How tough is the market for new issues in the GCC?

An article in Bloomberg describes the falling yields on GCC sukuk, Dubai World and the sovereign Dubai bonds and sukuk with some optimism. However, it notes that the spread on Dubai World's debt (it doesn't say what the spread is based on, but one would assume comparable maturity US Treasuries) from 647 basis points after the standstill to 545 basis points (it incorrectly says the spread is 545 percentage points). The yields on sukuk from GCC-based issuers was 7.17 percent on July 23 (compared to 8.76 after the Dubai debt crisis), the Dubai 6.396% soverign sukuk is yielding 7.38% (435 basis points higher than the recently issued Malaysian sovereign sukuk), the Dubai World yield is sitting at 8.4% (for the 6.25% sukuk).

These figures reflect only limited thawing of GCC credit markets in the aftermath of the financial crisis and, in particular, the Dubai debt crisis. It is hardly surprising that other articles written recently describe a move in momentum in sukuk issuance from the GCC to Malaysia. That is in many respects not entirely fair. The Dubai debt crisis was triggered by specific factors--primarily an overvalued real estate market in Dubai that saw significant declients. However, it does suggest a general attitude that sukuk from the GCC are more risky than other emerging market debt (including sukuk) offerings. This will reduce the level of issuance of sukuk in the near term from the GCC, which would hurt the emergence of sukuk secondary markets. If anything, investors need more sukuk issuance to fill the portfolios of long-term, hold-to-maturity investors (like takaful funds) and therefore a reduction in issuance from one of the largest markets (and the regional market for many of the funds investing in sukuk) could reinforce the hold-to-maturity mentality among many investors. Some of those investors are probably sitting on large losses from Dubai-related sukuk that they are unwilling to realize.

Meanwhile, Nakheel is working through its own debt restructuring. Reports suggest that full payment will be made over 5 years for its syndicated banks loans (including Shari'ah-compliant financing) and 7 years for its sukuk. According to Reuters, "Bankers have until the end of August to respond to undisclosed terms of Nakheel's multi-billion dollar restructuring plan, including the rates of interest and repayment schedules for syndicated and bilateral loans. " Reuters is usually pretty good at describing the presence of Shari'ah-compliance in financing facilities, so the description they give (while it may be limited by sources speaking on background) does reflect the lack of a structure for restructuring in Shari'ah-compliant transactions. The restructuring of the loans (many of which are based on ijara) is probably being done in a rather ad hoc manner. The interest rate and payment terms are dealt with first and the Shari'ah-compliant structure are dealt with later. If this is the case, there remain significant gaps in the Islamic finance industry in dealing with distressed situations that should be at the forefront of the agenda before the next crisis comes.

Other News

• Kuwait-based International Investment Group defaulted for a second timek on a sukuk this year, missing a $152.5 million payment.
  
• Mushtak Parker offers his thoughts on the Sukuk ALIM being issued by Cagamas working with Al Rajhi Bank to be viewed as Shari'ah-compliant in both the GCC and Malaysia. He also offers his thoughts on the recent entry into the Islamic finance markets by Japanese firms, several years after the country said it wanted to encourage Islamic finance in the country to attract capital.
  
• A former Supreme Court justice in India, Krishna Iyer, believes that Islamic finance can help in efforts to alleviate poverty.
  
• Arab News has an interview with the CEO of the Islamic Corporation for Development of the Private Sector, part of the Islamic Development Bank group.
  
• The state-owned Islamic bank in the Philippines is planning the country's first sukuk to "fund growth in Muslim Minanao".
  
• A Malaysian firm is providing the first financial guarantee for a sukuk.
  
• A writer in the Business Recorder in Pakistan, Saqib Masood Chisti, suggests that Islamic microfinance could be expanded in the country while criticizing a program that provides cash payments to poor families as causing inflation and creating dependency (I am not knowledgable enough about the program to comment, but the description given resembles the successful Bolsa Familia program in Brazil).
  

Friday night bullets

• A London-based healthcare organization may be the first corporate issuer of a sukuk, according to reports. The sukuk is expected to be GBP50 million ($76 million).
  
• Nakheel has asked for information on the identities of 2010 sukuk and bond holders, which may be an indication that they may want to restructure those obligations.
  
• The Saudi mortgage finance law is expected to increase the demand for Islamic banking services although there are concerns about the diminished liquidity if banks add illiquid Islamic mortgages to their balance sheets.
  
• Gulf Finance House continues to work through its debt deal and is close to a deal of another $100 million in debt coming due soon.
  
• The IIFM, now with a new website, released a sukuk report, which looks to focus on case studies, although I have not yet read it.
  
• The Philippines is considering its first sukuk issuance for about $500 million.
  
