Bonds take the lead in Middle East financing
The loan market has had a great couple of years in the Middle East but in 2019 the bond market stole its thunder. However, as the region tries to wean itself off hydrocarbons, the sheer scale of financing needed means both markets will have plenty to do over the next 10 years. Mariam Meskin reports
The Middle East’s rise from an occasional but lumpy user of international capital markets to a regular and important region for loans, bonds and equities has been impressively rapid. Indeed, the Middle East has undergone a period of rapid maturity in the past decade, with the region offering international lenders and investors a broadening range of financing opportunities.
It is a blossoming that is set to continue. With Russian markets sullied by sanctions and Turkey teetering on the brink of implosion, the Middle East — the bulk of which comprises issuance from the Gulf Cooperation Council, in many years constituting more than 90% of volumes across the region — has become one of the most lucrative regions for those involved in international financing markets. Low yields in developed markets have helped to ensure a steady stream of investors in the search for better returns. EM fixed income funds have enjoyed a flood of money throughout 2019, mostly at the expense of developed equity markets.
“Issuance for 2019 will very likely close at record levels, which is an indication that MENA is now an integral part of emerging markets,” says Khalil Belhimeur, executive director, EMEA bond syndicate at Standard Chartered in London. “The GCC has had a stellar performance in line with broader emerging markets, despite geopolitical volatility and commodity-related concerns, which shows the strength of the region.”
We should expect more of the same in the coming years. Vision 2030, Crown Prince Mohammad bin Salman’s ambitious programme to diversify Saudi Arabia’s economy through infrastructure investment and public-sector restructuring in an effort to lower its dependence on oil exports, is expected to require billions of dollars of equity and debt from the international capital markets. The process has already begun, with Saudi Aramco — the world’s most profitable company — likely to list in December, in what is expected to be one of the largest ever initial public offerings.
The Middle Eastern international debt market is already large in the world of EM: the combined size of the region’s bonds and loans market in 2018 was equivalent to $217.14bn, according to Dealogic, growing from $181.69bn in 2017. The region has been rapidly catching up with other emerging markets that have been a more familiar first choice for most Western investors. The size of the combined central and eastern European market in 2018 was $237.37bn, only 8% larger than the Middle East.
But for lenders, 2019 has not been a great year. Year to date volumes of signed deals have dropped 50% from 2018. The problem for them is the bond market. Issuers in Saudi — including the sovereign and its largest companies — and the five other GCC countries have successfully tapped fixed income investors in 2019, in the process raking in billions of dollars of debt at attractive levels, at the expense of traditional lender banks. As of mid-November, bond issuance compared with 2018 was up 12% in the Middle East and up 18% in the GCC. CDS spreads across all the countries have tightened sharply since the beginning of 2019. Saudi Arabia and Qatar have tightened by 40bp to 65bp and 45bp respectively, with the more fiscally-troubled Bahrain managing to come in from 320bp to 210bp.
Though investors were spooked by the drone attacks on Saudi Aramco’s facilities at Abqaiq and Khurais in the eastern part of the country in September, with Saudi and GCC credit spreads immediately widening, just days after the attacks Abu Dhabi was able to issue a $10bn bond with a minimal new issue premium and a heavily oversubscribed order book. Meanwhile, CDS levels across the region returned to normal within 10 days.
“The region’s geopolitical risks are well flagged and long-standing,” says Andy Cairns, head of global corporate finance at First Abu Dhabi Bank in Abu Dhabi. “And importantly, investors are well compensated for them. The GCC offers very attractive relative value in rating equivalency terms. The perception of geopolitical risk increases the further you travel, so GCC accounts demonstrate greater price elasticity for regional credit than international investors.”
At the end of 2018, bankers at the largest global lenders were singing the Middle East’s praises in anticipation of the business they expected to work on in coming years, following a jumbo year of issuance that saw more than $122.47bn of loans raised by the six Gulf states alone. But those expectations fell flat in 2019, with the number of deals signed across the region down by 53%. The Middle Eastern loan market tracked by Dealogic contracted sharply, from $126.8bn of borrowing signed in 2018 to $62.8bn by mid-November, leaving a giant Gulf-shaped hole in many lenders’ budgets. Looking just at deals run by bookrunners, borrowing fell from $76bn to $33bn.
