An Islamic bank has raised the first sharia-compliant bond backed by UK mortgages, highlighting the growing importance of Islamic finance for both capital markets fundraising and high-street lending in Britain.
The UK has sought to make itself a hub for Islamic finance in the western world, with the British government raising £200m through the first sovereign sukuk outside the Islamic world in 2014. However, Al Rayan Bank’s deal is the first time a UK lender has blended sharia-compliant financing with securitisation, in which bonds are raised against assets such as mortgages.
Islamic financing prohibits lenders from charging interest on loans. Rather a lender agrees to invest in a project and then shares in the profits. In this case, the Birmingham-based lender offers its customers the Islamic finance equivalent of mortgages, known as home purchase plans. Technically the bank co-owns the house and rents the part it is not using to the customer.
The bank bundled nearly 1,700 of these home purchase plans together as security for its sukuk, which was issued through a special-purpose vehicle called Tolkien Funding Sukuk, named after author JRR Tolkien, a famous Birmingham resident.
“We operate in the perfect environment here in the UK,” said Al Rayan’s treasurer Amir Firdaus. “The government has allowed sharia banking to flourish.”
Mr Firdaus added that the bank has written about £660m worth of home purchase plans to UK residents, with a further £250m worth on UK properties bought by Gulf buyers, and has seen zero losses on the loans. Al Rayan is ultimately owned by Qatari bank Masraf Al Rayan and the country’s sovereign wealth fund.
Raising debt secured on mortgages provides the bank with a cheaper alternative to deposit funding. While other UK challenger banks have had access to the Bank of England’s term-funding scheme — which provides cheap funding to banks and building societies — Al Rayan has not been able to tap this source of liquidity as it is not sharia compliant.
The availability of this cheap central bank funding has meant traditional high street lenders have had less reason to turn to the mortgage-backed bond market for funding. This has led to a recent dearth of “prime” residential mortgage-backed securities (RMBS), meaning that there was significant interest in Al Rayan’s deal from traditional UK securitisation investors.
“Although it has some relatively specific features around how the mortgages are structured, when you look at the loan quality it is very much a UK prime RMBS deal,” said Ben Hayward, a partner at TwentyFour Asset Management.
“If you can get comfortable with all that, then really it’s about establishing the premium you need to get paid to reflect the fact it won’t be as liquid as a typical prime deal from a UK lender.”
Al Rayan raised its triple A-rated sukuk at 0.8 per cent more than Libor, the floating rate lending benchmark. This offered investors a significant premium to traditional mortgage-bonds, with Nationwide raising a prime RMBS bond at 0.37 per cent above Libor on the same day.
While Al Rayan’s securitisation market debut saw strong demand, the bank’s treasurer said a recent legal wrangle between energy company Dana Gas and its sukuk bondholders had unnerved some investors.
The United Arab Emirates-based company has disputed the validity of a sukuk it raised from international investors such as BlackRock and Goldman Sachs, because it says the structure of the deal is no longer sharia-compliant. Dana Gas is yet to back down in its stand-off with its lenders, despite two rulings against it in the English high court.
“Dana Gas is the most spoken investment,” said Mr Firdaus. “For those that were not familiar with the sukuk market, it does spook them.”
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