Islamic bonds issued by financial services companies in the Persian Gulf are heading for their best year on record on prospects of debt restructuring and demand for higher-yielding assets in emerging markets.

Shariah-compliant debt from financial institutions in the six-nation Gulf Cooperation Council returned 15.7 percent so far in 2010, HSBC/NASDAQ Dubai GCC Financial Services US Dollar Sukuk Index shows, the most since HSBC started tracking their performance in July 2005. DIFC Investments LLC’s floating-rate note maturing in June 2012 gained 29 percent in price terms to 82.8 cents on the dollar, according to Bloomberg data. The 3.172 percent sukuk due September 2014 sold by Islamic Development Bank, a Jeddah-based multilateral lender, returned 9.9 percent, prices provided by Royal Bank of Scotland Group Plc show.

State-owned Dubai World reached an agreement with creditors in September to alter terms on $24.9 billion of borrowings, reducing the risk the state-owned company will default and bolstering investor appetite for debt from the region. Economic growth in the GCC will accelerate to 4.5 percent this year and 5.9 percent in 2011, from 0.4 percent last year, theInternational Monetary Fund said in its October Regional Economic Outlook report.

“Financials are among those names which have benefited from Dubai’s debt resolution and a greater risk appetite for regional bonds,” said Ahmed Talhaoui, the Abu Dhabi-based head of investment at Royal Capital PJSC, which is 44 percent-owned by United Gulf Bank BSC, an investment bank in Bahrain, said in an interview yesterday.

Banks Recovering

Funds focused on developing nations’ debt attracted $51.8 billion this year as of Nov. 17, exceeding annual tallies in EPFR Global data going back to 1995. Investors took money from emerging-market bond funds in the week ended Dec. 8, the Cambridge, Massachusetts-based research firm said in a Dec. 10 report.

Global sukuk returned 11.9 percent this year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. Bonds in developing markets gained 13.1 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows. Islamic bonds in the GCC returned 12.5 percent, theHSBC/NASDAQ Dubai GCC US Dollar Sukuk Index shows.

Gulf banks are showing signs of recovery after spending more than $20 billion on loan loss provisions and investment impairments since 2008, Standard & Poor’s said in a report Sept. 1. Lenders in the United Arab Emirates are “cleaning up, internally,” by streamlining policies, loans and provisions, Abu Dhabi Commercial Bank PJSC’s Chief Executive Officer Ala’a Eraiqat said Oct. 20 at a conference in London.

Sound Footing

Dubai may sell stakes in some companies to the public to reduce debt as the Persian Gulf emirate alters loan terms and restructures two of its main investment groups, Dubai World and Dubai Holding LLC, Sheikh Ahmed bin Saeed Al Maktoum, chairman of the Dubai Supreme Fiscal Committee, told a conference in the emirate Nov. 28. Dubai is on sound financial footing, he said.

Dubai Islamic Bank PJSC’s floating-rate note maturing in March 2012 gained 6.9 percent this year to 92.13 cents on the dollar Dec. 10, Bloomberg prices show. The U.A.E.’s biggest bank that complies with Muslim banking rules raised its stake in mortgage lender Tamweel PJSC to 57.3 percent from 21 percent in September to help boost lending.

Dubai’s Islamic bonds led a rebound in Persian Gulf sukuk last week, ending the worst stretch of losses in 10 months. Average yields on Shariah-compliant bonds from the Gulf Cooperation Council fell 13 basis points, or 0.13 percentage point, to 5.71 percent on Dec. 10, according to theHSBC/NASDAQ Dubai GCC Dollar Sukuk Index.

Preferring Sovereigns

Sovereign sukuk from the Gulf will be favored over Islamic bonds offered by financial companies, according to NCB Capital in Riyadh.

“Much of the bounce-back is over and now it’s going to be more measured growth in returns when compared to this year,” Jarmo Kotilaine, chief economist at NCB Capital, said in a phone interview yesterday. “Investors are more likely to look for opportunities in the regional utilities and solid sovereign credits rather than a story” tied to restructuring, he said.

Sales of Shariah-compliant bonds, which pay returns based on assets to comply with Islam’s ban on interest, dropped this year as debt restructuring in the Middle East crimped demand. Global issuance fell 27 percent to $14.5 billion in 2010 from a year earlier and a record $31 billion sold in 2007, according to data compiled by Bloomberg. Offerings from the six-nation GCC dropped 34 percent to $4.4 billion.

Cheaper Financing

The difference between the average yield for sukuk and the London interbank offered rate narrowed 32 basis points last week to 315, according to the HSBC/NASDAQ Sukuk Index. In the GCC, which includes Qatar, the United Arab Emirates and Kuwait, the gap shrank 32 basis points to 389.

The yield on Malaysia’s 3.928 percent Islamic note due June 2015 rose 22 basis points last week to 3.14 percent, according to prices provided by Royal Bank of Scotland Group Plc. The rate on Indonesia’s 8.8 percent bond maturing April 2014 climbed 18 basis points to 3 percent.

The extra yield investors demand to hold Dubai’s government sukuk rather than Malaysia’s narrowed 36 basis points to 345 last week, the least in two months, data compiled by Bloomberg show.

Islamic banks linked to governments led the sale of Islamic bonds from the Gulf this year. Abu Dhabi Islamic Bank PJSC, the U.A.E.’s second-biggest Shariah-compliant lender, sold $750 million of sukuk in October and Qatar Islamic Bank SAQ, the nation’s biggest Islamic bank, raised $750 million in September. Islamic Development Bank sold $500 million of sukuk in October.

“These banks have been able to raise much cheaper financing through the bond market,” Usman Ahmed, a senior fund manager at Emirates NBD Asset Management, which oversees $300 million of bonds at the unit of the U.A.E’s biggest lender, said in an interview yesterday. “These deals have been attractive to the foreign investors who are looking to avoid direct real- estate exposure and seeking safer investments.”

To contact the reporters on this story: Haris Anwar in Dubai on Hanwar2@bloomberg.net;