6 1 1 2 1.1
Total 49 70 12,896 1.9 21 27 25 1.1
Note: No default prior to 1997.
Source: RAM Ratings (2010)

Thus, it is interesting and important to investigate the issue of defaults, so that the
implication of sukuk defaults on the Malaysian capital market could be minimized in future.

5. Analysis of Sukuk defaults in Malaysia

Standing true to Islamic principles, sukuk are perceived to be ethically protected from turning
bad. However, when sukuk defaults had been scrutinised by the 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. This situation will also tarnish the reputation of
Malaysian capital market since Malaysia has been recognized as the hub for Islamic capital
market in the world. Unlike the high-profile default cases in the Middle East, Malaysia’s sukuk
defaults have received less criticism and scrutiny from global industry players. The reasons are
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. It is very interesting and vital to investigate the defaults issue and its
implication, especially for the sukuk since there are a lot of issues and debates in terms of their
structure and concept, particularly from the shariah perspectives (Rosly & Sanusi, 1999; Al-
Amine, 2001 & RAM Ratings, 2010).
Despite the wide variance in ratings, the default rate for Malaysian sukuk in 2009 was
relatively low at 0.46 per cent (SC, 2010). For the period of 1997 – 2010, there are altogether 24
cases of sukuk default, as illustrated in Table 3. Of all cases, they were mainly structured based
on murabahah and BBA contracts – 12 on murabahah, 11 BBA, and only one on ijarah. 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
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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, BBA sukuk contract will be used to securitize
shariah-compliant assets and it adds value to the debt facility, in terms of credibility and
liquidity.

Table 3: Total Defaulted Sukuk (1997 – 2010)

Issuance Rating Initial Issuer Type of Sukuk Amount Date of Final

Date Agency Rating# (RM mil) Default Rating
17 Apr 1997 RAM A2 Hualon Bai‟ Bithaman Ajil 150 21 Nov 2003 D
Ratings Corporation (M) Islamic Debt
Sdn Bhd Securities (BaIDS)

25 Jan 1999 RAM BBB3 Johor Corporation Murabahah Islamic 500 27 June 2002 D
Ratings Debt Securities

21 Sept 2000* MARC AID/ Europlus BaIDS 250 10 Mar 2006 DID
MARC- Corporation Sdn
2ID Bhd

11 Dec 2000 RAM BBB3 Moccis Trading BaIDS 50 3 June 2003 D

Ratings Sdn Bhd

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

24 July 2003 MARC MARC- Perspektif Perkasa Murabahah 188 10 Mar 2006 DID
3ID Sdn Bhd Underwritten Notes
Issuance Facility
(MUNIF)

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

28 Nov 2003 MARC AAID Malaysian BaIDS 120 2 Apr 2010 DID
Merchant Marine
Berhad

30 Dec 2003 MARC AID/ Evermaster Berhad BaIDS & 50 & 31 Dec 2008 DID
MARC- Murabahah 40
2ID Multi-Option Notes
Issuance Facility

1 Apr 2004 MARC A+ID/ Pesaka Astana (M) BaIDS 200 30 Sept 2005 DID
MARC- Sdn
1ID Bhd

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

7 Oct 2004 MARC AID/ Oilcorp Berhad Murabahah IMTN/ 70 7 Oct 2009 DID
MARC- MUNIF
2ID

19 Oct 2004 RAM A3/P2 BSA International Murabahah CP/ 150 28 May 2008 D
Ratings Berhad MTN

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4 Nov 2004* MARC AID/ Jana Niaga Sdn MUNIF 100 15 Nov 2007 DID
MARC- Bhd
2ID
12 Nov 2004 RAM A2/ P2 The Royal Mint of Murabahah Multi- 55 8 June 2007 D
Ratings Malaysia Option Notes
Sdn Bhd Issuance Facility

15 Dec 2004 MARC AAID PSSB Ship BaIDS 40 15 Dec 2009 DID
Management
Sdn Bhd

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

8 Mar 2005 MARC MARC- M-Trex Murabahah ICP 60 21 May 2009 DID
2ID Corporation Sdn
Bhd

29 Apr 2005 RAM A1(s)/ Oxbridge Height Murabahah IMTN/ 104/ 6 Apr 2009 D
Ratings P1(s) Sdn Bhd MUNIF 50

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

28 Oct 2005 RAM A2 Memory Tech Sdn BaIDS 320 7 June 2007 D
Ratings Bhd

31 Jan 2006 MARC A+ID/ Nam Fatt Murabahah ICP/ 250 6 Apr 2010 DID
MARC- Corporation IMTN
1ID Berhad

13 Apr 2007 MARC MARC- Straight A's MUNIF 200 11 Dec 2009 DID
1ID Portfolio Sdn
Bhd

17 May 2007 MARC A+ID Malaysian BaIDS 240 18 Nov 2009 DID
International
Tuna Port Sdn Bhd

#
Note: For details of rating definition used by MARC & RAM Ratings, refer to Appendix 1 & 2.
* Date of issuance is based from press releases on rating agencies’ website/internal database.

