Wednesday, October 06, 2010

Sukuk issuance from Europe, Amlak & Tamweel merger 'unlikely'

The Bank of London & the Middle East (BLME), a UK-based Islamic wholesale bank launched a division to advise on sukuk to attract investors from the GCC and Asia to UK and European companies. They expect to close their first deal within a year. The move comes shortly after the first UK corporate sukuk was launched. I have not had a chance to view the prospectus for that sukuk, but it was a 5-year convertible musharaka sukuk (with 10% coupon) issued to one investor, Millenium Private Equity. The conversion from debt into equity will occur on the meeting of pre-determined performance milestones, according to an article in Khaleej Times. The structure is likely to be complicated to incorporate both the convertible nature of the sukuk with a fixed coupon and remain in compliance with the new AAOIFI rules on musharaka sukuk. However, from the perspective of a private equity investor, the structure of a sukuk rather than an equity contribution makes sense. It gives the investor a higher priority claim on the business' assets than equity and also a coupon, although that will be unlikely to benefit the investor if the sukuk sours. The coupon on the sukuk (if both principal and coupon are convertible) provides the company with the incentive to meet the milestones for conversion earlier because the accrued coupon payments will translate into more dilution for the company's other owners the longer it takes to reach those milestones. One of the features of a musharaka is that both partners are permitted to be engaged in the management of the business (akin to private equity investors taking board seats of companies they finance). At the risk of generalizing without having read the prospectus myself, this structure sounds like a good way for Shari'ah-sensitive private equity investors to both provide themselves with greater security (or equivalent security to conventional private equity) but also use a structure that some scholars describe as "more genuine".

The Amlak and Tamweel merger is now 'unlikely' according to the chairman of Tamweel following Dubai Islamic Bank's acquisition of a majority stake in the Islamic mortgage company in Dubai. The lender still has a significant way to go before it can resume operations as normal and will likely need a capital injection. Tamweel is working on a plan to resume lending in the market and expects to release a plan in 'the next few months'. Another article citing the chairman of Tamweel says that they expect Q3 results to resemble the first two quarters of the year. They took significant provisions in 2009 and expect to "translate our revenues into some profits". In many ways the issue facing Tamweel is similar to what is facing other mortgage lenders in countries that have experienced a real estate boom and bust. The pain may be over (or nearly over) but a resumption of 'business as normal' will not happen overnight. The economic recovery globally has remained slow and the appetite for new debt is likely to be significantly constrained (the 'new normal'). The recovery for mortgage lenders like Tamweel will most likely be slow both because borrowers are more hesitant to take on new debt but also because the standards on which Tamweel will lend are likely to be far more stringent than before the property bubble collapsed.

There is a fantastic article in The Asset magazine about an interview with CIMB Islamic CEO Badlisyah Abdul Ghani that covers a broad variety of topics including the impact (and potential impact) of the credit crisis on Islamic finance and the need for better regulation of Islamic finance. It is a good, brief read. A few exerpts:
"One reason why Islamic banks were not as affected as conventional Western banks, argues Badlisyah, is that they were not sophisticated enough to participate in derivatives and other leveraged transactions. "The situation could have been much worse if the Islamic banks had been as sophisticated in employing leverage as their conventional banks’ counterparts were in the previous years."

"As in conventional finance, he says, Islamic finance relies on the creditworthiness of an issuer or a client to decide where liquidity is channelled and directed. "Whatever structure is in place – whether it is Islamic or conventional – credit is still credit and it needs to be paid."

"Badlisyah argues that everything that exists in Western capital markets that is of genuine value to banks and corporates has already been incorporated in Malaysia under the Islamic derivatives regime. This, he argues, is the reason why Malaysian Islamic banks have been successful in managing the volatility and fluctuations that have buffeted the industry in recent years. The ban on credit default swaps is completely justified, he feels, and will likely be for keeps."

"From Badlisyah’s point of view, that Malaysian Islamic banks emerged from the global financial crisis relatively stable and unscathed is due to the regulatory framework that was put in place. "Malaysian banks found themselves totally isolated from the crisis because they had not been allowed to invest as much overseas after the Asian financial crisis."

  • AAOIFI is expected to provide rules governing the entry into and exit from contracts that are Shari'ah-compliant. However, it is unclear at this time what this will mean.
  • Central Bank of Bahrain Governor Rasheed Al Maraj is quoted from a dinner honoring Professor Simon Archer: "Many remain comparatively small and focused on niche markets. The result is that we have an industry that comprises many small-scale firms engaged in very similar activities and with comparatively high concentrations of risk. As I have said several times in the past, for the long-term health of the industry it is important to generate greater scale and diversity. [...] the events of the past few years should have given the industry a clear signal that it must reduce its reliance on real estate as an asset class [and] The industry should look instead at the scope for increasing the finance it provides for productive assets such as factories, ports, mines and oil processing facilities. Financing these activities may appear less profitable in the short-term, but may be a better proposition on a risk-adjusted basis." I agree.
  • Islamic Finance Asia has a good article on the challenges to developing secondary market liquidity in sukuk.
  • The IMF study on Islamic vs. conventional banks in the crisis has been released.
  • A look back at the post-crisis (and especially post-Dubai debt crisis) dominance within the primary market for sukuk from Asia. A Bloomberg looks forward towards the potential issuance that could result from the 10-year, $444 billion Malaysian development plan.

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