• Sukuk issuance is expected to be $31 billion globally, with $10-15 billion coming from the Middle East according to Bank of America Merrill Lynch. Deutsche Bank sees sukuk issuance being 'weaker' in 2010.
  
• Standard Chartered's Malaysian Islamic banking subsidiary Saadiq is planning on offering new products targeted at small-and-mid-sized businesses. Standard Chartered will also begin offering Shari'ah-compliant hedging contracts.
  
• Arcapita is cutting workers to control costs.
  
• HSBC named William Ross as a co-head of Islamic finance at the bank. HSBC's chairman Stephen Green says that London can expand its financial business by offering more Islamic banking products.
  

Islamic finance & SRI, Islamic banking in Indonesia

Islamic Finance & SRI - A new report

Dinar Standard and Dar Al Istithmar released the results of a survey on Islamic finance and SRI where they surveyed 29 Islamic financial institutions (including Islamic windows and non-bank financial companies). The results of the study are well documented and, although the sample size is rather small (not something to fault the organizers for), they describe quite clearly the goals, insights and limitations of the data they present.

The final summary of the study is:

Within its limited sample, it is evident that the majority of IFIs have yet to embrace the concept of financial institution utility to enhance their social responsibility. Financial institutions have the ability to redirect funds from the capital rich to the capital deficient to ensure the redistribution of wealth in the long term.
As an example, one method to efficiently utilize an Institutions infrastructure is by maintaining policy targets for financing to SMEs and micro-finance entrepreneurs in the developing world. Micro-finance and SME finance has continuously proven to be a sustainable revenue stream, subject to appropriate risk management strategies, including portfolio diversification, low concentration risk and stringent credit and social collateral requirements.

[...]

At the same token, IFIs can also invest in particular industry sectors that demonstrate social and/ or environmental impact while providing profitable revenue streams, such as education, healthcare addressing the needy water desalination, waste management etc.

I would encourage everyone to take a look through the individual responses (available from the above link as a PDF).

On the conclusions about microfinance, I address my thoughts on Islamic banks and microfinance just below. With regards to the environmental/social/development investments of Islamic financial institutions, it is heartening to see that there are a majority who have investment quotas on these areas, but there remains limited exposure of these activities which may be a question of these quotas being too low. The current environment for business provides benefits for companies that promote their sustainability-related work (whether it is significant or 'greenwashing') and from the preparation of this blog, I read a lot of the press releases and articles about what the Islamic finance industry is doing and there remains limited visibility about sustainability-related business from Islamic banks. So either they are doing very little or they are not promoting what they are doing.

In either case, there is a lot Islamic finance could gain by grasping the sustainability agenda and promoting their involvement in it, especially in the West. I would be hard pressed to come up with a specific reason to switch to a Shari'ah-compliant financial product and many other non-Muslims (with less understanding of how Islamic finance works) may feel similarly. If Islamic financial institutions demonstrated their concern with sustainability, whether environmental, social or developmental, it would surely attract my interest as a non-Muslim consumer with concern for sustainability (for example, I just moved my banking relationship from a major bank to a local credit union). I think there are plenty of other people who share my views and this creates an opportunity for Islamic finance to expand outside of its natural constituency of Muslim consumers (particularly in the West).

I commend Sayd Farook and Rafi-uddin Shikoh (and all others involved in the report) on a job well done creating a thought-proviking and interesting report.

Islamic banking in Indonesia

I thought this article about Islamic banking in Indonesia was interesting. It describes the limited inflows of money into Islamic banking because of unclear regulations and pervasive corruption, but then points out the Islamic banking industry in Indonesia is more focused on small- and medium-sized businesses and microfinance than Islamic banks in other countries.

Although it is clearly sub-optimal for the Islamic banking system to be constrained by regulatory uncertainty and corruption, the Indonesian example shows that Islamic microfinance and banking focused on small and mid-sized businesses can work. I remember seeing Hans Dieter Seibel present a paper (available as a PDF) on institutional diversity in Islamic microfinance in Indonesia and the challenges in terms of capital adequacy and solvency between different types of Islamic microfinance institutions.

One thing I think is certain is that there is too little focus on Islamic microfinance and its impact as one component in poverty alleviation alongside other forms of aid including zakat and waqf. There is certainly enough smarts in the Islamic finance industry to be able to develop cost-effective Islamic microfinancial products and it would be a natural fit for the industry if some of this knowledge and experience were donated to develop Islamic microfinance without having to have the costs of development incorporated into the financial products and passed along to the end-consumers.

