Euroweek: Debt capital markets, November 18 2011

Euroweek, November 18 2011

INDONESIA

Indonesia dominated the Asian dollar capital markets this week, with a well-received $1 billion sovereign sukuk rapidly (some would say alarmingly so) followed by another $1 billion benchmark from state electricity company Perusahaan Listrik Negara (PLN).

The seven-year sukuk was priced on Tuesday morning Asia time and gave a clear demonstration of how positively Indonesia is now seen in world markets. It priced at 4% (strictly speaking this is a profit rate rather than a yield, since this is an Islamic security), the tight end of 4-4.125% guidance. It was widely agreed that the tight pricing reflected an assumption that Indonesia, rated Ba1/BB+/BB+, with a positive outlook in Fitch and S&P’s cases, will be upgraded one more notch to investment grade. It formed a sharp contrast with the 6.29% Italy paid for a Eu3 billion five-year bond on Monday – Italy is rated A2 by Moody’s.

“The good news is in the price with regards to the rating,” said one banker. “Indonesia certainly trades like an investment grade sovereign. People feel very positive about how the future looks down there. But an upgrade is not going to result in a dramatic tightening of yields again; ratings need to catch up with reality.”

Those close to the deal say it attracted a $6.5 billion order book. “4% was an excellent outcome for them considering their last deal was 8.8% in 2009,” said one. “Seven years is a respectable maturity profile. Everybody is pretty happy with that.” The choice of maturity reflects the fact that Middle East investors, who were key to the transaction, prefer shorter-dated bonds, ideally five years; since the issuer wanted funding of up to 10 years, seven was seen as a sensible compromise. Middle East investors accounted for 30% of the deal, and had been a clear target, with a roadshow that visited Riyadh, Doha, Dubai and Abu Dhabi. Indonesian investors took 12%, the rest of Asia 32%, the US8% and Europe 18%. Funds took 59% of the deal. Citi, HSBC and Standard Chartered were lead managers.

It is harder to demonstrate that the deal’s success was down to a growing conventional investor appetite for sukuk, though some believe that it was a contributory factor. “There was a strong bedrock of interest from Middle East and Asian sukuk-specific funds, but conventional players also recognised the quality of the issuer,” said one person close to the deal, who estimated that 40% of the book were conventional investors but stressed there was some guesswork in that number.

The PLN deal was a $1 billion 10-year offer which priced on Wednesday morning Asia time, led by Barclays Capital and Citi as joint bookrunners. It priced at a yield of 5.625%, the tight end of 5.625%-5.75% guidance (a coupon of 5.5% with notes reoffered at 99.054). Some in the market considered this cheap, particularly in light of the sovereign sukuk; but S&P rates it one notch below the sovereign at BB (unlike Moody’s and Fitch, who have it at Ba1 and BB+ respectively), suggesting a slightly weaker credit than the sovereign, in addition to which the PLN deal carried a longer tenor. It is the lowest coupon PLN has ever paid for a dollar bond and represents a 150 basis point spread over comparable-tenor conventional sovereign debt.

Despite its proximity to the sovereign deal – something another banker in the market described as “breathtaking arrogance in timing” – it attracted considerable interest, with $5.5 billion of orders from more than 200 accounts. Those close to the deal say it was not simply a method of mopping up excess demand from the sukuk, since the two were marketed in very different ways as reflected in PLN’s final distribution: European investors took 21% and US investors 35%, far higher than in the sukuk, while the Middle East was not a significant source of demand for PLN. Fund managers accounted for 64%, insurers and pension funds 19%, banks 7%, private banks 6%, and central banks and others 4%.

Those close to the deal say the timing was partly coincidence; a necessary revision to the documentation had only come through late on Monday New York time, and the bond was issued swiftly thereafter to take advantage of a brief window. It did, though, probably have an impact on the aftermarket performance of the sukuk, which started out trading up and dropped below par in the wake of the PLN issue (which traded up).

Structurally, the deal was interesting because it did not use a special purpose vehicle, as most Indonesian companies do and as PLN previously has. The SPV structure avoids a withholding tax charge, but PLN’s government ownership rendered that somewhat irrelevant. Ditching the SPV opened it up to a greater range of investors, according to people close to the deal.

IILM

The International Islamic Liquidity Management Corporation, a body designed to issue short term Shariah-compliant instruments to foster better liquidity management among Islamic banks, will issue its first bonds within “the first six months” of 2012, according to Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia.

Dr Zeti was interviewed on Tuesday in Kuala Lumpur, one day before a crucial IILM board meeting that was expected to move the body closer to its first issuance. She said the meeting should approve the parameters for issuance, including allocation of assets against which the issuance will take place, and the appointment of primary dealers who will make the market. “We are very close,” she said.

In the wake of the financial crisis, many Islamic finance leaders – Zeti prominent among them – conducted a study of the industry to establish what risks it faced and what to do about them. The lack of liquidity was one of the main findings and led to the formation of the IILM in late 2010. “We saw during this crisis that liquidity became an important issue,” she said. “With the internationalization of Islamic finance, cross-border flows require short term instruments to effectively manage, not only in stressful conditions but in normal times.”