Sources: RAM Ratings (2010)

Based on the RAM Rating’s data and the statistics provided by SC, the first defaulted
sukuk in Malaysian capital market is Murabahah Islamic Debt Securities issued by Johor
Corporation (JCorp), a market-driven Johor State Government-linked Corporation. The
corporation is one of Malaysia’s leading business conglomerates, comprising more than 280
member companies. As a public enterprise entity, JCorp plays a major role to foster economic
growth in the state particularly in several high potential economic sectors including agro-
business, industrial development, property and others. This sukuk was issued in January 1999
and defaulted after three years in June 2002. This is the first case of defaulted sukuk in Malaysia
and the largest amount of defaulted sukuk in the history of Malaysian capital market so far. There
is limited studies and discussion on this defaulted sukuk due to the status of this corporation as
the state government-linked corporation. As per today, JCorp continue to dedicate itself in

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creating new opportunities not only for its own corporate growth and expansion but also towards
contributing country’s economic enhancement.
On the other hand, the latest Malaysian defaulted sukuk is a Murabahah ICP/IMTN that
was issued by Nam Fatt Corporation Berhad. Nam Fatt is a multinational group with over 1,000
personnel employed in thirty-one subsidiaries and four associated companies. This company has
international presence in six countries through their worldwide offices and have gone beyond
Malaysian shores, to Singapore, Brunei, Indonesia, Thailand, Vietnam, China, Japan,
Turkmenistan, Sudan and the Middle East This 250 million Malaysian Ringgit sukuk used the
Islamic financing principle of Murabahah, a secured financing of an asset on a deferred payment
basis with a pre-agreed payment period. Figure 4 shows the timeline of Nam Fatt sukuk since it
was issued until defaulted on April 2010. Full information on the rating trend starting from initial
rating to the final rating in the event of default could be found in Appendix 3.

Figure 4: Nam Fatt Corporation Rating Timeline

Besides Nam Fatt, Tracoma is another case of sukuk defaults in the Malaysian capital
market. Tracoma’s vast experience and good track record as one of the leading local
manufacturers of automotive components, and its commendable financials was reflected in
November 2004, when MARC assigned an initial rating of AID to the issue. In October 2006,
premised on Tracoma’s delay in depositing the monthly amount in the PSA required for the
upcoming profit payments due in January 2007, MARC placed Tracoma’s RM100 million
BaIDS on a negative outlook. Due to Tracoma’s tight liquidity position and limited financial
flexibility, exacerbated by it’s weaker than expected cash flow, a couple of downgrades had been
instituted during the annual rating reviews on the BaIDS. In late January 2009, due to Tracoma’s

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failure to redeem its first RM50 million series based on the original scheduled maturity date of
28 January 2009, as confirmed by the trustee, MARC downgraded the rating of the BaIDS to
DID. The missed payment had been treated as an indication that the company was facing financial
distress. On 2nd November 2009, Tracoma’s proposed RM100 million restructured Bai‟
Bithaman Ajil Debt Securities was issued in response to Tracoma’s debt restructuring plan.
Based on this latest development, MARC has withdrawn its D rating and assigned CID rating on
the BaIDS. Since the restructuring plan, Tracoma has proposed further changes to the structure
of BaIDS, which have yet to be finalised. Finally, in July 2010, MARC has withdrawn its C ID
rating on Tracoma proposed BaIDS and reinstated it’s DID rating on the Tracoma’s defaulted
BaIDs. Figure 5 shows the timeline of Tracoma sukuk since it was issued until defaulted on July
2010.

Figure 5: Tracoma Holding Berhad Rating Timeline

MARC has taken the decision to discontinue analytical coverage on the BaIDS until the
conclusion of Tracoma’s debt restructuring. The rating agency will not be performing ongoing
surveillance on the BaIDS with immediate effect. By this time, there is no news on the
restructuring plan and MARC is still waiting for any restructuring progress confirmation by the
company.
Besides JCorp, Nam Fatt and Tracoma, Ingress sukuk is another case of sukuk defaults in
Malaysia. Since this sukuk was the only defaulted sukuk that structured based on ijarah contract,
it was a hot topic for the discussion among the market players and academia. As per the structure
in Figure 6, 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

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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.

Figure 6: Sukuk Ijarah Transaction Structure

Referring to Figure 7, it shows that on 8th June 2004, the rating of A+ID has been assigned
by MARC that reflects Ingress’ track record as one of the leading local automotive component
manufacturers with a diversified customer and geographical distribution. The rating has been
reaffirmed for a few times before being downgraded to A IS on 28th December 2007. 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. On 25th February 2009, MARC has downgraded its rating to
A-IS from AIS due to the deteriorating liquidity position and declining profitability of Ingress and
followed by a few downgrades until MARC has downgraded its rating to C IS from BB-IS on 6th
July 2009 due to ISB’s decision to postpone RM45.0 million of the RM50.0 million upcoming
first tranche sukuk payment due on July 9, 2009 for six months. Finally, the sukuk has been
downgraded to DIS on 13th July 2009 reflects to ISB’s failure to meet its first tranche sukuk
payment of RM50 million in full, based on the original scheduled maturity on July 9, 2009.

