Matang Highway Sdn Bhd - Feb 2010

MARC has downgraded its rating on Matang Highway Sdn Bhd’s (Matang) RM70.0 million Sukuk Musharakah issuance to AIS from AA-IS and concurrently removed the rating from MARCWatch Negative where it was first placed on August 6, 2009. The rating outlook is negative.

The rating actions reflect the tight liquidity of Matang as a result of the knock-on consequences of construction delay in Matang’s second phase construction of the Matang Route Project (Revised Matang Route or RMR) and delayed receipt of progress payments from the project obligor, Jabatan Kerja Raya Sarawak (JKR Sarawak). Despite positive progress made, work on the RMR remains significantly behind the original schedule and is exacerbated by difficulties in procurement of some materials. Measures put in place to address issues in Matang have not yet produced the intended results and will likely be insufficient to fully mitigate the effects of the construction and progress payment delay on Matang’s debt servicing ability. The timing for the resolution of currently outstanding variation order and expense claims and eventual amounts to be collected of approximately RM45.0 million is subject to uncertainty although MARC considers the foregoing to be a potential source of liquidity improvement. Matang’s low cash position and recent reliance on Zecon’s financial strength to fulfil its sukuk obligations are driving factors in the current rating determination.

Matang, a wholly-owned subsidiary of Zecon Berhad (Zecon), was established as a single-purpose entity to undertake the issuance of RM70.0 million Sukuk Musharakah. The proceeds from the Sukuk were used to refinance Zecon’s existing debts and to finance working capital requirements for the turnkey contract awarded by JKR Sarawak to Zecon for the design and construction of a highway linking Kuching City to the State of Sarawak’s proposed new Federal Administrative Centre (Matang Route Project). Matang and Zecon entered a Mudarabah arrangement under which Matang acts as capital provider for the turnkey contract and Zecon as the entrepreneur. Sukukholders invest in trust assets comprising Matang’s rights, entitlements, benefits and interest under the turnkey contract, the designated accounts under the proposed issue structure and other permitted investments. Cash flows generated from construction under the turnkey contract fund profit payments and capital repayments under the fully amortising three-year Sukuk. Apart from the creditworthiness of the obligor (JKR Sarawak), the other primary rating driver for the Sukuk Musyarakah is the continuing performance of the turnkey contract as this financing structure is essentially non-recourse to Zecon.

The Matang Route Project is divided into two phases: the Original Matang Route (OMR) with a contract value of RM203.29 million and the RMR with a contract value of RM124.15 million. The OMR reached physical completion as of August 16, 2009 and JKR Sarawak recently issued a certificate of practical completion on the OMR. The unforeseen delay in construction progress on the RMR was caused by challenges in procuring sand, the main raw material. Although JKR Sarawak had granted a further extension of time for completion of RMR to July 26, 2011, MARC is concerned that the overall progress of works remains significantly behind schedule. Actual construction progress on the RMR as of December 31, 2009 was 22.5% against scheduled progress of 44.2%. Actual collections in respect of the OMR and RMR up to November 2009 were RM186.4 million and RM23.5 million respectively, representing 91.7% and 18.9% of contract value for the respective segments.

To ease its constrained liquidity, Matang has sought and obtained a waiver and indulgence on the non-fulfilment of its September and October 2009 sinking fund minimum required balance. Matang was also allowed to reschedule the sinking fund build-up for its Series 2 principal repayment due in May 2010. Following this, Matang’s Sinking Fund Account (SFA) needs to be funded at not less than RM20 million by end-April 2010 (initial schedule end-November 2009) to meet the Sukuk principal repayment due on May 28, 2010. Matang is further required to build up its sinking fund to RM15.0 million by November 2010 for its Series 3 principal repayment due in May 2011.

MARC understands from the trustee that RM2.3 million out of the RM4.0 million additional build-up payment for the month of August 2009 was contributed by Zecon. MARC views this as a sign of Zecon’s commitment to fulfill Matang’s obligations to sukukholders despite the sukuk’s non-recourse financing structure. Currently, MARC maintains a public information rating of BBB on Zecon, below that of Matang’s. MARC has been informed by the trustee that Matang has built up RM14.0 million in the SFA to satisfy the minimum sinking fund required balance for January 2010. Current outstanding RMR collections totalling RM2.5 million as at February 18, 2010 are expected to cover the minimum sinking fund required balance for February 2010 and partly meet the remaining RM6.0 million to be deposited into the SFA by end-April. Matang expects the remaining amount to be covered by further RMR work-in-progress billing.

The negative rating outlook signals that uncertainty remains as to whether these efforts will be sufficient to forestall a shortfall in project collections vis-à-vis sukuk obligations, in particular for Series 3. MARC believes that Matang will continue to rely on Zecon to fund debt service shortfalls and could lower the rating if the project fails to generate sufficient cash flow to meet Matang’s sukuk obligations over the next several months.

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