Outlook for bonds – and Bobabs

Let us talk about bonds, and about Bobabs. I’m sure we all know what bonds are – tradeable fixed interest securities issued to raise money for companies, governments or institutions. They are huge business – more than $900 billion are traded every day on the world’s markets, most of that in the USA, of course.

Bobab? That is the acronym for a phenomenon we are just starting to become familiar with – it stands for “big old broke American bank” – and it seems certain we will hear much more of them in future, as undercapitalized and overstretched US financial institutions come begging for funds round the rest of the world.

The bond market, like the rest of the financial world, suffered for the second half of last year, and the pain continues into 2008. The conditions of sub-prime crisis and credit crunch discouraged all potential borrowers from raising fresh money, and this was reflected in a dearth of new bond issues round the world.

And there was a vicious circularity to the process – without new bond issues, the financial institutions lost income and became even more undercapitalized. If you were a Bobab, it was a very worrying trend.

In the GCC area, things were not so bad. Because of high energy prices, huge capital reserves and a steady stream of infrastructure projects, there was both liquidity and demand for big-ticket funding facilities.

And there still is, according to the experts at HSBC’s Middle East HQ in Dubai. According to their figures, the total amount of debt issued in conventional and sukuk forms amounted to $46 billion in 2007 – nearly double 2006.

The sukuk factor is vital. More and more Middle East borrowers want to be shariah-compliant, so an increasing volume of business is being done in this form. Moreover, with north American and European financial institutions increasingly under pressure, the temptation to seek relief through Gulf-funded recapitalizations is overwhelming. Citigroup and Merrill Lynch are the latest, but surely not the last, to tap the Gulf markets for cash. If being shariah compliant makes a Bobab more acceptable to Gulf investors, the Bobab will overcome any previous objections it had to Islamic finance.

But Gulf sovereign wealth funds may not be so easy to convince this time round. Though there is, according to HSBC, a steady stream of inquiries from western corporates and financial institutions about tapping into the regional bond market, the issuers can afford to be much more discriminating than in the past.

They will not only prefer a sukuk issue, but they will also seek assurances that money raised in the sukuk will be ring-fenced from the rest of the borrower’s capital. They will only consider globally recognised corporations with interests in appropriate sectors – energy, real estate or construction, for example – and they will insist on doing their own risk analysis of the borrower.

On top of all that, they would also probably prefer if the bond was issued in local currency.

Matching all those criteria is a tall order for many western companies these days, and would certainly be a tough hurdle for any cash-desperate Bobab.

General levels of bond trading in the GCC will continue in much the same way this year, HSBC believes, with roughly similar levels of business going through, though more of it in sukuk shariah-complaint form. But borrowers – and especially Bobabs – will have to be increasingly nimble to get access.