After a slow start to the year, the Middle East debt markets were in need of some good news. In early June, that came from the successful completion of a $1bn bond issue for Dubai’s flag carrier, Emirates Airlines.
The deal is likely to prove significant for several reasons. A large oversubscription allowed the issuer to both increase the size of the deal from the $500m to 750m it originally went out to the market for, and lower the yield from the initial guidance to 330 basis points over midswaps from 335.5bps.
More importantly, though, it showed that a huge investor base is still hungry for debt from the Middle East, despite the first half of the year being marked by political turmoil, and the issuer being owned by the government of Dubai, which is still going through a billion-dollar restructuring programme on its sovereign entities.
The Emirates Airlines deal proved to be a major boost for Dubai, whose credit default swap rates fell to about 320bps in the wake of that transaction, the lowest they had been since November 2009, just before it announced plans for a standstill on debts at the government-owned investment company Dubai World.
Tactical delay
Capital markets issuance from the Middle East was in need of a shot in the arm after political turmoil around the region put many issuers off going to the debt markets. Issuers, including the government of Bahrain and United Arab Emirates construction company Arabtec, decided to delay bond issues while they waited for market conditions to improve.
The problems that arose in the markets were particularly disappointing after the good year the region had in 2010, with about $30bn of issuance. At the beginning of 2011, bankers were talking of debt issuance this year being well above that level. After problems in the first half of the year, opinion is now divided.
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“There will definitely be more deals in 2011 than 2010,” says one Middle East bond analyst at an international bank. “There are more and more deals queuing up to hit the market and a lot of demand for them.”
Not everyone shares that enthusiasm though. “It is very difficult to tell if the pipeline is strong enough to make this year bigger than 2010,” says the head of Middle East debt capital markets at one international bank. “We had a slow start to the year and there have been a lot of missing weeks, so a big chunk of time has been lost.”
Promising performances
While the pipeline continues to build and await the right time to issue, potential issuers will get comfort from looking at the deals done so far in the region. Every deal that has been issued has been massively oversubscribed and the investor base has been in the hundreds. The Emirates Airlines issue orderbook was more than $6bn from 420 investors. Sharjah Islamic Bank, despite not being a well known name outside the region, also raised a $400m bond in late May from 200 investors. The orderbook on that deal was $3.75bn. Earlier in the year, the UAE’s Emaar Property had attracted an orderbook of $1.7bn for its $500m deal.
“Liquidity is still plentiful in the markets and interest rates are very low,” says Mark Watts, head of fixed income at National Bank of Abu Dhabi. “This forces investors to look for yield somewhere else and there is still a premium being paid by credits in this region compared with their peers with similar ratings elsewhere in the world.”
The debt capital markets head adds: “The market is very receptive with investors coming from Asia, the US, Europe, all over to look at the credits in this part of the world. There are just hundreds of investors from all over the world looking at the Middle East right now.”
Lack of new deals
The problem they face, though, is the lack of new deals. The political unrest has meant that even issuers from stable countries in the region have put off new deals to wait for things to calm down, while also adding to the sense of political risk. A London-based bond trader says: “International investors are piling on anything out of the region right now in their hunt for yield. There just isn’t enough supply to keep up with demand.”
Although international investors are currently attracted by the yield on offer in the region, that situation may not last much longer. “The environment is very attractive to take advantage of what we think is a misplaced risk premium on Middle East credits at the moment,” says Mr Watts. “But as time goes on that risk premium will be eroded as high demand puts pressure on pricing.”
The success of the Emirates Airline deal, along with a few other Dubai transactions earlier in the year, shows that investors have largely overcome worries about the emirate's debt problem. One banker, who has worked on all the recent Dubai transactions, says: “It’s not as simple as everyone has stopped worrying about the issues in Dubai, but the situation has dramatically improved and investors, especially from Asia, are really buying into the Dubai story.”
Demand for Islamic issuance
Both local and Asian investors are also playing a big part in absorbing the Islamic issuance coming to the market. The Sharjah Islamic Bank deal was predominately sold to Middle East investors, who took up 42% of the offering, and Asian investors who took up 24%. A sukuk issued by HSBC Middle East was also largely taken up by local and Asian investors, together accounting for 87% of the deal.
“Demand from Asia is just getting bigger all the time,” says the head of Middle East debt capital markets at one international bank. “[Rule] 144a transactions get good demand from US investors, but generally we are seeing very strong appetite across the board.”
Whether that appetite can last beyond the summer is unclear. Expectations are rising that the end of quantitative easing in the US will dampen some of the liquidity in international markets. The window for further bond issuance is also limited by Ramadan, due to start on August 1, when things traditionally slow down in the region.
As a result, many bankers expect a flurry of deals before the summer and a very active final quarter of the year, a repeat of last year when about $14bn of deals were completed in the final three months of the year. That was about the same as had been raised in the first nine months of 2010.
The recent transactions have shown one positive thing for issuers from the region, though. International investors are not being put off by the political uncertainty, even if they are demanding a higher risk premium. At the moment investors are getting the additional yield they are hungry for and issuers are getting access to funding, while banks remain reluctant to lend.
After several years of stuttering progress, a broad investor base willing to take on the risks associated with the Middle East seems to be emerging. Having gone through the Dubai debt crisis and the Arab spring, they have shown an increasing commitment to backing the growth of the region. If 2011 turns out not to be as active as 2010, it should not detract from the fact that the Middle East capital markets are finally coming of age.