Capitas Group

The Islamic Corporation for the Development of the Private Sector signed a deal with Capitas Group, a U.S.-based company that develops Shari'ah-compliant finance companies. Other companies within their portfolio are the U.S.-based Zayan Finance and Zayan Takaful which provide commercial real estate financing and takaful, respectively. The new company will be based in Jeddah, Saudi Arabia and according to Capitas Group CEO Naveed Siddiqui, "there is a huge demand for mortgage finance in Saudi Arabia and the broader region". With a new mortgage law expected soon in Saudi Arabia, this will probably be the focus of the new company.

Other News

• Tamweel is considering its options in case the merger with Amlak falls through. The merger has been in the works since 2008 and is expected in the first quarter of this year, but there appears some doubt on the part of Tamweel officials that it is a sure thing.
  
• Officials at the Philippines' only Islamic Bank, Al-Amanah Islamic Bank, expect the country to miss the growth in Islamic finance in Asia as it continues to 'refurbish' and 'rebrand' the bank after a capital infusion from the Development Bank of the Philippines. S&P released another report on the future growth of Islamic finance today.
  
• The state-owned Islamic Bank of Thailand is planning 55 billion baht ($1.66 billion) sukuk issuance. 5 billion baht would be raised as a local Islamic bond with the remaining 50 billion baht as a sovereign sukuk.
  
• During the last year, the "brand value" of Islamic banks grew rapidly. The article about the study from Brand Finance plc did not define how this was measured.
  
• In a long overdue change, Kuwait Finance House upgraded its website.
  

Malaysian standardized commodity murabaha deposits, GCC sukuk issuance 2009H1, Nakheel sukuk update

Malaysian Islamic banking groups approved a Corporate Murabaha Master Agreement which will standardize the deposit murabaha agreement where an Islamic bank deposits funds that are used by the depositor to purchase a commodity and resell it to the bank with deferred repayment on a cost-plus basis. It standardizes a reverse murabaha agreement that is similar to a reverse tawarruq product. The agreement is seen as a beneficial innovation in Islamic money markets by the Association of Islamic Banking Institutions Malaysia (AIBIM) which secured the approval. Reuters reports the product will be similar to the Islamic interbank money markets already in operation. IIFM, an industry body in the GCC estimates that commodity murabaha accounts for $100 billion in annual activity.

Sukuk markets for new issuance in the first half of 2009 continue to be lackluster in the GCC with only $1.1 billion in sukuk issued and all but one of the new issues coming from the Bahraini government through its regular salam and ijara sukuk and a new $500 million longer-term ijara sukuk.

Nakheel and the government of Dubai could have saved up to $1 billion by buying back the sukuk instead of allowing it to mature at par with deferred lease payments in December. I describe this in greater detail in an article forthcoming in Business Islamica magazine.

Other News

• National Bank of Kuwait continues to expand its ownership in Boubyan Bank to increase its Islamic banking industry exposure.
  
• BIMB plans further innovation in its Islamic financial products.
  
• Nomura plans to expand its operations into Islamic finance to attract GCC-based liquidity.
  A RAM Holdings analyst predicts greater growth in the industry in response to the financial crisis although his rationale as quoted in media reports seem to ignore the impact of the financial crisis in exposing speculative bubbles in real estate in the GCC that has had significant negative impacts on Islamic financial institutions that were overexposed to the sector.
  
• The Filipino government is increasing the capital of the sole Islamic bank in the country, government owned Al-Amanah Islamic Investment Bank.
  

Islamic finance affected by credit crisis, should improve resiliency, takaful asset management problems, BBA on the way out, WIEF concludes

Shari'ah scholars say that the bai bithaman ajil (BBA) type of sale with deferred repayment that synthesizes an interest-bearing loan is losing favor and will eventually disappear. The contract is widely used in Malaysia, but is considered to not be Shari'ah-compliant in the GCC. Several courts in Malaysia have criticized the contract's validity. This demonstrates the growing maturity of the industry and its ability to gradually move away from contracts that were developed out of necessity, but which are not substantively different from interest-based financing. As the industry develops, there should be further movement away from the replication of conventional financial products in favor of financial products which are distinct from interest-based products.

An article in Asian Investor magazine discusses another consequence of the shortage of sukuk: takaful asset management. Most takaful companies face significant problem in investing the premiums they receive in Shari'ah compliant ways and in many cases end up overexposed to equities compared with sukuk, in stark contrast with the investment profiles of conventional insurers. This creates an additional risk for takaful companies because equity values are more volatile than traditional fixed income products that comprise the bulk of conventional insurers' investment portfolios.

