There was this tweet today
I clicked on the Bloomberg piece but there weren’t many details about the Sukuk beyond that it’s an Rs.2 billion Sukuk.
Pakistan’s financial platform Abhi has raised the first-ever Sukuk bond for a fintech firm in the region, opening a new funding line for startups that have seen a slowdown in venture capital.
The Karachi-based startup raised 2 billion rupees ($6.8 million), an industry first for the Middle East, Africa and Pakistan region, said Omair Ansari, chief executive officer and co-founder. Demand exceeded expectations with subscriptions reaching twice the anticipated amount, he said in an interview.
I reached out to a couple of people in the NBFC space and they provided me the requisite information.
The first one was Kaiser Souze (pseudonym) who referred me to PACRA rating of the Sukuk. Below is an extract from the rating report.
Profit rate: 6M KIBOR + 250-300 bps
Tenor: 6 months
Credit Enhancement:
The security structure of the Sukuk would be secured by way of i) charge/lien of collection account: The Company's customers deposit their repayments into the Faysal Bank Account. The Company shall issue irrevocable instructions to Faysal Bank to transfer funds equivalent to 1/6th of the Sukuk repayment amount from the Faysal Bank account, on a monthly basis to the Sukuk Payment Account (SPA) maintained with the Faysal Bank ii) lien marked on and a right of set-off, on SPA iii) registered lien in favor of the trustee, over short-term liquid investments amounting to PKR 1bln (in NBP Islamic Income Fund and at Habib Metropolitan Bank amounting PKR 500each), these funds would be earmarked in favor of Debt Service Repayment Accounts maintained with the Habib Metro Bank and NBP Islamic Income Fund, until maturity for the benefit of the investors iv) hypothecation over the present and future receivables of Abhi (Pvt) Limited would be created in favor of the trustee and iv) Fifty percent (50%) of the issue size shall be available for deployment from the day of the issue, while remaining 50% shall be placed in a Bank(s) or money market fund(s) rated AAA or AA+. The remaining 50% would be gradually available for deployment, in proportion to the retention of funds in the DPA. Proportionate to the amount held in DPA, an equivalent amount from the cash fund can be utilized for deployment in business
To summarize:
The Sukuk amount of Rs.2 billion is 50% secured by lien over Rs.1 billion liquid investments i.e., Rs.500 million NBP Islamic Income Fund units and Rs.500 million term deposit receipt maintained with Habib Metropolitan Bank.
The company is only allowed to borrow Rs. 1 billion initially with the remaining 50% placed in a bank or money market fund.
Thus, the company is borrowing Rs.1 billion against a lien on cash-like instruments of Rs.1 billion. As far as Sukuk investors are concerned, 50% of the investment i.e. Rs.1 billion lent through Sukuk is credit-risk free.
For the balance of Rs.1 billion, the following mechanism is in place. The company has set up a Sukuk Payment Account (SPA) on which a lien is placed. The company collects Rs. 2 billion every month from customers. 1/6th of this amount will be placed in SPA every month. The company can now additionally borrow from the money that was initially placed in the bank/money market fund equivalent to the amount routed to SPA.
While in the case of the first Rs.1 billion of Sukuk proceeds, the company is borrowing against assets that it cannot access (let’s assume that there is a heavy penalty for breaking the Habib Metro Bank TDR and the company wants to avoid it), the second Rs.1 billion borrowings are completely unnecessary: the company is receiving cash on one hand which it is depositing in SPA and using it as a security, getting access to the equivalent amount of Sukuk proceeds.
Hence, while the perception may be that the investors have trust in the business of ABHI and that is why they have lent it Rs.2 billion, the reality is, the loan is 100% secured by liquid investments of the company that are held by third-party banks/FIs under a lien and a right of set-off:
Rs.1 billion is lent against Rs. 500 million in NBP Islamic Income Fund and Rs. 500 in Habib Metro Bank Term Deposit Account
Rs. 1 billion against the equivalent amount of cash held in SPA with Faysal Bank.
Thus, for the investors it doesn’t matter whether the company is profitable or if its business model makes sense. They are lending money against a lien on very liquid credit-risk-free cash-like assets.
Who are the Sukuk investors and what do they get out of it?
They get to earn around 25% (6M KIBOR at 22% + 300bps spread) on a 100% cash-secured risk-free loan. What is not to like? That is why Saudi Pak has placed almost half a billion rupees. The next one is Faysal Asset Management with Rs. 300 million under their various funds followed by U Microfinance Bank with Rs. 200 million.
Saudi Pak also gets to brag about it on LinkedIn
What does ABHI get out of it?
With the equity markets dead, ABHI gets to show its investors or prospective investors that it can access debt capital markets even when frozen out of equity markets. I tried to calculate how much ABHI makes from this deal.
It turns out that assuming an interest rate of 2.5% on their invoice factoring business, the net income from the business is just enough to pay the interest expense. We are being aggressive on the interest income side by assuming that ABHI will be able to lend 100% of the amount on the day it is allowed to lend it.
In addition, we can also consider the return earn by the company on the 50% of the funds initially placed in the Money Market Fund (MMF). The NBP Islamic Income Fund had a return of 14% p.a. for Feb 2023. I have assumed a 20% return rate for the funds placed in MMF.
Thus, the best-case outcome of the entire exercise is a net return of Rs.66.7 million received from placing the funds in MMF.
We have ignored the upfront arrangement and the banking fee which can be around 4-5% of the issue size. If we add that to the cost of funds, the net return from this strategy would be zero or negative for Abhi.
If you think about it, the company earns 20% on the Rs.500 million placed in NBP Islamic Income Fund. Using it as a security, the company is borrowing Rs.500 million through the Sukuk at 25%. That’s a loss of 5%. Wouldn’t it be better to encash the Rs.500 million MMF and use that to lend? Why did the company do this?
In certain loan covenants, there is a requirement for the borrowers to maintain a minimum amount of liquidity. However, there is no such requirement for Abhi as it has no borrowings at the moment.
The most likely reason the company issued a Sukuk is to show growth in the balance sheet.
Below is a simplistic example of various scenarios.
So while it may look naive to us that the company is having a negative carry i.e., earning 20% on MMF while paying 25% on Sukuk, the company is showing growth in the balance sheet. In the above illustrative example, a company doubled the size of its balance sheet by borrowing through a Sukuk. If the company had encashed the units to lend money, the balance sheet size would have remained the same.
Alternatively, their hope is to get it refinanced when it matures and over time, as people get comfortable with the credit, to try and remove the cash collateral requirements.
I want to say something about PACRA and their rating methodology but let’s keep it for another post.