Credit crunch hits Gulf Islamic bond sales

Sales to be subdued this year compared with past expectations as crunch bites - poll.
By Mohammed Abbas
Mon 26 May 2008 03:39 PM

Gulf Arab Islamic bond sales are likely to be subdued this year compared with past expectations as the global credit crunch bites, but sales may still top last year's record of $12 billion, a poll bynewswire Reuters hasshown.

Before defaults on US home loans last summer triggered a global credit crunch, bankers had been expecting a bumper 2007 for Islamic bond sales and even better for 2008. But now many planned sales are on hold as borrowing costs have risen.

Five of 13 bankers polled said sales of Islamic bonds, or sukuk, could range between $15 billion and $18 billion. Four bankers expected sales at between $12 billion and $15 billion.

"There's still a disconnect between returns investors want and what many issuers are willing to pay," said Gilles Franck, head of capital markets at Standard Chartered.

Gulf Arab sales of sukuk, which comply with Islam's ban on interest, were about $12 billion last year, according to Moody's Investors Service. Gulf investors have raised about $4.3 billion in sukuk so far this year, Reuters data showed.

The Gulf is awash with funds after a six-fold increase in oil prices since 2002, and bankers are scrambling to invest excess liquidity. "If you look at the Islamic money available, investors are happy to put money into projects, real estate, bilateral deals that pay a lot more than sukuk returns," Franck said.

Bankers say there is a backlog of sukuk sales waiting for borrowing costs to fall.

"Markets are still nervous about lending because of the credit crunch... we have a serious crisis out there. I haven't seen the end of it," said one banker who did not want to be identified.

Poll respondents were divided between those who thought borrowing costs would fall slightly, and those who saw them staying relatively high through the third quarter.

Four of the 13 respondents expected spreads on the GCC/DIFX sukuk index to be between 175 and 200 basis points more than the London Interbank Offered Rate (Libor) by October, when a spike in sukuk sales is expected after the summer holiday and a Ramadan lull.

Ramadan is when Muslims fast for a month from dusk to dawn, this year due in September.

The GCC/DIFX index tracks returns from Gulf Arab dollar sukuk over Libor, and was at 225.85 basis points more than the benchmark on May 23, up from 175 at the start of the year and more than three times pricing in June last year before the subprime crisis.

"Common sense will return," said Ahmed Abbas of Bahrain's Liquidity Management Centre. "Many of the big issuers now have longer track records and their credit has improved."

An equal number of bankers expected higher pricing. Four respondents saw third-quarter spreads at between 200 and 225 basis points over Libor.

"We haven't seen the worst of the sub-prime impact... major international players will have to downsize and credit reviews will be more stringent," said a banker who did not to be identified.

Still, sukuk sales have accelerated in the last few weeks, most of which have been priced in Gulf currencies rather than dollars.

Investors are buying Gulf securities denominated in local currencies on speculation that Gulf states may revalue their dollar-pegged currencies in a bid to control soaring inflation. All but Kuwait peg to the dollar.

Bankers say dollar bond sales attract a wider range of buyers. Eight of those polled expected dollar sukuk to return to the market by the first quarter of next year.

Gulf central bankers and finance ministers have repeatedly denied plans to revalue, and almost all poll respondents did not expect a change in that message before year-end.

Aside from the Gulf, Malaysia is the world's biggest Islamic banking market. More cooperation between the Gulf and Asia has been touted in recent years, especially as cash-rich Gulf investors are keen to diversify their holdings.

However, nine out of the 13 polled cited differences in Islamic financial law, particularly a prohibition on the trading of debt, as the main constraint on greater Islamic deals between the two regions.

"In Malaysia, their Islamic financial law is very liberal," said Philip John of Dubai Bank. "They allow the trading of debt."

Citigroup, Dresdner Bank, Dubai Bank, Liquidity Management Centre, Standard Chartered, Morgan Stanley, Qatar Islamic Bank, European Islamic Investment Bank, Moody's, Fitch and Standard & Poor's were among those that took part in the poll. (Reuters)

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