Credit rally erodes sukuk advantage

Mon Sep 17, 2012 9:37pm IST

LONDON, Sept 17 (IFR) - In a market galvanised by central bank action in the US and in Europe, strong appetite for emerging market bonds have eroded the pricing advantage enjoyed by sukuk over conventional paper say origination bankers, at a time when yield-starved Islamic investors have started to become more selective.

The shift might carry significant implications for the sukuk market, where issuers used to be able to save as much as 40bp by printing Sharia-compliant bonds as opposed to conventional notes. Meanwhile, as much as USD19.2bn has been raised so far this year by borrowers according to S&P.

"The issue price you can achieve in the conventional market is very aggressive at the moment," said an origination banker in London. "About a year ago, issuers had a 30bp-40bp advantage by doing sukuk deals. That's been squeezed down to closer to 10bp now."

The banker points to Abu Dhabi-based First Gulf Bank's (FGB) debut sukuk in 2011 as one example of the generous pricing advantage once enjoyed by the format. Back then, targeting Islamic investors resulted in a 30-40bps pricing advantage for the issuer, reckons the banker. "A conventional deal would have been very unlikely to price so tightly," a European banker familiar with the transaction told IFR at the time.

By contrast, Dubai property developer Majid al Futtaim's (MAF) debut sukuk at the end of June this year seems to reveal a much thinner differential in terms of pricing between Islamic and conventional formats. "It was primarily a liquidity advantage," said the banker. "They could have priced a conventional more or less at the same level."

WEIGHING OPTIONS

While the opportunity to tap cash-rich Islamic investors is encouraging an increasing number of borrowers such as Turkey and South Africa to make their debut in the sukuk market, issuing Islamic bonds is not a seamless exercise, especially for names looking at a one-off foray into the market.

"It's a lot of work to get a sukuk done. You need to have some pricing advantage [for the effort to pay off]," added the banker, who reckoned borrowers were likely to question whether choosing the sukuk format to save 5bp-10bp in spread terms is worth all the trouble.

"[As an issuer,] you would expect to save 15bp-20bp by doing a sukuk," noted another banker. "But in this market, you should be able to price a conventional close to a sukuk."

For some, the Republic of Turkey's debut 5.5-year sukuk, slated to hit the market on Tuesday, will be a litmus test of the potential that the Islamic format can offer in such a bullish market. The deal will also shed some light on the willingness of Islamic accounts, the biggest buyers of sukuk, to leave the shores of the Arab Gulf and South-east Asia and buy into names farther away from home.

EYES ON TURKEY

Turkey (Ba1/BB/BB+) is not the most atypical newcomer to sukuk. Some of its Sharia-compliant participation banks have issued Islamic bonds before, and bankers argued that issuing in the Islamic format made perfect sense for the sovereign. Historically, however, the country has preferred to focus on conventional issues, in order to build a liquid benchmark curve.

"I very much doubt that they are doing this because it will be cheaper [form of funding]," said the first banker, noting that the sovereign is able to price conventional bonds at tight levels already.

A banker familiar with the deal said that Turkey aims "to foster interest among a community of investors" who are relatively new to it, while other suggest that this could be just the first of a series of Sharia-compliant issues for the country.

Turkey's price guidance suggests that the premium it is offering over its conventional curve is between 10bp and 20bp. Revised guidance of 180-190bp over mid-swaps compares with a level of 180bp over swaps for its April 2018 note just prior to the sukuk's pricing announcement. The order book is already more than USD5bn, with investors in Europe, the Middle East and Asia still able to put in bids.

The mandate allows Turkey to raise up to USD1bn, although the final size has yet to be decided. Citigroup, HSBC and Liquidity House are the leads on the transaction, which is expected to price on Tuesday and is structured as a ijara, backed by real estate assets. (Reporting By Davide Scigliuzzo; Editing by Sudip Roy)