Saturday, April 11, 2009

Sukuk illiquidity & the pipeline for sukuk

The sukuk market illiquidity is now having an impact on the issuance of new sukuk as issuers are afraid that it will distort the pricing of new sukuk. Back at the beginning of February, I wrote a post on my blog over at Zawya that the lack of liquidity in sukuk markets was distorting the pricing of outstanding sukuk using the Jebel Ali Free Zone sukuk which had traded at 66, but for which there was little trading. This translates into a yield to maturity of 18%. Since then this sukuk has traded as low as 53, which means it would yield 29% if held to maturity (using the EIBOR+1.31% as of April 10 which is 4.31%).

An article in Arabian Business describes the additional impact this lack of liquidity is having for new issues and cites an estimate from Standard & Poor's that there are $45 billion in new issuance in the pipeline. Badlisyah Abdul Ghani, the CEO of CIMB Islamic, describes "the problem of reluctance on the part of the issuer to issue in the sukuk market. If it's illiquid, then price distortion may occur, and it might reflect badly on them. It creates a benchmark for themselves". The illiquidity of outstanding sukuk--only 25% are publicly listed according to a report by McKinsey--means that when new issues are being priced, they will be based on the prices of sukuk trading in the sukuk market, and a distorted price will increase the cost to issuers. In comparison with conventional bonds, even the most liquid secondary market for sukuk in Malaysia is illiquid. The total trading volume of sukuk in Malaysia is 88% of the total outstanding value compared with 209% for conventional bonds. One of the impediments to secondary market trading is that, besides the good yields offered by sukuk, there are few sukuk traded that one could buy to replace a sukuk sold. It's a vicious circle for creating a secondary market: in order for a secondary market to develop, there need to be sukuk available to buy for holders of sukuk to be willing to part with the ones they have.

PBS, the U.S. public television channel, has a segment on the availability of Islamic home finance in the U.S. and focuses the segment on the Islamic finance company Guidance Residential. Guidance is one of the largest Islamic finance companies in the U.S. and has financed over 5,000 home purchases and during the middle of 2007, the company passed the $1 billion mark for total value of financing closed. Although there is some criticism of Islamic finance companies receiving financing for the Islamic mortgages from government-sponsored enterprises like Fannie Mae and Freddie Mac, an alternative is currently lacking.

Reuters has an article on the growth in Islamic finance that is fairly broad in its scope but includes some focus on the growth of the industry in non-Muslim majority countries.

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