Wealthy Islamic banks explore partnerships in the West
A noted Muslim law scholar, Yusuf DeLorenzo, recently pored through the books of Continental Rail, a business that runs freight trains up and down the East Coast.
Along with examining the company's financial health, Mr. DeLorenzo sought to make sure that the rail cars didn't transport pork, tobacco or alcohol. He was brought in by American investment bankers who want to take rail cars bought by Continental Rail and package their leases into a security. The investment is being built for banks that are run according to Islamic law, which, among other things, prohibits investments in those three commodities. If the cars are acceptable, or halal, the deal will be one of the first in the United States to be completed in compliance with Islamic law.
"It's a new territory for all of us," said John H. Marino Jr., chief executive of Continental Rail.
The deal is a sign of how banks that comply with Islamic law are making inroads into the global banking scene and how Western businesses are working to meet the expectations of those banks. The banks can't find enough acceptable places to park their money, many industry insiders say, so investment bankers are scurrying to assemble deals.
(Read more: Islamic bond issuance set for long-term growth)
Over the last 30 years, the Islamic financial sector has grown from virtually nothing to over $1.6 trillion in assets, according to data from the Global Islamic Financial Review, an industry publication. The financial crisis has only encouraged the growth. Industry assets grew 19 percent in 2011 and 20 percent in 2012, in contrast to the less than 10 percent growth at non-Islamic banks in most of the world.
Until recently, Islamic banks have largely put their money to work in the Middle East — or, if they invested in other parts of the world, in real estate. Real estate is among the most popular investments under Islamic law, also known as Shariah, because a deal can be structured that does not require interest payments, which are prohibited by Shariah. But as the banks grow larger they are looking for new, more diverse places to put their money.
The deal with Continental Rail is attractive because the rail cars will spin off lease payments, rather than interest, and can be bought in bulk. The cars are also in the United States, which will help bring geographic diversity to the bank portfolios. The deal was brokered by a newly created team at Taylor-DeJongh, a Washington investment bank, looking to bring money from Islamic banks to the United States.
There are similar pushes around the world. A few non-Muslim African countries, including South Africa, have recently been talking about raising money using the Islamic financial instruments known as sukuk, which function much like bonds. Prime Minister David Cameron of Britain announced in late October that England planned to become the first European country to issue sukuk. The global bank Société Générale is preparing to raise money from Islamic banks in the coming months.
"There is a gap between all the money coming in to Islamic banks and the deployment of that money into real economic assets," said Sayd Farook, the global head of Islamic finance at Thomson Reuters. "A crazy amount of money has gone into their coffers and they need somewhere to invest it."
The first modern Islamic banks were founded in the 1970s, motivated by the Quran's ban on riba, which has been interpreted as any fixed payment charged for money lending. Islamic banks have focused instead on putting their money into real assets and property, and sharing any resulting profits from the performance of an asset. Muslim mortgages, for instance, are structured so that the bank buys the house and then sells it to the occupant slowly over time. Stocks are generally considered acceptable as long as the companies issuing the stock adhere to Islamic law; casinos, banks and weapons companies are forbidden.
Islamic banks have religious scholars, like Mr. DeLorenzo, review their operations on a regular basis. Yet some Islamic scholars have criticized the banks for straying too far from the spirit of the Quran into the speculative realms of Wall Street. Sometimes it is hard to tell the difference between a Western investment and a Shariah one. For instance, an Islamic bank's fixed-deposit account ties up a customer's money for a set period of time, like a certificate of deposit. Instead of offering interest, the account offers a share of the profit from its investments. The "profit rate" of a one-year deposit currently is 1.9 percent at one major Middle Eastern bank.
There is a debate among Islamic scholars about what qualifies as halal. "The industry is going through soul-searching," said Ayman A. Khaleq, a lawyer specializing in Islamic finance at the Morgan Lewis law firm in Dubai. "It's far from settled."
But these problems have not stopped the flood of deposits into banks like the Sharjah Islamic Bank, which is named for the city in the United Arab Emirates where it is based. The bank has 24 branches, some of which offer separate spaces for female and male customers. From 2006 to 2012, deposits there almost tripled to about $3 billion.
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Muhammed Ishaq, the head of the treasury division at Sharjah, said that the bank's problem was not attracting money, it was figuring out what to do with it. "It's not very easy when any financing needs to be backed by some kind of asset," Mr. Ishaq said.
Real estate has been a very popular investment in the Islamic world, but when real estate was hit hard during the 2008 financial crisis, many investors were reminded of the need for more diverse portfolios. For many banks the answer is sukuk. Like bonds, sukuk make regular payments to investors. But unlike a bond, which is a money loan, sukuk are structured as investments in hard assets that generate payments.
The amount of sukuk sold each year has grown sixfold from 2006 to 2012, to some $133 billion, according to Thomson Reuters's Islamic financial data service, Zawya. A joint venture between Dow Chemical and Saudi Arabia's national oil company sold a $2 billion sukuk this year to raise money for an oil complex. But this is falling far short of the demand from banks. "There are serious supply-side bottlenecks," said Ashar Nazim, head of Ernst & Young's Global Islamic Banking Center.
Now there are several efforts to create more supply. The Bank of London and the Middle East was founded in London with Kuwaiti money to find these new investment opportunities. "They wanted a wider range of Islamic assets that could be originated away from the Middle East," said Nigel Denison, the bank's treasurer.
Yavar Moini, the former head of Islamic banking at Morgan Stanley, said he was establishing an operation in Dubai that would gather assets from around the world that can be packaged into sukuk, like Fannie Mae and Freddie Mac do in the United States with mortgages. Mr. Moini said that "it's the absence of sufficient product or opportunities for Islamic investors that drives them into the conventional arena."
In the United States there have been a few attempts at sukuk. In 2006, a Texas oil company sold a $166 million sukuk to finance oil exploration, but the company went bankrupt during the financial crisis. Then in 2009, General Electric issued a $500 million sukuk tied to aircraft leases.
Taylor-DeJongh, the 30-year old, energy-focused investment bank, is hoping to take advantage of the shortage. Ibrahim Mardam-Bey, who worked on the 2006 Texas sukuk, joined Taylor-DeJongh at the end of 2012 and has built a team of five bankers working on Islamic finance.
One deal would provide financing for private toll bridges. The other, which is further along, will bundle the rail cars managed by Continental Rail. The team has already signed a deal to buy 1,000 rail cars in Pennsylvania, and is looking to acquire 5,000 more.
Mr. Mardam-Bey said that some American businesses were hesitant to take money from Islamic banks, perhaps a byproduct of negative associations with Shariah since the Sept. 11 attacks. But in the Texas deal, and in many others, that tends to fade as the financial possibilities become clear.
"The borrower was a Texan wildcatter who couldn't spell 'sukuk,' " Mr. Mardam-Bey said. "But at the end of the day when I brought the check he didn't care if I prayed to Allah. He just wanted the money."