Now that we are well into the second quarter of 2013 it is possible to look back at US dollar sukuk issuance on a year-to-date basis and make some observations about the current state of the market, based on the type of transactions and pricing levels which have been successful.
The theme where demand outstripped supply of public US dollar sukuk certificates in 2012 is one which continues to define the current market. However, the average yield on the HSBC/NASDAQ Dubai US Dollar Sukuk Index fell from 4% on the 29th December 2011 to 2.81% on the 31st December 2012, but this year rose by 28 basis points to a level of 3.087% on the 23rd April. Why has the Index yield increased in 2013, particularly when the credit environment in the GCC regions remains benign, demand remains robust, supply has been moderate, and the interest rate level has not risen by much (5 year US dollar swap rates increased by only 1 basis point during the year to 23rd April)?
A clue to the increase in index yield, can be seen in the weighted-average-life of the index. The index life has increased from 4.47 years to 5.3 years so far in 2013, and with an upward sloping yield curve, long-dated fixed income obligations generally convey a higher yield than short-dated alternatives. When we observe specific sukuk transactions issued this year, we can see that the typical 5-year tenor deal has been replaced by longer-dated transactions. For example, in January Malaysian conglomerate Sime Darby issued $400m and the Government of Dubai issued $750m in the 10-year space; in March Dubai-based airline carrier Emirates issued $1bn in the 10-year space; while in April we have seen utility firm Saudi Electric Company issue $1bn in the 10 year space and $1bn in the 30-year space. To be clear, we are now seeing issuers easily place 10+ year paper in a market where a 5-year tenor used to be the norm. This development partly reflects investors' strong appetite for yield, as well as the desire of issuers to lock-in a low cost of funding for as long as possible.
There is another phenomenon at play however which is contributing to the higher yield and greater average life of the US dollar sukuk market: subordinated issues. As the hunt for yield searches far and wide, investors are now willing to accept greater credit risk, in the form of subordinated creditor rights, by investing in certificates which allow bank issuers to increase their capital adequacy ratios. From the issuers' perspective, this trend is partly a response to the requirements of pending regulation (Basel III). By far the majority of public US dollar sukuk transactions in recent years have been of the unsecured senior-ranking creditor type, but Abu Dhabi Islamic Bank's $1bn perpetual sukuk issue in November 2012 was an innovation in that the structure provided investors with a relatively high-yield asset, given the coupon of 6.375%, and allowed ADIB to raise Tier 1 capital at a low cost. Not to be outdone, Dubai Islamic Bank issued $1bn perpetual sukuk in March this year at 6.25%, boosting that bank's Tier 1 capital. Similarly Turkish financial issuer Bank Asya issued $250m of Tier 2 paper at 7.5% with a 10-year maturity. Currently Turkish bank Albaraka Turk is understood to mulling a similar type of sukuk issue.
Some investment practitioners believe there is a bubble in current bond market valuations following massive increases in the money supply in the US and Europe, and one might argue there are signs of desperation in the US dollar sukuk market, as some investors sign-up for low-yielding long-dated fixed income investments and subordinated creditor rights. On the other hand, these latest transactions generally come from established borrowers in highly regulated industrial sectors who may be best-placed to meet the demand of sukuk investors for high yield in the current low profit rate environment.
Paul Bateman has been a Senior Risk Manager at Bank of London and The Middle East since 2009. Prior to this he was a consultant at Threadneedle Asset Management. In 2008 he completed an MBA from Cass Business School and a Business Research Project at Strategic Investments Group. Prior to this he also held Analyst roles at Standard Bank, NIBC and Credit Suisse.
© Zawya 2013
