* Falling oil price may widen this year's budget gap
* Civil unrest also an issue for investors
* But overall debt level still very low
* GCC expected to support Bahrain as needed
* Yield curve attractive versus other BBB credits
By Mala Pancholia and Rachna Uppal
DUBAI, June 21 Running a state budget deficit
and facing a prolonged period of civil unrest, Bahrain is not in
the same league for investors as the Gulf's wealthier oil
exporters. But good timing and strong demand for regional assets
in general mean a planned bond issue by the tiny kingdom is
likely to go well.
Bahrain is sounding out investor appetite at roadshows this
week for a possible issue of an international, conventional
bond. Bankers said Bahrain's first conventional debt offering
since 2010 would be open to qualified investors in the United
States and elsewhere, and might be as large as $1.25 billion.
Bahrain last tapped the international market in November
with a $750 million, seven-year sukuk (Islamic bond), which was
largely sold to investors in the Middle East. The upcoming issue
will not be able to count on interest from a deep pool of
Islamic investment money in the Gulf, so it will be a tougher
test of market confidence in Bahrain.
Bankers said Bahrain was eyeing a seven- or 10-year issue,
which should appeal to institutional investors in the West, who
have been showing interest in Gulf debt as a safe haven while
the financial crisis has hurt other markets around the world.
"The timing is very good for Bahrain; this issue has been
rumoured for a long time now and we are seeing GCC (Gulf
Cooperation Council) credit markets trading at some of the
tightest yields for years," said Thomas Christie, sales trader
at Rasmala Investment Bank in Dubai.
"Combined with the fact that the market is very liquid
currently and searching for yield, we should see any Bahrain
issue do well."
With oil prices sliding, Bahrain's state finances may come
under pressure. Brent crude oil fell to an 18-month low
of $91 a barrel on Thursday, from above $120 early this year;
the oil price which Bahrain needs to balance its budget jumped
to $114 in 2011, the highest level in the Gulf, from just $80 in
2008, the International Monetary Fund said in April.
The government's budget deficit shrank to $83 million in
2011, the lowest shortfall in three years and well below a
projected gap of $3.3 billion, because oil prices were higher
than expected. But with oil now sliding, this year's deficit may
be larger than last year's.
Another issue for investors is protests by Shi'ite majority
Muslims against the Sunni-dominated government, which have
continued for over a year. They have not prevented the economy
from resuming growth after a brief contraction early last year,
but it is not clear how the political problem may be resolved in
the long term.
For now, however, the signs are that investors will happily
accept these risks. One positive is that the country's absolute
level of external debt is still very low, at 14 percent of gross
domestic product, according to Bahrain's bond prospectus.
Perceptions that Saudi Arabia's Sunni rulers will do what is
necessary to support Bahrain's government, fuelled by a Saudi
proposal in recent months for a closer union of Gulf states, are
The bond prospectus said that although a $20 billion fund
planned by wealthy Gulf Arab states last year to aid Bahrain and
Oman had not yet been capitalised, Bahrain expected to receive
an allocation soon, which would come in addition to money
already earmarked in its budget for priority projects.
Bahrain already relies on output from Saudi Arabia's Abu
Safa oil field for some 70 percent of its budget revenue.
Analysts have said Riyadh might give Manama more oil from the
field if its budget runs into trouble.
These factors, along with a general tightening of Gulf bond
spreads, have helped to cause an impressive drop in the cost of
insuring Bahrain's debt against default over the last several
months. Its seven-year credit default swaps were
at 353 basis points on Thursday, compared to 394 bps at the end
of last year.
Analysts said the need to attract conventional investors
with the new bond, rather than Islamic investors facing a very
limited supply of sukuk, meant Bahrain would have to be fairly
generous in pricing the debt.
"They will have to price more competitively, given it's a
conventional; a sukuk would probably be cheaper," said Raza
Agha, senior economist for the Middle East at RBS in London.
The Bahraini sukuk issued last year was
yielding 4.94 percent on Thursday, off a low of 4.78 percent hit
on May 1, Thomson Reuters data shows.
Bahrain's 10-year, $1.25 billion conventional bond issued in
2010 was bid at 5.64 percent on Thursday;
yields have compressed about 27 bps in the last two weeks.
The new issue will need to offer a spread in the low 400 bps
area over midswaps for it to interest investors, Christie said.
Currently, 10-year midswaps are around 1.75 percent, he added,
so this would equate to a yield of at least 5.75 percent.
Christie said he hoped the new conventional bond would
create a more liquid benchmark for the sovereign, since the
recent Bahraini sukuk was majority-held by local Bahraini
Dubai's CDS trade at a similar level to Bahrain's, so the
performance of Dubai's $650 million, 10-year sukuk
since its issue in May is encouraging. The sukuk
was bid at 5.74 percent on Thursday, having tightened more than
Bahrain is rated BBB by Standard & Poor's. It is unlikely to
achieve a yield as low as most sovereigns with the same rating,
because international investors demand a regional premium from
the Gulf. But the comparisons still look positive for Bahrain;
Russia, also rated BBB, issued a $2 billion, 10-year bond
in April which was yielding 4.00 percent on
Lithuania, rated BBB, issued a $2 billion, 10-year bond
just weeks before Bahrain's last conventional
issue in 2010. The Lithuanian bond, priced at 7.375 percent at
the time, was yielding just over 4.50 percent on Thursday,
according to Thomson Reuters data.
Bahrain's "current curve is attractive at current levels
compared to other credits rated BBB," RBS's Agha said. "There is
no question of any sovereign repayment difficulties given the
close ties Bahrain enjoys with other GCC countries, particularly
JP Morgan Chase, Citigroup Inc, Standard
Chartered and Gulf International Bank are
mandated to arrange the investor meetings, which will run until