The “conventional wisdom” of indicative sukuk pricing
One of the most known misconception among prospective issuers (in the emerging & frontier markets) that sukuk pricing differs from bonds. Well, it is not! Debt Capital Market Bankers use the same conventional wisdom for pricing of bonds. Knowing the indicative pricing is the most decisive factor for reluctant issuers who weigh the other option of using loans or bonds.
Know-how
Depending on the initial term length (tenor), a relative benchmark would be used for the Sukuk pricing. The size of the spread is denominated in basis points (bps) and it varies according to the risk of the borrower. The relative value of indicative pricing is driven by the following:
- The issuer’s own Sukuk/bonds outstanding
- The issuer’s credit default swaps
- Peer group analysis
If there is a lack of benchmark for a sovereign in terms of its own bonds, peer bonds could be used as a proxy to arrive at final pricing. Remember that “pricing is an art”. Hence, there could be other methodologies that will deliver almost the same results for the indicative pricing.
In certain trades, there will be marginal/no difference in pricing between a Sukuk and a conventional bond for the issuer
Distribution and the demand
By capitalizing on demand / supply gap, cost of funding can be lowered for the issuer. Sukuk supply/demand imbalance may offset new-issue premium. Sukuk attracts both conventional & Non Interest demand across different investor classes. Some 50% of the sovereign Sukuk issues are subscribed by conventional bond investors. The addition of Islamic investors in the funding pool will create price tension between these two distinct investor types leading to better price discovery. All investor classes (Islamic, regional & international) are important to create price tension.
Ratings
Credit Rating Agencies assess the relative credit risk of debt securities, borrowing entities (issuers of debt), and the creditworthiness of governments and their securities. Obtaining such rating will facilitates the marketability of the sukuk. From a credit perspective, Sukuk represent the same credit risk as that of the underlying obligor (“borrower”)
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What Sukuk Issuers Can Learn From Aramco’s Pricing of Fixed Income Instruments
The $100 billion-plus of orders that Aramco’s generated for its maiden $12 billion bond sale will be also remembered as the issuance that was marketed by WallStreet celebrities and bankers. It is indeed the ““one-of-a-kind emerging markets deal”. But at the same time, Sukuk issuers can learn how to rely on your internal debt capital market team to price your issuance at the fair value rather than putting money on the table (for investors).
Wider positive effect to GCC debt capital market
Almost all the Saudi (sovereign) yields (including its sukuk issuance) have registered their lowest in more than a year. It means that the cost of borrowing for sovereigns and corporates will be much lower than before. Aramco has brought the sovereigns yields down with it. This ripple effect of Aramco bonds has been seen in the repricing of the Saudi yield curve and naturally this will tighten the yield curve of Abu Dhabi & Kuwait as well.
When investors are turn apart
There was new liquidity that we rarely see coming to Saudi Arabia. These were the investors who focused on investment grade, and those who invest in corporate bonds.
These two types of investors changed the level of pricing they turned the table against the traditional investors (Emerging Market investors whom some of them threatened not to subscribe after seeing the initial price thoughts. EM investors had so many reservations on Aramco pricing. This new liquidity changed everything.
Trading Through Sovereign
The conventional wisdom in our fixed income industry that it is rare for DEBUT bonds of a state-owned company to yield less than the sovereign debt. Don’t take my word for it. “It’s unlikely that Aramco’s bonds will trade tighter than Saudi Arabia’s”, Bloomberg Intelligence said in an insight before the issuance was closed.
However, in a Linkedin post, I said “make no mistake that Aramco will try to price inside the yield curve. In 2015, Aramco (A+ but unrated at that time) managed to obtain two dollar tranches that were priced at 12 basis points above Libor. That’s lower than the 15 basis points above Libor that Exxon Mobil (AAA) paid for its $5 billion revolving credit facility signed in 2013.
Having priced inside the sovereign curve by 10 to almost 25 bps, we can say now that Aramco made the impossible possible.
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