Friday, 14 December 2018

Fill the gap

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Middle Eastern sovereigns have hit the bond market in size this year to fund budget deficits and supply shows no sign of drying up.

The bond issue of Saudi Arabia last year is the symbolic moment when it all started. Not only was the US$17.5bn offering from the Middle Eastern kingdom the largest transaction by any emerging markets issuer to hit the markets, it was also the largest publicly syndicated sovereign bond deal ever when it appeared to the sound of trumpets in October last year.

By any measure the deal was success. It was priced to sell, with the US$6.5bn 30-year tranche grabbing most of the headlines. But the biggest effect that it had was psychological. It proved there was both a market and a demand for Middle Eastern debt. It was just what was needed for a region that had been kicked hard by the collapse of the price of oil and had seen its budgets deficits flare up.

In the slipstream of Saudi Arabia, the sentiment towards Middle Eastern debt has been welcoming.

“Last year, we saw over US$60bn issuance from the region and the supply was very well received. The momentum is even stronger now,” said Salman Ansari, head capital markets, Africa & Middle East, Standard Chartered Bank.

Year-to-date, Middle Eastern names have raised around US$30bn and, say bankers, the easy bridge to US$40bn will come in H2. No one appears to have the slightest concerns about supply.

But it is worth remembering how (comparatively) recently the GCC debt capital markets have reopened.

“When the oil price dropped, all sovereigns turned to the loan market first. It is only since last year that they have been willing to come back to DCM,” said Cecile Camilli, head of CEEMEA DCM at Societe Generale Corporate & Investment Banking.

That is certainly also a reason why there are so many lead manager names on the ticket for sovereign issues (there were seven banks on Oman’s recent bond deal): payback for loans when international markets were not quite to welcoming.

Oiling the wheels

What has driven the issuance is eye-watering, double-digit budget deficits that have faced regional governments since the price of oil collapsed.

“There is no question that the main driving force for the rise in bond issuance is the sharp fall in oil revenues,” said Jan Friederich, head of Middle East and Africa sovereign ratings at Fitch.

The average budget deficit of GCC rated sovereigns is expected to narrow this year, but it is still going to remain hefty, at 5.2% of GDP, according to figures from Fitch. More to the point, there is considerable variance within the region. Bahrain’s fiscal deficit, for example, is likely to come in at around 12.3% of GDP, while Oman is battling a deficit that widened last year to US$13.5bn, or 22.6% of GDP.

And while deficits are improving, there is no knight in shining armour coming to help the oil producers any time soon. The price of oil is going to remain depressed for the foreseeable future.

“The emergence of the US shale oil sector is a structural shift because shale oil production capacity can be expanded relatively quickly, and for short time periods,” explained Fitch’s Friederich. “As a result, prolonged periods of oil prices above US$100 now seem unlikely. Our assumption is that Brent will average US$65 [per barrel] in the long term.” he added.

The first name to hit the market this year was a distinctly drive-by US$600m tap of its 2028s from Bahrain at the end of February. The deal, which took the bond’s size up to US$1.6bn, was swiftly executed by Bank ABC, BNP Paribas, Credit Suisse, JP Morgan and Standard Chartered. “There was lots of demand and reverse enquiry,” said one banker on the deal. “It was an easily covered execution with no need for a roadshow.” 

Although the deal was a success by any metric and almost three times covered, it was merely an amuse bouche of what was to come next.

The Oman deal showed that appetite was there in droves. When it hit the market with a US$5bn three-trancher at the start of March, the appetite was significant. “It was overwhelmed by the time it landed on New York desks,” said one banker on the deal.

In the end, Oman saw US$16.7bn demand, with the five-year, 10-year and 30-year pieces all oversubscribed. The US$1bn 3.875% March 2022s priced at 99.488 to yield 3.989%, the US$2bn 5.375% March 2027s at 99.618 to yield 5.425%, and the US$2bn 6.50% March 2047s at 99.36 to yield 6.549%. More to the point, the bonds all behaved in a textbook manner in the secondary market, gaining 100bp or so in price terms after the break.

A significant dynamic seen in both 30-year regional bonds that have been sold is the appetite from Asia. While sovereign paper has gone to the familiar accounts and continued to make inroads into US funds and real money accounts, the longer dated paper has been able to tap pent-up liquidity from Asian life insurance companies. These are truly global bonds.

As with Saudi Arabia, there is no doubt that Oman’s deal was priced to sell. There is some debate about how much was left on the table, but by most reckonings it was around 15bp across the curve on all three tranches. But despite the premium, in one fell swoop, Oman raised the vast majority of its external funding needs for this year.

And next on the list in mid-March was Kuwait, with a US$8bn two-tranche transaction. The US$3.5bn five-year bond priced at Treasuries plus 75bp and the US$4.5bn 10-year tranche came at plus 100bp, with an order book that hit US$29bn. If pricing was tighter than its regional colleagues, that was a reflection of having a stronger balance sheet than many of its peers.

All in the timing

A significance about all these deals is the timing. Of course, the primary objective was make sure that the sovereign could make a size that would cover the majority of the budget deficit, but the clock was ticking.

By early March, it was apparent that the US Federal Reserve intended to hike interest rates and that would push up borrowing costs. With robust nonfarm payroll figures on March 10, “a rate hike …  remains a formality after this stronger-than-expected print”, said David Lamb, head of dealing at FEXCO corporate payments. The rate rise was duly announced on March 15.

Another consideration has been ratings, especially in the case of Oman, which has had a downgrade sword of Damocles hanging over its head. Oman’s S&P investment-grade BBB– rating is under threat and was given a negative outlook in November last year.

“The outlook revision reflects that Oman’s fiscal consolidation could take longer than we expect,” the agency said, adding that it expects the country’s fiscal deficit to widen “significantly” in 2016, up from earlier estimates of 13% of GDP. But on the roadshow, this did not play as heavily as might have been expected.

It is also noticeable that the investor approach to Middle Eastern names has changed. No longer are these credits a novelty or a pure yield play, they are intrinsically interesting in and of themselves. This is apparent on roadshows.

“Investors have done their homework; they are not asking generic questions. They are very well informed and questions are credit specific,” explained Standard Chartered’s Salman.

Of course, investors did ask about what had changed in the opinions of the ratings agencies but, said one banker, “it is not a sticking point”.

Beyond politics

It is a similar story with politics. Geopolitics does not really come into the mix, and bankers laugh when asked about whether there has been any noticeable effect from the presidential change in the US.

“The policy of the new Trump administration on the Arab issuers has not been clarified sufficiently to have a noticeable impact,” said Fitch’s Friederich.

The one genuine effect from politics in fact supports further issuance.

“Social issues, including the Arab Spring, are a core reason why fiscal policies have been so generous and why most governments have been very cautious in scaling back expensive social policies,” says one analyst. All of that needs funding.

The pipeline remains full. With Saudi Arabia planning a US dollar sukuk transaction and Qatar and Dubai also potentially issuing this year, a natural question is whether investor interest will hold up to support further regional sovereign supply later on in the year.

“The liquidity is certainly there, domestically and internationally,” said Aymeric Arnaud, director, DCM origination, Middle East, Turkey & Africa, at Societe Generale CIB. “And bear in mind redemptions too. There is roughly US$26bn falling due in the Middle East this year.”

So, if the deals come, there will be buyers. The hope now is that multi-tranche sovereign issues have provided enough of a curve for regional financial institutions and corporates to find the liquidity that they need. The stage has certainly been set.

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