Asian banks are considering the advantages of issuing higher-yielding hybrid sukuks after Abu Dhabi Islamic Bank (ADIB) successfully sold the world’s first Basel III- and shariah-compliant bond earlier this month, achieving a low yield due to the rareness of the deal.
On November 8, Islamic lender ADIB sold a US$1 billion perpetual sukuk, also known as an Islamic bond, to raise core Tier I capital ahead of the implementation of Basel III rules on January 1.
To comply with presumed Basel III regulations, ADIB structured its bond to include equity-like features. Because of this additional risk to investors, ADIB – as well as other issuers of Basel III-compliant bonds – must pay a premium to entice investors.
However, analysts say ADIB’s unique structure of being both Basel III-compliant and a sukuk it achieve a more favourable price, with a 6.375% coupon. This is something that Asian banks – especially Malaysian ones – could take advantage of.
“Malaysian banks would be a leading contender to do this looking forward because they’re more familiar with Islamic sukuks and have a strong funding base,” said Allan Redimerio, a credit analyst at Standard & Poor’s (S&P). “Investors have some interest in this sort of hybrid issuance given the yield pickup, and there is a lot of interest in these banks given that they are well-capitalised and they carry good credit ratings. So even the conventional Tier I hybrids would sell well and with the additional sukuk structure this would open up more opportunities.”
According to one Asia-based banker close to the ADIB deal, the investors were keen to buy the bond despite the zero write-down clause because the hybrid offered a very rare higher yield for a sukuk.
“There are two sets of investors that are drawn to these types of products. First is those looking for Tier I bank capital, and then you have another set that are shariah-compliant, and for them it’s a new thing to invest in a perpetual,” said the banker.
He explains that the majority of shariah-compliant products in the international debt market are either investment-grade debt issued by Middle Eastern banks or sovereigns, vanilla senior debt rather than Tier I or II products. These tend to yield approximately 3% - nowhere near the 6%-plus that perpetuals and hybrids will offer.
“Higher-yielding sukuks are quite limited in the international market. Even recently we saw that Indonesia issued a 10-year sukuk and that yielded 3.3%,” said the banker. “But this is an opportunity for investors to actually get some yield. The fact that the ADIB deal wasn’t just a Basel III bond but also a sukuk helped expand the order book.”
This appetite helps to lower the yield. ADIB paid 6.325% for its bond, considered a favourable price for a Middle Eastern issuer in this rare format. Comparatively Rabobank paid 8.4% for its Basel III-compliant bond – the world’s first - sold November 2011. And Macquarie Group, which issued the first Tier I Basel-III compliant bond on March 21, paid 10.25%.
The banker also believes that Malaysian banks and corporates, and to a lesser extent Indonesian banks, would be the prime candidates to issue these bonds in the future. Not only are these markets more familiar with sukuk structures given their strong base of Islamic investors and Islamic banks, but investors believe in their positive growth and strong capitalisation. Further, many of the world’s emerging Islamic investor base comes from Asia Pacific, and having brand recognition with this investor base will also help deals succeed.
“[The ADIB deal] by allocations had 38% of its investor base from Asia Pacific,” said the banker. “There is a lot of robust demand for the bond in the region, and there’s a lot of follow-through demand on the secondary market. For Asian issuers interested in Basel III sukuks you have the opportunity for a good benchmark.”
However, the likelihood that that Asian banks will launch these deals in the immediate future are slim, mainly because they have strong core capital ratios and until 2013 they have the opportunity to continue selling “old style” bonds – or bonds that raise core capital without having to include write-down features.
“Malaysian banks are well placed to meet Basel III requirements, but some of them (such as Maybank) have continued to issue old-style capital instruments before the January 1, 2013, deadline, after which the new Basel III rules will impose more onerous requirements on such instruments, such as non-viability conversions or write-offs,” said Ivan Tan, a credit analyst at S&P.
But the need for core capital to meet adequacy ratios will loom in the future. Following the implementation of Basel III in January, Malaysian banks will be required to maintain a common equity ratio of 4.5%, Tier I capital ratio at 6%, and Tier II capital adequacy of 2%.
The banks appear to have strong capitalisation now but as they look to continue their bond programmes and grow in the future, they will begin to turn to these hybrids.
And when they decide to issue, it’s highly likely they’ll consider a sukuk deal.
“Pricing is the main consideration for banks and corporates, and the other main consideration is tapping into a more diverse investor base and sources of funding,” concluded Redimerio. “In terms of cross-border US dollar sukuks, there’s not a lot of flow because most sukuks have been issued in local currencies. If you’re a Malaysian bank or corporate issuing into this market and introducing a Basel III-compliant bond you can definitely spur a demand, especially if you’re a well-capitalised bank that can offer investors a level of security.”