Syndicated deals executed in the first half of 2020 totalled $50.1 billion in the core Islamic finance countries, which represented about 40% of total transactions in2019, said S&P Global Ratings in a new report.
By contrast, total sukuk issuance dropped 27% in the first half of this year. “We've observed some improvement recently however, suggesting that the steep drop in sukuk issuance volumes might not be indicative of the market's full-year performance,” said S&P in the report.
The Islamic syndicated loans market has been modestly outperforming the sukuk market this year, the report said, noting that Islamic syndications could increasingly complement traditional financing options.
Islamic countries tend to seek conventional financing in times of crisis. This year, GCC governments and government-related entities have tapped the conventional markets for bonds and syndications more often than the sukuk market. There are several reasons for this, but the most common relates to the complexity of issuing Islamic instruments, particularly sukuk, due to a lack of standardization. Faster execution and larger amounts are the main factors behind GCC sovereigns' decision to take the conventional funding route in 2020.
Governments' heightened need for financing stems largely from the oil price slump and the economic fallout of the Covid-19pandemic. The last time we saw a similar surge in conventional issuance was in 2015.
Compared with classic bank loans, by nature, syndicated deals, could attract larger amounts for longer tenors, since a consortium of banks would share the financing risks. Although syndicated transactions rely on underlying assets and mechanisms to ensure their capacity to generate revenue for the syndicates in a sharia compliant manner, they reportedly require less time and documentation than sukuk.
Bank lending will become more selective as credit risk rises
Central banks in some core countries have increased the flow of liquidity, asking banks to channel these funds to local corporations to support economic activity. Yet we expect banks' risk appetite will lessen in light of the economic stress in the region. Corporates have so far sought bank financing mainly to meet near-term liquidity needs, and most have been accessing bank financing to take advantage of subsidized rates rather than to support expansion.
S&P forecasts that bank lending will increase by low- to mid-single digits in most core Islamic finance countries in 2020. The lower pricing of bank facilities versus market financing could act as an incentive for corporates. Nevertheless, corporates have cut capital expenditure and introduced cost-reduction measures, particularly in more exposed sectors such as real estate, aviation, and tourism. Some have also reduced dividends and rolled over short-term bank borrowing to preserve their cash balances.
Islamic syndication gives borrowers tangible benefits
Islamic syndication could make up for sukuk shortfalls in terms of complexity and time. Syndicated finance enables corporate entities and governments to raise large amounts for a longer duration, while avoiding the intricacies of capital market issuance. This is because of the smaller number of parties and faster execution.
Also, for conventional syndications, legal documents are standardized and tested. For Islamic syndication, the issuance process tends to be more complex, but the involvement of few parties make them relatively easier to execute compared with sukuk. In addition, these transactions are not market transactions and therefore do not require market authorities' approval.
Another key benefit is that Islamic syndications would attract Islamic banks, whose assets totaled$1.8 trillion at year-end 2019, as well as conventional ones. A larger investor base could help the market flourish, since Islamic governments and corporates usually prefer Islamic instruments.
Economic and market uncertainties may favour syndication
At the end of the day, executing Islamic syndication could prove more cumbersome than the issuance of conventional instruments. The necessity of having one or several underlying assets, agreeing on Sharia standards, and structuring transactions in an income-generating manner are just a few examples. In addition, recent market volatility has made it more difficult for corporates to access the market amid rapid changes in creditworthiness.
While market conditions are slowly improving, we think issuers with good credit quality are likely to remain on investors' radar. The choice of instrument will depend on considerations related to cost, timeliness, complexity, and Sharia preferences.
“In this context, we believe that syndication could become a more permanent vehicle for Islamic finance, complementing the sukuk market,” S&P said in the report.
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