Saudi Arabia’s $17.5bn debut sovereign bond was the biggest ever emerging market deal and attracted wide interest in the light of its National Transformation Plan. Rating adviser and global co-ordinator JPMorgan was tasked with getting the story across, which was unique in many aspects, as Edward Russell-Walling explains.

JPMorgan team of the month 0117 teaser

It was the biggest emerging market bond issue ever. As the debut international deal from the kingdom of Saudi Arabia – a G20 member and the world’s biggest oil producer – it transcended specialist appeal, and everyone wanted a piece of it. JPMorgan, which has been active in the Middle East since the birth of the local oil industry, was a global co-ordinator and the country’s ratings adviser.

The $17.5bn deal crowned a memorable 2016 for JPMorgan in this corner of the market. “It has been a very busy year in emerging markets debt capital markets [DCM],” says Stefan Weiler, JPMorgan’s head of central and eastern Europe, Middle East and Africa (CEEMEA) for DCM. “And it has been a record year for sovereign issuance, with about $130bn supply from emerging markets, compared with an annual average of approximately $80bn.”

Highlights of the year included Argentina’s stunning $16.5bn return to the international bond market in April. The size of the deal, in which JPMorgan also played a leading role, set an emerging market record, although, as it turned out, not for long.

Volumes have reflected favourable market conditions. In a low interest rate environment, investors have been looking for yield, and the more generous returns available on emerging market debt have stimulated demand, at least before Donald Trump’s US election win triggered a sell-off. One driver of supply has been low oil prices boosting issuance from the Middle East, where oil-producing states have been running unaccustomed budget deficits. This is likely to continue in 2017.

GCC exclusive

JPMorgan was the only bank to have led all of 2016’s sovereign deals from Gulf Co-operation Council issuers. It has been providing banking services in the region for more than 80 years, and arranged the first payment for the 1933 concession agreement between Standard Oil of California and the Saudi Kingdom.

Saudi Arabia has responded to the low-price environment with its Vision 2030 plan and associated National Transformation Program 2020 (NTP). The wide-ranging and ambitious goals include eliminating 2015’s $98bn deficit by 2020, expanding the non-oil economy, and modernising the country's society. Among the financial and economic elements are: the sale of a small stake in giant state oil company Aramco via an initial public offering (which could turn out to be the world’s largest); building the world’s biggest sovereign wealth fund; and increasing inward foreign investment.

In April, Saudi Arabia borrowed $10bn from a consortium of international banks. The five-year loan was reported to have priced at about 120 basis points (bps) over US dollar Libor, with JPMorgan as a lead lender alongside Bank of Tokyo-Mitsubishi and HSBC. While this was Saudi Arabia’s first venture into international debt markets for 25 years, it had already sounded out global banks about the possibility of an inaugural international bond issue. Once the loan had been completed, mandates for a bond deal began to be awarded.

There was no attempt to keep the bond project under wraps. Springing a surprise on the market could have been self-defeating, as investors would not have had the time to do their homework. The gradual encouragement of pent-up appetite was likely to be far more effective.

Investor interest in the bond itself would be intense, but it was more than matched by bankers’ interest in the mandate. After a busy beauty parade, Citi, HSBC and JPMorgan won roles as global co-ordinators. JPMorgan led the work on documentation, as Saudi Arabia made comprehensive disclosures regarding its assets for the first time.

“A big first step was to get all that information into the prospectus,” says Hani Deaibes, JPMorgan’s Dubai-based head of Middle East DCM. “Disclosure went beyond the standard requirements and needed a lot of work internally, with information having to be collected from different ministries.” Beyond that, the bankers had to tell the country’s story: not the narrative that investors thought they already knew, but one that embraced the NTP. “We had to deliver a story that said what was in the plan and why it would be a success,” says Mr Deaibes.

Diversification plan

The education phase of the deal included explaining Saudi plans to diversify its heavily oil-dominated economy. Together with fiscal and structural reforms, these include expanding its defence industry, growing the small and medium-sized enterprise sector, and setting up special zones to encourage investment in logistics, tourism, industry and finance.

There was also the market challenge. “We had to assess the capacity in the market for this unique name,” says Nick Darrant, JPMorgan’s head of CEEMEA syndicate. “There was nothing else out there like this, so we needed to work out what was right for the trade. And we had to leave a lasting impression, because this would likely be the first of a series.”

Investors wanted to know how big the deal was likely to be, and where it would price relative to other sovereigns. However, roadshows in London and the US in early October avoided any guidance on likely size or pricing. “There were no numbers at this stage of the process,” says Mr Deaibes. “That gave us a lot of flexibility. We said we would recommend what we thought was right, based on the feedback.”

The team deliberately avoided using valuations of 'comparable' sovereigns as a starting point for pricing. Their declared aim was to establish a benchmark for the region, not to be referenced to other issuers. “We were more driven by a process of building demand, hearing where investors saw value, and deciding on an optimal point to start,” says Mr Darrant.

Investors were not reticent about sharing their own ideas on the appropriate tenor, size and price, and this intensified during the roadshow. “Investors wanted to show us their hand in advance, and we had a lot of visibility on the potential book,” says Mr Darrant. “It does happen, but I have never seen it quite to the same extent as in this transaction.”

The level of interest was “unprecedented”, he says. “We realised we were on the brink of something special – an offer of significant volume at very attractive spreads, which few others could match.”

Undeterred by forecast 

Saudi Arabia then launched its debut Reg S/144A US dollar bond in five-, 10- and 30-year tranches, with price guidance of Treasuries plus 160bps area, 185bps area and 235bps area, respectively. Almost simultaneously, the International Monetary Fund predicted that Saudi economic growth in 2016 would fall to its lowest level since 2009, to 1.2%, compared with 3.5% the previous year. It revised its forecast for non-oil GDP growth in 2016 from 1.6% to 0.3%.

This did not appear to curb anyone’s enthusiasm and the bookrunners were able to log orders worth $67bn, equivalent to the GDP of Uzbekistan. “The knowledge that Saudi Arabia would issue had affected other issuers’ timing, and market conditions were very supportive,” says Mr Weiler.

As the price was tightened, there was negligible loss of demand, according to the bankers, and the total deal size was set at $17.5bn. The five-year tranche was $5.5bn, with a re-offer spread of 135bps, yielding 2.59% coupon. The 10-year piece totalled another $5.5bn, with a 165bps spread yielding 3.41%, and the $6.5bn 30-year tranche yielded 4.62% on a spread of 210bps. The bonds traded up in the secondary market.

While dedicated funds were very much present in the order book, its complexion differed noticeably from other emerging market issues. “We expanded the investor base for emerging markets to attract more high-grade investors and a number who had not looked at the region in the past,” says Mr Deaibes. “Size played to our advantage, because people knew it would be a large, liquid benchmark.”

Mr Darrant concurs. “It was more akin to a developed market issue,” he says. “There is a sense that emerging markets is a niche operating within its own ecosystem. But this name transcends emerging markets.”

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