Up, up and away
Sukuk issuance has grown at an exponential rate, with the total global outstanding jumping by more than 100% since 2006. William Thornhill reports.
Paying little heed to the global crisis, the breakneck rate of growth in sukuk issuance has been driven by eye-watering demand and supply fundamentals in the Gulf Co-operation Council (GCC) region; a region that this year has spawned two new prototype structures based on the latest Sharia-compliant conventions.
Cash-rich investors from the Middle East have shown an ever-growing appetite for financial products that are faith-compliant. At the same time, the GCC region is in the throws of massive infrastructure construction projects that require enormous funding. Local banks have been anxious to offset their inexorable escalation of real estate lending with robust, sustainable long-term funding.
These demand and supply drivers saw outstanding sukuk issuance jump from less than US$30bn two years ago to an expected US$70bn this year, says S&P. According to the International Monetary Fund (IMF), the GCC region has been the real powerhouse of this growth, as it accounted for as little as 10% of the global sukuk total in 2004 – but today that proportion has grown to about one-half. S&P and the IMF expect to see a sustained pick-up in growth, not just over the second half of this year, but well into the years ahead.
"The post-Ramadan outlook for sukuk issuance looks healthy, with about US$20bn–$30bn in the pipeline globally and with growing interest in the structure worldwide," said Mohamed Damak at S&P. The IMF recently published a report in which it predicted that total issuance outstanding was likely to more than double to exceed US$200bn by 2010 (from US$90bn issued in total at the end of 2007). Of this 2007 figure, US$40bn was issued in structured Islamic securities. While the majority of supply to-date has been from sovereign entities, bankers say that prospective growth will be driven by corporations.
Nonetheless, the IMF and S&P concede that the global crisis has taken its toll. During the first quarter of 2008 issuance was almost half the level seen a year earlier based on IMF data. S&P said issuance was down from US$23bn in the January to August period last year to US$14bn in the same period this year.
But that slowdown could also be due to uncertainty about what is, and is no longer, a Sharia-compliant deal. According to S&P, more than half the sukuk issued in the first half of 2008 were "ijara", which it believes is a direct consequence of the debate among some Sharia scholars regarding the Sharia-compliance of most sukuk previously issued.
Ijara structures are a form of pooled portfolio sale-and-leaseback securitisations based on identifiable, stand-alone assets on the balance sheet of the originator and placed into an SPV. This compares with musharaka sukuk, where there is risk-sharing in a proportionate manner, usually enforced by the lender taking an equity stake, as with venture capital financing in the West.
Mudaraba sukuk are partnerships based on finance trusteeships in which the lender entrusts funds to the borrower. Once the project is finished, the borrower returns the principal and a pre-agreed share of the profit.
Sun's partial recourse
Citi and Merrill Lynch have both played key roles in bringing deals that are likely to prove a template for future structures from the GCC region.
The Citi deal, called Sun Finance, was the first full Sharia-compliant transaction structured to the latest guidelines and features partial recourse, as opposed to full recourse, to the originator – Sorouh Real Estate PJSC. Merrill Lynch's Villamar Sukuk was notable for being the first non-recourse ABS real estate finance deal.
Non-recourse means lenders can take the property pledged as collateral to satisfy a debt, but they have no recourse to other assets of the issuer or sponsor. Sales made with full recourse allow the buyer to resell a portion of the assets back to the seller, and thus from an accounting perspective are treated as financing and not a true sale.
"Sharia scholars have recently expressed concern over pure-recourse deals and as a consequence previously Sharia-compliant deals would no longer be compliant if proposed today," said Robin Ward, a director at Citi, which acted as the deal's global lead co-ordinator on Sun Finance.
The deal saw Sun Finance, a Jersey SPV, issue Dh4.016bn (US$1.09bn) of sukuk certificates. The sukuk al-mudaraba al-muqayyada certificates are backed by scheduled instalment payments owed by sub-developers arising from the sale of plots of land on the Shams and Saraya developments.
"Sorouh's liability to meet this obligation is outside the structure. In other words, the structure has no contractual obligation to provide the infrastructure. The obligation to deliver infrastructure remains with Sorouh alone," said Ward. "This is the first Islamic securitisation of land and associated rights to payment. It's backed by freehold title to the land in the form of an instalment sale contract that is secured by land," he added.