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Figure 7: Ingress Sukuk Berhad Rating Timeline

Finally, MARC has withdrawn its DIS ratings on Ingress Sukuk Berhad’s (ISB) RM160
million Sukuk Al Ijarah Programme with immediate effect following the full redemption of the
sukuk and cancellation of the programme on July 2, 2010.
Based on the defaulted sukuk cases discussed, even though sukuk default may not pose
significant threat to the capital market, however, it does have an impact on the overall reputation
of Malaysia as the international hub for Islamic finance, where investors and other countries
worldwide monitor the development of this particular capital market, the sukuk issuance. For a
corporation that issues the sukuk in order to raise capital, the failure to make a timely payment as
agreed in the contract raises the probability of default on that particular sukuk. If it fails to pay on
time and finally declares a default, the rights of the firm's shareholder are affected as well.
Therefore, it is crucial that the sukuk issuer takes immediate action if it foresees a possibility of
defaulting. In this case, the issuer could opt for a refinancing or a restructuring. There are cases
where defaults on sukuk had almost been declared, but the issuers took actions before the
defaults were declared, and the sukuk was either restructured or refinanced. As evidence, Talam
Corporation had already restructured its sukuk before declaring a default, whilst in the case of
Ingress; the firm restructured its sukuk only after having declared a default.
Another major issue in sukuk default is the investors' right and protection. Since many
perceive that sukuk should be more secured rather than the conventional bonds, the default
should be seen as something to be avoided from the perspective of investment attraction. In this

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case, since sukuk has a different structure compared to conventional bond, the protection actually
depends on the structure of the contract; i.e investors' protection in ijarah sukuk structure might
be different, as compared to musharakah sukuk structure. That is why it is very interesting to
investigate and explore defaulted sukuk contracts in Malaysia since their structures are totally
attractive from the financial and investment perspectives. This may be due to the different school
of thought in Malaysia, opposed to the Middle-East countries.
From the legal point of view, the discussions and debates in the Islamic finance world
show that any disputes in the contract may lead to shariah non-compliance risk. Like the Middle
East countries, Malaysia has also had its fair share of sukuk defaults, albeit a lower issuance
value. Nonetheless, what protected Malaysia from the negative impact 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 a
financial obligation, whereby the investors are recognised as creditors and rank equally with
other conventional creditors. This provides some level of comfort to the investors, knowing that
they are adequately protected in any unfavourable event.

6. Conclusion

In the current environment, the demand for sukuk is significantly exceeds the supply. The
phenomenal demand has been spurred by the high levels of surplus savings and reserves in Asia
and Gulf regions. The sukuk market brings with it many benefits to both issuers and investors.
Issuers can benefit from the huge increase in liquidity in the Islamic world, and can tap on these
new sources of funds. An increased number of multilateral agencies are issuing sukuk to finance
development projects. In addition, both government agencies and the corporate sector have
considered the sukuk market as an attractive source of financing.
What are the wider impacts for the sukuk defaults in the Malaysian capital market? Sukuk
default in Malaysia may not pose significant threat to the local capital market; however it does
have an impact on the overall reputation of Malaysia as the hub for global Islamic finance. In the
Middle East, investor sentiment for sukuk issuances has been severely damaged when the
Nakheel initial debt standstill and this might have halted strong rebound of the sukuk market in
the wake of continued uncertainty about investor protection.
Generally, there is a concern about whether shariah compliance might hamper an orderly
dispute resolution under conventional law and about the legal enforceability of asset claims
under the AAOIFI recommendations on sukuk structures. Considerable heterogeneity of
scholastic opinion continues to hamper the creation of a consistent regulatory framework and
corporate governance principles. Islamic jurisprudence is neither definite nor bound by precedent
in absence of unified principles on which shariah scholars decide on compliance of new
products. Fragmented opinions of shariah boards have inhibited universal recognition and
enforceability of rulings, which has raised the issue of “non-shariah compliance risk”.
Malaysia conforms to consistent and clear investors' protection whereby the investors are
well aware of their position and options. Whilst the investors' protection is very much intact and
market-tested, the legal and recovery process is 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 to 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

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ensures that every sukuk issued in Malaysia, is in full compliance with the Shariah. All these
factors provide sufficient protection to investors in the sukuk and conventional bond markets.
The tight rules and regulations that bind the sukuk market have protected Malaysian
capital market from the negative perception. Issuers have to abide by similar standards,
guidelines and laws that govern both sukuk and conventional bonds. Sukuk are also considered as
financial obligations since the sukuk investors are recognized as creditors and rank equally with
other conventional creditors. Knowing that they are adequately protected in any unfavourable
event, this provides some level of comfort to investors. Besides, the 10th Malaysia Plan which
spurs numerous proposals for the construction, facilities and utilities projects, makes sukuk as
one of the alternatives for the project financing.

