Dec 21 - 27, 2009

The fears that Rs8 billion Sukuk issued by Maple Leaf Cement Factory would face default came true with the announcement of Pakistan Credit Rating Agency that downgraded the rating of MLCF Sukuk issue of Rs8 billion to 'D' from previous rating of 'BBB'. Meanwhile, the entity ratings are placed on Selective Default. The rating denotes that the financial obligations are currently in default.

The ratings reflect the company's non-performance on its debt obligations (Sukuk's interest payments), emanating largely from material deterioration in its financial profile, an outcome of the company's highly leveraged capital structure and subdued cash flow.

This has severely impacted company's ability to meet its financial obligations on a timely basis. Meanwhile, the business prospects of the company are subdued due to challenging dynamics of the cement sector.

According to PACRA the management of the company is currently in negotiations with lenders for debt restructuring. Nevertheless, a favorable restructuring outcome may lead to revision of the ratings from its current level. The Sukuk is being traded at Rs85 and likely to go down further when market opens on Monday. This may also cause redemption pressure on mutual funds having exposure in MLCF Sukuk.

Earlier, MLCF having failed in settling its liability requested restructuring of its Rs8 billion Sukuk. The default was third in quick succession and was likely to aggravate woes of the nascent Islamic financial institutions (IFIs) operating in Pakistan.

Earlier, New Allied Equipment and Kohat Cement Sukuk went delinquent. The news created some redemption pressure on Islamic mutual funds irrespective of their exposure in Sukuk issued by the cement manufacturers.

Allied Bank, which acted as arranger for Maple Leaf Sukuk, has an exposure of about Rs3.19 billion and the list of other investors is long. Meezan Bank acted as Shariah Advisor to the issue. Reportedly, mutual funds collectively have exposure of over Rs3 billion in Maple Leaf's Sukuk.

The three quick defaults of Sukuks will not only hurt the credibility of the Islamic financial institutions, but raise many serious questions about the way these Sukuks were structured. The situation demands quick review of the situation and more stringent risk appraisal criteria.

Failure of Maple Leaf to timely discharge its liability raises some questions about the business model being followed by the cement industry. It is no secret that most of the cement companies have borrowed heavily. It seems that having exhausted their borrowing from conventional banks these companies opted for Sukuk and both the lead arranger and the Shariah advisor got trapped.

PACRA has hinted at the fragile financial condition of Maple Leaf. A peep into the recent history of cement industry provides some interesting details. These Sukuks were floated prior to the imposition of fines on the cement manufacturers by the Competitive Commission of Pakistan and the cement glut appearing in the global markets. With the decline in capacity utilization most of the units were expected to face liquidity crunch but no one expected so quick defaults.

Investment in Sukuk provided an opportunity to the Islamic banks to meet their statutory liquidity requirement. However, it seems that in haste these financial institutions accepted whatever was offered without examining the soundness of the business model.

Shariah Advisor may say that the product was fully compliant to Shariah tenets and they do not have any obligation beyond that. However, is it not the responsibility of Shariah advisor to ensure security of the investment? Meezan Bank is a full fledged commercial bank and it should have acted more prudently in evaluating the business model of the issuer.

Whatever has happened cannot be reverted. Now, the real test for the financial institutions is to restructure repayments. While the borrower is trying to get the best possible concessions, the probability of restructuring is very low. The financial condition of Maple Leaf is going from bad to worse with outlook for cement industry getting bleaker.

It is on record that financial institutions facing such a situation prefer to close the Pandora box by offering new concessions. The time has come that they face the situation more courageously. They should not hesitate in initiating liquidation proceeding against the erring borrowers.

It must also be kept in mind that most of the defaults are the result of imprudent decision making by the financial institutions. Either they are carried away by the persuasion by the borrowers or lack the acumen to scrutinize the threats underlying the transactions.


Maple Leaf should be examined as a test case by all financial institutions and particularly the central bank. There is also a need to fix the responsibilities of lead manager and Shariah advisor. While it is often said that there are many circumstantial defaulters the list of habitual defaulters is much longer. Only the financial institutions could be held responsible for the prevailing circumstances.

There is also word of caution from the experts that in no way financial sickness of the industries should be allowed to pass on to the financial institutions. A prudent and strong banking system can withstand sickness of industrial units but when financial institutions become sick the whole economic system may collapse.

The ongoing global financial crisis is the result of imprudent and reckless lending. Even the US government had to inject billions of dollars to save its banks and insurance companies from eventual default. Pakistan government cannot afford such an extravaganza. Barring a few bad transactions, commercial banks have behaved prudently only because of a vigilant central bank. It has withstood the pressure of borrowers in the past and should show no leniency towards the habitual defaulters.