The figures speak for themselves. Last year, Islamic sukuk issuance by Middle Eastern issuers fell 50% from $13.1bn (equivalent) in 2007 to just $6.5bn in 2008, according to data company Dealogic. The deterioration in new issuance in dollars was most marked from 12 dollar issues totalling $7.6bn in 2007, new issuance fell to $350m in 2008 with just one dollar deal being priced.
At the end of 2007 and the beginning of 2008 there were unprecedented flows of liquidity into the Middle East as investors speculated on the likely depegging of the UAE dirham from the dollar. But by September, the financial crisis had combined with strong signals from the UAEs central bank that depegging was unlikely in the near term, to ensure that this liquidity, mainly from hedge funds, swiftly evaporated.
According to some estimates, between $20bn and $30bn of dirham liquidity flowed into and then out of the region in just a few months, causing credit spreads to widen and stock valuations to plummet Dubais financial markets have lost 66% of their value since last January.
But while spreads have widened and new issuance has all but disappeared, bankers in the region insist that the problem for the Middle East remains one of liquidity, not of credit.
"The local sell-off is more a factor of liquidity, and in particular currency flows as opposed to the global credit crisis," says Samad Sirohey, chief executive officer of Islamic banking at Citigroup in Dubai. "The impact of this outflow of liquidity, coupled with a global deleveraging in credit markets on secondary market spreads has been dramatic, driving prices lower across the sukuk asset class, with strong single-A credits trading in the 50-60 cents range.
"There are undoubtedly high quality credits whose sukuk are trading at distressed levels. For real money investors who are willing to put in the work to understand the credit fundamentals, there is real value to be had."
Club of issuers continues to growHopes were high in 2007 that non-Islamic corporate issuers would move to take advantage of liquidity in the Middle East and Muslim Asia to issue sukuk. Although few have done so, according to Sirohey sensible borrowers should be exploring sukuk issuance as part of their funding diversification strategy for the future. "People should be looking to the region as a potential source of liquidity like other niche markets," he says. "And the best way to access this market and to ensure the widest possible appeal is through Islamic structures."
In October, UK chancellor Alistair Darling delivered a symbolic blow to the Islamic finance cause when he announced the Treasury was (temporarily at least) abandoning plans for a sterling sovereign sukuk, citing the turmoil in global financial markets.
Despite the UKs decision, the sukuk market continues to attract investors from a growing band of countries. Issuers in more than 15 countries, mostly non-Muslim, have expressed their interest in issuing sukuk. Azerbaijan, the CIS, Kazakhstan, the Kyrgyz Republic and Russia are developing legislation for sharia-compliant instruments. North African countries including Algeria, Egypt, Libya, Morocco, Tunisia and Sudan are keen on future sukuk issues while in Europe, Switzerland, France and Italy are also contemplating legislative platforms for sharia-compliant instruments.
Islamic banks: weathering the stormThe Islamic banking industry escaped the immediate fallout from the financial crisis, largely because the ban on interest prevented banks from investing in the assets that turned toxic for conventional banks.
The exit of foreign investors has hit equity and real estate valuations in the Middle East, two asset classes to which Islamic banks are heavily exposed.
Asset liability mismatches have also been highlighted in the crisis at the end of 2007, only 10% of the Gulf Islamic banks liabilities were long term, compared with 23% at conventional banks.
Analysts think, however, that this rapid growth of real estate finance and widening maturity mismatches on the balance sheets of GCC banks could promote further sukuk issuance. "The regional environment therefore seems increasingly fertile for the emergence of securitisation both Islamic and conventional," according to a report issued by Standard & Poors in September.
Mohammed Damak, credit analyst at S&P in Paris, remains confident that the return of liquidity to the region will spark new sukuk issuance. "The outlook depends on market conditions, but there are huge financial needs in the region and the pipeline of sukuk issuance remains healthy. More than $40bn of announced or rumoured sukuk issues are sitting in the global pipeline," he says.