End Notes:
1
AAOIFI Shari’ah Standard No. 17 (Investment Sukuk) as adopted on May 8, 2003.
2
An Islamic religious ruling, a scholarly opinion on a matter of Islamic law.
3
A contract made between two parties to finance a business venture. The parties are a rabb al-mal or an investor
who solely provides the capital and a mudarib or an entrepreneur who solely manages the project. If the venture is
profitable, the profit will be distributed based on a pre-agreed ratio. If the business is a loss, it will be borne solely
by the provider of the capital.
4
A partnership arrangement between two parties or more to finance a business venture whereby all parties
contribute capital either in the form of cash or in kind. Any profit derived from the venture is distributed based on a
pre-agreed profit sharing ratio and a loss is shared on the basis of capital contribution.
5
A contract made between two parties to finance a business venture. The parties are rabb al-mal or an investor who
solely provides the capital and mudarib or an entrepreneur who solely manages the project. If the venture is
profitable, the profit will be distributed based on a pre-agreed ratio. If the business is a loss, it will be borne solely
by the provider of the capital.
6
A manfaah (usufruct) type of contract whereby a lessor (owner) leases out an asset or equipment to a client at an
agreed rental fee and pre-determined lease period upon the `aqd (contract). The ownership of the leased equipment
remains in the hands of a lessor.
7
A contract referring to the sale and purchase transaction for the financing of an asset on a deferred and installment
basis with a pre-agreed payment period. The sale price includes a profit margin.
8
A contract whereby payment is made in cash at point of contract but delivery of asset purchased is deferred to a
pre-determined date.
9
A purchase order contract of assets whereby a buyer places an order to purchase an asset to be delivered in the
future. The buyer requires the seller or a contractor to construct the asset and deliver in the future according to the
specifications given in the sale and purchase contract. Both parties decide on the sale and purchase prices and the
settlement can be delayed or arranged based on a schedule of work completed.
10
There are two licensed CRAs in Malaysia which provide independent opinions on the credit risks and potential
default risks of specific issuers. The first rating agency, RAM Rating Services Berhad (then, Rating Agency
Malaysia Berhad (RAM), was established in November 1990; and the second is Malaysian Rating Corporation
Berhad (MARC) was incorporated in October 1995.

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References
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al-Amine, M.B.M. 2001. The Islamic Bonds Market: Possibilities and Challenges International
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International Islamic Financial Market (IIFM). 2010. Sukuk Report: A Comprehensive Study of
the International Sukuk Market. 1st Eds. Retrieved: 5 September 2010. Available at
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Raja Teh Maimunah Raja Abd Aziz, 2010. “Sukuk Have Lost A Lot of Credibility of Late. Is
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RAM Ratings. May 2010, Sukuk Focus, RAM Rating Services Berhad, Kuala Lumpur. RAM
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www.zawya.com/sukuk/report

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Appendix 1

MARC’s Rating Symbols and Definitions

Islamic Capital Market Instrument Ratings

Long Term Ratings

MARC’s Long-Term Ratings are assigned to Islamic capital market instruments with maturities
of more than one year. These ratings specifically assess the likelihood of timely payment of the
instrument issued under the various Islamic financing contract(s).

Investment Grade Description

AAAID Extremely strong ability to make payment on the instrument issued
under the Islamic financing contract(s).
AAID Very strong ability to make payment on the instrument issued under the
Islamic financing contract(s). Risk is slight with degree of certainty for
timely payment marginally lower than for instruments accorded the
highest rating.
AID Strong ability to make payment on the instrument issued under the
Islamic financing contract(s). However, risks are greater in periods of
business and economic stress than for instruments with higher ratings.
BBBID Adequate ability to make payment on the instrument issued under the
Islamic financing contract(s). Vulnerable to moderately adverse
developments, both internal and external.

Non-investment Description
Grade
BBID Uncertainties exist that could affect the ability of the issuer to make
payment on the instrument issued under the Islamic financing
contract(s).
BID Significant uncertainty exists as to timely payment on the instrument
issued under the Islamic financing contract(s). Slight adverse
developments could impair issuer’s ability to fulfill such obligation.
CID Possesses a substantial risk of default, with little capacity to address
further negative changes in financial circumstances.
DID Failed to make scheduled payment on the instrument issued under the
Islamic financing contract(s).

Notes : Long-Term Ratings from AA to B may be modified by the addition of a plus (+) or minus (-) suffix to show
relative standing within the major rating categories. Bank-guaranteed issues will carry a suffix (bg), corporate-
guaranteed issues, a (cg), issues guaranteed by a financial guarantee insurer (FGI), an (fg), and all other supports,
an (s) when such guarantees or supports give favourable effect to the assigned rating.

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Short-Term Ratings

MARC’s Short-Term Ratings are assigned to Islamic capital market instruments with original
maturities of one year or less, and are intended to assess the likelihood of timely payment of the
instrument issued under the various Islamic financing contract(s).

