After two months of near-inactivity, the Gulf's primary bond market is open for business again with two issues in one week, but pricing levels suggest the market may for now remain prohibitively expensive for some issuers.

On Wednesday, Bahrain sold $1.5 billion in 10-year sovereign bonds at a yield of 6.20 percent. It conducted investor meetings last month but then held off issuing, waiting for some stability to return to global markets after a panic caused by the prospect of tighter U.S. monetary policy.

Its gamble paid off; yields have fallen back globally and by issuing this week, Bahrain gained a first-mover advantage, satisfying pent-up demand. During the market's two-month hiatus, a $630 million aircraft leasing deal from Emirates airline was the only major activity in the Gulf.

Order books for the Bahraini bond swelled to near $8 billion by the early afternoon in London on Wednesday.

But the fact that Bahrain provided very high initial yield guidance of 6.50 percent suggested it was not totally confident of demand. And Bahrain ultimately attached an attractive new-issue premium to the deal of between 20 and 35 basis points, depending on the method used to calculate it.

On Thursday, Abu Dhabi's Shuweihat 2 (S2) power and water plant is expected to price a project bond worth up to $825 million, after the deal was announced on Tuesday.

But initial price guidance was set at 6.25 percent on Tuesday before being tightened to 6.0-6.125 percent on Thursday afternoon, again suggesting issuers feel the need to offer attractive concessions.

"Issuers have to be nimble and take advantage of these windows of opportunity when they present themselves," said Chavan Bhogaita, head of markets strategy at National Bank of Abu Dhabi.

"These deals will be something of a litmus test to see whether investors are demanding a higher premium in the context of the ongoing uncertainty regarding the Fed's stance on QE and other macro issues."

PREMIUM

Earlier this year several Gulf issuers, including unrated Dubai, managed to price new issues inside their existing yield curves because buyers were so desperate to enhance their returns in a global low-yield environment.

Because of its fiscal and current account surpluses and its currency pegs to the U.S. dollar, the Gulf has outperformed most emerging markets over the past two months. But this week's issues indicate the days of near-zero or negative new-issue premiums are over.

Bahrain's new issue premium of 20-35 bps on its latest bond compares with 7.5-12.5 bps when it issued in July 2012 a $1.5 billion, 6.125 percent bond maturing in 2022.

The country's sovereign bonds have been among the worst-performing in the Gulf during the recent global volatility. The yield on the 2022 bond is up 172 basis points from May 22; spreads on Gulf Cooperation Council bonds widened about 60 bps on average in that period, according to the HSBC Nasdaq Dubai GCC conventional dollar bond index.

Behind Bahrain's underperformance are the fact that it is alone among GCC nations in running a sizeable budget deficit relative to its economy, and the unrest among its Shi'ite majority that shows no clear sign of ending after more than two years. These factors are sapping the tiny state's role as a business hub and financial centre.

But its weaknesses are to a large degree offset by diplomatic and economic support for Bahrain from Saudi Arabia, which has strong political reasons to keep Manama stable.

"In Bahrain, the economic outlook is weighed down by the politics," says Raza Agha, chief economist for the Middle East and North Africa at VTB Capital in London.

"That said, the positives include spread/yield pick-up over other BBB-rated credits in face of the fact that a sovereign event is unlikely, while support from wealthier GCC countries is expected to remain strong."

S2

S2, which is 54 percent owned by A3-rated Abu Dhabi National Energy Co (TAQA), has none of the weaknesses of Bahrain - but the guidance on its project bond also represents a generous premium to investors.

TAQA's $1.25 billion 2023 bond is the main point of reference. Differences in duration and structure mean calculating the new-issue premium involves guesswork, but the bond is trading at a Z-spread of about 179 bps, implying the premium for S2's issue will be at least 50 bps.

The weighted average life of S2's amortising bond is 21.1 years, with semi-annual repayments beginning from February 2032. The Z-spread is an expression of the TAQA bond's spread over the U.S. Treasury curve.

The S2 bond is due to price on Thursday during New York hours, indicating U.S. investors are the target for the bond.

"This pricing will be attractive for them, especially as high-yield bonds in the U.S. are trading around 6 percent on average. Of course, Shuweihat is not in their back yard, but it is investment grade and they know the TAQA name well," a lead banker said.

Although this week's two deals signal the Gulf market has reopened, issuers which rely more on demand from investors within the region, and which are less keen to raise cash quickly, may continue to hold off at least until after the end of the Ramadan fasting month in the second week of August.

One possible issuer is Dubai mall developer Majid Al Futtaim, which said on Thursday that it still planned to sell a hybrid bond that would partly fund its buyout of Carrefour's stake in a joint venture. MAF delayed plans to raise at least $500 million from the bond in June.

"The magnitude of the order books for the Bahrain deal can be interpreted as showing that investors are willing to put money to work again," NBAD's Bhogaita said.

"Lower-rated issuers may remain a little nervous of coming to the market until there is real evidence of the investor appetite having returned." – Reuters