When the UK’s Al Rayan Bank needed funding to sustain expansion, it was bound by sharia rules on interest. Its innovative solution was a residential mortgage-backed securitisation, which successfully attracted a mixture of investors, as David Wigan reports.
Amir Firdaus
Al Rayan Bank was the first Islamic high street bank launched outside the Middle East. Starting operations in 2004 and growing a balance sheet in the vicinity of £2bn ($2.8bn) since then, it is part of the crop of UK challenger banks trying to muscle into a market dominated by a handful of global giants. However, when it comes to funding, the bank has been competing with one hand tied behind its back.
Al Rayan runs its business in compliance with sharia law, which means it cannot pay interest. This blocks access to liquidity sources such as the Bank of England’s term-funding scheme (which ended in February 2018), which has helped many challengers keep pace with larger rivals. To survive, it has had to think differently.
“As the UK’s first sharia-compliant retail bank, and because of our relatively small size, we have been required to take a considered approach to our funding strategy,” says treasurer Amir Firdaus. “Our main source of funding has been from the retail market in the form of deposits, and we have also had equity funding from our main shareholders.”
Keen interest
The bank received a cash injection in 2014 when it became a majority-owned subsidiary of Masraf Al Rayan, Qatar’s most profitable sharia-compliant bank, and in turn changed its name from Islamic Bank of Britain. Demand accelerated from the UK’s Muslim population of nearly 3 million, leading to 49% compound annual growth of the bank’s assets from 2013 to 2016. As its business expanded, the bank realised it needed a more sustainable source of funding, the obvious source being the capital markets.
“We got to a point where we were approaching the critical mass required to justify a capital market transaction,” says Mr Firdaus. “Also, last year when it was announced that the Bank of England’s term funding scheme was coming to an end, we realised that many challenger banks would be coming back to the retail market for funding, and competition would rise sharply, so from a timing perspective we felt that it was a good time to make our move.”
In November 2017, Moody’s awarded Al Rayan an Aa3 deposit rating, citing support from its parent. The rating came with a 'negative' outlook, which the agency said reflected the possible impact of Qatar’s ongoing dispute with neighbouring countries amid accusations of links with terrorism.
“Once our rating was in place we were in a position to move forward, and our plan was to secure the cheapest possible funding, so that we could be as competitive as possible,” says Mr Firdaus. “Sharia-compliant home finance tends to be more expensive [than conventional mortgages] anyway, so we wanted as much as possible to offset that disadvantage.”
Broader investor appeal
Given the bank’s mortgage-dominated balance sheet, it made sense to look at a securitisation. The bank wanted a structure that was amenable both to Islamic and conventional investors. The prohibition of interest means sharia-compliant mortgages differ from normal home loans; rather than lending on a property and taking a charge, it co-invests with the customer and shares in the profits.
The Birmingham-based bank bundled together nearly 1700 of these 'home purchase plans' and set up the Tolkien Funding Sukuk, a special purpose vehicle named after author JRR Tolkien (a former Birmingham resident). “We wanted to ensure that from the investors’ point of view it looked like a completely normal residential mortgage-backed securitisation [RMBS], despite the sharia properties,” says Mr Firdaus. “We spent a lot of time showing how it is a conventional UK-regulated product that is enforceable under UK law.”
Some investors were concerned in general about sukuk markets after United Arab Emirates-based energy company Dana Gas’s recent claim that an outstanding sukuk was no longer compliant with Islamic law, and therefore that it had no obligation to pay. “We had to reassure investors that there was no way the deal would not remain sharia-compliant, because compliance is built into the structure,” says Mr Firdaus. “So, for example, the trustee would not switch to an interest-bearing account.”
Due to its relatively small size, Al Rayan did most of the marketing itself, visiting conventional and sharia-complaint fund managers and pension funds in January and early February. It also instructed Standard Chartered to do some of the heavy lifting on documentation and on the issuance itself.
Getting it right
The deal was announced in mid-February and book building progressed over several days, based on a price indication of Libor plus 80 basis points (bps) for a £250m transaction. A conventional RMBS would be expected to price at about Libor plus 40bps. Ultimately, the book was 1.5 times oversubscribed, pricing in line with initial talk and at the advertised size.
“We were happy to pay 20bps more because it was a sukuk and another 20bps because we were a first-time issuer,” says Mr Firdaus, who thought Al Rayan would have to pay more. “We also made sure there was some allocation to dealers so that investors could be certain there would be liquidity if they wanted it,” he adds.
In the following month, the bond was trading about 70bps over Libor, which suggests Al Rayan got it about right, and promises a rosy future for the UK’s nascent market in sukuk RMBS.
