For perhaps the first time in the modern history of Islamic finance, some debt issuers are finding it cheaper to raise money through sukuk than through conventional bonds.
"The reason the sukuk market performed as well as it did in the past, and why sukuk held up in the secondary markets, is because there was an imbalance on the supply and demand side," said Usman Ahmed, senior portfolio manager at Emirates NBD Asset Management.
Now, that imbalance looks likely to partially correct itself with a spate of sukuk issues from Abu Dhabi and elsewhere in the region, potentially eliminating any pricing advantage of Islamic bonds for issuers.
"With the new burst of issuance, you'll see that imbalance even out a little. We expect the existing sukuk to sell off slightly -- it's already happening -- in anticipation of the new issues, which are offering investors more concession," Ahmed said.
Two Gulf issuers may tap Islamic debt markets with a sukuk issue on Wednesday. One is Bahrain, hit by political unrest earlier this year, which completed roadshows earlier this week for an eventual bond. Guidance for Bahrain's seven-year benchmark-sized sukuk was set at 450 basis points over midswaps on Wednesday.
Meanwhile, Abu Dhabi Commercial Bank is eyeing at least $500 million from its debut dollar sukuk; on Wednesday it set price guidance in a range of 275-287.5 bps over five-year midswaps. The last sukuk from an Abu Dhabi financial institution was issued in late July, just before the euro zone sovereign debt crisis rattled global markets and dampened issuance of many kinds of debt.
"The reality is that Islamic banks still have a lot of money to put to work and some, anecdotally, have significant liquidity. There is still unutilised demand out there, and so pricing on a sukuk will be tighter than a conventional deal -- maybe by 10-20 bps," said one regional banker, declining to be identified.
"Before, it was all about the big-name London investors but now, the power has been transferred to Middle Eastern investors and much depends on their appetite."
First Gulf Bank priced a $650 million five-year sukuk at 200 bps over midswaps in July, offering a coupon of 3.797 percent. The bond is currently bid at around 103.00, yielding 3.1 percent; it has narrowed over 40 bps since the end of September.
Similarly, Abu Dhabi Islamic Bank's outstanding $750 million five-year sukuk maturing 2015 was trading at 102.1 on Wednesday, according to Thomson Reuters data; the yield is about 70 bps lower than levels a year ago.
By contrast, Abu Dhabi's Union National Bank tested appetite for a conventional issue earlier this month, raising $400 million in five-year debt. The bond was issued at 287 bps over midswaps, and fell short of raising the intended $500 million minimum due to weak investor response.
If ADCB can price its sukuk at the tighter end of guidance, it will suggest new sukuk issuers are still avoiding paying any premium to conventional bonds -- a sign that heavy underlying demand for sukuk persists.
"There might be the need to be a bit more generous to get the wheels in motion, but the money is there to be put to work," said a London-based banker.
However, new sukuk issuance is starting to prompt sales of existing sukuk -- a sign that the supply-demand gap in the market is beginning to close, and that future issuers may not be able to impose terms that are quite as cheap. The bid on FGB's sukuk temporarily came off to 101.25 on Wednesday morning, after ADCB's price guidance was issued.
Another indicator is Indonesia's new sukuk, issued this week. The $1 billion, seven-year issue drew massive demand of some $6 billion and was priced at 4 percent, 25 bps tighter than guidance and offering no sukuk premium; its new-issue premium was only 20 bps over the country's conventional sovereign bonds. But the sukuk is now trading lower in the secondary market.
"What you'll see is coming sukuks will pay better now, because that's the tone that has been set," said a regional fixed income trader. "No one is bidding the old sukuk now."
Later issuers in the pipeline may now face significantly higher costs than earlier issuers. Among possible future issuers, ADIB will kick off investor meetings on Nov. 17 for a potential dollar sukuk, while Abu Dhabi's Al Hilal Bank has signalled it could print an Islamic deal in the first quarter of 2012.
"This is like a runway. You can't land all the planes at once," said an Asia-based banker.