By Laura Cochrane and Haris Anwar
Oct. 26 (Bloomberg) -- Islamic bonds are poised for record gains amid confidence that Nakheel PJSC, the developer of palm- tree shaped islands off the Dubai coast and the market’s biggest issuer, will avoid default.
“Nakheel is the flagship,” said Yannick Lopez, who helps oversee Paris-based OFI Asset Management’s $30 billion in assets. “A default by Nakheel could have wider implications” on the Islamic bond market, he said. “Our view is that the probability of default on this name is quite low.”
Almost non-existent a decade ago, the Islamic bond market has grown to $130 billion, according to Moody’s Investors Service. Prices are rebounding after three defaults in the past year because investors expect Dubai’s government to prevent state-owned developer Nakheel from failing to make payments on its obligations. The company’s bonds due Dec. 14 rose to a record 108 cents on the dollar this month, up from 93.5 on Sept. 2 and 70 percent higher than a February low.
Securities that follow Shariah laws, known as sukuk, have returned 27 percent this year, an HSBC Holdings Plc index shows. Last year, the market fell four times as much as investment- grade corporate debt that doesn’t comply with religious edicts against interest payments as oil prices tumbled and credit markets froze.
Sales to Double
The bonds are climbing almost twice as fast as global companies’ non-Islamic debt and heading for the best annual gain since the benchmark HSBC/Nasdaq Dubai Sukuk Index’s introduction in 2005. Sales of international Islamic debt will double in 2010 to $14 billion as businesses including General Electric Co. plan debut issues, HSBC says.
The Dubai government yesterday set up a $2.5 billion Islamic bond program as part of a $6.5 billion fund-raising plan, as the emirate seeks to sell international bonds for the first time in more than a year. The sale may take place as soon as next week, said two investors who didn’t want to be identified because meetings are private.
Nakheel, a unit of government-controlled Dubai World, owes more than $5 billion by 2011 in Islamic bonds and is among the biggest losers in a real-estate crash that cut home prices in half. The company is a “litmus test” for the debt of other emirate-owned enterprises, Moody’s said in June.
‘Uncertainty’
Dubai World has guaranteed Nakheel’s December bond, the offering prospectus says. Standard & Poor’s in June downgraded Dubai World’s companies citing “uncertainty” over the emirate’s willingness to help the firms pay their debt. Dubai World may be able to sell bonds to refinance Nakheel’s obligations, two bankers familiar with the group’s plans said last week.
“The United Arab Emirates authorities are acutely aware of the amount of profile the Nakheel 2009 sukuk instrument has in the international capital markets,” said Chavan Bhogaita, head of credit research at National Bank of Abu Dhabi PJSC, the U.A.E.’s second-largest lender by assets. “In our opinion, they fully intend to repay this bond.”
Thomas Brund, who helps manage $3.5 billion in fixed-income assets at Sydbank A/S in Aabenraa, Denmark, said the region’s bonds have become too risky after the premium paid for owning them plummeted. The gap between average yields on Middle East debt and the London interbank offered rate for loans between financial institutions has fallen by half to about 300 basis points, or 3 percentage points, in the past six months, HSBC/Nasdaq indexes show.
‘Too Far’
“The spreads have gone too far,” Brund said. He has pared Gulf debt purchases in recent months because the premiums over Libor don’t “reflect the risks if things turn around again in the global economy,” he said.
Mohieddine Kronfol, the managing director at Dubai-based Algebra Capital Ltd., said his fund has returned 25 percent so far this year after buying Islamic securities when yields were near record highs in March.
“The question remains open of what to do from here? Decisions are harder than they were in March,” Kronfol said. Franklin Templeton Investments owns 40 percent of Algebra Capital.
Islamic debt is governed by Shariah laws barring investors from profiting from the exchange of money, as happens with interest payments on other bonds. Returns from exchanging funds for assets is allowed, as long as gambling, guns and alcohol aren’t involved. Bankers structure sukuk to generate income from real estate and other permitted investments.
Created in the 1970s after almost a 20-fold jump in oil prices over 10 years, the Shariah finance industry caters to the world’s 1.57 billion Muslims.
House Prices
Investors fled the Islamic-debt market last year. Sales of international and domestic sukuk plunged almost 55 percent to $14 billion as oil and real-estate prices slumped and eroded Middle Eastern wealth, Bloomberg data show.
Oil fell 54 percent in 2008, the most since at least 1987. Dubai home prices have tumbled about 50 percent from their peak in 2008’s second quarter and may drop another 20 percent this year after a construction boom created thousands of houses just as demand began to evaporate, Deutsche Bank AG said in June.
The HSBC/Nasdaq sukuk index declined 19 percent in 2008, the most since its inception and quadruple the 4.7 percent loss of investment-grade bonds in Merrill Lynch’s Global Broad Market Corporate Index. The slide worsened as investors fled all but the safest government debt after the collapse of subprime- mortgage securities froze credit markets in 2007.