Investment Grade Description

MARC-1ID Extremely strong capacity to make timely payment on the instrument
issued under the Islamic financing contract(s).
MARC-2ID Strong capacity to make timely payment on the instrument issued under
the Islamic financing contract(s). Timeliness of payment is slightly
susceptible to adverse changes in operating circumstances and
economic conditions.
MARC-3ID Adequate capacity to make timely payment on the instrument issued
under the Islamic financing contract(s). Moderately adverse changes in
operating environment and economic conditions may weaken financial
capacity to fulfill such obligation.

Non-investment Description
Grade
MARC-4ID Vulnerable to non-payment of instrument issued under the Islamic
financing contract(s). Capacity to make payment on the instrument is
dependent upon favorable business, financial and economic conditions.
DID Failed to make scheduled payment on the instrument issued under the
Islamic financing contract(s).

Notes: Short-Term Ratings will also carry a suffix (bg) for bank-guaranteed issues, (cg) for corporate-guaranteed issues, (fg) for FGI-guaranteed
issues, and (s) for all other supports when such guarantees or supports give favorable effect to the assigned rating.

Subscript „ID‟ for Long-Term and Short-Term Ratings denotes Islamic Private Debt Security.

Rating Outlook

MARC’s Rating Outlook assesses the potential direction of the Islamic Capital Market
Instrument Rating over the intermediate term (typically over a one to two-year period). The
Rating Outlook may either be:

Outlook Description
POSITIVE indicates that a rating may be raised;
NEGATIVE indicates that a rating may be lowered;
STABLE indicates that a rating is likely to remain unchanged; or
DEVELOPING indicates that a rating may be raised, lowered or remain
unchanged.

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Appendix 2

RAM’s Rating Symbols and Definitions

Debt-Based Sukuk

An Issue Rating for a debt-based sukuk is RAM Ratings' current opinion 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.

Long-Term Ratings

Grade Description
AAA A sukuk rated AAA has superior safety for payment of financial obligations. This is
the highest long-term Issue Rating assigned by RAM Ratings to a debt-based sukuk.
AA A sukuk rated AA has high safety for payment of financial obligations. The issuer is
resilient against adverse changes in circumstances, economic conditions and/or
operating environments.
A A sukuk rated A has adequate safety for payment of financial obligations. The issuer
is more susceptible to adverse changes in circumstances, economic conditions and/or
operating environments than those in higher-rated categories.
BBB A sukuk rated BBB has moderate safety for payment of financial obligations. The
issuer is more likely to be weakened by adverse changes in circumstances, economic
conditions and/or operating environments than those in higher-rated categories. This
is the lowest investment-grade category.
BB A sukuk rated BB has low safety for payment of financial obligations. The issuer is
highly vulnerable to adverse changes in circumstances, economic conditions and/or
operating environments.
B A sukuk rated B has very low safety for payment of financial obligations. The issuer
has a limited ability to withstand adverse changes in circumstances, economic
conditions and/or operating environments.
C A sukuk rated C has a high likelihood of default. The issuer is highly dependent on
favourable changes in circumstances, economic conditions and/or operating
environments, the lack of which would likely result in it defaulting on a particular
sukuk.
D A sukuk rated D is either currently in default or faces imminent default on its
financial obligations, whether or not formally declared. The D rating may also
reflect a distressed exchange, the filing of bankruptcy and/or other actions pertaining
to the issuer that could jeopardize the payment of a particular sukuk.

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Short-Term Ratings

Grade Description
P1 A sukuk rated P1 has high safety for payment of financial obligations in the short
term. This is the highest short-term Issue Rating assigned by RAM Ratings to a
debt-based sukuk.
P2 A sukuk rated P2 has adequate safety for payment of financial obligations in the
short term. The issuer is more susceptible to the effects of deteriorating
circumstances than those in the highest-rated category.
P3 A sukuk rated P3 has moderate safety for payment of financial obligations in the
short term. The issuer is more likely to be weakened by the effects of deteriorating
circumstances than those in higher-rated categories. This is the lowest investment-
grade category.
NP A sukuk rated NP has doubtful safety for payment of financial obligations in the
short term. The issuer faces major uncertainties that could compromise its capacity
for payment of a particular sukuk.
D A sukuk rated D is either currently in default or faces imminent default on its
financial obligations, whether or not formally declared. The D rating may also
reflect a distressed exchange, the filing of bankruptcy and/or other actions pertaining
to the issuer that could jeopardise the payment of a particular sukuk.

For long-term ratings, RAM Ratings applies subscripts 1, 2 or 3 in each rating category from AA to C. The
subscript 1 indicates that the issue ranks at the higher end of its generic rating category; the subscript 2 indicates a
mid-ranking; and the subscript 3 indicates that the issue ranks at the lower end of its generic rating category. In
addition, RAM Ratings applies the suffixes (bg) or (s) to ratings which have been enhanced by a bank guarantee or
other supports, respectively.

Partnership-Based Sukuk

An Issue Rating for a partnership-based sukuk is RAM Ratings' current opinion on the
creditworthiness of a particular partnership-based sukuk. It reflects the overall capacity and
willingness of an issuer to meet the payment of capital and expected returns on a full and timely
basis, taking into account the expressed terms and conditions of the investment contract. 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.

