Tuesday, June 16, 2009

Sukuk defaults attracting wider attention

In addition to an article about sukuk defaults in the Wall Street Journal, there are a number of pieces of news about sukuk. The Wall Street Journal article focuses on the defaults and provides some updates about the bankruptcy case that were not available when I wrote an article for Islamic Business & Finance about the bankruptcy in March. Where the case was left when I wrote the article that an announcement was expected on whether the sale of the overriding royalty interest (ORRI) in the East Cameron fields would be judged a true sale which would have protected sukukholders' interests from other creditors' claims. East Cameron claimed that the ORRI was not actually transferred to the SPV, Louisiana Offshore Holdings, and thus the loan was just secured by the ORRI.

As I mentioned in the article, a law professor I spoke to familiar with US bankruptcy laws and its effect on securitizations (which involve similar true sales), absent unusual circumstances, the sale would be judged a true sale. So far the judge has agreed with sukukholders' claims that the transfer of the ORRI to the SPV was in fact a 'true sale' saying that "holders invested in the sukuk certificates in reliance of the characterization of the transfer of the royalty interest as a true sale". If this ruling is finalized, the prospects for sukukholders will be strengthened and, more importantly for the industry, there will be a case history in US courts that supports the legal basis for many types of sukuk that rely on sales of assets to SPVs. With respect to sukukholders who will probably end up losing money they invested in the sukuk, the East Cameron Bankruptcy could provide impetus for new issues of sukuk by US-based companies shut out of the conventional financial markets in the wake of the credit crisis.

Reuters blogger Felix Salmon adds his take to the sukuk default story from the WSJ with some interesting comments about the difference between sukuk and conventional bonds:
"The first sukuk (Islamic bond) defaults have arrived, and no one has a clue how they’re going to shake out. Which might actually be a feature rather than a bug, going forwards.

Bondholders often have a large amount of complacency derived from the fact that an enormous amount of equity needs to be wiped out before they take any hit at all. And that complacency does the system no favors in the long term. If capital structures get muddied a little, and debt takes on more equity-like uncertainty — as seems to be the case in the sukuk market — then maybe investors will be more assiduous about examining underlying risks, rather than relying on capital structures to protect them."
Another sukuk, the Golden Belt 1 sukuk issued by the troubled Saudi firm Saad Group, will provide another test of how sukuk function in a reorganization as the company restructures its debts.

In addition to the ongoing sukuk default and restructuring, the issuance of new sukuk fell during the year to June 14 compared to the same period in 2008. The number of issued fell 21.5% from 88 to 69 while the total value of new sukuk issues fell from $9.35 billion to $8.46 billion, a decline of 9.4%. There is some good news in this release in that the average sukuk size increased year-over-year. One of the developments in 2008 was that the average size of each sukuk declined compared with previous years, most likely because of an absence of large sukuk like the $3.52 billion Nakheel sukuk which was issued in 2006.

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