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Monday, 17 December 2007

Sukuk market set to see rise in subordinated debt

SINGAPORE: The Islamic bond market is likely to see a surge in subordinated debt in 2008 as Shariah-compliant banks seek capital to match their fast-growing assets. This blossoming in bank-capital sukuk issuance should add a higher-yielding dimension to the senior unsecured paper that now dominates the Islamic market. “I think the next level for the sukuk market will be hybrid, or sub-debt, instruments which will help Islamic financial institutions establish efficient capital structures,” said Arshad Ismail, head of global sukuk at HSBC Amanah. The Islamic banking division of the Hong Kong-and London-listed HSBC Holdings was the leading bookrunner for sukuk issuance in the third quarter, according to the London-based Islamic Finance Information Service. Regulators require the growing number of Islamic banks to set aside a minimum amount of capital, like their conventional counterparts, as a cushion against adverse events. Subordinated bonds, which rank below senior bonds, are the cheapest form of bank capital. Subordinated bonds are commonplace in developed bond markets around the world, but the Islamic bond market has so far seen only one internationally acceptable bank-capital deal. Malaysia’s Malayan Banking Bhd raised $300mn in April for its new Islamic bank. Islamic banks conduct their activities in line with the Qur’an. In addition, sukuk are structured to comply with Islamic law, which, for example, bars interest. Instead, such bonds make coupon-style payments derived from underlying assets. Maybank’s deal – seven times subscribed by investors from Asia, Europe, and the Middle East – was backed by Shariah-compliant hire-purchase contracts for goods such as cars. Arshad forecast upcoming deals could mimic that structure. Behind the expected blossoming in bank-capital sukuk is a dramatic expansion in balance sheets at Islamic banks as more of the world’s 1.2bn Muslims turn to banks that conduct business in compliance with their faith. Reliable numbers are hard to come by, but the General Council of Islamic Banks and Financial Institutions estimated assets at Islamic banks and in Islamic windows of conventional banks at $450bn in 2005 and most agree that growth has been dramatic since then. Banks have been set up in both Islamic and non-Islamic jurisdictions and existing Shariah-compliant banks are broadening their range of products. The growth should continue. In Malaysia, Islamic banks now account for around 12% of total banking assets and the central bank aims to boost that to 20% by 2010. As assets expand, capital efficiency becomes increasingly important. Bank capital – typically set at a minimum of 8% of risk-weighted assets – is traditionally made up largely of shareholder equity. Under current Bank for International Settlements rules followed by most countries, Islamic and conventional banks can issue a limited amount of cheaper Tier 2 and hybrid Tier 1 subordinated debt, which is faster to issue than equity. In the conventional market, investors tend to like such paper because the subordination means they get an additional yield pickup with relatively little extra risk. Bankers say it is possible conventional banks could also start tapping the subordinated-sukuk market to diversify their investor base and, potentially, gain cheaper funding than they might in the conventional bond market. Either way, subordinated sukuk will add a fresh dimension to a market that is expected to expand again next year. In the third quarter, there were $37.3bn in new sukuk issues, more than double that of the same period last year and up from virtually nothing at the start of the decade, IFIS said. As with the standard bond market, the extent of the growth will depend on how quickly markets recover from worries over the future of the US economy, Arshad said. “We expect to see a lot of growth in the Saudi market simply because it is the largest market in the Gulf Co-operation Council and its need for capital in the next few years is large,” he added. In Asia, Malaysia – currently the source of around 62% of outstanding sukuk but being fast chased by the Gulf – will continue to be important, and 2008 could see the Indonesia government sell its first international sukuk. A number of non-Muslim majority nations including the UK, Japan, and Thailand could also throw their hats into the ring. All three are working on the relevant paperwork to sell sukuk. Issuance from the US – where only one company has tapped the sukuk market – is likely to be virtually nonexistent largely because the highly liquid local market provides no incentive to look elsewhere. Convertible and exchangeable sukuk will also remain rare despite the good reception to multibillion-dollar deals from borrowers such as Dubai’s Ports Customs and Free Zone Corp and property developer Nakheel in 2005 and 2006. It will take a few more years for Shariah-compliant exchangeables and convertibles to become mainstream, Arshad said, “because businesses in the GCC need to mature to enable the owners to extract the most value from any such transaction.” – Dow Jones Newswires

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