Abu Dhabi’s debut passes the acid test

  • 07 Dec 2007
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Abu Dhabi’s $1bn debut sovereign bond in July will be remembered as one of the region’s benchmark bonds of 2007. And with a growing variety of corporate issues, the long term prospects for the Middle East’s bond markets are encouraging. However, the GCC has not proved immune to the global credit crunch — the main casualty is expected to be the speed of progress in the short term. Philip Moore reports.

How long does it take Abu Dhabi to earn $1bn? That depends on whose numbers you believe. Estimates of the total assets under management at the famously secretive Abu Dhabi Investment Authority (ADIA) range from between $500bn to almost $1tr, meaning that given a fair wind in the global capital market it could scoop up a billion or so in its sleep.

It could, of course, lose the same amount in a similarly short time span. But the point is that when the Emirate of Abu Dhabi came to the international bond market for the first time in July, with a $1bn five year issue led by Citigroup and Deutsche Bank, it clearly did not need the money.

"Perhaps some of the proceeds may go towards some of the big projects the Abu Dhabi government has in the pipeline, but it’s not as though it has a budget deficit to finance," says Brendan Goffinet, executive director of global capital markets at Morgan Stanley in Dubai.

This is just as well, because the timing of the deal for the Aa2/AA/AA rated emirate was shocking, coinciding with falling stockmarkets, widening credit spreads and growing concerns about a global credit crunch.

Those worries put a dampener on Abu Dhabi’s original plans to issue a $2bn 10 year benchmark. But they did not prevent demand for Abu Dhabi’s debut bond reaching $2.7bn, allowing for pricing to come at the tight end of its indicated range of 18bp -20bp over mid-swaps.

To some analysts, pricing at the tighter end of guidance did nothing to erode the fundamental attractiveness of Abu Dhabi’s bond. HSBC’s Dubai-based head of credit research, Chavan Bhogaita, made his feelings plain in the market round-up that he sent to his clients the day after pricing. "The credit is rated Aa2/AA/AA but in our view its credit fundamentals would almost certainly give it a triple-A rating were it located anywhere else geographically," he wrote, adding "come on people, Abu Dhabi risk at Libor plus 18bp!!"

In off-the-record asides, however, some bankers say that as well as emphasising the economic and financial muscle of the Gulf Cooperation Council (GCC), the Abu Dhabi bond was symptomatic of a weakness that has characterised the region’s financial markets for years.

The bond came at a time when Dubai was also working on a debut benchmark of $3bn-$5bn, with JP Morgan and UBS already having been appointed as rating advisers.

Some bankers say that, by stealing a march on Dubai in the bond market, Abu Dhabi perpetuated the region’s perennial game of beggar-my-neighbour. "If you want to kill any uncertainty about how strong your federation or union is, issue a federal bond," says one local banker, who also said that by borrowing as individual emirates, Abu Dhabi and Dubai are passing up a golden opportunity to put the ‘United’ back into the United Arab Emirates.

Beyond the politics, the same banker says that a federal UAE issue would inject into the market the liquidity that the region’s bond market needs. "I see nothing less than $5bn across the curve as being sufficient to provide the liquidity that would allow people to hedge dynamically, and to allow for the development of a CDS market," he says.

To other observers, however, the Abu Dhabi bond has been the clear landmark transaction of 2007 for the contribution it has made to the evolution of the GCC’s broader debt capital market. "The single biggest event this year in terms of supporting the development of the capital market has been Abu Dhabi’s decision to get a rating and issue a benchmark bond," says Philipp Lotter, senior credit officer at Moody’s in Dubai. "Although government-related issuers have been able to test the water, it is the government itself that should be creating the yield curve around which the wider market can grow."

Bankers’ sentiment is that although developments in the global capital market have shelved Abu Dhabi’s plans for the time being, its July bond should not be regarded as an isolated exercise, but as the first in a series of transactions that will eventually see the Emirate establish benchmarks in the five, seven, 10 and ultimately the 30 year maturities.

Lotter says that the Abu Dhabi bond builds on the momentum in the corporate sector that was already gathering pace in 2006 and the first half of 2007, when bank issuance ceased to be the driving force of the GCC bond market.

"2006 was the first year that we started to see a meaningful diversification of issuance in terms of volumes in the corporate bond market, but also in terms of maturities," says Lotter. "Last year’s 30 year deal from Taqa [Abu Dhabi’s national energy company], for instance, was a remarkable step forward for a market in which the usual maturity had been five years."

Corporate diversification, crunch stalls progress
The process of diversification continued in the first half of this year. "In 2006, four issuers made up about 75% of the corporate market," says Lotter, "and issuance was concentrated among UAE-based borrowers. Although the UAE is still the main driver of issuance, we have been seeing some interesting activity in markets like Saudi Arabia and Qatar."

Even though the UAE has led the way in terms of new bond issues, the market senses there is plenty more to come from Dubai and Abu Dhabi-based borrowers.

A recent report on Abu Dhabi banking by HSBC says, "despite its small size, the UAE bond market has grown at a very rapid pace, from a total issue size of $2.1bn in 2003 (4% of corporate credit demand) to $18bn in 2006 (13% of corporate credit demand). We expect this trend to continue as corporates diversify their funding base... and the risk management processes of banks limit their ability to increase exposure to large corporates. As such, we see the bond market’s financing share increasing to 40% of aggregate corporate borrowings by 2011." (see graph on page 11).