“It has not been a great year for Middle Eastern loan volumes. It has been difficult for both international and regional banks,” says Zvi Wohlgemuth, managing director, head of project, asset financing and CEEMEA loan syndicate at Société Générale in London. “We are headed for similar volumes as 2017, but it is always difficult to match the bumper years like 2018, which had a couple of jumbo deals.”
The value of the deals signed in Saudi Arabia by November was nearly half of that seen in 2018. In March, Saudi Aramco finally announced it would be purchasing compatriot petrochemicals firm Sabic from Saudi’s sovereign wealth fund, Public Investment Fund (PIF), for $69.1bn in a bid to inject capital into the Saudi state in preparation for the reforms. Lenders were excited that a chunk of that financing would be done in the loan market, with some pointing to the $16bn and $11bn jumbo loans raised by the sovereign and sovereign wealth fund in 2018 as a sign of the country’s affinity with loan markets.
But the deal did not materialise — instead, lenders were tapped by PIF to raise a moderate (in relative terms) $10bn bridge loan, in a largely self-arranged transaction.
“The highly anticipated wave of financing activity driven by Vision 2030 out of Saudi Arabia has not yet materialised,” says Rizwan Shaikh, co-head of loan syndication EMEA at Citi in London. “It is a question of time.”
Bonds gain where loans lose
Despite outbursts of geopolitical volatility and the persistently low oil price leaving funding markets on edge, Middle Eastern borrowers are being hunted down by lenders who are still very much committed to the region. Société Générale’s Wohlgemuth says: “Sentiment has been rather good across the GCC — while country risk of course exists, there is not as much mention of it as previously.”
Borrowers were driven to the bond market where regional issuance flourished in 2019 and issuers locked in tight pricing as credit spreads tightened across the GCC in line with a reduction of US dollar yields. “There has been a migration of [corporate] borrowers from syndicated loans to fixed income markets, evidenced by debut trades from Saudi Aramco and Almarai,” says Cairns at FAB.
As he points out, while in 2018 syndicated loans dominated (volumes were 29% higher than bond issuance), in 2019 bonds have come out on top, with $100.01bn issued in the Middle East, compared with $62.8bn of loans.
Global loan volumes are on the decline, with the number of EMEA loans signed down 39% on 2018, and the Middle East is no different. But for issuers, that does not matter as the bond market has proved a reliable and deep funding pool this year.
“Some borrowers have rotated from the loan market into debt capital markets to lock in better pricing and tenor, given how favourable the environment is,” says Shaikh at Citi.
Should global monetary policy remain dovish and should US Treasury yields continue declining, yields will remain low across EM, stimulating bond issuance and potentially stealing more business from the loan market.
“It has been a record year for MENA issuance; it is only the second year on record where DCM volumes have exceeded syndicated loans,” says Cairns. “We expect something similar in 2020, with bonds and sukuk remaining the region’s preferred fundraising format and total issuance around $100bn.”
Some lenders are more optimistic, though, that volumes may pick up in 2020, with a number of large loans coming to maturity and therefore refinancing. “We expect a bounce-back in volumes next year across corporate and project financing in GCC,” says Citi’s Shaikh.
But others are less certain, pointing to more attractive conditions in the bond markets, which have been aided by the GCC’s inclusion into key EM indices. “The loans pipeline does not point to a strong pick-up in 2020 volumes in the Middle East,” says a banker at a European lender. “The big question is whether we will see more sovereign activity. Saudi tapped lenders heavily in 2018 and the other GCC countries do not seem likely to come just yet. Qatar has a jumbo deal maturing soon, though they may take advantage of the bond market conditions and refinance it there.