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Long-Term Ratings

Grade Description
AAA A sukuk rated AAA has superior safety for payment of capital and expected returns.
This is the highest long-term Issue Rating assigned by RAM Ratings to a
partnership-based sukuk.
AA A sukuk rated AA has high safety for payment of capital and expected returns. The
issuer is resilient against adverse changes in circumstances, economic conditions
and/or operating environments.
A A sukuk rated A has adequate safety for payment of capital and expected returns.
The issuer is more susceptible to adverse changes in circumstances, economic
conditions and/or operating environments than those in higher-rated categories.
BBB A sukuk rated BBB has moderate safety for payment of capital and expected
returns. The issuer is more likely to be weakened by adverse changes in
circumstances, economic conditions and/or operating environments than those in
higher-rated categories. This is the lowest investment-grade category.
BB A sukuk rated BB has low safety for payment of capital and expected returns. The
issuer is highly vulnerable to adverse changes in circumstances, economic
conditions and/or operating environments.
B A sukuk rated B has very low safety for payment of capital and expected returns.
The issuer has a limited ability to withstand adverse changes in circumstances,
economic conditions and/or operating environments.
C A sukuk rated C has a high likelihood of not meeting the payment of capital and
expected returns. The issuer is highly dependent on favourable changes in
circumstances, economic conditions and/or operating environments, the lack of
which would likely result in it not fulfilling the terms of the investment contract.
D A sukuk rated D is either currently not meeting or will not meet the payment of
capital and expected returns. The D rating may also reflect a distressed exchange,
the filing of bankruptcy and/or other actions pertaining to the issuer that could
jeopardize the fulfillment of the investment contract's terms.

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Short-Term Ratings

Grade Description
P1 A sukuk rated P1 has high safety for payment of capital and expected returns in the
short term. This is the highest short-term Issue Rating assigned by RAM Ratings a
partnership-based sukuk.
P2 A sukuk rated P2 has adequate safety for payment of capital and expected returns in
the short term. The issuer is more susceptible to the effects of deteriorating
circumstances than those in the highest-rated category.
P3 A sukuk rated P3 has moderate safety for payment of capital and expected returns in
the short term. The issuer is more likely to be weakened by the effects of
deteriorating circumstances than those in higher-rated categories. This is the lowest
investment-grade category.
NP A sukuk rated NP has doubtful safety for payment of capital and expected returns in
the short term. The issuer faces major uncertainties that could compromise its
capacity for fulfilling the terms of the investment contract.
D A sukuk rated D is either currently not meeting or will not meet the payment of
capital and expected returns. The D rating may also reflect a distressed exchange,
the filing of bankruptcy and/or other actions pertaining to the issuer that could
jeopardize the fulfillment of the investment contract's terms.

For long-term ratings, RAM Ratings applies subscripts 1, 2 or 3 in each rating category from AA to C. The
subscript 1 indicates that the issue ranks at the higher end of its generic rating category; the subscript 2 indicates a
mid-ranking; and the subscript 3 indicates that the issue ranks at the lower end of its generic rating category. In
addition, RAM Ratings applies the suffixes (bg) or (s) to ratings which have been enhanced by a bank guarantee or
other supports, respectively.

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Appendix 3

Rating Trend for Defaulted Sukuk

a) Ingress Sukuk Berhad

Rating History Date Rating Status Event

Rating Jun A+IS INITIAL  MARC has assigned a rating

8, of A+IS that reflects Ingress’
2004 track record as one of the
leading local automotive
component manufacturers
with a diversified customer
and geographical distribution;
and above average financial
results characterized by its
favourable operating profit
margin.
Rating Dec A+IS AFFIRMED  The rating affirmation of A+IS
8, on ISB Sukuk Al Ijarah
2005 Issuance is underpinned by
Ingress track record as one of
the leading local automotive
component manufacturers
with a diversified customer
and geographical distribution;
and its fairly strong financial
profile.
Rating Oct A+IS REAFFIRMED-  MARC has affirmed Ingress
12, STA Sukuk Berhad’s (ISB) RM160
2006 million Sukuk Al Ijara
Issuance at A+IS with stable
outlook; reflecting Ingress
track record as one of the
leading local automotive
component manufacturers
with a relatively diversified
customer base and
geographical distribution, and
it’s fairly strong financial
profile.

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

MARCWATCH Jul A+IS MARCWATCH-  The MARCWatch placement

31, DEV follows a recent confirmation
2007 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.
MARCWATCH Oct A+IS MARCWATCH-  Ingress Sukuk Berhad’s
30, DEV (Ingress) A+IS rating on its
2007 RM160.0 million Sukuk Al
Ijara Issuance Programme
remains on MARCWatch
Developing pending the
completion of MARC’s
annual rating review.
 The rating has been placed on
MARCWatch Developing
since July 30, 2007 as a result
of a breach in the Debt to
Equity Ratio according to the
Ijarah Agreement dated 1 July
2004.
Rating Dec AIS DOWNGRADED  MARC has lowered its rating
28, (MARCWATCH- from A+IS, and removed it
2007 UPL) from MARCWatch
Developing.
 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.
MARCWATCH Apr AIS MARCWATCH-  MARC has placed rating of
11, DEV AIS on MARCWatch
2008 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.

