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ANALYSIS

High bond yields push Gulf borrowers towards alternatives

Dubai, August 8, 2013

By Rachna Uppal

Two Gulf Arab borrowers have attracted heavy investor demand for international bond sales in the past two weeks, but higher yield premiums are prompting many other potential issuers in the region to seek alternative funding sources.

U.S. dollar bond issuance in the Gulf, conventional and sukuk, stands at about $17.3 billion year-to-date, up from $11.4 billion in the same period a year ago, according to data from Zawya, a Thomson Reuters company.

But the vast majority of this year's total was issued before late May, when U.S. Treasury yields began rising sharply on expectations that the U.S. Federal Reserve would start cutting back its monetary stimulus this year.

Since late May, new international bond issuance has been modest, and most borrowers who have come to market appeared to have special reasons for wanting to raise funds quickly.

Borrowers who need money less urgently have held off on issuing - and since general yield levels are still much higher than they were in May, borrowers are exploring options such as bank loans and tapping their own cash flows, which are healthy because of strong economic growth in the Gulf.

"With U.S. yields still higher by 100 basis points from the May levels, immediate recovery to issued levels looks tough," Biswajit Dasgupta, head of treasury and trading at Abu Dhabi asset manager Invest AD, said of the recent rise in Gulf yields.

DEMAND

Bahrain issued a $1.5 billion bond late last month which generated order books of nearly $8 billion. The bond has performed well since issue; it was yielding 6.15 percent in the secondary market on Tuesday, down from 6.20 percent at issue.

Similarly, an $825 million project bond issued by Abu Dhabi's Shuweihat 2 (S2) power and water plant, issued at 6.0 percent, was yielding 5.78 percent on Tuesday.

But these performances should not be taken as a sign of the general mood in the market. Both bonds are performing well because of scarcity value - little other debt has been issued in recent weeks - and because the issuers were willing to pay high premiums: in Bahrain's case, a coupon of over 6.0 percent for a BBB-rated sovereign issue.

Bahrain appeared to need the cash fairly quickly to cover its rising budget deficit; Shuweihat was a project bond, and the project behind it was subject to deadlines.

"Both issues were priced to leave some money on the table for investors, which in my view was smart given the market conditions, at a time when the interest rate view had softened after a fairly brutal sell-off. So some people were looking to get back in," Dasgupta said.

Other potential Gulf bond issuers, which just three months ago might have tapped the market opportunistically to raise cheap funds, are now reconsidering their strategies.

During past episodes of volatility in the market for conventional bonds, sukuk have been an attractive option for issuers, because global supply of sukuk has not kept pace with demand from cash-rich pools of Islamic funds. The imbalance has allowed sukuk to be issued more cheaply than conventional debt.

This year, however, sukuk have not been spared the impact of rising U.S. yields. Spreads on Gulf Cooperation Council conventional bonds widened an average of 57.8 bps between May 22 and June 26, the period of most volatility, while spreads on Gulf sukuk widened 45 bps - not much of an outperformance. The absolute difference in spreads between conventional bonds and sukuk at the start of this month was just 13 bps.

Sukuk sales in the Gulf total just under $15 billion year-to-date, down from $19.8 billion a year earlier, according to Zawya. The figures include local currency sukuk sales.

BANK FINANCING

So bank financing is re-emerging as a more accessible and cost-efficient alternative to debt capital markets in the Gulf - at least for now.

"Companies in the region are already exploring other options, especially in the bank market, thus taking advantage of their own improved credit metrics as well as the fact that many banks in the region are very liquid and need to grow their loan books," said Chavan Bhogaita, head of markets strategy at National Bank of Abu Dhabi.

In the United Arab Emirates, for example, bank deposits were up 6.7 percent year-to-date in May while total bank lending was up only 2.9 percent. As recently as the end of 2011, outstanding loans exceeded deposits; now deposits exceed loans by 10 percent, according to central bank data.

The increase in excess deposits is continuing to push down banks' funding costs - the one-year Emirates interbank offered rate is at a multi-year low of 1.27 percent, down from 1.37 percent in mid-May - and raising pressure on the banks to extend corporate loans at lower rates.

The borrower-friendly conditions in the loan market can be seen in a spate of renegotiations of loan deals by Dubai entities over the last several months.

Last month, Dubai Duty repriced a $1.75 billion, six-year loan facility from 325 bps over the London interbank offered rate to 225 bps over on a dirham-denominated tranche and 250 bps over on a U.S. dollar tranche.

In June luxury hotel chain Jumeirah Group, part of the Dubai Holding conglomerate which has seen some of its units restructure debt, secured a six-year, $1.4 billion loan at an aggressive margin of only 275 bps over the London interbank offered rate. Jumeirah had been seen by the market as a candidate for a bond issue.

A Dubai-based syndicated loan banker at a European bank said the pricing on the Jumeirah deal was "too tight" for his bank to participate - but cash-flush UAE banks were keen to participate.

Some borrowers, such as Dubai mall developer Majid Al Futtaim Holding, have had enough cash on their balance sheets to hold off on issuing bonds.

Earlier this year, MAF announced it would issue a hybrid bond to help finance its buyout of Carrefour's stake in a joint venture; it said it already had enough liquidity on hand for the deal, but wanted to issue a bond to ensure no risk to its credit rating. MAF subsequently said it was delaying the issue because of market conditions.

In the case of Saudi Arabia, companies that might have issued bonds in the international market may now choose to issue in the country's liquid riyal-denominated bond market.

In May a senior executive at Saudi dairy firm Almarai hinted at a preference for an international bond issue, but last month the company appointed banks to structure a hybrid bond which, sources familiar with the situation said, is likely to be riyal-denominated.

Because of ample market liquidity, riyal bonds have been outperforming dollar debt. The yield on Saudi Electricity Co's riyal bond maturing in 2029 has tightened 1 bp since June 18 to 1.47 percent, while the yield on its dollar bond maturing in 2023 has widened 35 bps to 3.97 percent.

"Some prospective borrowers, especially in Saudi, who may have been considering diversifying into dollar funding may prefer to use the local currency market if the difference in borrowing costs between the two is too big," said Bhogaita.

"Local currency-denominated issuance is an alternative to international bond sales as issuers scrutinise cost of funding more closely." – Reuters




Tags: Currency | bond | Financing | money | US Dollar | borrowers |

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