* Offshore bond deals in Gulf to resume from September
* Some issuers keen to diversify beyond bank loans
* No significant outflows of foreign funds due to
* Arab Spring "stress-tested" the region
* Slight spread widening in recent weeks due to illiquidity
By Archana Narayanan
DUBAI, Aug 25 A revival of international bond
issues from the Gulf is set to draw heavy demand from local and
foreign investors, despite the latest geopolitical upheavals in
the Middle East and the approach of higher U.S. interest rates.
Gulf bond issuance has dried up since early July, because of
a traditional summer lull in local investor activity as well as
global market instability due to the crisis in Ukraine.
During that period, tensions in some parts of the Middle
East have worsened dramatically. In June, Islamic State
militants in Iraq stepped up a campaign that threatens to
dismember the country; fighting in Libya has intensified, and
Yemen's government has moved closer to collapse. Israel has
launched a war against Palestinian militants in Gaza.
On the face of it, that is a poor environment for a series
of Gulf bond issues which is expected to start next month, and
is likely to include a sovereign sukuk from the Emirate of
Sharjah as well as a sovereign U.S. dollar conventional bond
from the Kingdom of Bahrain.
But the vast majority of investors have decided that the
geopolitics do not come close to posing any existential threat
to the rich Gulf Cooperation Council economies.
That means next month's bond issuers will be able to demand
favourable terms as investors focus on the GCC's economic
strengths, including big current account and budget surpluses
that set it apart from many other emerging markets.
"While geopolitical fears are always on foreign investors'
minds, they are unlikely to temper any demand for solid credit
stories in the likes of Abu Dhabi, Dubai and Qatar for example,"
said Anthony Simond, a London-based emerging market debt analyst
at Aberdeen Asset Management.
Over the last few months, only a small amount of foreign
money has been withdrawn from Gulf bonds in response to
political events in the Middle East - and it has been easily
offset by fresh inflows of money from local funds, said Zafar
Nazim, credit analyst for the region at JPMorgan.
"Dedicated emerging market funds are staying put in the
region and consider the region a safe haven," he said, noting
that some GCC economies - especially Dubai - were still
attracting capital flight from less stable countries in the
Middle East, Africa and South Asia.
International bond issuance from the Middle East shrank 16
percent from a year earlier to the equivalent of $22 billion in
the first half of 2014, according to data from Thomson Reuters
and Freeman Consulting. The drop occurred largely because
cash-flush banks in the Gulf are eager to lend and offering
rock-bottom pricing on loans.
But the process of loans replacing bonds may be close to
reaching its limits, for several reasons. One is that issuers
are looking ahead to higher U.S. interest rates as soon as next
year, which would work through the Gulf's currency pegs to boost
local loan rates.
Some issuers want to maintain or establish presences in the
bond market now, so that they have another option when the loan
market eventually starts to tighten.
"Many names are looking to tap the bond/sukuk market to take
advantage of low coupons and also to replace bank borrowings,
where they see upward re-pricing risks," said Stuart Anderson,
Middle East head at credit rating agency Standard & Poor's.
In the United Arab Emirates, there are two additional
motives for issuance. Last November, the central bank announced
caps on banks' exposure to local governments and the companies
linked to them. Banks have five years to comply with the rules,
but in the long run they are likely to push many state-run firms
towards financing via bonds.
Also, Dubai is keen to develop itself as a centre for
Islamic finance; one way to do so is encouraging sukuk issuance.
These factors are expected to push international bond
issuance to resume in September as bankers and investors return
from summer holidays and issuers decide they can wait no longer.
The first issue may be from Sharjah, which appointed HSBC,
National Bank of Abu Dhabi and Standard Chartered earlier this
year to manage a debut sukuk. The Sharjah deal, likely to be at
least $500 million, is expected to hit the market in early
September, a banker with knowledge of the deal said.
DIFC Investments, the investment arm of the company running
Dubai's financial free zone, may follow soon afterwards with a
sukuk deal. The issue may aim to refinance a $1 billion
syndicated loan which DIFC took out in May 2012, a banker said.
Bahrain has hired four banks including Citigroup, Gulf
International Bank and Standard Chartered to arrange its
sovereign bond issue, and has plans to issue before the end of
the year, bankers familiar with the plan said.
Meanwhile, Bahrain's Gulf Finance House said this
month that it planned to issue $200 million of sukuk "in coming
months" to repay outstanding debt and for acquisitions; the
paper would be listed on NASDAQ Dubai.
Other issues from firms in Dubai and Qatar are possible but
less certain in coming months, bankers said. In June the Emirate
of Ras Al Khaimah sent requests for proposals for a sukuk deal,
but it has since sent RFPs for a syndicated loan, casting doubt
over whether the sukuk sale will go ahead.
Anderson said there had been strong interest among some
government-related enterprises, companies and smaller banks in
the Gulf in seeking credit ratings over recent months, possibly
in preparation to issue bonds. He declined to name the firms.
The primary market is likely to have no problem coping with
this surge of issuance, even if geopolitical tensions in the
region worsen further. That's because most investors - foreign
as well as local - believe the GCC has managed to insulate
itself from the turmoil.
The Arab Spring uprisings of 2011 were seen as potentially a
much bigger threat to stability in the Gulf, because they were
domestic threats to the stability of governments. Since GCC
authorities showed they were able to cope with that crisis, the
markets are largely unconcerned about sectarian conflict in
non-GCC countries such as Iraq.
"The Arab Spring stress-tested this region and the results
were largely positive," said one international fund manager in
In late June, one-year U.S. dollar/Saudi riyal forwards
- commonly used as a proxy for risk in the region -
briefly jumped to their highest level since 2011 as events in
Iraq triggered a burst of hedging activity by foreign banks in
thin volume. But forwards began retreating on the following day,
and are now back at their previous levels.
The cost of insuring Dubai bonds against non-repayment with
credit default swaps rose as much as 37 basis
points between late June and early August. But that followed an
80 bp drop to six-year lows since the beginning of this year.
CDS for China and Indonesia
rose between 20 and 25 bps during the same period, suggesting
Dubai's move was mostly due to global trends; its move may have
been relatively sharp because of historically greater volatility
and lack of liquidity.
"We have not seen any significant outflows in foreign
liquidity to-date, though in recent weeks international
investors have shown a preference for shorter-dated
instruments," said Mohsin Ali Nathani, chief executive for the
UAE at Standard Chartered Bank.
"In our numerous conversations with local and international
investors, we continue to note an optimistic tone towards
participation in local deals and we don't anticipate this to
change in the near future."
More than geopolitics, the biggest threat to the Gulf's
primary bond market may be expectations for U.S. interest rates.
The currency pegs mean eventual U.S. rate hikes are expected to
feed through into official Gulf interest rates quickly.
But because of its current account and budget surpluses -
and in Bahrain's case, the implicit financial support of Saudi
Arabia - the Gulf looks likely to outperform most emerging bond
markets if U.S. rate hikes cause global instability.
This year the "Gulf premium" - the mark-up that issuers in
the Gulf have to pay over developed-country issuers when they
sell similarly rated paper - came close to disappearing as the
region gained ground as a mainstream investment destination.
In recent weeks the premium has widened slightly, but
traders and analysts attribute this to low secondary market
activity in the Gulf during the summer rather than to any change
in investor perceptions of the region.
The spread of Abu Dhabi's dollar bond maturing in April 2019
above Canada's December 2019 U.S. dollar bond
, which was 16 bps in mid-June, has widened back to
28 bps. Canada is rated two notches higher than Abu Dhabi.
(Editing by Andrew Torchia)