Sun Finance is also the first sukuk to feature subordination, being structured into a senior A class and two further subordinate B and C classes. The A class of Dh2.761bn, rated A/Aa3 by S&P and Moody's, was priced in line with guidance at one-month Eibor plus 200bp. The Dh251m BBB+/A3 rated B class was priced at plus 250bp and the Dh1.004bn BBB–/Baa3 rated C class at plus 350bp. All the notes, which have an expected maturity of 2012, were placed with local investors. Other lead managers involved in the deal were Abu Dhabi Commercial Bank, First Gulf Bank, National Bank of Abu Dhabi and Noor Islamic Bank.
Sun Finance provides financing for two developments, Shams and Saraya. The 1.3m2 Shams development is part of a project to develop Al Reem, a natural island off the coast of Abu Dhabi city and part of the new central business district that is at the centre of the Emirate's ambitious 2030 Urban Plan.
That plan includes proposals to build more than 100 skyscrapers, accommodating some 200,000 residents. Sorouh, the second-largest real estate developer in Abu Dhabi, is one of the three master developers on the island. Saraya is a smaller development of 125,000 square metres on the Abu Dhabi main island.
The sale and purchase agreements that were entered into between Sorouh and individual sub-developers require a downpayment of about 15% and instalment payments of roughly 10% each half year for four to five years. Ownership is transferred only upon the receipt of the last instalment. Most of the contracts were entered into between late 2006 and 2007.
The structure benefits from over-collateralisation, subordination, an enforcement reserve fund, a liquidity reserve fund and an infrastructure reserve fund. The infrastructure reserve fund is pre-funded to the tune of Dh1.735bn at closing to ensure the structure's bankruptcy-remoteness by provisioning for all remaining infrastructure costs payable to contractors, project managers and supervising consultants, with an additional contingency on top.
Several months before Sun Finance was priced, Merrill Lynch priced what it also described as an innovative sukuk securitisation, structured on a musharaka basis.
"This is the first non-recourse asset-backed real estate deal for the Islamic market and involved detailed financial engineering, incorporating non-recourse financing within a sukuk framework," said Christopher Flinos, head of real estate investment banking for the MENA region at Merrill. "It's a significant milestone for the regional market."
The sukuk issuer, Villamar Sukuk, is a Cayman Islands entity sponsored by Gulf Holding Company and provides funding for a mixed-use development in the Bahrain Financial Harbour.
The unrated US$190m five-year sukuk was priced midway within the plus 250bp to 300bp guidance, at a fixed-rate coupon of Libor plus 275bp, some 15bp inside where regional Single A rated sukuk of the same maturity are currently trading. Flinos said the transaction garnered a strong reception, being oversubscribed and placed with clients of the firm's institutional and private client platforms locally.
"We think this deal's distribution and structure will prove to be the way forward for Islamic financing in the region," he said, adding that other borrowers had already made enquiries, suggesting similar deals would be seen in the next few months.
More on the way
Another real estate company looking to raise funding for its real estate business is Tamweel. It recently confirmed that it would be undertaking a Sharia-compliant asset-backed issue worth as much as US$500m before the end of the year.
Tamweel said it was in discussions with a couple of international banks regarding the transaction, which would come to market in October or November.
Having been sole bookrunner on its US$300m convertible sukuk issue, which closed in January, Barclays Capital is favourite for the mandate. However, Morgan Stanley and Standard Chartered could also be in the running as they worked on a similar asset-backed transaction for Tamweel last July.
This may not be the company's last visit to the market this year as it has said its funding requirements for 2008 would be between US$3bn and US$3.5bn. Including this prospective US$500m issue, it will have raised US$2.135bn. It closed a five-year US$1.1bn sukuk issue in July and a US$235m syndicated bank facility in April.
Deyaar, a Dubai-based property developer, is also looking to launch a Dh5bn (US$1.36bn) sukuk programme to finance expansion. Deyaar chairman Nasser Al-Shaikh has said he is confident the firm will be able to raise debt, which is planned for the last quarter of this year or the beginning of 2009.
S&P also recently assigned a preliminary Single A rating to the US$2bn sukuk al-ijara certificates issued by Cayman-based special-purpose entity RAK Capital. The programme rating is reliant on the rating on the Emirate of Ras Al Khaimah (A/stable/A-1).