GCC bond market to bounce back in 2011

Bond and sukuk issuance in Gulf oil producers are expected to gain momentum in 2011 due fiscal consolidation, reforms in some countries and heavy investment requirements for infrastructure, a major Saudi bank has said.

The recovery in 2011 will follow a sharp decline in such issuances in the six-nation Gulf Cooperation Council (GCC) by around 28.8 per cent from a record $61.5bn in 2009 to nearly $43.8bn, National Commercial Bank (NCB) said in a study sent to 'Emirates 24/7'.

“Nonetheless, a clear positive momentum began to develop in the second half of the year, although the keenly awaited turnaround proved highly uneven. It continued to be held back by local debt restructuring concerns and the persistent uncertainty caused by the global economic crisis, most notably the recurrent sovereign debt woes in the Euro-zone,” it said.

Its figures showed more than two-thirds of the new GCC issuance took place in the second half of the year, particularly in October- November.

But the report noted that issuers once again largely retreated when the Irish debt woes heightened market anxiety in December.

Although the foundation for a proper regional bond and sukuk market now appears to be in place, questions still persist as to the sustainability of some of the positive trends we have seen, the report said.

The figures showed total GCC bond and sukuk issuance during Q4 reached $19.7bn.

The vast majority of this was corporate issuance with sovereigns only making up$3.8bn in conventional issuance and 174.9mn in short-term Government of Bahrain and Central Bank of Bahrain sukuk.

Also the share of sukuk remained modest, in spite of a pronounced rebound, with total issuance of $2.3bn during the quarter.

US dollar-denominated conventional bonds were by far the most dynamic component of the debt market turnaround in the closing months of the year. The report showed their aggregate value reached $13.7bn, some 78.8 per cent of total conventional issuance during the quarter.

In the UAE, total issuance reached $8.32bn and the most important events were the closure of a $1.25bn dual-tranche issue by the Government of Dubai, a $2.5bn issue by the International Petroleum Investment Company (Ipic) in five- and ten-year notes in November, and a $two bn sale with similar tenors by the Dubai Water and Electricity Authority DEWA in October.

Emaar Properties in December settled a $500mn convertible five-year note issue. Several leading UAE banks tapped the market with total issuance of $970.8mn in the conventional and $1.25bn in the Shariah-compliant space.

“In spite of the uneven recovery in 2010, as well as the persistence of major risks, the ongoing bond and sukuk market recovery appears to be gaining confidence and is underpinned by a number of important structural drivers,” NCB said. It listed the following reasons for the recovery.

Restructuring: The global financial crisis has left a legacy of substantial corporate restructuring needs in the region. Sukuk and bonds have a potentially important role to play in enabling key sectors such as financial services and construction/real estate to position themselves for the ongoing recovery. For instance the Dubai-based developer Nakheel is planning to issue sukuk as part of its efforts to settle with its trade creditors. Similarly, Aldar’s restructuring serves as a reminder of the persistent stress points in the market. The developer is estimated to require some Dh10bn of new funds this year in order to be able to continue its operations. The economic rebound is also paving the way for an
increase in mergers and acquisitions. In a landmark deal, etisalat is expected to seek bond financing for its bid for a 46% stake in Zain.

Government issuance: Fiscal consolidation has emerged as a theme also in the GCC with especially Dubai expected to cut spending this year in order to contain its deficit. However, even the more indebted governments, as reflected by Ras Al Khaimah’s actions, can use bond and sukuk markets to restructure their debt on more favorable terms. Dubai alone (including government-controlled corporates) faces debt repayments of $30bn over the coming two years. The publicly disclosed debt of Dubai government-controlled entities totals $111.1bn.

In an important structural development for the regional debt capital markets, the federal government of the UAE is currently refining its plans to tap the debt capital markets. A federal bond is now seen as a possibility before the end of the year. This follows the adoption of a new public debt law by the Federal National Council last year. The new law caps federal debt at 25 per cent of GDP or Dh200bn, whichever is smaller. The law further provides for an organized secondary market in national bonds at one of the stock exchanges.

Infrastructure: The regional infrastructure pipeline, estimated at as much as $2trn, remains exceptional by international standards and offers attractive opportunities for long-term fund-raising through bonds and sukuk. The new Saudi Development Plan foresees government spending of $386bn over the next five years. GCC petrochemicals producers are expected to invest $50bn by 2015 in order to boost output by 46% to 154mn tn annually. In spite of the potential, however, progress to date has proven slow because of the lack of longterm structures, a particular concern in the sukuk space.

Low yields: The GCC bond and sukuk markets may very well be experiencing something of a sweet spot with historically low yields. This has been particularly pronounced in the sukuk space with average yields on the HSBC/Nasdaq Dubai US Dollar Sukuk Index declining by 252 basis points to 4.74 per cent as of 31 December. However, yields have begun to edge up again, suggesting that the
window of the most favorable issuance conditions may soon close. Moreover,  with the total refinancing needs of GCC bond and sukuk issuers estimated at some $70bn this year, there is concern of risk premiums and, hence, capital raising costs rising in the course of the year. This may encourage companies to bring forward their issuances.