Zeti Akhtar Aziz, the governor of Bank Negara, Malaysia's central bank, describes the risks facing the Islamic financial system with greater clarity than I have seen elsewhere:

"the global financial crisis has highlighted several structural weaknesses and imbalances in the international financial system. Whilst Islamic finance is not insulated from the effects of the current environment, the Shariah principles and values that underlie Islamic finance provide an important underlying foundation. [...] As it becomes part of the financial globalization process, Islamic finance has however become increasingly exposed to the systemic implications of external developments...its potential for sustaining financial stability and... how robust is the industry to external shocks."

The solutions she proposes are very straightforward to describe, but far more difficult to implement: global regulatory coordination, the development of an international interbank liquidity management market (a 'lender of last resort'). Finally, she describes the strengths of Islamic finance in a way that eschews the simplistic "Islamic finance is based on real economic activity" explanation that abounds from other sources. She elaborates that Islamic finance is seen as a facilitator of the real economy and the links between financial and productive flows acts as a check that limits excessive leverage, imprudent risk taking and speculative activities.

However, even Islamic finance is not immune from global economic shocks nor dumb lending decisions, although the risk profile of many Islamic financial products like mudaraba, musharaka and ijara, provide banks with greater incentive to do more extensive due diligence into the use of funds they provide. They will bear a greater risk of loss in many of these financing structures than they would as a conventional senior secured creditor. Her explanation should provide the beginning of a discussion that should not degenerate back into unsupported declarations that 'Islamic finance is immune from crisis' or 'Islamic finance is inherently more stable than conventional finance'. Even if they were true, they would be unhelpful in progressing the discourse into areas where improvements in the Islamic financial industry could benefit practitioners, regulators and consumers.

Another article talks with a few people about the exposure of Islamic finance to the credit crisis. A Netherlands-based author, Abdul Gafoor, describes something that I have been saying as well: "Islamic banks] go mostly for real estate and that kind of thing. And when real estate prices go down, [their portfolios] also go down. It depends on whether they invested directly in real estate or through securities. Here, you cannot make a general claim [about the strength of Islamic banking]. It depends on each individual bank -- how they behaved." Neil Miller, a lawyer with Norton Rose also observes that "The thing about Islamic banking, at the end of the day, in some respects, it is going back to banking the way it used to be done. So it is very much based on relationships, on analyzing risks, and understanding the risk and the relationships in the specific projects or company that you are looking to finance and getting comfortable with that." It is another example of what I think should be the focus in journalism about Islamic finance: avoid denials of problems and work to improve the resiliency of the Islamic finance industry in the future.

Although this is not a new announcement, the Financial Times reports on the possibility that The Investment Dar, the troubled Islamic investment bank in Kuwait, will sell at least part of its stake in Aston Martin which it acquired in a Shari'ah-compliant leveraged buyout in 2007.

The lack of secondary market liquidity in sukuk markets may affect or delay the issue of new sukuk. If pricing in the secondary markets are distorted by illiquidity, new issues may be priced less favorably for issuers.

World Islamic Economic Forum

The WIEF concluded with the issuing of the Jakarta declaration which includes a section on Islamic finance:

OVERCOMING GLOBAL FINANCIAL CRISIS:

• Support the efforts of the OIC to accelerate greater regional economic cooperation through the effective implementation of its 10 year Plan of Action.
  
• Support the Islamic Development Bank (IDB) Task Force for Islamic Finance and Global Financial Stability to promote Islamic Finance and Banking as a viable alternative to the conventional financial system.
  
• Call upon Governments and Islamic banks to expand Shariah compliant micro-credits.
  
• Support the call for effective regulations in the global financial industry to mitigate risk and failure.
  
• Support the establishment of Islamic Banking Training centres with harmonised standards.

An editorial in the Jakarta Post says the country could benefit from Islamic finance through attracting funds from the oil-rich GCC, although the same conditions apply as with attracting conventional funds: Legal certainty and reasonable returns The Philippines Stock Exchange may launch a Shari'ah-compliant equity index while Thailand is planning the launch of its own next month.

Canadian Islamic mortgages, Standardization

At the Islamic Finance World North America conference organized in Canada on Islamic finance, participants discussed the requirements needed to fit Islamic financing, particularly home financing, into the regulatory environment of Canada which restricts financial institutions' holdings of real estate. Because Islamic home financing is less common in Canada than the U.S., the products are significantly more expensive in Canada where they are 100 to 300 basis points more expensive compared to 40 to 100 basis points higher in the U.S.

The Central Bank of Bahrain will issue standardized Islamic financial products by the end of this year.

Ernst & Young will launch the 1st annual "Islamic Funds & Investments Report" soon.

Dubai Islamic Investments Managing Director Marwan Al Khatib believes that the Malaysian government's active encouragement and participation in the development of the country's Islamic financial industry was important for its success.

Philippine Banco de Oro may be interested in bidding on Al-Amanah Islamic Investment Bank of the Phillipines which the government is trying to privatize.