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 8th International Conference on Islamic Economics and Finance

MARCWATCH Jul AIS MARCWATCH-  MARC’s AIS rating on Ingress

11, DEV Sukuk remains on
2008 MARCWatch Developing
following an extension of the
remedy period given to
Ingress until July 26, 2008, to
resolve a breach in certain
financial covenants under the
Ijarah Agreement.
MARCWATCH Jul AIS MARCWATCH-  MARC has revised its
28, NEG MARCWatch placement from
2008 Developing following Ingress’
failure to rectify the breach in
certain financial covenants
under the Ijarah Agreement.
 MARC has been informed by
Ingress that the remedy period
granted by the Sukukholders
up to July 26, 2008 has not
been further extended and the
company has yet to conclude a
refinancing scheme in relation
to the Sukuk.
MARCWATCH Oct AIS MARCWATCH-  MARC’s long-term rating of
30, NEG AIS remains on MARCWatch
2008 Negative, where it had been
placed on July 28, 2008
following the company’s
failure to remedy the non-
compliance with certain
financial covenants of the
Sukuk.

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

Rating Feb A-IS DOWNGRADED-  MARC has downgraded its

25, NEG rating to A-IS from AIS.
2009  The rating remains on
MARCWatch Negative where
it had first been placed on July
28, 2008.
 The downgrade incorporates
the deteriorating liquidity
position and declining
profitability of Ingress and
continuing existing non-
compliance with certain
financial covenants under the
Sukuk.
Rating Mar BBB-IS MARCWATCH-  MARC has lowered its rating
31, NEG to BBB-IS from A-IS and
2009 maintains the lowered rating
on MARCWatch Negative
where it had been first placed
on July 28, 2008.
 The downgrade considers
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 July 9,
2009.

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 8th International Conference on Islamic Economics and Finance

Rating Apr BB-IS DOWNGRADED-  MARC has lowered its rating

10, NEG to BB-IS from BBB-IS.
2009  The lowered rating remains on
MARCWatch Negative.
 Since MARC’s downgrade of
ISB’s sukuk rating on March
31, 2009, ISB has failed to
make a RM25 million
payment into the Ijarah
Service Rental Account
(ISRA) within the required
deadline of April 9, 2009.
 Therefore, the MARCWatch
Negative incorporates the
possibility of the rating being
further lowered if ISB fails to
meet its sinking fund build-up
requirement within the 30-day
remedy period.
Rating Jul 6, CIS DOWNGRADED  MARC has downgraded its
2009 rating to CIS from BB-IS.
 The rating remains on
MARCWatch Negative.
 The rating action is based on
ISB’s decision to postpone
RM45.0 million of the
RM50.0 million upcoming
first tranche sukuk payment
due on July 9, 2009 for six
months.
Rating Jul DIS DOWNGRADED  MARC has downgraded its
13, rating to DIS from CIS.
2009  The rating of DIS reflects
ISB’s failure to meet its first
tranche sukuk payment of
RM50 million in full based on
the original scheduled
maturity on July 9, 2009.

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

Rating Feb DIS UPDATE  MARC has issued this rating

2, update in connection with
2010 Ingress pursuant to a
confirmation received from its
facility agent that approval
has been obtained from the
sukukholders for a further six-
month extension of the
redemption date of the first
tranche of the sukuk
programme to July 9, 2010
from January 9, 2010.
 The redemption dates for the
second and final tranches of
the sukuk remain unchanged
at July 9, 2010 and July 8,
2011, respectively.
 MARC’s rating of DIS on the
sukuk remains unchanged and
continues to reflect an
uncured payment default on
its first tranche of the sukuk
programme based on its July
9, 2009 original scheduled
maturity.
 The rating will remain at DIS
until the default is cured or the
rating is withdrawn upon the
completion of parent, Ingress
Corporation Berhad’s
(Ingress), restructuring
process.
Current Rating Aug DIS WITHDRAWN-  MARC has withdrawn its DIS
13, REDEEMED ratings following the full
2010 redemption of the sukuk and
cancellation of the programme
on July 2, 2010.

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 8th International Conference on Islamic Economics and Finance

b) Nam Fatt Corporation ICP/IMTN

Rating History Date Rating Status Event

Rating Dec MARC-1ID INITIAL  MARC has assigned a rating
21 /A+ID of MARC-1ID /A+ID. The
2005 rating reflect a tight issue
structure with pre-determined
criteria of contracts.
 The structural element of this
contract enhances the credit
strength of Nam Fatt with
good operating track record
and improving financial
profile.
Rating Dec MARC-1ID AFFIRMED  The rating affirmation of
21, /A+ID MARC-1ID /A+ID with stable
2006 outlook premised on the tight
issue structure governing the
facility.
 With strict drawdown and
restriction type of contract
which includes other
clearance from MARC the
contract will not have
negative impact.
Rating Aug MARC-1ID REAFFIRMED  MARC has affirmed Nam Fatt
1, /A+ID Corporation Berhad’s (Nam
2007 Fatt) ratings for its RM250
million Islamic Commercial
Paper/Islamic Medium Term
Notes Programme (ICP
/IMTN) at MARC-1ID /A+ID.
 The rating predicted on the
facility’s tight issue structure
confines the utilization of
drawdown for specific
contracts or projects ensure
them with creditworthy
counterparties can be
financed.

