Why do Saudi Corporates favour floating rate for their Sukuk & Islamic loans?
For unknown reasons, Saudi issuers have over-relied on the floating rate when it comes to pricing riyal denominated Islamic bonds (sukuk). We are not taking about short-term tenor here, rather medium-term. It is a unique feature that differentiates its local debt capital market from any part of the world. I would estimate 95% of total corporate Sukuk issues in Saudi are linked to Saibor (The Saudi Arabian Interbank Offered Rate). Saudi companies who follow this pricing practice for fixed income securities expose themselves to interest rate fluctuations, which can have a detrimental effect on pricing. This practice is in the interests of investors, not issuers. The same practice is also applied to long term loans.
Shortcomings
Saudi Arabia has implemented many reforms in the local debt capital market (in which IMF has recently pointed them out). However, there are some shortcomings spurred from the private sector:
A) Changing the mentality: Treasurers of firms need to realise that short terms loans (with floating rate linked to SAIBOR) is not the answer for their long-term funding needs. The government does price its sukuk with fixed profit rate and therefore they need to build up on the sovereign yield curve. Even if they manage to overcome this issue, the limited size of investors base may dictate the use of floating rate for sukuk. If this is the case, then they need to consider dollar denominated issuance (fixed rate);
B) The challenge of finding Saudi debt capital market specialists is a real dilemma. This is illustrated by the fact that 95% of the Saudi banks are not on the list of top lead arrangers in the Middle East.
The listing and tradability, of local currency bonds and sukuk with fixed rate, could, nevertheless, gradually create the culture of pricing corporate bonds through fixed rate. The majority of DCM deals are priced at floating rate, probably because the investors base are banks and they are dictating what sort of rate they are looking for (which will be in their favour when the local reference rate (SAIBOR) moves up. This is in turn is negative for the corporate, because it will eat into their profits.
Changing mentality
It is hard to determine the average size of corporates Saudi issuance due to the fact that the majority are private placement. The majority of local lenders are not aggressively after debt issuance deals (either it is not part of their strategy, lack of combination of marketers and DCM bankers (who can demonstrate the added value to clients) or the focus more on traditional banking loans (from part of banks and clients). In October, however, Almarai, the Gulf’s biggest dairy company, is considering its debut dollar denominated sukuk (fixed rate) after its Riyal-denominated one (floating rate) has recently matured (first encouraging sign of departure from floating rate that will not be recommended.
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