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Mon 31 Jan 2011 04:56 PM

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Project financing boom to spur sukuk

At least $3.9bn of the Islamic bond sales announced this year will fund building of oil refineries, steel mills, petchem plants

Project financing boom to spur sukuk
ISLAMIC FINANCE Global sales of sukuk dropped fifteen percent in 2010 to $17.1bn

Plans by Saudi Arabia, Malaysia and Qatar to spend almost $1 trillion on development projects over the next decade will overwhelm the amount banks can provide in loans, reviving sales of sukuk, according to HSBC Holdings Plc and BNP Paribas SA.

At least $3.9bn of Islamic bond sales announced this year will fund the building of oil refineries, steel mills and petrochemical plants, according to data compiled by Bloomberg. New York-based law firm Chadbourne & Parke LLP estimated last year that Sharia-compliant project financing in the Gulf Cooperation Council will account for 30 percent of the total by 2012, up from 12.5 percent in 2006.

“The capacity of the Islamic commercial banking sector may not be sufficient to satisfy demand for capital,” said Rafael Dalmau, the Singapore-based head of the Islamic portfolio unit at BNP Paribas, in an interview January 18. There will be “greater activity and transactions in the capital markets,” he said.

HSBC expects to arrange more project financing after helping to manage a ringgit-denominated sukuk in November for a gas pipeline in Thailand, the first such issuance in Malaysia since 2008, said Mukhtar Hussain, global chief executive officer at the Islamic unit HSBC Amanah, in Kuala Lumpur. Global sales of Sharia-compliant bonds will increase seventeen percent this year, rebounding from the slump in 2010, according to Dalmau at BNP.

Saudi Arabia approved a $384bn five-year development plan in August, while Qatar aims to spend $100bn as it prepares to host the 2022 soccer World Cup. Malaysia unveiled $444bn of programs in 2010 to stimulate economic growth over the next decade.

The “huge” funding requirement will prompt governments and companies to turn to Islamic bonds as well as loans, HSBC’s Hussain said in an interview on January 11.

Global sales of sukuk, which pay asset returns to comply with the religion’s ban on interest, dropped fifteen percent in 2010 to $17.1bn, with offerings so far this year of $176m, according to data compiled by Bloomberg. Issuance in the six-nation GCC declined 32 percent last year to $4.5bn. Dalmau predicts sales will rise to $20bn in 2011.

Sharia-compliant bonds returned 12.4 percent over the last twelve months, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Debt in developing markets gained 11.8 percent, JPMorgan Chase & Co’s EMBI Global Diversified Index shows.

The difference between the average yield for sukuk and the London interbank offered rate narrowed five basis points, or 0.05 percentage point, this year to 285 on January 26, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Average yields have dropped two basis points to 4.72 percent.

The yield on Malaysia’s 3.928 percent Islamic notes due June 2015 fell three basis points to 2.79 percent today, according to prices from Royal Bank of Scotland Group. The debt has returned 7.2 percent since it was issued in June.

The difference in yield between the Dubai Department of Finance’s 6.396 percent sukuk due November 2014 and Malaysia’s Islamic note shrank three basis points to 336 today, according to data compiled by Bloomberg.

Sukuk issued to fund construction and development projects are typically limited to maturities of as many as ten years, said Jarmo T Kotilaine, the Jeddah-based chief economist at National Commercial Bank, in a telephone interview January 25. Financing is required over longer periods, he said.

“Project financing will be one of the reasons why sukuk sales will rise this year,” said Kotilaine. “In general, the outlook for the sukuk market is looking increasingly bright.”

‘Fertile Opportunity’

Islamic bonds backed by assets under construction are often based on Istisna, a contract where one party builds a specific asset according to an agreed delivery date and price. The lender provides payments in stages to the borrower during the construction phase. Once the project is completed, the structure shifts to the Ijarah-type sukuk, or a sale and lease agreement.

Saudi International Petrochemical Co will sell at least SAR1.5bn ($400m) of sukuk in the first quarter for project financing, while Saudi Electricity Co, the Arab world’s largest utility by market value, plans to raise money for the more than SAR30bn of construction projects.

HSBC, the third-biggest Islamic bond underwriter in 2010, helped manage a 600 million-ringgit ($196m) sukuk sold by Trans-Thai Malaysia (Thailand) Ltd, a joint venture between state-owned oil and gas company Petroliam Nasional Bhd and PTT Pcl, Thailand’s largest energy company.

The structure was of the Murabahah type and the bond had maturities ranging from five to fifteen years, according to the term sheet. Murabahah refers to a transaction where the costs and profit margin are agreed by all parties involved.

“Project finance is an area that offers a fertile opportunity for Islamic finance to grow because it finances real assets in a real economy with real cash flows,” Hussain said. “In many ways the Thai sukuk was a benchmark transaction.”