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Fri 1 Oct 2010 08:02 PM

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Sukuk poised for best run since 2007 on demand

Declining sukuk sales and investors hunting for higher yielding assets spurred demand

Sukuk poised for best run since 2007 on demand
BONDS ADVANCE: Islamic bonds are poised to advance for the fourth straight quarter, and post their longest stretch of gains since 2007. (Getty Images)

Islamic bonds are poised to advance for a fourth straight quarter and post their longest stretch of gains since 2007 as increased confidence in Arabian Gulf issuers’ ability to pay obligations helps lure funds.

Sukuk handed investors a 4.9 percent return in the third quarter, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, extending a rally of 0.8 percent in the previous three months and a 5.1 percent gain in the first quarter.

The last time Islamic bonds posted a yearlong winning streak was three years ago when issuance rose to a record.

Emerging market bond funds took in $15.2 billion in the three months to Sept 30, putting the year’s total at $39.5 billion, according to Cambridge, Massachusetts based research firm EPFR Global.

The combination of declining sukuk sales and investors’ hunt for higher yielding assets is spurring demand for Islamic notes, according to Dubai investment banks Rasmala Investment Bank and Royal Capital.

Dubai World’s creditors’ accord last month to reorganize $24.9 billion of debt reduced the risk the state controlled company will default.

“The rally will continue,” Azdini Nor Azman, the head of fixed-income at Bank Muamalat Malaysia Bhd. who helps manage 4 billion ringgit ($1.3 billion) of assets at the Islamic lender based in Kuala Lumpur, said in a telephone interview yesterday.

She said: “There’s so much liquidity out there and there is just not enough paper in the market.”

Azdini said she expects fourth quarter returns will be similar to the past three months.

The spread between the average yield for sukuk and the London interbank offered rate narrowed 65 basis points, or 0.65 percentage point, to 378 in the third quarter after widening by 41 in the previous three months, the HSBC/NASDAQ index shows.

Global sales of the bonds, which pay returns from assets to comply with Shariah law’s ban on interest, have fallen 17 percent to $11.6 billion this year from the same period in 2009, the lowest in four years, data compiled by Bloomberg show. Issuance totaled $20.2 billion in 2009, $14.1 billion in 2008 and $31 billion in 2007.

In a Sept 29 interview from Dubai, Louis Najem, fixed income trader, Rasmala Investment Bank, said: "Investors are now seeing more clarity on the situation in Dubai in particular compared to a year earlier."

The restructuring “is going to be successful and international investors will be coming back for more,” he said.

The Arabian Gulf plans about $4.8 billion of sukuk sales for the fourth quarter, more than double the $2.1 billion estimate for Asian issuance, according to data compiled by Bloomberg.

The average yield for sukuk sold by Gulf Cooperation Council issuers dropped 129 basis points in the third quarter to 6.19 percent, the HSBC/NASDAQ Dubai GCC US Dollar Sukuk Index shows. The yield climbed to as high as 8.76 percent on Dec 11, two weeks after Dubai World announced plans to delay debt payments.

The gap between the Dubai Department of Finance’s 6.396 sukuk maturing November 2014 and Malaysia’s 3.928 percent note due April 2005 narrowed 43 basis points in the quarter to 374.

The cost of protecting against a default on debt sold by Dubai’s government fell last quarter, after rising in the previous three months. Dubai credit default swaps declined 59 basis points to 437 in the period, according to data provided by CMA. They traded below 300 in October 2009.

Credit default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

In an email on Thursday, Takamitsu Oi, fund manager, Nomura Islamic Asset Management, said:“The latest development is indeed positive for Dubai but it is still early days and the markets will soon be looking for stronger commitment from both Dubai and Abu Dhabi over the medium to longer term."

He added: "A key indicator that investors are still cautious about is that the Dubai five year CDS are still trading” above 430, he said.

Ahmed Talhaoui, the head of portfolio management at Royal Capital, said in an interview on Sept 29 that he prefers Middle Eastern sukuk over Asian notes because they offer higher yields.

Investors will prefer sovereign securities with “clearly defined cash flow” over corporate debt and equities because they are worried about weakness in the recovery of US and European economies, he said.

Japan’s outlook is “anemic” and there’s a high probability of another recession in the US, New York University Professor Nouriel Roubini told reporters in Kuala Lumpur on Sept 27.

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