Transparency
“Lack of transparency has become a hindrance in the market because the need for information and rating requirements are much higher these days,” said Harald Eggerstedt, a credit strategist in Edinburgh at bond broker and advisory firm RIA Capital Markets Ltd.
Some of the biggest Islamic debt losses were on Dubai-based companies’ bonds. DP World Ltd.’s 6.25 percent sukuk due 2017 lost 34 percent in last year’s second half and its yield spread over Treasuries reached 1,486 basis points in February, Bloomberg data show. Anything above 1,000, or 10 percentage points, is considered distressed.
Investors sold out of Dubai on concern it would struggle to repay $80 billion in debt after the credit crisis ended its four-year real-estate boom and forced the U.A.E. to work on a bailout of the emirate’s two biggest mortgage lenders. Sheikh Ahmed bin Saeed al-Maktoum, chairman of Dubai’s Supreme Fiscal Committee, said on Oct. 5 that he is confident the emirate can meet its obligations.
Aston Martin
The cost of protecting Dubai bonds from default has fallen to about 294 basis points from a peak of 977 in February, five- year credit-default swap prices show. The contracts, which get cheaper as perceptions of credit quality improve, remain the sixth costliest of 39 emerging markets, Bloomberg data show.
Several sukuk issuers have defaulted in the credit freeze’s aftermath. In May, Kuwait-based Investment Dar Co. reneged on a $100 million bond maturing in 2010, triggering concern about untested restructuring laws for such debt. The company, which owns half of luxury carmaker Aston Martin Lagonda Ltd. in Banbury, U.K., hasn’t reached a restructuring agreement with holders yet, the company said in an Oct. 12 e-mail.
Saad Group, in the Saudi Arabian oil city of Al-Khobar, also doesn’t yet have an agreement with holders of its defaulted $650 million sukuk, according to an Oct. 7 statement from bond trustee Citicorp Trustee Co. released by the Bahrain Stock Exchange.
Defaults
Houston-based East Cameron Partners LP, which issued $165.7 million of sukuk, sought bankruptcy protection in October 2008. The debtor is working on a “consensual plan of reorganization,” according to a Sept. 3 filing in U.S. Bankruptcy Court in Lafayette, Louisiana. “The case is still in that same posture,” said Michael H. Piper, a Baton Rouge, Louisiana, lawyer who represents unsecured creditors, in an Oct. 22 interview.
“There are only three to four defaults in the Islamic market, not 3,000,” said Sheikh Nizam Yaquby, a board member of the Bahrain-based Accounting & Auditing Organization for Islamic Financial Institutions, in an interview. “Standards are in place” for defaulted securities, said Yaquby, who serves on the boards of about 40 firms, including New York-based Citigroup Inc., HSBC of London and Paris-based BNP Paribas.
Sukuk Sales
International sukuk sales will total at least $7 billion in 2009 and $14 billion in 2010, up from $5 billion in 2008, said Mohammed Dawood, a director of debt capital markets at HSBC, this year’s second-biggest underwriter of such bonds. Including domestic issues, total sales may hit $15 billion in 2009 and $20 billion in 2010, said Wan Murezani Mohamad, a senior analyst based in Kuala Lumpur at Malaysian Rating Corp.
International Finance Corp., a World Bank unit, said Oct. 21 that it wants to sell larger sukuk issues after it completes a $100 million sale this week. The state-owned Dubai Civil Aviation Authority may refinance $1 billion of debt due Nov. 2 with Islamic and non-Islamic bonds, two bankers familiar with the transaction said. Indonesia said it will sell its second sukuk in 2010.
This year’s 27 percent gain for the HSBC/Nasdaq sukuk index compares with a 14.7 percent increase for investment-grade corporate bonds in Merrill Lynch’s global gauge.
“We are seeing an extremely bullish and optimistic market,” Dawood said.
The recovery of global markets and investor appetite is encouraging borrowers outside the Gulf region to consider issuing sukuk for the first time.
General Electric Capital Corp., whose parent last year formed an $8 billion venture with Abu Dhabi’s investment company Mubadala Development Co., met with potential Islamic debt investors last week, said two bankers who declined to be identified because details are private.
‘New Entrants’
Asian companies and governments, which Standard & Poor’s says account for 60 percent of 2009’s Islamic bond sales, will lead the increase, said Mohd Effendi Abdullah, head of Islamic Capital Markets in Kuala Lumpur at AmInvestment Bank, the third- largest underwriter of sukuk this year.
“We have seen new entrants in Singapore and Indonesia, and potentially Korea and Japan as well,” he said.
Hong Kong’s government said in May it is changing its laws to facilitate Islamic finance. Abu Dhabi’s Tourism Development & Investment Co. offered $1 billion of sukuk Oct. 13 and ended up getting orders for $7 billion.
“The sukuk market is maturing,” said Yavar Moini, executive director of global capital markets at Morgan Stanley in Dubai. “Investors aren’t shying away.”
To contact the reporters on this story: Haris Anwar in Dubai on Hanwar2@bloomberg.net To contact the reporter on this story: Laura Cochrane in London at lcochrane3@bloomberg.net
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