Credit conditions will put sukuk issuance into reverse, says S&P

Islamic finance

S&P Global Ratings expects global sukuk issuance volumes to plummet in 2020 due to the effect of Covid-19 on core Islamic finance markets, low oil prices, and waning investor appetite.

"Complexity of issuance will likely make sukuk a secondary funding option for certain governments, and we expect most will instead tap the conventional bond market," says S&P Global Ratings head of Islamic finance Mohamed Damak. "The current environment will probably also result in a spike in default rates, especially for issuers with weak creditworthiness, which would test the robustness of sukuk legal documents."

The company believes the sukuk market will see a significant reduction in issuance volumes in 2020. The drop in oil prices and restrictions related to the COVID-19 pandemic will take a toll on important sectors in core Islamic finance countries, including real estate, hospitality, and consumer-related businesses. What's more, government measures will result in lower issuance from both corporate entities and central banks. In addition, we believe most government issuers may turn to conventional bond markets rather than issue sukuk as they grapple with the impact of weaker economic environment on their budgets. Sukuk issuance is still more complex than for conventional bonds. Added to this is investors' increasing risk aversion in the uncertain environment and widening spreads, which imply that financing conditions will be extremely tight for issuers with weak credit quality.

"A market recovery is likely from the third quarter, but we don't think issuance in the rest of 2020 will be sufficient to compensate for the first-half decline," adds Damak. "Sukuk issuance volumes fell 32 per cent in the first quarter of this year and we expect the decrease to be even steeper in the second quarter, since most core Islamic finance countries started implementing measures related to COVID-19 in March. Overall, we forecast around USD100 billion of sukuk issuance this year, about 40 per cent lower than in 2019. In the current environment, the number of defaults among sukuk issuers with low credit quality will likely increase."

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. The company believes the measures adopted to contain COVID-19 have pushed the global economy into recession. As the situation evolves, we will update our assumptions and estimates accordingly.