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Liquidity problem: an utmost worry for Modarabas says AMML CEO Karim Hatim

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June 25, 2021 (MLN):  We have all heard the policymakers and banking executives give the usual of promoting financial inclusion and increasing access to capital for the underserved segments. Their favourite pointer is often regarding the small and medium enterprises – who we are told are the backbone of the economy. With the growth of Islamic finance, more and more people are embracing the formal sector, the usual pitch goes. 

Yet, if one digs the issue, the problem has been more from the supply side than demand. Individuals and businesses already borrow, only that the formal channels are often not accessible to them. Be it the cumbersome documentation asking for salary slips or the just the bureaucratic delays, the overall financial sector actively discourages borrowers, and particularly shuns the small ones. That’s a gap non-banking financial companies have tried to fill, albeit with limited success of late. 

With regards to that, Mettis Global took an interview of Awwal Modaraba Management Limited (AMML) CEO Karim Hatim to get a proper insight of the issue. Awwal is one of those companies that is licensed under the Registrar of Modarabas, Securities and Exchange Commission of Pakistan to float and manage multipurpose Modaraba Funds. Moreover, the is a perpetua and is primarily engaged in providing Working Capital, Term Finance, Ijarah, Musharika, Morabaha and other Shari’ah compliant investment / instrument to credit worthy customers.

Below are the transcripts.

Awwal’s profitability has been heading down for the past couple years. Why is that? 

The Covid-19 created a lot of uncertainty about the overall economic environment and what sectors will survive or take a hit. Given the situation, we decided to slow down activity as it was the public’s money and didn’t feel it was worth putting capital at stake for the sake of profitability. 

Unlike banks who have multiple revenue streams, such as capital markets, treasury etc, we had only one line of business and went for the cautious route. If you look now, Awwal alone is sitting around Rs500 million of cash and combined with our three other Modaraba’s, the number goes over Rs1 billion. Deploying that capital is the easiest thing but you have to wait for good opportunities. This is why you see a dip in profitability of late. 

Lately, we slightly shifted our focus and applied permission for new business activities under Modaraba. First was for a credit rating company, keeping in view the unique experience we have gained over the years with respect to distressed firms. However, the Securities and Exchange Commission of Pakistan said, and rightly so, that it had to be done through setting up a separate entity. 

Then we have just gotten approval for real estate projects from the regulator. Broadly speaking, we want to get more into the real business activity, such as warehousing for agricultural products as well as earth-moving rental equipment and locomotives. The financing side is already present in various areas from Awwal looking after Modarabah, then our parent company, Pak Brunei, doing the conventional. 

These are the areas where we are partnering up with players who have technical knowledge and will help them with leasing while they manage operations. However, the past few years have disrupted some plans upside down.  

Can you explain what areas Awwal is particularly interested in and what’s the business model? 

When we started Awwal Modaraba, our primary objective was to cater to distressed assets and usually non-bankable customers. For conventional financing, there was already Pak Brunei Investment Company, so Awwal wants to go beyond that. Distressed companies basically have two avenues for funds: either they borrow from a private money lender, usually around 3% per month, and the second is to get goods on credit, which costs more or less the same. 

What we do is serve as a solution provider between a money lender and a corporate commercial banking and support those entities get out of the Credit Investigation Bureau. Once the company is out of the woods and streamline their operations and cash cycle, we get our money back. Or sometimes, a bank enters even before that with cheaper financing and we get to exit prematurely. It’s like doing the private equity in debt model.  

Is that the usual mode of exiting? What have been some of the notable transactions Awwal helped turn around? 

The first criteria to even get into the deal is that the company needs to have a self-liquidating cash flow model. At times, we have exited after a bank intervened before even getting to that tailend but that’s not the basis on which we finance. To ensure ourselves protection, we structure the debt and write covenants but try not to burden the transaction for a return. 

Nimir Resins is one of the major transactions we helped finance at the time of its management buyout. Soon after the transformation, banks came in and they paid us back before the original maturity of the debt as the company was looking to scale further. On the other hand, Martin Dow started generating enough cash flow and returned our money. Then Pak Brunei was also part of structuring the debt for Bunnys Ltd to help streamline its cash cycle, and the company eventually listed on the stock market as well. 

Both the number of Modarabas and the sector’s assets have stayed stagnant over the past few years. Why is that? 

Initially when Modarabas came into being, there were around 57 players. But some of them began investing in the equity market or financing in their group companies. They didn’t focus on their line of work and with time, many collapsed. Secondly, Modarabas – which were mostly in the leasing model – started facing an increasingly competitive environment when banks launched their own leasing products. Lastly, the investor focus phased out and the players didn’t capitalise themselves, rendering them unable to properly meet the market’s financing needs of the day. 

The biggest issue is that Modarabas have a major liquidity problem: unlike banks there’s no access to current or savings accounts and borrowing from banks is expensive in addition to the competition factor. There are a few players that have still grown but they often get strength from their sponsors: we have Pak Brunei behind us, Orix has its international experience etc. 

Considering these limitations, what role do you believe the sector can still play in unlocking the potential of SMEs and ensuring them access to capital? 

To cater to the small and medium enterprises, a different set of skills is required, which Modaraba players are well equipped with. You need to go to the field and roll up your sleeves for even a Rs1m loan. Banks neither have the time nor the incentive to go deep into the sector. Their disbursement targets don’t leave much room for small transactions that SMEs need. What they should do is create a bundle of loans and securitize that. 

Years ago we had development finance institutions with cheap credit lines and helped build a number of sectors, but when they faltered, it created a gap in the market. If you look at India as well, they have thousands of non-banking finance companies which are playing exactly this intermediary role. 

What’s your stance on the Modaraba Regulations introduced in 2021? 

To their credit, the SECP drafted these regulations in consultation with the sector and listened to us, which was a good gesture. Now the onus obviously is on Modaraba companies, who need to do a bit of cleaning up as well. There are currently a number of inactive players which I feel should either streamline their processes or exit as they dent the sector’s overall performance. That said, there is a major liquidity problem which needs to be addressed for not only this sector to grow but also the overall SME space too.

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