Other GCC markets will follow, although they may be slower to gather a similar momentum. "We would certainly like to see more Saudi companies funding themselves on a cross-border basis," says Jacco Keijzer, head of Middle Eastern debt origination at ABN Amro in Dubai. "I think this will happen over time, as more middle market companies look to diversify their sources of funding, but it won’t happen overnight because there is so much liquidity in the local market."

While the longer term prospects for the GCC’s bond market are encouraging, for now the global credit crunch has hit the debt capital market of the GCC region at a primary as well as a secondary level, which is a source of frustration and bewilderment for would-be corporate issuers.

"We have had numerous discussions with a number of leading companies in the region which believe that GCC corporate bond issues should be regarded as a flight to quality in current market conditions," says Mark Waters, regional head of debt capital markets at BNP Paribas in Bahrain. "I share their frustration, because we have a number of transactions in the pipeline, but although issuers are keen to diversify their sources of funding, they won’t do so at any price. So I imagine we will have to wait until the first or even the second quarter of 2008 for issuance to gather momentum again."

Bankers say that where bonds have been successfully sold since the summer, they have — like Abu Dhabi’s benchmark — needed to offer something close to irresistible value.

The most conspicuous case was the $2bn two-tranche transaction launched by Abu Dhabi’s National Energy Company, Taqa, in October. Led by Citigroup and TD Securities, the $1.5bn five year tranche was offered at 155bp over Treasuries, with the $500m 10 year piece priced at 175bp over, a level regarded as a virtual giveaway in light of the company’s strategic importance to Abu Dhabi.

Busy secondary market, CDS horizons
Much of the withdrawal from GCC credits by international bond investors reflects heightened risk aversion combined with the mass exodus from anything perceived to be illiquid. But the assumption that GCC bond markets are thinly traded, say bankers, is rash. "One of the common misperceptions about the region’s bond markets is that there is no secondary market," says HSBC’s Bhogaita. "That is absolutely wrong. At HSBC, we trade about 100 GCC debt instruments, of which about a quarter are sukuk [Islamic bonds]. That number is growing very rapidly with new products being developed and a more active secondary market taking shape across the board."

Increased liquidity, say others, has mainly been the by-product of the launch of a few jumbo corporate bonds over the last 12-18 months.

"The $500m bonds that the region’s banks used to issue under their MTN programmes were generally placed with buy-and-hold investors and were seldom traded," says Jean-Marc Lejeune, a director at Barclays Capital in Dubai. "The deals that we have done recently for PCFC [Ports, Customs and Free Trade Zone Corp], Nakheel and Aldar — for $3.5bn, $3.52bn and $2.5bn — have all been much more liquid than anything else ever issued in the region. We trade about $10m of the PCFC deal each business day, and about the same in Nakheel, which means that secondary market volume has now been roughly equal to the original size of the deals."

The depth and breadth of the secondary market for GCC bonds could only be enhanced, say bankers, by the development of a credit derivatives market. "Some banks are already quoting CDS prices on a few GCC credits," says Bhogaita. "It’s still not a very active market and the frequency and reliability of those prices can be questionable. Trading CDS with Islamic investors is a complex issue, but over time we will see a CDS market trading parallel with the cash market that is taking shape in the GCC, just as it has in Europe."

Quasi-government risk at great prices
The assumption that GCC bonds are illiquid, say bankers, is not the only misunderstanding about the region that some investors have. Bankers argue that much of the spread widening in GCC corporate bonds in recent months has been caused partly by a misunderstanding of the credit profile of some local borrowers.

"An important dynamic in this part of the world is that many issuers in the sukuk as well as the conventional market are in some shape or form government-related borrowers," says HSBC’s regional head of debt capital markets, Declan Hegarty. "That means that although they do not have formal government guarantees there is a very strong assumption that they would not be allowed to fail."

While this relationship between the region’s governments and its leading companies is accepted as a positive factor by investors in the GCC, Dubai-based bankers say that it is still not understood by the global investor community. Nor, they add, do many US investors, for example, have an implicit understanding of the difference between the credit stories of the region’s issuers.

"Companies like DP World, Dubai Holding and others are very different but tend to trade at the same level," says one local trader. "US investors in particular will often ask for a price on the cheapest 10 year Dubai bond we can find, without making any effort to understand the basics of the credit they’re buying."

The consequence, at the height of the subprime crisis, was a bout of indiscriminate spread widening which created what some analysts assessed as irresistible value in credits such as DP World, Dubai Holding, DIFC Investments, Taqa and Qatar Petroleum. As HSBC’s Bhogaita wrote in a note to clients, "bearing in mind that these credits represent... quasi-government risk, the fact that spreads on these issues have been dragged out along with the general population provides investors with a good opportunity to buy low risk government-related (or in many cases wholly government-owned) credits at what seem to be simply ridiculous prices."

  • 07 Dec 2007

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 31,385.40 114 7.52%
2 JPMorgan 29,232.19 105 7.00%
3 Goldman Sachs 27,645.83 55 6.62%
4 Barclays 26,090.00 67 6.25%
5 Deutsche Bank 23,883.15 74 5.72%

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1 ING 299.85 1 21.73%
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1 BNP Paribas 299.85 1 21.73%
5 UBS 60.22 1 4.36%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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2 Credit Suisse 1,301.65 4 18.30%
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4 BNP Paribas 522.35 4 7.34%
5 SG Corporate & Investment Banking 444.17 3 6.24%