Strong employment gains in the US during October and testimony given by Janet Yellen in front of Congress this week are raising expectations that the Federal Reserve will raise rates at its December meeting. The rise in US rates, if it occurs as expected, could boost efforts by the European Central Bank to stimulate the Eurozone economy by lowering the Euro relative to the dollar. The efforts to stimulate the economy in the Eurozone would have a positive spillover in North Africa including for Morocco which is targeting automotive exports to Europe as well as being a financial hub for West Africa (see below).
Debut sukuk from IDB-linked Islamic Corporation for the Development of the Private Sector planned by year-end, could reach $200-300m
The Islamic Corporation for the Development of the Private Sector (ICD) is expected to issue its debut sukuk by year-end to fund its geographical diversification efforts which are focused on Sub-Saharan Africa as well as Asia. The size of the sukuk is not mentioned in the Fitch Ratings report reaffirming the AA rating it has had for the ICD in 2014 that coincided with the ICD’s announcement that it would seek $1.2 billion in financing from long-term debt including sukuk. Based on our analysis, Finance Forward expects that any issuance by the end of 2015 will likely be in the range of $200 to $300 million.
The sukuk structure expected by year-end is a wakala sukuk which requires a mix of ‘tangible’ assets (either equity-based structures, leasing, or sukuk) and ‘intangible’ assets (financial receivables) with a minimum tangible assets of between 30% and 51% depending on the Shariah preference. Even using the most conservative assumptions of a 51% tangible asset level plus assuming that only 50% of the ICD’s equity interests would be eligible to be included give sufficient assets for more than benchmark sized.
However, it is unlikely that the ICD would issue a sukuk that large because its needs are different than, for example the Islamic Development Bank, which has looked to larger sukuk issuance to provide high quality liquid assets (HQLA) to banks. The ICD is a much more specialist organization and would also bear more risk because its asset portfolio is of lower quality (an average rating of B+) and the ICD would provide a guarantee covering periodic distribution shortfalls.
Fitch notes that “ICD’s liquidity has weakened over the past two years, with short-term assets covering only 56% of short term debt at end-2014” and many of its short-term assets are placements with low-rated or unrated financial institutions. This is expected since the ICD has focused about half of its activities on financial sector development in its member countries. This means that not all of an issuance can be directed into longer-term assets; some must be used to shore up its liquid assets position (the rating describes “funds raised by the end-2015 debt issue will help replenish the liquidity reserve.”)
To estimate the size of a likely debut sukuk, Finance Forward mapped out a possible evolution of the ICD’s balance sheet assuming growth over recent years in asset growth continues with relatively similar risk-weightings and that the ICD will not let the debt-to-equity ratio rise significantly and it will retain a buffer over the internal requirement to keep the capital adequacy ratio at 35% or higher. Based on this exercise (this should be treated as a guide not a prediction), it is likely that the ICD will issue a $200 to $300 million sukuk this year and return in future years for sukuk as well as using other (non-sukuk) non-IDB debt such as rolling over the 1-year, $300 million murabaha facility it received from Dubai Islamic Bank, First Gulf Bank and Mizuho Bank in June 2015.
This would allow the ICD to expand its balance sheet at an annual rate of 18% over the next 4 years which is only modestly slower than during the previous 4 years (annualized growth rate of 21%). This growth path would allow the ICD to build up its liquidity reserve, continue to grow its assets, diversify its funding sources and leverage the anticipated $1 billion in capital increase planned over the four years starting in January 2017. Issuing a sukuk now versus in future years may also benefit the ICD because its rating could be lowered in future years if the rating on Saudi Arabia were cut as it was by Standard & Poor’s. Fitch noted that the ICD’s rating would not be at risk from a small cut but would be if there were a “multi-notch downgrade of Saudi Arabia’s ratings”.
Given the reduction in liquidity that many commodity producing countries that are home to the ICD’s customers, the ability of the ICD to expand its financing portfolio in the coming years will be beneficial in supporting private sector growth. Without sources of financing that can continue to grow even as market liquidity falls, the private sector growth would be hurt by the reduction in availability of financing as local banks reduce their financing growth as liquidity dries up. This makes it an opportune time for the ICD to issue its first sukuk.
Islamic finance to be instrumental in supporting Morocco’s’ future growth goals
Morocco’s first Islamic finance subsidiary, Dar Assafaa which is wholly owned by Attijariwafa Bank, started operations in October. Prior to the Islamic banking law passed earlier this year, a handful of conventional banks and other financial institutions in the country launched ijara, musharaka and murabaha Islamic banking products. However, through 2011, the sector was worth little more than Dh1bn ($100 million). There were several reasons behind this failed attempt- lack of a supportive regulatory framework due to shortage of expertise, double taxation issue along with restrictions on marketing- all leading to a non-existent participative banking sector.
Since 2011, there has been a series of challenges that have hindered the development which included the European debt crisis which decreased imports and economic activity in countries like Morocco. However a change in the political leadership in 2012, led by the moderate Islamist Justice and Development Party, pushed forward measures including those making changes in the banking and finance regulations that could accommodate and promote the Islamic banking sector in Morocco. In January 2012, the Moroccan government drafted a bill regulating shariah-compliant banking products and allowing foreign Islamic banks to operate in the country’s banking sector.
The bill made provisions to allow foreign lenders to set up Islamic units in Morocco and also have regulations, which support the growth of Takaful companies as well as sukuk issuances. The major breakthrough of this bill was to ensure that a centralized Shariah board is formed. In July 2015, the Ministry of Finance and Economy approved an earlier circular outlining the banking licensing process including those for Shariah complaint units/windows.
Amongst those that have reportedly considered expanding into Morocco are Abu Dhabi Islamic Bank (ADIB) and Emirates Islamic Bank. Al Baraka Banking Group is working with a domestic Moroccan banking group, BMCE. The interest shown by these banks in the Moroccan banking industry is based on both the domestic banking demand and the potential for Morocco to act as a financial hub in the West African region.
Moroccan Association of Participative Financiers projects that investment in Shariah compliant products will hit USD7 billion by 2018, which is still less than 5% of expected total market share. Moreover the Moroccan government’s aims to create a regional hub- the Casablanca Finance City- to work for the mutual benefit of both the bankers and the government in making the best of Morocco’s strategic trade location and facilitate the development of the financial sector.
If the government can work towards providing the support needed to develop human capital to implement Islamic finance, there is a great potential for Islamic finance to boost the growth of the Moroccan economy and the next five to eight years can be important for the Islamic finance industry. One sector where demand from financing could be significant is the automotive sector, growth in which is expected to support $10 billion in annual exports by 2020 which will raise the share of industry in GDP by 4 percentage points.