After slumping in 2016, issuance of Islamic bonds from the Middle East looks likely to recover next year
After slumping in 2016, issuance of Islamic bonds from the Middle East looks likely to rebound next year as Gulf states take advantage of unsatisfied demand, but investors may shun the long end of the curve.
As governments scrambled to cover budget deficits due to low oil prices this year, they overwhelmingly turned to conventional debt - a shift from the traditional pattern in which sukuk and conventional bonds had roughly equal shares of the region's international bond issuance.
In the first half of 2016, governments in the six-nation Gulf Cooperation Council raised just $1.1 billion or 5 percent of their total debt issuance through longer-term sukuk, against 38 percent a year earlier, Moody's estimated. Saudi Arabia's $17.5 billion debut bond in October was entirely conventional.
Meanwhile, GCC corporate and project-related sukuk issuance totaled $2.5 billion in the first eight months, up marginally from $2.3 billion a year ago but down sharply from $5 billion in 2013 and $6.5 billion in 2014, Standard & Poor's estimated.
With cheap oil tightening liquidity in their banking systems, Gulf governments were forced to rely more on foreign investors rather than Islamic banks and funds, which pushed them towards conventional debt.
Also, as oil prices sagged, governments were in a hurry to raise money and did not want to spend extra time planning sukuk issues - which tend to be more complex than conventional bonds - or explaining their intricacies to investors.
Sukuk documentation can vary across the GCC in terms of structure, legal requirements and compliance with sharia standards, noted Ruslena Ramli, head of Islamic finance at Malaysia's RAM Ratings.
"In the GCC, sukuk issuances are typically supported by real assets. Identifying sufficient assets to support sukuk issuances may add to the funding timeline and affect the overall financing cost."
Issuance may become more normal in 2017. With oil rebounding and austerity policies in place, GCC governments are somewhat less pressed for cash and have more time to plan sukuk.
Also, this year's dearth of new sukuk has left unsatisfied demand among Islamic investors, including banks that need high-grade sharia-compliant bonds to meet liquidity standards.
"Sukuk are very much in demand and global sukuk issuance is on an upswing," said Mohieddine Kronfol, chief investment officer for global sukuk and Middle East fixed income at Franklin Templeton Investments.
"Going forward we should expect sovereign issues to be less lumpy and more diverse in format and currency," he said.
Saudi Arabia is believed to be considering an international sukuk issue in the first quarter of 2017. Bahrain could sell sovereign sukuk in that period, though the central bank told Reuters no decision had been made.
Conventional bonds look likely to retain one attraction for Gulf issuers, however, because long maturities above 10 years seem more feasible for conventional debt.
"The sukuk market still lacks a significant investor base for the long end of the curve. Sukuk buyers are traditionally more involved in five- and 10-year paper," said a Dubai banker.
Saudi Electricity Co (SEC) issued 30-year sukuk in 2013 but secondary market trading in its bonds suggests demand is weaker for that maturity than for conventional debt.
Its 30-year sukuk is at a premium of 75-80 basis points over the 30-year tranche of the Saudi sovereign bond, against an initial 50 bps in October.
For shorter tenors, SEC's 2022 and 2023 sukuk are almost flat to Saudi sovereign bonds maturing in 2021 and 2026.
Given the pricing advantage of conventional paper at the long end, Riyadh could choose maturities of five and 10 years for a sukuk issue next year, said Doug Bitcon, head of fixed income funds and portfolios at Rasmala Investment Bank.