Dubai Crisis Prompts Sukuk Holders to Seek Asset Rights: Islamic Finance
The Dubai debt crisis is prompting investors in the $130 billion Islamic bond market to seek stronger rights of ownership of assets to protect against defaults, said a U.S.-based Shariah scholar.
Funds will favor asset-backed debt, in which the ownership of collateral is transferred after a default, said Sheikh Yusuf Talal DeLorenzo, the Washington-based chief Shariah officer at Shariah Capital Inc., a consulting company. Only 4 percent of the $32 billion of Islamic bonds Moody’s Investors Service rated in 2009 contain such provisions, the company said in an April report. The rest rely on the issuer agreeing to a sell assets financed by the bonds if they can’t make payments on time.
“Clearly, Islamic investors have felt that the present generation of sukuk has not met expectations for ownership, so changes are being demanded,” DeLorenzo said in a telephone interview on July 7. They “will require greater due diligence with regard to transfer of ownership,” he said.
Sales of Islamic bonds have fallen 22 percent this year as demand waned after Dubai World, one of the United Arab Emirates three main state-owned business groups, announced plans to restructure debt in November. Kuwait’s Investment Dar Co. was the first company from the Persian Gulf to default on a $100 million sukuk in April last year.
Global sales fell to $6.6 billion in 2010 even as Dubai World, whose unit Nakheel PJSC is building palm-shaped islands off Dubai’s coast, said in May its main creditors agreed to restructure its $23.5 billion of liabilities. Yields on Nakheel’s 2.75 percent $750 million fixed-rate Islamic notes due in January 2011 have fallen to 15.14 percent after reaching 140 percent on Dec. 9, according to prices compiled by Bloomberg.
The difference between the average yield for emerging- market sukuk and the London interbank offered rate narrowed 10 basis points, or 0.1 percentage point, in the past week to 421 basis points yesterday, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. It’s still up from 348 on Nov. 25, when Dubai World announced its restructuring.
The yield gap between the Dubai Department of Finance’s 6.396 percent sukuk maturing in November 2014 and the Malaysian government’s 3.928 percent Islamic note due June 2015 has widened 29 basis points since May 28 to 409 basis points, according to data compiled by Bloomberg.
Bonds in the Islamic finance industry, with $1 trillion of assets, need to comply with the religion’s ban on interest payments. Assets such as real estate are typically leased out and payments to investors are usually in the form of rental income or profit streams. Issuers set up special-purpose companies that hold the transferred property and ownership remains in the hands of the borrower.
Investors in most Islamic debt have “no recourse” to the underlying property and cannot force the company to liquidate if it defaults, Khalid Howladar, a Dubai-based senior credit analyst at Moody’s, said yesterday.
“The only way they’ll get their money back following a default is if the company restructures and pays them back, or from the proceeds of a liquidation,” he said in an interview. “Investors in an asset-backed sukuk have a secured legal claim to the underlying assets and can elect to sell the assets if a company defaults on its payment.”
Investment Dar, the Kuwait-based company that owns half of luxury carmaker Aston Martin Lagonda Ltd., said in May 2009 that it defaulted on $100 million of Islamic bonds maturing in October 2010. The Musharaka sukuk is based on profit and loss sharing underpinned by new and used vehicles, according to the sale prospectus.
Dubai World and its seven biggest lenders will present its restructuring plan to almost 70 creditors on July 22, a person familiar with the matter said on July 11. Nakheel, which reorganizing $10.5 billion of liabilities, is holding a separate meeting with its lenders on July 14, Khaleej Times reported July 6, citing Chairman Ali Lootah.
The quality of the asset that underlies a security is more important than the debt’s structure, James Atkinson, a senior associate at Norton Rose (Asia) LLP in Singapore, said in an interview in Kuala Lumpur on July 6.
“Being a secured creditor doesn’t automatically place you in a better position than you would be where you only have a direct contractual claim against an issuer or guarantor,” he said. “If it’s a low-quality credit, it will provide little in the way of credit support.”
DeLorenzo, who frequently meets with investors, said they are demanding debt underpinned by more stable and reliable assets than real estate because they have “taken a beating.”
Pledging assets to back Islamic bonds may be a challenge in some countries, Mohammed Dawood, director of debt capital markets at HSBC Holdings Plc, said in an e-mail response on July 11. HSBC is the top underwriter of sukuk so far in 2010.
“The legal environment in many countries is not fully supportive of asset-backed structures,” Dawood said, predicting they will remain less than 10 percent of total issuance. He said many corporate and government covenants “prohibit these issuers from selling or pledging assets as part of any fundraising exercise.”