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Bond price tumbles as investors fret archipelago nation will miss October payment

The Maldives will test the global market for Islamic finance in the coming weeks, as the debt-burdened archipelago nation hunts for a bailout that will prevent it becoming the first country to default on a key form of sharia-compliant debt.

The price of a $500mn bond-like sukuk issued by the government has collapsed to about 70 cents on the dollar over the past month ahead of a payment due in October, as its foreign reserves run low.

A default on the bond, which matures in 2026, would be the first by a sovereign for sukuk debt, of which about $860bn were in issue at the start of the year, according to Fitch Ratings.

“The questions everyone is asking: will the Maldives be the first [sovereign] sukuk to default,” said Joshua Loud, senior emerging markets portfolio manager at Danske Bank. “Given this has never happened, I don’t think the market fully understands the impact.”

The country has struggled to pay back its two main bilateral creditors, India and China, from which it borrowed heavily to finance growing budget deficits. Debt repayments now threaten to drain its reserves.

But the Maldives, known for both idyllic honeymoons and its exposure to rising sea levels, has been caught in the increasingly fraught competition for regional influence between its two huge Asian neighbours.

Global observers and investors worry that neither power will extend support to the Muslim-majority nation of half a million people, risking a complicated default and restructuring process.

Sukuk follow the Islamic principle of shunning traditional interest payments, instead offering creditors a share of profit from an underlying financial instrument.

The sharia-compliant bonds have been sold by governments around the world including the UK, Malaysia and Nigeria although they are usually associated with cash-flush Gulf governments and banks. S&P Global is forecasting up to $170bn in sukuk issuance this year, and Moody’s expects more than $200bn.

But the Maldives’ struggles threaten to upset the outlook. Tourism has bounced back after the pandemic, but the country depends heavily on imports, and global inflation and high spending on strategic infrastructure projects have caused its debt to balloon.

Mohamed Shafeeq, the Maldivian finance minister, said last week that the government could make the October payment of about $25mn. But net foreign exchange reserves fell below $50mn in July as the government also tried to hold the rufiyaa currency’s peg to the US dollar. Gross reserves dropped under $400mn, down from about $500mn in May.

“Reserves are down to a critically low level,” said George Xu, a director with Fitch Ratings in Hong Kong. “The risk of default seems more probable.” Fitch last month downgraded the country’s debt for the second time in two months, deepening global investor concern.

As well as global asset managers such as BlackRock and Franklin Templeton, Emirates NBD, a Dubai government-owned bank, owns a small slice of the Maldivian sukuk, according to ownership data.

A spokesperson for the Maldivian president’s office told the Financial Times that the country was working to increase its foreign currency reserves “including exploring green bonds and potential currency swap agreements”.

The government was “engaging with bilateral and multilateral partners to address both immediate and medium-term financing needs”.

But economists and restructuring specialists say a default will test legal boundaries. In theory, sovereign sukuk are based on assets which an issuer typically sells to a special-purpose vehicle and then leases back, with the lease being filtered to investors as payments.

The Maldivian sukuk uses a Cayman Islands-based vehicle, and the government has referred in the past to using the country’s largest hospital, which was built for $140mn, as an underlying asset.

In practice, investors cannot easily seize or sell these assets to collect payment in a default.

The sovereign advisory arm of Alvarez & Marsal, the consulting firm, said this year that although “the restructuring process for sovereign sukuk is an opaque and poorly understood area of law”, terms limiting access to assets mean it would probably work much like typical unsecured sovereign bonds.

Some analysts have wondered whether one of the country’s bilateral partners — India, China or the countries of the Gulf Cooperation Council — might step in to help it avert default.

“Because they have this track record of no sovereign defaults, a country like Egypt has been able to issue sukuk [at better rates]. No one wants to see that reputation hit,” said Loud of Danske Bank.

Gulf monarchies, themselves big issuers of sukuk, have in the past stepped in to keep the reputation of sukuk unblemished. In 2018 Bahrain was bailed out by its Gulf neighbours.

“Total external debt service will increase to $557mn in 2025 and exceed $1bn in 2026. The amount is huge for this economy, but the Maldives does have strategic partners, including India, China and the GCC,” Fitch’s Xu said. “For that reason, the government may still continue to be able to rely on external financing support from bilateral and multilateral creditors.”

The Maldives Monetary Authority, the central bank, said after Fitch’s downgrade in August that it was seeking a $400mn currency swap through a south Asian regional body, in effect a bailout from India.

But others are less certain the money will be forthcoming. Last year Mohamed Muizzu won the presidency on an “India out” programme and asked the country’s small military contingent to leave before the two sides patched up relations.

