From Bonds to Sukuk

The year 2011 offered a roller-coaster ride for the GCC capital markets. Things didn't prove as eventful in any area as in the growing market sub-segments of bonds and sukuk. The year saw extraordinary volatility in the conventional space accompanied by a steady consolidation and increasingly consistent growth in the area of sukuk. It is now looking increasingly clear that the sukuk segment has successfully established itself as an important – and growing – segment of the regional capital markets.

Whereas the conventional bond market has developed significant traction during the global crisis, in many ways living up to its ‘reserve tire’ function, 2011 offered major challenges. The three first quarters saw a precipitous decline in issuance to a record low of $0.9 billion in the third quarter. However, the closing three months of the year brought a clear revival with a total of 14 issuances, with maturities of more than a year amounting for a total value of $11.9bn. The year as a whole saw $28.4bn worth of issues with tenors in excess of one year. This was only marginally down on the total of $31.5bn in 2010 while the overall number of issuances fell from 59 to 36.

Corporate issuance has remained dominant in recent years. The year 2010 saw a total of 45 corporate issuances with maturities in excess of a year while there were eight sovereign issues. The aggregate value of the corporate bonds reached $25.5bn while the sovereign paper totalled $5.9bn. The number of corporate issuances fell to 31, worth a total of $16.1bn in 2011. The five sovereign issuances totalled $12.33bn in value, with a $45bn bond by Qatar assuming the lion’s share of the total.

2011 as a whole has been a landmark year for the global and regional sukuk markets. The positive trend continued throughout the closing months of the year and there are strong indications of a strong momentum going into 2012 as sukuk are increasingly viewed as one of the main areas of resilience within the regional financial markets. Overall, issuance in the Gulf nearly tripled in value from $6.9bn in 2010 to $19.4bn in 2011. The number of issuances (including short-term paper with maturities of less than a year) rose from 33 to 44. The Government of Qatar was the leading issuer with a total of $9.0bn worth of issuances and hence accounts for much of the increment year-to-year.

A number of important developments have taken place in the sukuk market and they have the potential to significantly boost the growth prospects of the market even further. Building on earlier steps on resolving distressed situations and streamlining structures, there has been significant progress toward increasing maturities beyond the previous five-year de facto cap. Most encouragingly, sukuk are beginning to be used to finance infrastructure projects, which potentially offers a massive opportunity for pooling private capital for fuel. The fourth quarter opened with the conclusion of $1.0bn project sukuk by the Saudi Aramco Total Refining and Petrochemical Co (SATORP), which will use the funds to finance its $13bn refinery in Jubail. Highlighting the strong interest in the issuance, subscriptions totalled Sar3.7bn.

In an eagerly awaited development, plans for a sovereign – or at least quasi-sovereign sukuk are thought to be well advanced now that the Kingdom’s public debt to GDP ratio has fallen clearly below the previously announced 10 per cent target. Government officials have described infrastructure projects, notably the country’s ambitious airport developments, as a potential opportunity thanks to their revenue-generating potential. Saudi Arabia’s General Authority for Civil Aviation is expected to issue sukuk in the first quarter of 2012 to help finance the Sar27bn ($7.2bn) Jeddah airport. The first tranche worth some Sar4.5bn is due to take place in the first quarter of 2012 and is expected to be followed by two more tranches in the subsequent months. The first issuance is supposed to be a 10-year private placement.

Most of the corporate sukuk issuances during Q4 of 2010 took place in the financial sector. The landmark deals of Q4 were the $500 million five-year sukuk issuances by Abu Dhabi Commercial Bank and Abu Dhabi Islamic Bank in November. ADCB, interestingly, had a Gbp500mn bond due in mid-November and hence the latest issuance reflects a transition from conventional to Shariah-compliant financing.

More generally, the developments of Q4 highlight the continued heavy reliance of the regional sukuk market on a relatively small number of large blue chip corporate deals. The GCC saw a total of 12 corporate sukuk with a total value of $5.6bn. This was up from a total of seven corporate issuances in 2010. Their total value reached $4.3bn. It looks fairly clear that the continued growth of the GCC market – as indeed that of its Malaysian counterpart – will be critically linked to sovereign and quasi-sovereign issuances. Most of these remain short-term paper sold for liquidity management purposes, above all by the Central Bank of Bahrain.

However, October saw the issuance of a $750mn seven-year sukuk by the Kingdom of Bahrain. This replaced an original plan for a $1bn conventional bond offering a profit rate of 6.273 per cent and attracted a demand of $1.8bn.

The regional secondary bond and sukuk markets have stabilised significantly after the turbulence of the spring. Qatar, Saudi Arabia, and Abu Dhabi are generally recognised as the most stable markets. Even though credit default swaps and yields have declined across the region, markets such as Dubai and Bahrain remain more sensitive markets and tend to experience spikes during periods of market shocks, whether regional or international. In terms of asset classes, sukuk have continued to outperform conventional bonds and have been more stable in terms of their yields.

The prospects for bond markets nonetheless remain ambiguous with significant evidence of diminished appetite by Western banks for GCC bonds at a time when there are major redemptions pending. Sukuk, in contrast, still offer diversification potential and draw interest from Asian Islamic investors. The total volume bonds and sukuk maturing in 2012 is estimated by Standard & Poor’s at $25bn while the corresponding figure for 2013 is $35bn.

Dubai remains the most sensitive regional market, even if its resilience has increased markedly since Dubai World deal and the resumption of economic growth. Nonetheless, Dubai’s main problem – a very high level of leverage – will require a long time to work through and will constitute a potentially major vulnerability in an uncertain economic environment. The Government of Dubai and related companies and organisations are estimated to owe a total of up to $129.3bn of which $15.5bn is maturing this year.

While 2012 as a whole promises considerable activity for the regional bond and sukuk markets, a backdrop of continued global uncertainty may well create at least short-term challenges for the more leveraged names. This is likely to continue to contrast with relative resilience and growth in the sukuk space.

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