Quantitative easing: The unconventional monetary policy pursued by a number of Western central banks should ensure extremely loose monetary conditions in the near term. Under these circumstances, investors are likely to continue to channel a substantial proportion of this liquidity to emerging market securities, a trend that quality issuers in the GCC should be well positioned to capitalise on.
According to the HSBC/Nasdaq Dubai US Dollar Sukuk Index, sukuk returned 12.8 per cent last year as compared to 12.2 per cent for emerging market debt, as measuredby the JP Morgan EMBI Global Diversified Index.

Regulatory reform: A number of governments, including Lebanon, Australia, and Afghanistan, are reviewing their treatment of Islamic finance in order to encourage issuance. This in turn should boost market confidence and liquidity, even if progress has proven somewhat uneven. The South Korean National Assembly in December rejected proposals to review the treatment of Shariah-compliant finance and the UK this month announced that it had no near-term plans for a sovereign sukuk.

Product development: One possible avenue for development are longer-tenor notes which would enable greater Shariah-compliant funding for projects, for instance. The current array of instruments typically does not offer funding beyond 10 years. Longer tenors would also attract Islamic institutional investors, such as takaful companies to the market. Efforts are also underway to address some of the fault lines revealed by the crisis. The International Islamic Financial Market is seeking to develop a new master agreement for asset-backed sukuk. Such structures currently offer investors no recourse in the event of a default-type situation. It was recently estimated that as little as 4% of the USD32bn worth of sukuk rated by Moody’s in 2009 ensure such rights. Moreover, such structures tend to be quite complex and the infrastructure to evaluate and monitor the assets in question is still typically underdeveloped. Transferring the title of the underlying assets poses costs and legal challenges in parts of the region.

Improving market infrastructure: Qatar Exchange is expected to launch a secondary market for bonds and sukuk this year. The Bahrain Financial
Exchange intends to set up a ‘Bait al Bursa’ for Shariah-compliant products. Similarly, Malaysia is planning to allow sukuk sales to retail investors on an organised secondary market. In order to overcome some of the limitations of Shariah-compliant finance, a new International Islamic Liquidity Management Corporation is being set up in Kuala Lumpur by 11 central banks. The company is establishing a $250mn Islamic cash fund.

Growing demand: Sukuk and bond investments in the region are very low by international standards, yet the number of institutional investors – including most notably insurance companies and mutual fund managers – is growing. Their longterm liabilities in many cases make bonds and sukuk an attractive and prudent option. In their relative absence, for instance UAE insurance companies last year had almost Dh17bn invested in property, shares and fixed deposits. Shares made up 37 per cent of the total while the share of land and buildings was 26.1 per cent. Also bond funds are increasing in number with NBAD the latest one to announce plans for a Dh200m fund.

The regional bond and sukuk pipeline includes a number of important issues. First Gulf Bank of Abu Dhabi is understood to be planning a CHF200mn five-year bond, having delayed a $500m issue in November. Emirates NBD is expected to continue issuing under a pre-existing $7.5bn programme. The Gulf General Investment Company has already conducted a road show of its planned
issue. In Bahrain, United Gulf Bank has announced plans for a bond issue, while Al Baraka is expected to raise as much as $500mn. Qatar’s Doha Bank has announced a $500mn issue expected in 1Q11. Kuwait’s Gulf Investment Corporation is planning a MYR3.5bn ($1.1bn) sukuk program and also Kipco has announced issuance plans.

Nakheel is expected to place up to $3.2bn in sukuk as part of its restructuring efforts. Both Aldar Properties and Arabtec Holding have this year announced convertible bond issues. Arabtech Holding is planning to call for an extraordinary general assembly to place a $150mn five-year convertible bond issue. Also, a number of industrial companies are planning to turn to the debt capital markets.

The Saudi petrochemical company Sipchem is planning a $400mn sukuk. Aramco and Total are understood to be planning a sukuk issue worth some $1bn to raise the funding for a Jubail oil refinery. The petrochemicals and steel producer Industries Qatar is seeking a credit rating. The Jebel Ali Free Zone has a Dh7.5bn sukuk due in 2012 and may well go to the market this year. GE Capital

is planning a follow-on to its benchmark $500mn issue. Etisalat has set up a $7bn medium-term note programme and a $1bn sukuk programme. The Government of Dubai is understood to be interested in raising up to $1.5bn through a multi-currency sukuk issued in Malaysia. This would be the first Malaysian sukuk issue by a foreign sovereign but may necessitate Dubai acquiring a rating. Yemen is thought to be considering a $500mn sukuk issue.

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