“Dubai has placed very successfully at the tight end of the pricing range and the rationale for it doing a deal of this kind is a good one,” said one portfolio manager in the United Arab Emirates. “But investors need to think very carefully. We are not enthusiastic about recent issues and have seen a disquieting pattern that has grown in significance.”
Dubai had done everything it set out to do with the deal, bankers said, adding that they were also encouraged by the return of UAE issuers such as Mubadala and Taqa. Yet some investors in the region fear a sell-off could be coming — especially with over $4bn of Dubai World debt falling due next year.
High yield issuers such as Dubai Investments Park and Damac Real Estate Development have recently achieved notably oversubscribed sukuk offerings. “Deals of this kind should in themselves be red flags that we are topping out,” said one investor. “When they reverse they will reverse on a dime and you need to be in [the exodus] from the beginning.”
“Both the regional fundamental and technical pictures are positive, but there is a gnawing sense of exuberance starting to permeate the market,” said another portfolio manager. “Identifying the catalyst and timing the exit, therein lies the challenge. There are a lot of nervous longs out there in the market. We are holding elevated levels of cash across all our funds and portfolios and this has impacted performance. At what point do you capitulate?”
Dubai credits have made a sustained rally in recent months. The emirate’s 2023 sukuk has climbed around five percentage points to 98.5 since the end of January, having suffered during the sell-off that hit emerging markets last May. Its 2043 conventional bond has gained over 10 points since the start of the year to 94.5 earlier this month. It fell back to 92.75, but in the past week rose again to 93.5.
While much of Dubai’s recent good news has already been priced in, many of its challenges — and those of the global market appear to have been forgotten, the manager added.
“We can see lots of positive noise out of Dubai about the 2020 Expo, logistics numbers, bank lending, trade, the sovereign’s [recent $20bn] rollover of debt and companies turning a profit,” he said. “But we are still in a situation where there is a large amount of debt, competition is high, global politics is a concern and so is the local geopolitical situation.”
In particular, the threat of rising US interest rates continues to hang over the market. This risk is even more pronounced for longer dated credits than it was when Dubai issued its 30 year bond last year.
Moreover, Dubai’s standing as a credit has detached from other regional countries that have been rocked by economic and political setbacks.
Dubai decouples
“Over the last four years, Dubai was a credit you would compare with places like Bahrain and Turkey, and Dubai would trade roughly in line,” said the second UAE investor. “But now Dubai CDS is much tighter, and without it having improved its transparency, its market structure or policy in any meaningful way. Dubai CDS was 200bp last May, before the market sold off, but now it is 30bp tighter. And you are also looking at increased US interest rate risk for longer dated stuff.
“We are happy to see the recent achievements, but now we are there, we think it is time to take our foot off the pedal and stand back to see what happens,” he added. But he allowed that implementing such a stance was harder for fixed income investors than equity holders.
“Sell in May and go away is a good strategy for equity investors but in fixed income it has its own risks,” he said. “Not participating in deals can also be painful if you miss out.”
These warnings may not go down well with the broader base of Islamic finance investors, who are only just starting to see the sukuk market pick up. After only $2.1bn of dollar sukuk were issued in the first quarter, April has already brought $4.7bn of Islamic bonds.
“Our general conclusion is that the [Dubai] new issue remains cheap, but given the structure, lack of rating and tenor, foreign institutional and local retail investors may be less interested,” said an investor in London. “In addition, there’s a lot of prospective and recent supply, including Damac, Mubadala and Taqa.”
One potential cloud hanging over the local market beyond this year is government-owned Dubai World’s $4.4bn of crisis-era debt, which matures in 2015. Earlier this month the firm hired Blackstone Group as an adviser, a move that some investors have interpreted as increasing the likelihood Dubai World will again try to restructure the debt. The firm has another $10bn to repay in 2018.
No roadshow
Dubai achieved some $2.3bn of orders with no roadshow as it priced the $750m 15 year sukuk at 5% on Tuesday afternoon. That was the tight end of initial price thoughts of 5%-5.125% given at 9am.
Dubai Islamic Bank, Emirates NBD Capital, HSBC, National Bank of Abu Dhabi and Standard Chartered managed the sale — the same banks that arranged the emirate’s last deal, a $750m 10 year sukuk and $500m 30 year conventional bond in January 2013.
The sukuk was free to trade from 9am Dubai time on Wednesday and held above reoffer at 100.05/100.10 on the break. It was still trading around that level on Thursday.
“It was a smart intraday execution,” said Spencer Maclean, head of syndicate, west at Standard Chartered. “It sends a very strong message to the market, particularly as Dubai’s last three deals have been 10 years and above. It’s hard to say whether it will encourage other issuers to come to market soon, but it shows there is an opportunity to do longer dated sukuk issuance.”
The 3.875% 2023 was quoted around 4.1% on Tuesday morning and the 5.25% 2043 around 5.7%, but the notes rallied during the day. As a result, fair value for the new sukuk was somewhere between 4.9% and 5% area, according to Maclean — so the final price gave only a small new issue premium.
“We saw the long end rally,” he said. “Often you see existing notes trade off a bit when a borrower comes to market, but in Dubai’s case it was different as people expected the deal and this gave them a boost.”
Middle East investors took 61% of the paper, UK 17%, other Europe 11%, Asia 9%, and others 2%. Banks took 63%, fund managers 27% and others 10%.
“The 2023 tightened during the day, so 5% is a good yield concession for the extra six years,” said one buyside official. “Still, the initial guidance was 5%-5.125%, so it was well indicated to begin with.”