Islamic Asset Securitization

Introduction to Global Debt Capital Markets

Global bonds are now around $130 trillion. It’s one of the biggest financial markets in the world.

Global Islamic bonds, or sukuk, were first issued in 2001 from the government of Malaysia. Since then, sukuk outstanding have reached nearly $1 trillion by end-2024, a phenomenal rate of growth.

Yet, while Muslim economies are estimated at 22% of global GDP, sukuk comprise only 0.6% of global bonds. Clearly there is a lot of room to expand global sukuk.

Who Can Issue Sukuk?

The most attractive areas of sukuk issuance are in private-sector companies with at least $100 million in EBITDA, or public agencies willing and ready to sign offtake agreements for 20 or more years.

More critical is cash flow. Any company or project that can achieve a steady state 2.0X or higher Debt Service Coverage Ratio (DSCR) is potentially eligible for an investment-grade rating. This is key. While there is plenty of demand for sukuk with ratings below investment grade, it’s those rated BBB or higher that experience the highest global demand.

Typically, investment-grade global sukuk are almost always many times oversubscribed. This ensures the tightest pricing, lowest cost of funds, and the flexibility that global capital markets funding provides.

Sukuk vs Bank Loans

Sukuk easily beat bank loans. Normally they have much less stringent terms, and there is no risk of a borrower being reclassified, a major headache with bank loans. Banks worldwide are under increasing stress from Basle III regulations, where each corporate loan is forced to go through a process similar to ratings. The result is bank loans that have stringent and unpredictable conditions, rarely favorable to a corporate or agency borrower.

Ultimately, sukuk cost less, have much more flexibility, and better match most borrowers’ long-term capital needs.

Examples of Sukuk

Corporates with at least $100 million in EBITDA can easily enter the sukuk market, but even smaller levels of cash flow can be securitized.

In the Saudi domestic market, we have done sukuk programs as small as SAR 500 million, with individual tranches as low as SAR 100 million. While bigger is better, these small-sized sukuk are more than feasible given enormous local market demand.

In global markets, a sukuk issuance of $300 million is considered the minimum, although most professionals prefer $500 million or more, what is called a “benchmark” issuance.

Sukuk are often issued in programs. That means for a $500 million sukuk program there could be as many as four individual issuances of $125 million each, all over up to 36 months.

Projects are ideal for sukuk where there is a long-term offtake agreement (10-50 years) by a rated entity, either corporate or government. For example, an airport can guarantee a minimum number of passengers. A housing ministry can guarantee support for a minimum number of home sales. A university can guarantee a minimum rent for faculty housing. A water desalination project can guarantee the purchase of a minimum number of liters of fresh water. The list is endless.

Frequently, sukuk are issued by a special-purpose vehicle (SPV), a company created by the beneficiary solely for issuing the sukuk.

The ideal sukuk has underlying assets tied closely to the sukuk buyers. Such assets must be linked to a minimum cash flow, dedicated to repay sukuk holders first and all others afterward (subordination).

The Sukuk Ecosystem

No one person is responsible for issuing a sukuk program. It requires a team of specialists across multiple disciplines.

  • Issuer Counsel is the law firm representing the sukuk issuer
  • Sukuk Counsel represents the interests of the sukuk buyers
  • Rating Agents are responsible for arm’s-length assessment of credit quality
  • Custodians administer the sukuk program (audits, registrar, compliance)
  • Investment Banks register sukuk programs with regulators, and distribute them to investors
  • A Financial Advisor builds financial models for ratings agencies, supervises legal and investment banks, and leads successful funding

Thankfully, each of these roles is well endowed with multiple high-quality professionals. Each have extensive experience and knowledge of the sukuk origination process.

Sukuk Origination Costs & Time

While sukuk are more costly to originate than bank loans, that cost is more than offset over time by the lower cost of funds and increased flexibility of sukuk. These costs run up to $1 million or more, which can be capitalized and depreciated over time.

A sukuk program unhindered by problems can be originated and sold within six months. Where problems occur, the time needed will increase based on the complexity of the underlying barrier.

Other Corporate Finance

In the process of preparing for a sukuk program, it’s not uncommon to find internal problems, in particular with a corporate issuer. These are often related to incomplete internal accounting or corporate governance matters. Or they could result from large, unpaid receivables, or inappropriate accounting of historic liabilities. In any case, preparation for the capital markets, and ratings, exposes these problems and creates an opportunity to repair them.

In addition, in the process of modeling the issuer’s historic and projected financials it may become apparent that other support is needed. For projects, this will likely include adding credit enhancements from one or more sources. These enhancements can come through third-party insurance to cover a portion of the principle or profit payments, or may be in the form of support of offtake agreements.

For companies and projects, the credit enhancement may be in the form of additional privately placed equity or subordinated debt.

In all cases, sophisticated financial modeling prepared by the Financial Advisor is required to expose the final credit profile of the issuer, ensuring the highest possible rating.

Role of the Financial Advisor

A competent Financial Advisor can source, contract and lead each member of the sukuk program team, ensuring the fastest time to market and lowest origination costs. The Financial Advisor is also the link to ratings agencies, communicating the issuer’s credit profile with solid financial modeling and real-world operating data.