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

Rating Nov MARC-1ID AFFIRMED-DEV  MARC has affirmed its rating

24, /A+ID of MARC-1ID / A+ID on Nam
2008 Fatt Corporation Berhad’s
(Nam Fatt) RM250 million
Islamic Commercial Paper/
Islamic Medium Term Notes
Programme (ICP/ IMTN).
 The affirmed ratings reflect
the structural protections
afforded to noteholders under
the rated facility.
MARCWATCH Dec MARC-3ID MARCWATCH-  MARC has downgraded its
& 30, /BBB+ID NEG & ratings on Nam Fatt
Rating 2009 DOWNGRADE Corporation Berhad’s (Nam
Fatt) RM250 million Islamic
Commercial Paper/Islamic
Medium Term Notes
Programme (ICP/ IMTN) to
MARC-3ID/ BBB+ID from
MARC-1ID/ A+ID, and
concurrently placed the
ratings on MARCWATCH
Negative.
 The downgrade reflects
significant and severe
deterioration in the credit
profile of Nam Fatt due to
material delays in the progress
of certain existing projects
and unresolved claims in
respect of its Sudan-based
Melut Basin contract.

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 8th International Conference on Islamic Economics and Finance

MARCWATCH Mar MARC-4ID DOWNGRADED  MARC has downgraded its

& 16, /CID (MARCWATCH- ratings on Nam Fatt
Rating 2010 UPL) Corporation Berhad’s (Nam
Fatt) RM250 million Islamic
Commercial Paper/Islamic
Medium Term Notes
Programme (ICP/IMTN) to
MARC-4ID/CID.
 The rating downgraded
reflecting from Nam Fatt’s
failure to meet its principal
and interest payment of about
RM13.2 million to Bank
Kerjasama Rakyat Malaysia
Berhad on March 15, 2010
MARCWATCH Apr DID MARCWATCH-  MARC has downgraded its
& 6, DEV long- and short-term ratings
Rating 2008 on Nam Fatt Corporation
Berhad’s (Nam Fatt) RM250
million Islamic Commercial
Papers/Islamic Medium Term
Notes Programme
(ICP/IMTN) as follows:

 Long-term debt rating to

DID from CID
 Short-term debt rating to
DID from MARC-4ID

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 Center for Islamic Economics and Finance, Qatar Faculty of Islamic Studies, Qatar Foundation

c) Tracoma Holding Berhad

Rating
Date Rating Status Event
History
Rating AID  Tracoma’s vast experience
and good track record as one
Nov
of the leading local
29, INITIAL
manufacturers of automotive
2004
components, and its
commendable financials
Rating AID  Tracoma Group’s proven track
Apr record as a Tier-1 local
7, AFFIRMED automotive component
2006 manufacturer coupled with its
on-going expansion plans.
MARCWATCH Oct AID
MARCWATCH-  Tracoma’s delay to deposit the
3, monthly built up in the PSA
NEG
2006
MARCWATCH BBB+ID  Current negative domestic
& automotive industry outlook
Rating Feb DOWNGRADED reflecting weak industry
26, (MARCWATCH- fundamentals , have an
2007 UPL) adverse impact on Tracoma’s
future operating & financial
performance.
MARCWATCH BBB+ID  Reflects heightened concerns
Jul
MARCWATCH- about Tracoma’s ability to
25,
NEG make a RM 25 million
2008
scheduled payment
MARCWATCH Jul BB+ID DOWNGRADED  Company’s tight liquidity
& 31, (MARCWATCH- position and limited financial
Rating 2008 NEG) flexibility
MARCWATCH
Oct
BID DOWNGRADED-  Heightened concerns over
& NEG Tracoma’s ability to redeem
30,
Rating (MARCWATCH- its first BaIDS series
2008
UPL)
Rating Jan CID  No payment made on its first
DOWNGRADED-
23, BaIDS series of RM 50
NEG
2009 million
Rating DID  Tracoma’s failure to redeem
Jan DOWNGRADED
its first BaIDS series of RM
29, (WITHDRAWN-
50 million, company is facing
2009 DEFAULT)
financial distress.

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 8th International Conference on Islamic Economics and Finance

Rating Nov CID RESTRUCTURED  Proposed structured, reflects

2,
2009
Rating Mar CID
5,
2010
Rating July DID DOWNGRADED  The rating agency notes that
15, since the assignment of the
2010 preliminary rating to the
restructured debt instrument in
November 2009, Tracoma has
proposed further changes to
the structure of the BaIDS,
which have yet to be finalised

37