Why Investors May Prefer Sukuk Over Conventional Interest Bonds – Expert
TAJ Bank Limited recently launched a capital of 100 billion naira Mudarabah Sukuk bond (in series), starting with N10 billion. The offer, opened on September 20, 2022, is expected to close on October 28, 2022.
To help our audience better understand Sukuk Bonds As an investment option, Nairametrics decided to use TAJ Bank’s Sukuk Bond offering as an example. For this, we spoke to Kenneth Ero of Greenwich Merchant Bank Limitedthe main issuer of the offer.
Before we get to what he has to say, note that TAJ Bank Limited is a licensed national interest-free bank. It started its activities on December 2, 2019, initially as a regional bank before transforming into a national bank.
Nairametrics: what is Sukuk for an investor?
Kenneth Ero: Sukuk is an investment certificate that represents the ownership of the holder of an asset or a pool of assets and/or a Project/Company entity. The certificate holder has the right to receive a return/benefit.
Nairametrics: How would you rate it against FG Sukuk and conventional corporate bonds such as MTNN Bond?
Kenneth Ero: The issuance program of Taj Sukuk SPV Plc, sponsored by TAJBank, is different from the typical Ijarah type Sukuk that the market is familiar with. It is hybrid and has elements of debt and equity. The TAJBank Sukuk is based on the principles of Mudarabah, and it is the first of its kind in Nigeria. FGN Sukuk is based on Ijarah principles and is quite different from TAJBank Sukuk which is based on Mudarabah contracts.
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Nairametrics: How would you rate the TAJBank Sukuk against other assets such as equities in terms of the proposed return in the face of a rising inflation rate, currently at 20.95%?
Kenneth Ero: The Profit Equalization Reserve (PER) account in which a percentage of excess profits will be kept as a reserve for the payment of profits during periods of deficit tends to smooth the return profile of the Sukuk and reduces the volatility of returns on the investment horizon versus stocks that do not have this feature built into them.
Nairametrics: Conventional bond yields are significantly affected by monetary policy, especially interest rates. What would be the impact of interest rates on the TAJ Bank Sukuk bond and being a perpetual bond redeemable after 5 years, how would investors be protected against the reinvestment risk that would arise from this purchase feature?
Kenneth Ero: The movement of interest rates, as with any other bank, will affect TAJBank’s business. Rates on interest-free bank financing activities are fixed in nature as they are not allowed to revalue the price during the life of a transaction. In addition, investors generally price instruments, including Sukuk, off market benchmark interest rates, so decisions made by investors in the Taj Sukuk would have been informed.
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On the call date, the Mudarabah assets will be redeemed at the fair market value of the assets, so investors can benefit from the upside potential of the Sukuk asset which will offset any reinvestment risk that may arise from the option to redeem. purchase if the issuer decides to exercise this option when it expires.
Nairametrics: We understand that, unlike conventional interest-bearing bonds, Sukuk are backed or based on well-defined underlying assets and projects of commercial value, would they then have this inverse relationship between price and yield, just like contractual obligations?
Kenneth Ero: Mudarabah Sukuk is not a requirement and the pricing mechanism is different. But, just like conventional bonds, Sukuks can also be priced based on yield to maturity (YTM). However, the TAJBank Sukuk is perpetual with a call date of 5 years. It can either be based on the 5 year redemption date or left open.
Nairametrics: Conventional bonds are fixed income investments; how would you describe TAJ Bank Sukuk distinctively?
Kenneth Ero: The issuance program of Taj Sukuk SPV Plc, sponsored by TAJBank, is different from the typical Ijarah type Sukuk that the market is familiar with. It is hybrid and has elements of debt and equity as mentioned earlier. The TAJBank Sukuk is based on the principles of Mudarabah in which the investors (Rab-al-maal) inject capital and the manager (Mudarib) only manages the business which must be Shariah compliant. The proceeds will be mixed with the bank’s assets and used in the bank’s regular activities to earn a targeted amount of profit that is achievable. A profit sharing ratio has been agreed between the Mudarib and the Rab-al-maal and the share going to Sukuk holders is projected at 15%.
Nairametrics: Why should an investor prefer it over the conventional interest bond, with reference to the Taj Bank Sukuk features that are currently being issued?
Kenneth Ero: Unlike conventional bonds, Sukuk holders are the owners of the Sukuk assets (Mudarabah Assets) managed by the Bank. Their profit comes directly from the profit generated by Sukuk assets compared to conventional bonds which are generally cash flow based.
Further, the sales of the investor’s unit in Sukuk are the sales of its ownership in the Sukuk Assets, whereas, in conventional bonds, investors sell the discounted cash flows of the bonds.
Investors in Sukuk are entitled to an appreciation/value of Sukuk assets on maturity or redemption date.
Nairametrics: Based on the split formula (75%:25%) of the projected 15%, what is the likely risk-reward variability?
Kenneth Ero: This means that the minimum expected profit for Sukuk holders is 15%. The bank will establish a Profit Equalization Reserve (PER) account where a percentage of excess profits will be kept as a reserve for the payment of profits during periods of deficit.
When the projected profit is less than the actual profit earned in a given year, the bank uses the profit equalization reserve to make payments to sukuk holders to cover the shortfall. This mechanism tends to smooth the Sukuk return profile over the investment horizon.
Nairametrics: With the embedded call option one would have expected a higher projected earnings yield, how did you arrive at this projected yield of 15% being the first privately issued Sukuk?
Kenneth Ero: The projected profit is based on the expected return of the assets where the Sukuk proceeds will be deployed. In other words, the return is based on the projected profit to be generated from the Mudarabah asset (Sukuk assets).
Nairametrics: We understand the proceeds would be used to support the Bank’s Tier-1 capital adequacy as well as general business operations. Does this mean that the bank’s capital adequacy ratio does not meet the required standards, what about?
Kenneth Ero: Proceeds from the Sukuk will constitute additional Tier 1 capital of the bank and will be used in the general business activity of the bank. The bank is well capitalized and currently has a CAR of 18%, which is well above the regulatory minimum of 10% for interest-free domestic banks.
Nairametrics: How is Taj Bank financially?
Kenneth Ero: The PBT as of September 30 was N4.0 billion. Total assets as of September 30 are N161 billion. The shareholders’ fund is N17 billion.
Nairametrics: What is the capital structure and risk (beta) of TAJ Bank currently?
Kenneth Ero: TAJBank currently has no debt and is fully 100% equity funded.
Nairametrics: How do you rate the Sukuk bond market?
Kenneth Ero: The sukuk market in Nigeria is a growing market, due to the number of issuances year on year. The market has seen significant growth in sub-sovereign and corporate issuances over the years. However, there is still room for growth in the issuance of other types of Sukuk (green Sukuk) and the tradability of Sukuk in the secondary market. Currently, Sovereign, Sub-Sovereign and Corporate Sukuk have been issued in the Nigerian market.