Arab Petroleum Investments Corporation (APICORP), which invests in the Organization of Arab Petroleum Exporting Countries (OAPEC) countries’ energy sector, recently announced a $3 billion sukuk program that could transform the balance sheet of this smaller, lesser known Saudi multilateral development bank (MDB) as well as its future investment strategy. The major shift in the balance sheet would lengthen its maturity profile and strengthen its resilience to liquidity risk, but would also meaningfully increase its total leverage. The changes that the sukuk program could bring about financially may also be a catalyst for a transformation that also affects the types of investments APICORP as well as the markets where it looks for funding.
To date, APICORP has been highly reliant on short-term deposits from banks and corporates, which provides cheap funding but adds liquidity risks, something that has been less acceptable for banks after the financial crisis. During 2008, APICORP was granted a $1 billion line of credit by its shareholders to provide a liquidity backstop. Whereas during the pre-crisis period the riskiness of short-term funding could be offset to some degree by a conservative leverage position (which APICORP has), the experience of the financial crisis has made that model less appealing particularly for financial institutions subject to Basel III. In its 2014 highlights, APICORP lists having developed a liquidity risk policy in line with Basel III as a ‘key development’ suggesting that some of the changes in funding structure may be due to the demands of the liquidity coverage ratio which would make reliance on short-term funding more difficult.
APICORP has formal support of its sovereign members, including sovereigns with significant wealth to support the institution; this support doesn’t extend as far as being a sovereign guarantee. However, it strengthened the level of sovereign support by introducing a flexible form of callable capital that Moody’s described as being “unique, even in the MDB universe”.
The form of callable capital is not just callable to support its debt service – it can also be called “to expand development operations (while maintaining capital adequacy ratios), or to absorb losses from treasury or development-related assets”. This form of support is useful given that its assets are more risky than a typical bank because they are concentrated in the energy sector and include a large share of equity investments compared to most banks. Out of its $5.9 billion of assets, APICORP’s available for sale direct equity investments represented $866 million at the end of 2014.
If APICORP issued sukuk worth its entire program size and did not use the debt to refinance or replace any of its existing funding sources, it would allow it to add about 51% to the size of its balance sheet. On the liability side, it would increase the bank’s leverage, doubling the debt-to-equity from 104% today to 211% after the program’s issuance is complete. However, it would likely lower the liquidity risk by reducing the proportion of its funding from sources other than its shareholders from 43% of total liabilities today to 25% if it issued the entire $3 billion in sukuk.
The assumption that APICORP could issue the entire $3 billion even in a short period is not realistic, of course, because the structure relies on having sufficient tangible assets, most of which would be ijara assets. Currently APICORP has $871 million of Islamic financings so even if they were entirely represented by ijara assets, it would allow issuance of $1.71 billion in sukuk (since 51% of the sukuk has to be made up of tangible assets and the remainder can be synthetically created using commodity murabaha).
But, it can build its ijara assets over time to support rising issuance which would shift APICORP’s funding towards longer-term liabilities that better match the maturity profile of its assets, which include multi-decade equity investments and project financing. Amidst the growth in its balance sheet there are two opportunities that could dramatically shift its operations: 1) its energy focus, which has been primarily hydrocarbon-focused, could shift to include measurable exposure to renewable energy; and 2) its funding which has focused on the US dollar to match its assets could find a new funding currency via its sukuk—RMB—appealing.
On the first point, APICORP’s strategy as an MDB is focused on the “Arab hydrocarbon and related energy industries” but its financing activities include investments across the energy value chain including upstream, downstream, midstream, utilities and in energy-intensive industries. In the utility sector, it is permitted not just in conventional power and water but also in renewables (some of which, like solar, can be used to power water desalinization plants). This sector has been more important as domestic consumption of oil takes away from exports that are needed—particularly with oil prices low—to cover budget deficits (Saudi Arabia recently issued its first sovereign bond since 2007 to cover a swelling deficit).
In a press release following the release of APICORP’s Energy Investment Outlook at the end of 2014, its CEO Ahmad Bin Hamad Al Nuaimi highlighted that “APICORP was a regional pioneer in financing renewables and is now helping investors make smart choices as countries in our region increase their energy security,” describing it as a “growth area”.
Additionally, the shift to include the option for RMB sukuk, is an unusual one given the traditional focus of APICORP on dollar-denominated assets and liabilities. After all, APICORP makes avoidance of exchange risk a key component in its stated financing policy. The sukuk market has not embraced Renminbi as a funding currency despite efforts in 2011 and 2012 when two issuers brought what remain the only two RMB-denominated sukuk in Malaysia.
However, the funding environment for infrastructure and project finance is shifting towards a greater connection to China with the founding of the Asian Infrastructure Investment Bank (AIIB). The AIIB has, since its foundation, been studying Islamic finance according to the IDB President and that opens up a potential funding source that APICORP may not intend to tap immediately, but which could become an important source in the future. As mentioned above, APICORP prioritizes projects that are absent of exchange rate (which means US dollar denominated in a practical terms) but it also seeks “the maximization of export credits and multilateral loans” particularly in “difficult countries”.
None of the changes underway at APICORP will be completed overnight. However, the trajectory that they indicate is clear in what it could signal about the role for renewable energy growing in the MENA region and the potential attraction of Islamic finance to RMB-denominated investors (including multilateral). In the transition towards these new priorities (where the support of sovereigns without their explicit guarantee may be less valuable), APICORP is both expanding its balance sheet but also strengthening its capital resiliency and limit its liquidity risk, increasing its ability to attract investors from outside its home markets.