MARC has downgraded the rating of PSSB Ship Management Sdn Bhd’s (PSM) RM40 million Bai’ Bithaman Ajil Islamic Securities (BAIS) from AA-ID to A+ID with negative outlook. Factors contributing to the downgrade include consistently higher than anticipated vessel operating cost, deteriorating financial position of project sponsor – PSSB Strategic Holdings Sdn Bhd (PSSB), and PSM’s failure to adhere to timely reporting requirement to the Facility Agent/Trustee as required under the principal terms and conditions of the BAIS. Although the source of repayment for the BAIS is backed by a 10-year charter contract between PSSB and the Government, in which the future rental proceeds from a vessel have been identified/assigned as repayment for the facility, downward rating pressure may be aggravated by the performance risk associated with the said contract.

With regard to the contract, in September 2000, PSSB, the holding company of PSM, entered into a Rental Agreement with the Government in respect of the charter of a vessel for the Royal Malaysian Navy‘s (TLDM) training programme. In return, the Government shall pay PSSB an annual rental payment of RM8.8 million for a tenure of ten (10) years. PSM is a special purpose vehicle established for the sole purpose of capturing the rental proceeds from the Government, which shall serve as the source of repayment for the BAIS facility. The annual rental payments from the Government should lend stability and predictability to PSM’s cash flow. Based upon past records, the Government has been prompt in its rental payments; within 30 days after receiving the invoice, as stipulated in the contract Agreement. For rental payment invoiced in early August 2006 however, MARC was informed that PSSB has yet to receive it from the Government.

Nevertheless, liquidity risk under the transaction is mitigated through the priority ranking accorded to payment obligations under the BAIS. The amount due within the next twelve months under the BAIS shall be credited into the Debt Service Reserve Account (DSRA) out of the annual rental payments received net of statutory payments, but before capital and operating expenditures. In addition, PSM shall deposit RM500,000 annually into a Sinking Fund Account to ensure sufficient monies for the redemption of the final tranche (RM10 million) in FY2011.

Meanwhile, PSSB’s revenue has been fluctuating with thin operating profit margin over the past several fiscal years. Based on the unaudited financial statement for FY2004, the company registered a net profit of RM1.0 million on the back of RM16.7 million of revenue. However, based on its FY2005 unaudited account, PSSB financials worsened, registering a net loss of approximately RM1.1 million wherein the company cited difficult business condition and intensifying competition for government related contracts/projects as the main causes for its deteriorating financial performance.

Furthermore, the FY2005 unaudited account revealed PSSB’s shrinking shareholders’ funds at RM3.32 million with retained losses of RM8.28 million. Its Debt-to-Equity ratio appears high at 9.98 times in spite of additional capital injected by the shareholders of PSSB in late 2004 amounting to RM1.6 million. The equity injection somewhat demonstrated PSSB’s shareholders’ willingness and ability to inject additional funds into the company, when required.

Base on PSM’s base case cash flow projections, the average debt service coverage ratio (DSCR) over the remaining tenure of the BAIS, is calculated to be 2.45 times while the minimum of 1.02 times expected in the final year of repayment in FY2011.

MARC takes cognizance of PSM’s failure under the principal terms and conditions of the BAIS, among others, to deliver its quarterly budget on the operation of the vessel before commencement of each quarter of a financial year to the Trustee. Further, PSM, upon receipt from PSSB, is required to provide the Facility Agent/Trustee a semi-annual actual statement on the operation of the vessel to be reconciled with the yearly operating budget of the Operating Account. MARC has been informed that apart from the operating budget for 1QFY2006, no other operating budget and semi-annual actual statements for FY2006 have been furnished to the Facility Agent.