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The UK's first Islamic bank sukuk issue

Al Rayan Bank securitised its home purchase plans for the same reason conventional banks issue mortgage backed securities — to free up regulatory capital.


Posted 30 April 2018

I was very pleased that this February saw the first sukuk issue by a UK based Islamic bank.

Accordingly, in my 4 April 2018 column in the magazine "Islamic Finance News" I explained some of the basic economics of the sukuk issue.

The issuing bank, Al Rayan Bank plc is the UK's largest retail Islamic bank, and was formerly called Islamic Bank of Britain plc. It issued the sukuk for the same economic reasons that conventional banks issue conventional mortgage backed securities.

The full 211-page prospectus is available from the website of the Central Bank of Ireland but is hard reading unless you are used to such documents.

My Islamic Finance News article is reproduced below.

Islamic and conventional securitisations have essentially the same economics

I was pleased that in February the UK’s largest retail Islamic bank, Al Rayan Bank, issued a sukuk which is the first from any UK Islamic bank.

The prospectus issued by Tolkien Funding Sukuk No.1 Plc, (the sukuk issuing special purpose vehicle) is freely available on the internet. It makes interesting reading, at least if you are used to such turgid documents!

The 211 pages reinforce something I have said previously. Islamic banking is banking, and the business models of Islamic banks are essentially the same as those of conventional banks. The only difference is that Islamic banks conduct their business in accordance with guidelines set by Shariah scholars. In the case of this sukuk, my point is demonstrated by asking two questions:

  1. How does Al Rayan Bank benefit from issuing the sukuk?
  2. What do the investors get from buying the sukuk?

Al Rayan Bank used to be called Islamic Bank of Britain (IBB). As IBB, it made losses for many years because its capital base was relatively small, restricting its ability to provide finance to customers while the bank had significant operating costs and received large amounts of customer deposits that it could not usefully invest, instead having to lend them for low returns in the interbank market.

After IBB was taken over by the Qatari bank Masraf Al Rayan in 2014 and renamed, it received a big capital injection. This allowed it to provide commercial property finance, and residential finance in the form of home purchase plans, which are diminishing musharaka transactions. Since then, the bank has been profitable. The most recently published accounts, for the year ended 31 December 2016, show that during 2016 commercial and residential property financing combined increased from £726 million to £1,029 million.

Consequently, the bank’s Common Equity Tier 1 ratio fell from 23.2% to 17.1%. Assuming that customer financings continued to grow during 2017 (the accounts have not yet been published), the CET1 ratio will have fallen further, which is undesirable.

Banks sell assets to securitisation vehicles to remove them from the balance sheet, thereby improving their CET1 ratio. In this case, Al Rayan Bank sold home purchase plans on which customers owed £301 million to Tolkien for £245 million + a promise to pay the £56 million balance in the future. That removed £245 million of home purchase plan risk from Al Rayan’s balance sheet; the £56 million not paid reduces the riskiness of the sukuk for the investors, allowing the sukuk to receive a high credit rating.

What the investors receive from the sukuk will be income payments computed as 3-month Sterling LIBOR + 0.8%. This will be paid from the rental payments that Tolkien will receive from the householders under the home purchase plans. If there is an income shortfall, neither Tolkien nor Al Rayan Bank are liable, but this is very unlikely given the levels of rent payable by the householders and the £56 million deferred consideration.

After three years, the income payments will increase to 3-month Sterling LIBOR + 1.6%. Unless Al Rayan Bank is then in difficulties, it can be expected to exercise its contractual right to buy back all the home purchase plans for a price equal to the outstanding balance on the sukuk.

Effectively, the sukuk investors will receive what any securitisation investor receives, namely a return specified in advance (here LIBOR + 0.8%) provided that the underlying assets perform more or less in accordance with expectations. What they will not receive, nor expect, is any upside from the underlying assets.


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