Zeti said there will be a program of issues like to be around $2 billion to $3 billion apiece, with regular issues through the year. A first issue will be smaller, “to test the system”. Issues can come in a number of currencies but are initially expected to be in dollars; the first, pilot issue, is certainly expected to be in the US currency. “They will be high quality short-term liquid instruments and will be in demand by other funds managing portfolios – even conventional,” she said.

Issuance will be from IILM itself, which is a corporation established and backed by 12 central banks (Indonesia, Iran, Kuwait, Luxembourg, Malaysia, Mauritius, Nigeria, Qatar, Saudi Arabia, Sudan, Turkey and the UAE) and two multilaterals (the Islamic Development Bank and the Islamic Corporation for the Development of the Private Sector) as shareholders. It is understood that a formal rating will soon be announced for IILM, a vital precursor to issuance and something Zeti described as “a long process”.

The need for IILM is likely to become particularly acute if world capital markets lock up in the wake of problems in Europe. “Almost the entire world uses Treasury bills: they are highly traded and can be used to manage the liquidity of any portfolio or any financial business,” she said. “For Islamic finance, there is no sovereign that issues short term paper of that nature, and therefore IILM was established. It took us two years of work.”

Other founders agree the start line is near but that there is more to be done. “We are still crossing the Ts and dotting the Is,” said Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria. “There are still issues in terms of the rulings of the Shariah Council on what we can and can’t do and how it will be structured. We’re still going through the process of structuring IILM to get the kind of rating we would like to have. It will take a little time for us to be out there.”

NIGERIA

Nigeria is set to become a fixture in the Asian debt capital markets with plans for a Malaysia-domiciled benchmark sukuk and possibly a dim sum bond next year.

In an interview in Kuala Lumpur, Malam Sanusi Lamido Sanusi, Governor of the Central Bank of Nigeria, said the country had been receiving advice from HSBC and CIMB on a sukuk, although the banks had not been formally appointed onto a deal. “We would like to see if we can issue a sukuk next year,” he said, probably in the second half. “We think that anything from five to seven years should be good for an initial offering, with the amount $700 million to a billion. That gives the kind of liquidity you want, and it also fits the tenor for most of the Arab funds who are not interested in 10-year instruments” – a consideration which also affected the choice of tenor in this week’s Indonesian sukuk (see separate story).

“The European funds tend to go for longer tenors, the Arabs for shorter, but given where Europe is, it makes a lot of sense to structure something to the areas that have a lot of liquidity,” he said.

But although Middle East investors would be targeted, Sanusi said the sukuk would “most likely” be issued out of Malaysia. “The central bank of Nigeria has had a very strong relationship with Bank Negara since I became governor,” he said, partly because Nigeria had recovered from a domestic banking crisis by studying Asian responses to the financial crisis there and had decided Malaysia was the best role model. “The Malaysian Islamic finance market is obviously the most advanced at the moment in terms of product, size and innovation, and the natural place to be.”

As with many sovereign sukuks, the hope in Nigeria is that it would prompt corporate issuers to follow. “Capital markets generally work better if you have a sovereign benchmark, that’s my view.” He also said that sukuk markets appeared to show better pricing than conventional finance. “Italy is paying 7%, so if Indonesia can raise at 4.125%, that’s a reflection of the liquidity in the sukuk markets. There is increasing interest: once conventional fund managers accept sukuk it is almost a no-brainer, as a sukuk targets both conventional and Islamic investors so you’ll probably have tighter pricing.”

He said the likely projects that would underpin the sukuk would be infrastructure, and could include aviation assets.

Sanusi also said that Nigeria’s recent decision to put 5-10% of its reserves into RMB could pave the way to a dim sum bond. The shift in reserves, he said, “is a strategic decision and recognizes the fact that China has become a major trading partner for us. It recognizes the possibility of Chinese investments in infrastructure coming in to Nigeria, and opens up for me, from a central bank perspective, the possibility of coming to the RMB market for dim sum borrowing.”

He said there was a natural argument for RMB funding. “Think of it theoretically. If we agree to accept RMB in payment for oil sales to China, you immediately generate RMB cash flows. If you have long term contracts to supply crude oil to China, you could securitize those, and raise dim sum bonds; that pays for what infrastructure investments you require from China.

“You hedge the currency risk, you get finance, and come to a very liquid market where the yields are lower and the spreads tighter than you would get in Europe at this point in time.”

A wish to avoid risk-averse European investors as a source of funding appears to be driving these moves towards Asian markets. “It is extremely important for the country to look to Asia as one likely source of borrowing,” he added. “That’s why the sukuk market in Malaysia and dim sum market in Hong Kong are markets we believe Finance [the Ministry of Finance] should be looking at.”

BEA

The Bank of East Asia’s China subsidiary has issued RMB3 billion of financial bonds in China’s interbank bond market – the second tranche in a RMB5 billion program, following a RMB2 billion launch in March.

The interest rate was set at 4.81% for the two-year bonds, which provides a reflection of how market sentiment has changed through the year; the first tranche, with the same tenor, priced at 4.39%, albeit for a larger volume.

The joint lead managers on the deal were ICBC, CICC, UBS Securities and Bank of Communications, with CICC as bookrunner. They sold the bonds only to institutional investors.