Pakistan flushed with success of PIS bonds

Islamic Republic scores new capital markets success with debut Sukuk issue.

The Islamic Republic of Pakistan priced an increased Sukuk bond issue yesterday (January 18) raising $600 million from a five-year FRN issued in the name of Pakistan International Sukuk Company Ltd (PIS).

Under the lead management of Citigroup and HSBC, the B+/B2 rated sovereign priced a Reg S deal at par on a spread of 220bp over six-month Libor. Fees were 19bp and there were five co-managers comprising ABC Islamic Bank, Arab Bank, Dubai Islamic Bank, Habib Bank and National Bank of Pakistan.

The deal was fully complaint with Shariah law and came at the tight end of revised indicative pricing. A $500 million deal was initially marketed at a spread of 220bp to 235bp over Libor, before being honed down to 220bp to 225bp over.

The sovereign attracted a large order book of $1.2 billion and participation from 82 accounts. Specialists describe the order book as one of the most diversified they have ever seen.

By geography, about 47% of the deal was placed with accounts in the Middle East, with 31% going to Europe and 22% to Asia. By investor type, Islamic banks took 20%, government agencies 25%, asset managers 23%, private banks 11%, banks 18% and insurance/corporates 3%.

Investors are likely to have been encouraged by the secondary market performance of Pakistan's outstanding 2009 eurobond and continuing momentum in the sovereign's credit profile. In February last year, Pakistan raised $500 million from a five-year deal that represented the sovereign's first international benchmark since 1997.

This deal was priced on a coupon of 6.75% to yield 370bp over Treasuries, or 335bp over Libor. By the end of the third quarter - when Standard & Poor's raised the sovereign rating by two notches from B- to B+ - the deal had tightened nearly 100bp to the 240bp area.

Bankers say it has recently been range trading in a 102% to 103% band and was bid around 215bp to 219bp over Libor when the new deal priced. Given that the additional year in maturity is worth about 10bp on the curve, the new bond has come about 5bp to 9bp through the existing one on a like-for-like basis.

Relative to the Republic of the Philippines, pricing is also tight. Pakistan priced about 65bp through the Ba2/BB- rated Philippines on a like-for-like basis.

When it came to market in February 2004, the differential between the two was a slimmer 43bp. However, the Philippines underperformed throughout 2004 and was downgraded one notch by Standard & Poor's this week to BB-.

Pakistan's achievement is all the more impressive in the context of other Sukuk deals, which tend to price flat to their theoretical sovereign curves. This is where the Federation of Malaysia fixed its pricing in the summer of 2002, for example, when it completed the world's first global Sukuk issue.

One of the reasons why Pakistan has been able to clear a deal at tight levels is because its paper is likely to stay locked away by the buy and hold investor base. However, investors clearly believe there is potential for further rating upgrades, particularly from Moody's, which lags Standard & Poor's by one notch.

Dr Ashfaque Khan, Director General of the debt office in the Ministry of Finance agrees. "Over the course of the roadshow, investors kept saying they believe our economic fundamentals are much better than our ratings would suggest," he says." Moody's has not visited our country for a long time and we would invite the agency to come and see how much progress we've made.

"The success of this deal is a huge vote of confidence in Pakistan and the reform programme we've undertaken," he adds. "We're delighted with the response."

He also outlines how successful the country has been at improving its financial metrics over the past five years. At the height of the country's balance of payments crisis in 1999/2000, Pakistan was only able to manage GDP growth of 2.6%. By 2004, that figure had leapt to 6.4% and the government is targeting 6.6% in 2005 - one of the five highest growth rates in the world.

Likewise the government has been able to give itself more leeway to spend money on much needed educational, housing and infrastructure projects by bring down its overall debt burden and annual debt servicing costs.

During the 1980's and 1990's Pakistan averaged a budget deficit of 7.2%. In 2004, the deficit was down to 2.4%.

In 2005, Dr Khan says the figure may rise to about 3% because of oil costs, but he adds that public sector debt to GDP continues to decrease.

"In 1998/9, public sector debt stood at over 100% of GDP," he comments. "In 2004, the figure was 68.8% and in 2005 we're projecting it will fall further to 52%. By 2008/9 we want to get the figure down to 46%."

As a result of this, debt servicing costs are now 25% of annual revenue, down from 52% just over five years ago. Analysts say Pakistan has been successful at retiring expensive debt in favour of cheaper multilateral loans and Dr Khan adds that the government has made big strides improving tax collection. This has doubled to Rp600 billion over the past few years - 10% of GDP.

He concludes that the government wants to open a regular dialogue with investors, but says it has not yet decided whether it will return to the international bond markets again in 2005.

The PIS bonds were structured to be compliant with shariah law, which forbids the receipt or payment of interest. PIS purchased Highway Land from the government-owned National Highway Authority and leased the land to Pakistan for a period concurrent to the bond issue (trust). The assets themselves are held in a trust on behalf of the holders of the trust certificates. In lieu of paying interest on a bond, the government makes a series of lease payments to PIS, which match the distribution payments (coupons payments) on the trust certificates.

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