Global volatility may stall new Gulf bond issuance
Dubai, June 6, 2013
Volatility in US Treasury yields and a dip in investor appetite for emerging market credits could put a brake on new issuance from the Gulf Arab region in the near term, as both sides of the market wait for prices to stabilise.
Borrowers from the Gulf have been tapping bond markets actively in the last several weeks amid historically low interest rates and strong global demand, which have allowed issuers to price deals very aggressively.
But regional bonds have not been immune to the sell-off across emerging market credits, and this could cause pricing in the Gulf to become more closely aligned with risk.
Earlier this week, Dubai shopping mall developer Majid Al Futtaim (MAF) Holding said it was delaying plans to raise at least $500 million from a hybrid bond sale - potentially the first such deal by a non-bank private company from the region - citing weak market conditions.
Global credit markets took a battering last week from robust U.S. economic data which fanned speculation that the Federal Reserve might soon begin reining in its bond-buying programme.
A surge in U.S. Treasury yields, off which many regional dollar-denominated bonds are priced, is pushing the cost of borrowing for Gulf issuers higher. The 10-year U.S. Treasury yield rose 40 basis points in May, and was at 2.12 percent bid on Wednesday.
"The pipeline of new issues from the Gulf will remain fairly intact, but the tap may be turned off for a while until conditions settle and issuers feel more comfortable about investor sentiment and appetite," said Chavan Bhogaita, head of markets strategy at National Bank of Abu Dhabi.
At the end of May, emerging bond funds suffering their first weekly outflow in a year, according to data from EPFR Global. Many market analysts believe the emerging markets sell-off could continue through June and into July.
In the Gulf, longer-dated bonds have been worst hit, including high-grade paper such as Qatar sovereign bonds. Yields on Qatar's $2.5 billion, 5.25 percent bond maturing in 2020 rose about 40 bps between May 17 and May 30, according to Thomson Reuters data.
The most recent issues, which were already struggling in secondary market trade because of aggressive pricing, also came under pressure. Emirates NBD, which printed a $1 billion Tier 1 capital-boosting bond in late May, saw the paper fall nearly 2 price points as soon as it became free to trade; it traded 5 points lower at one stage last week.
Initial pricing guidance for the bond before issue was in the low 6 percent area, and that was cut to 5.75 percent in the space of a few hours. Major tightenings shortly before final pricing have been a feature of Gulf bond issues over the past year; the experience of the past two weeks may change that to some extent.
"This was another case of tight pricing and the huge issuance size also contributed to poor performance," Abu Dhabi-based asset manager Invest AD said in a note this week.
"It is becoming increasingly clear that investors need to be very careful when deal terms are changed at the last minute, a practice that in developed markets would affect the long-term credibility of the issuer."
Bond issuers and arrangers may have to reassess the balance between ensuring demand for their paper is strong and issuing as cheaply as possible, some market participants believe.
SECONDARY MARKET SUPPORT
Another potential consequence of the recent volatility may be that bond holders can no longer count on local investors to provide solid support for secondary market prices near current levels.
After an initial back-up in U.S. Treasury yields in January and February, such support faded briefly and then quickly returned. This time, yields have risen significantly above their February peaks - by about 10 bps, in the case of the Qatar sovereign - so the same degree of support may not return.
"What we see now is pockets of buying by regional accounts on selective names, as a few names have reached the approved yield levels for them," said one regional fixed income trader, declining to be identified.
"Even so, we are not seeing all-out buying as regional accounts also think they can get the paper cheaper. hence they have been averaging their buy-down."
NBAD's Bhogaita said regional investors would probably be the first to see value in Gulf paper if pricing dropped excessively amid the uncertainty, but he cautioned:
"Despite seeing the value or indeed opportunities on paper, regional investors are likely to be cognisant of how global investor nervousness can affect the pricing in the secondary market."
A longer-term result of the bond market volatility, if it continues for at least a few months, may be that regional issuers increasingly turn to local currency debt markets.
Liquidity among Gulf banks, the region's major investors, remains high, and local asset managers are becoming increasingly active in fixed income investments.
An expansion of local currency issuance seems most likely in Saudi Arabia and possibly Qatar, where a local currency yield curve is already well-established or the government is keen to develop one.
"As global investors are not looking to add any risk here, we are left with only regional investors who have excess liquidity to deploy," the fixed income trader said.
"I think if the global risk-off mode continues to deteriorate, maybe we could see issuers start issuing in local currency as the major orders have always been from local investors.” – Reuters