Gulf spree rekindles liquidity fears

The last few months have been busy in the Gulf region’s bond markets – all the more notable given the snoozefest that was the beginning of the year. Qatar raised an eye-popping US$9bn at the end of April and was quickly followed by a rush of sub-sovereign trades, but bankers say this is just the thin end of the wedge.

“The region’s funding needs over the next 18 months are very high,” said Simon Williams, chief economist for the CEEMEA region at HSBC. “A growing portion of that is going to come through the capital markets.”

Ooredoo, Taqa, IPIC and Bank Dhofar are at different stages of raising debt, according to a mix of bond bankers and official announcements, while bonds from the Emirate of Dubai and Kuwait are also heavily expected by bankers from the region.

But the big deal on the horizon is for Saudi Arabia, which held talks with bankers in early June as the sovereign looks to reduce a widening fiscal deficit due to cheap oil.

The issuer is expected to raise somewhere in the region of US$15bn, according to multiple debt capital market and syndicate bankers who wished to remain anonymous throughout this article.

One bond banker said this was directly linked to the Saudi deal, as no one wanted to be seen as potential leak to the media when such a lucrative trade was up for grabs.

But even Saudi Arabia’s potentially jaw-dropping transaction is only a fraction of the funding needed throughout the Gulf in the near term.

HSBC analysts reckon that around US$250bn of funding is required in 2016 and 2017, though not all will come from the bond markets.

“If that figure is right, then there will be a problem for the market to absorb that,” said a syndicate banker at another UK bank. “At most, it’s been around US$50bn a year in bonds from the region. The precedent for anywhere near US$250bn has not been set.”

Regional support

There are some chinks of light despite the large sums of money required. Crucially for market sentiment, Middle East investors have been big buyers in recent deals, snapping up more than half of many of the recent trades printed from the region.

This is a marked difference from last year, when Middle East investors – mainly banks – saw liquidity dry up with falling oil prices and so did not support regional deals as strongly as they had in the past.

The most high-profile casualty of this was Abu Dhabi Commercial Bank, which was forced to pull a deal after releasing initial price thoughts in September 2015.

But now, bond bankers are confident that with oil hovering around US$50 a barrel, the region’s liquidity worries are over.

“There’s plenty of demand there now, I don’t see any problem,” said a banker based in Dubai. “Especially if you look at sukuk, where there is still lots of liquidity and premiums are tighter than on conventional bonds.”

Emirates Islamic Bank, for example, paid zero new issue premium for a US$750m 3.542% due 2021 sukuk transaction at the beginning of June.

Middle Eastern investors bought 58% of that trade.

One thing that has helped the market cope with the influx of deals is that they all have a slightly different spin – bank capital trades, sovereigns and sukuk have all featured.

And it might not fall to Gulf investors to pick up all the slack.

“I’m hopeful that as the region becomes a more prominent issuer it will attract a wider range of investors,” said Williams at HSBC. “I can’t say that a US$250bn funding requirement is a good thing, but it will accelerate the development of the market.”

This is not a hope universally shared, as syndicate bankers say they are running out of international numbers to call to try to place deals.

“I’m not seeing a huge amount of interest from investors who are not already involved in the Middle East,” said the syndicate banker. “I may be wrong, but I can’t see who else there is to bring into the fold.”

Nonetheless, issuers are trying. Commercial Bank Qatar visited Asia as part of the roadshow for its US$750m June 6 deal, and got 18% participation from the region – a level leads lauded as a success in terms of investor diversification.

Figures tell a different tale

Whether Gulf issuers can drum up interest from new investors could prove critical, as Williams at HSBC is bearish on how much money is sloshing around the Middle East.

“The widening spread between local interbank rates and US dollar Libor makes it very clear that there is a liquidity squeeze in the region,” he said.

An HSBC note authored by Williams said: “While oil at US$50 rather than US$30 slows the pace at which liquidity is deteriorating, it is insufficient to reverse the trend.”

Williams is not alone in that thought. Moody’s analyst Mathias Angonin said: “Low oil prices are testing even strong institutions.”

The statistical evidence is damning. Deposit growth in the GCC is at its slowest rate in more than five years, according to the HSBC note. This is largely due to a reduction in public sector deposits as oil-exporting governments in the region free up cash to shore up their own finances.

The region’s governments have also increased their borrowing from local banks, which only compounds the issue.

This has led to a “sharp increase” in the banking system’s reliance on foreign financing, said the note.

Banks have reacted to the increased government demand for their funds by ramping up overseas liabilities. These had grown 23% year-on-year as of February, to make up 16% of Gulf banks’ balance sheets.

To make matters worse, plans by Gulf governments to diversify their funding streams away from their banks, such as implementing a GCC-wide value-added tax of 5% from 2018, will not be enough to stem the flow of money that was once filled with petrodollars, according to Moody’s. Existing plans to increase corporate income and remittance taxes will also not turn back the tide, the ratings agency said.

“The reforms – while positive – will only partly compensate for the continued oil price slump,” said the agency in a research note. “As such, Moody’s expects that fiscal and external constraints will persist beyond 2016.”

Another worrying indicator that the Middle East market is becoming overburdened is the shaky secondary performance of some deals soon after pricing, notably those from DP World and Noor.

Both issuers saw their notes sinking in the immediate aftermarket, with bankers on and off the trades unable to agree on any clear reason.

But these deals have since bounced back and most recent trades from the region are bid at around reoffer.

“I think that will be the telling sign, when secondaries don’t hold up,” said the syndicate banker. “But there’s been a bit of a rally. If there was an issue of absorbency in the market, we would probably see all the new bonds a few points down.”

Though this rally is not solely down to investors’ desperation to scoop up Middle East bonds.

“We are in an incredibly technical environment and have been for the last two to three months,” said a DCM banker at a house that is chasing the Saudi deal. “So it’s hard to know how much of the secondary support is just from that.”

And there are other signs that the market is not in the healthiest place, particularly for banks hired to run transactions.

Arranger slots on trades became increasingly bloated in the second quarter, as there was still not enough volume to support all the banks vying for the business.

The number of banks hired to run deals in the Middle East shot up from the typical five or six arrangers. Qatar had 10 banks, DP World and Emirates Islamic Bank nine each and Noor Bank had a more modest seven.

“We’re not happy at all with the practice,” said another DCM banker based in the region.

Issuers are engaging in the age-old trade-off of rewarding banks with bond mandates for providing cheap loans. All 10 firms on Qatar’s bond, for example, were part of a 14-bank syndicate that lent the sovereign US$5.5bn in January.

Before the recent spurt of issuance from the region, Gulf borrowers had signed US$21.6bn in syndicated loans this year, according to Thomson Reuters LPC. Only US$13.5bn of bonds had been issued.

Compare this with 2013 and 2014, when US$34bn and US$37bn of bonds were placed by Gulf issuers, against syndicated loan volumes of US$17bn and US$21bn, respectively.

Abu Dhabi showed in April that an issuer can use far fewer arrangers and still get a good outcome, after raising US$5bn with three banks running the trade.

But with the huge amount of dollar funding forecast in the Gulf, perhaps issuers will be keen to cram as many arranging banks onto deals as possible, in the hope of gaining access to every nook and cranny of the investor base.