One emerging market investor, who asked not to be identified, said they had seen “no sign” of India or China stepping in to help, adding that the bonds still seemed expensive relative to the risk of default.

“The complexity of a default is exacerbated by it being a sukuk and uncertainty with how a sukuk restructuring will be handled and thus you could argue that bonds aren’t fully reflecting the default risk despite [the] precipitous drop.”

Italian lender’s move could signal start of long-awaited European banking consolidation

Commerzbank is open to talks about a potential tie-up with UniCredit, according to people familiar with the discussions, after the Italian bank built a 9 per cent stake in its German rival and announced it was taking regulatory steps to increase its stake further.

UniCredit forked out up to €1.4bn to become the second-largest Commerzbank shareholder after the German government, acquiring a 4.5 per cent stake from the Finance Agency on Tuesday night and a similar amount of shares on the open market.

The move by UniCredit’s chief executive Andrea Orcel, the highest profile dealmaker in European banking, could open the door to long-awaited banking consolidation on the continent.

Berlin last week said it was planning to sell down its 16.5 per cent stake in Commerzbank, which it has held since rescuing the lender during the financial crisis in 2009.

UniCredit said on Wednesday it would submit regulatory filings for authorisation to potentially increase its stake in Commerzbank to more than 9.9 per cent “if and when necessary”. The German government, whose stake has now fallen to 12 per cent, has committed to a lock-up period of 90 days before selling any more Commerzbank shares.

Future decisions would “depend on the investment meeting UniCredit’s strict financial parameters which have been clearly and consistently communicated to the market”, UniCredit said.

People familiar with Commerzbank’s internal discussions told the Financial Times that the German lender had not previously been contacted by UniCredit and learnt about the transaction on Wednesday morning via regulatory statements.

But the people added that Commerzbank would assess UniCredit’s plans with an open mind, pointing to the boards’ legal duty to act in the best interest of its shareholders. Commerzbank declined to comment.

UniCredit said on Wednesday morning that it would “engage with Commerzbank AG to explore value-creating opportunities for all stakeholders in both banks”.

Shares in the German lender shot up 16 per cent in early trading in Frankfurt on Wednesday, trading at the highest level since July with a market capitalisation of €17.3bn. UniCredit shares rose by as much as 1.95 per cent in Milan, giving it a market value of close to €60bn.

UniCredit’s move on Commerzbank underlines the growing appetite for consolidation in Europe, which has previously stalled in part because of political and regulatory hurdles.

Speaking to the Financial Times in May, Orcel said “most rumours” about the bank looking at potential targets were “true” as it was constantly looking for M&A opportunities. UniCredit has been one of the Eurozone’s strongest performers this year, rising 46 per cent in Milan.

The Italian bank already owns Munich-based lender HypoVereinsbank and has long been considered the frontrunner for an acquisition of Commerzbank, as a combination of both operations has the potential to generate a German finance powerhouse.

UniCredit struck a similar deal last year when it bought a 9 per cent stake in Alpha Bank from the Greek government. The purchase was seen by M&A advisers as a way for UniCredit to gain more information on the lender while it considered taking more control.

The finance ministry said the government had sold the 4.49 per cent stake in Commerzbank to UniCredit because its bid was “by far” the highest. “The government is bound by the principle of economic efficiency,” the German finance ministry said on Wednesday.

A merger of HypoVereinsbank and Commerzbank would create a German banking juggernaut able to challenge the country’s largest lender Deutsche Bank.

HypoVereinsbank for now has a regional focus on Bavaria in Germany’s south as well as the Hamburg area while Commerzbank has a footprint across the country, so the overlap of both lenders would be limited.

Deutsche walked away from merger talks with Commerzbank in 2019 because of an overlapping client base among German companies. However, insiders expected that Deutsche would likely reconsider a potential merger in case of a foreign bid for Commerzbank to avoid the creation of a bigger domestic rival.

Deutsche said it did not “comment on our competitors”, adding that it was “focused on its growth strategy and [its] return on tangible equity target of above 10 per cent for 2025”.

Asked about a potential takeover of Commerzbank by UniCredit last week, Deutsche’s chief executive Christian Sewing told Handelsblatt that the lender would not “see [such a transaction] critically per se”, adding that “competition is good for business”.

UniCredit’s stake purchase comes hours after Commerzbank said its chief executive Manfred Knof would not seek another term and depart by the end of next year. While Knof said he was willing to stay until December 2025 the bank said it would start the search for a successor “immediately”.