Newswires suggest that the government of Saudi Arabia could issue a sukuk, or Islamic, sharia-compliant bond as soon as next week. The sukuk market is based around issuing securities that while they may have the same cash flows as Western bonds would, they do not legally pay interest but instead pay based on profit shares. Having peaked in 2012, last year the sukuk market picked up steam; according to sources 2016 saw an increase in over 13% of issuance globally, to ~USD75bn, of which over 60% are issued by corporates.
Apparently the new Saudi government issue will replicate a similar ‘hybrid’ structure to the locally currency-denominated (riyal or SAR) Saudi Aramco sukuk issued yesterday. Aramco, the state-owned oil-giant has reportedly raised as much as SAR 11.25bn (USD3bn) in its debut bond offering, which is rumored to be higher-than-expected, as the company moves to raise ~USD 10bn worth of funds for a programme designed to diversify away from hydrocarbon activities. This is not an issue we could hold as we currently only invest in hard currency bonds, however the impending Saudi government sukuk deal could be of some interest. Provisionally rated A1 by Moody’s, the same level as the Saudi government, the deal is expected to reach USD 10bn. After the demand we saw for the debut USD government offering last year, which was incidentally the largest ever developing market bond deal at USD 17bn, we are excited.
Our current exposure to the sukuk market is via state-owned utility company, Saudi Electricity (SECO). These sukuk bonds offer some of the most attractive risk-adjusted returns across our portfolios, and have been some of the best performing bonds so far this year. Rated A2/A- the SECO 5.06% 2043s, for example, have tightened almost 25bps to a still very attractive yield of over 5%. Trading at a spread of ~215bps over UST the bond offers an attractive expected return around 15% if it were to trend to fair value, and has over 3.5 notches of credit cushion.
The UK government was the first non-Islamic nation to issue a sukuk back in 2014; the GBP200m Islamic, sharia compliant issue, maturing in July 2019, was reportedly 11.5 times oversubscribed. The following year UK Export Finance underwrote its first ever guarantee for a USD 913m sukuk, issued by Emirates Airlines, for the purchase of a raft of aircrafts. Despite the recent rise in sukuk issuance few investors look to hold these bonds as they are still in short supply, often ‘difficult’ to understand and sometimes priced more expensively than conventional bonds. However, there clearly is demand for such instruments as the restructuring of global capital flows becomes more widely recognised and accepted.