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It proved to be a groundbreaking year for the Islamic bond market. Not only did primary issuance volumes hit a record high, but more significantly the market at last moved beyond the US$500m five-year transaction from a financial institution that had become the stereotype in the international arena.
Sure, there had been some groundbreaking transactions in the past, such as when Saxony-Anhalt or GE Capital issued sukuk or when the likes of Indonesia printed blockbuster deals, but 2012 was the year the asset class came of age. Tenors were pushed out, a more diverse issuer base sought sukuk funding, and pricing dynamics for much of the year was more favourable than in the conventional market.
There were plenty of notable deals, including those by Saudi Electricity, Banque Saudi Fransi, General Authority of Civil Aviation, Jafza, Qatar and Turkey and Development Bank of Kazakhstan, as well as some interesting domestic issuance in Malaysia.
But one deal stood out, one that more than any other illustrates just how fast the sukuk market is evolving – Abu Dhabi Islamic Bank’s US$1bn hybrid Tier 1 non-call perpetual sukuk note, which was printed in early November.
Bank capital has been a big theme in the emerging markets over the past year and new structures had already been evident in Brazil and Russia. But in a conservative market such as sukuk, this transaction was akin to Felix Baumgartner’s jump from space.
It was the first Sharia-compliant Tier 1 instrument. It was also the first publicly targeted Tier 1 out of the MENA region ahead of the expected Basel III implementation in the UAE. To be precise, the deal is Basel II compliant with future Basel III eligibility when the UAE introduces the latest rules.
Despite the terminology, the structure was deliberately designed to be kept as simple as possible. The instrument was compared with preferred shares hybrid Tier 1 deals done by US banks. As preferred shares are accounted for as equity rather than as liabilities, they do not have to include loss-absorption provisions at the point of non-viability. Basel III only requires this type of loss absorption feature (either conversion into equity or principal write-down) if the instruments are accounted for as liabilities, which is the case in Europe.
It was this simplicity that allowed investors to concentrate on the credit’s strengths and the pricing. And while the traditional sukuk investor largely kept away from the deal as they have limited scope to buy other banks’ capital instruments, the transaction still generated a US$15bn order book from 330 orders.
Demand was largely driven by Asian private banks, though asset managers, especially European funds but also offshore US accounts, were keen to get a good allocation – testimony to the deal’s broad appeal.
Some bankers away from the deal were a little critical about the execution process as pricing was aggressively tightened from the 7% area to a final level of 6.375%. But given the uniqueness of the transaction, there was always going to be an element of price discovery about the process.
Part of the challenge for the leads was the wide range of investor views during the roadshow, with one account arguing that the notes should come at low to mid-5% at one extreme, while others sought 8% at the wide end.
The structure was also perfectly attuned with Sharia principles, given that the flexibility to cancel coupons and the perpetual maturity provided equity-like features to the instrument.
The bonds, which priced at par, were trading at 103.25 a week later, suggesting healthy demand in the aftermarket as investors still sought the opportunity to buy a Gulf security offering a decent yield.
The bookrunners were ADIB, HSBC, Morgan Stanley, National Bank of Abu Dhabi and Standard Chartered.