On 22 February, UK-based Al Rayan Bank PLC (ARB, Aa3 negative, baa21) issued the UK’s first asset-backed Sukuk through a special-purpose vehicle, Tolkien Funding Sukuk No. 1. The issuance, a £250 million securitization of Sharia-compliant home purchase plans (HPPs), widens the issuer base for Sukuk outside the core Islamic markets of Gulf Cooperation Council (GCC) and Southeast Asian countries. It also opens new funding options for ARB and other Islamic financial institutions given the limited activity in the asset-backed Sukuk market since the global financial crisis. Both developments are credit positive.
This Sukuk issuance will support overall activity in the Sukuk market, whose issuance in 2017 grew 17% to around $100 billion from a year earlier, primarily reflecting large GCC sovereign issuance. We expect Sukuk issuance to remain broadly stable at $90-$100 billion in 2018, again largely driven by sovereigns. Growth in the Sukuk market provides a steady supply of higher-yielding assets to Islamic financial institutions that are restricted from investing in conventional bonds. Islamic financial institutions globally face a greater challenge than their conventional peers in
sourcing high-quality liquid assets owing to the still-limited availability of the Shariah compliant instruments in the market. As a result, these institutions keep relatively larger amounts of cash and bills, which is positive for their liquidity, but negative for their profitability.
The HPPs backing ARB’s asset-backed Sukuk are structured as leasing contracts extend to individuals in England and Wales. At origination, the customer has chosen a property and agreed on the price, but the property is then purchased jointly with the bank, which holds the legal title to the property. As a co-owner, the customer increases his share of the property by acquiring the bank’s share in monthly installments (the acquisition payments).
In addition to the monthly acquisition payments, the customer pays rent to the bank for the portion of the property not yet acquired. The rent is assessed quarterly, in line with the Bank of England base rate, although the rent can be fixed for a period of time. Given the specific characteristics of the assets, the transaction is exposed to risks that regular residential mortgage-backed securities are not.
This transaction supports the UK’s effort to establish itself as an Islamic finance hub. The UK government was the first non-Islamic nation to issue a sovereign Sukuk, a £200 million Sukuk in 2014. The issuance appeared to be a one-off issue rather than part of a regular programme, but in 2017 the UK government indicated that it would reissue the Sukuk upon its 2019 maturity. In 2017, GCC countries, Malaysia and Indonesia constituted 80% of all Sukuk issuance. In addition, ARB’s asset-backed Sukuk comes after a lengthy period of subdued activity market following the global financial crisis. Therefore, it will open new funding opportunities for ARB and other Islamic financial institutions similar to their conventional counterparts. However, the Sukuk market remains small compared with conventional bond markets in terms of size ($100 billion Sukuk issued in 2017).
Nitish Bhojnagarwala +9188.8.131.5263 VP-Senior Analyst
Rodrigo Conde +44.20.7772.1422 AVP-Analyst