“However, we still expect part of the Aramco-Sabic financing to come from the loan market. The PIF will receive another $60bn from Aramco at some point, but until that happens I would not exclude the PIF coming back to the market.”
Bond issuance across the GCC has been boosted in 2019 by the phased inclusion of five of its states in the JP Morgan emerging market index (EMBI), a move that put the total value of GCC bonds in the index at about $165bn (Oman was already part of the index). Belhimeur at Standard Chartered says: “As a result of the index inclusion, the amount of investors following the GCC has improved dramatically. We have seen a tightening of spreads on the back of increased demand, and in general, we have seen improved market access for most issuers from the GCC.”
The Kingdom of Saudi Arabia tapped international investors three times in 2019: for $7.5bn in January through a conventional 10 year and 31 year bond; for €10bn in July via its euro bond debut with maturities between eight and 20 years; and for $2.5bn in October through a 10 year sukuk.
The inclusion has led to an increase in passive investor flows into the GCC, which now comprises almost 12% of the index. “Institutional investors are index-crazy,” says Jan Dehn, head of global research at Ashmore in London. “They will buy whatever goes into the index as long as markets are performing well.”
After a stellar year, issuers look set to enjoy even better bond market conditions. “Though many issuers have pre-funded or will pre-fund their liabilities, we do not expect volumes to decline from levels we saw in 2018 and 2019,” says Standard Chartered’s Belhimeur. “If the market is constructive, some issuers that did not come to the market in 2019 will look to 2020 for potential opportunistic trades.”
The characteristically low-key Kuwait is one of those trades that investors are patiently on stand-by for, with its CDS spread having tightened by 20bp to 44bp in 2019.
“There will still be substantial issuance in Saudi Arabia, despite the government cutting spending in 2020,” says Jason Tuvey, senior emerging markets economist at Capital Economics in London. “But if the Aramco IPO proceeds are used to finance the deficit, that could remove some of the impetus for sovereign debt raising.
Corporates called to the frontline
But in the face of a slowdown in China and the creeping fear of a US recession, global markets are at a critical point. To sustain the pace of issuance within an increasingly challenging macro-economic environment, more companies need to enter the market, say bankers. Some corporate trades this year set the market alight: Saudi Aramco made a landmark debut in April when it issued for the first time in international markets, a $12bn bond with maturities between three and 30 years that amassed a final order book of $100bn — unprecedented for a debut EM deal.
“Demand for corporates in the Middle East is outstripping supply, it is the sovereigns and banks dominating the market,” says Dehn at Ashmore. “The fundamental picture in the Middle East is getting worse — slower global growth will impact all currencies pegged to the dollar, but because of the supply-demand imbalance the market remains strong in the Middle East. There is strong excess demand for corporate debt — while sovereign issuance expanded this year to $49bn, the corporates have been lagging behind.”
GCC goes green
Corporate issuance could be boosted by green financing, a trend that has been slowly but steadily gaining traction among GCC issuers, as they look to diversify their investor bases. Although the amount of green debt raised in the GCC is a tiny proportion of total volumes, it is the topic dominating conversations and conferences across the region.
In May, Dubai-headquartered shopping mall operator Majid Al Futtaim (MAF) issued a $600m 10 year green sukuk — the first of its kind by an issuer from the region — and sparked discussions across EM capital markets about the new product after it achieved a zero new issue premium. The success of that deal led the issuer to tap the market again in October with an identical green sukuk issuance.
“Green bonds are gaining more traction, but it will take some time for GCC corporates to fully come to terms with the prerequisites, such as the continuous ESG reporting, the publication of comprehensive financial reports and the increased transparency,” says John Arentz, head of treasury at MAF.
Lenders remain hopeful that a sustainability push across the GCC will result in swathes of sovereigns, government-related entities and corporates tapping debt markets. Following the 2016 Paris Climate Agreement, all six GCC states announced plans and programmes to wean themselves off their oil dependency and increase their generation and use of renewable energy. That shift, expected to occur over the next 20 years, coupled with international investors threatening to dump bonds issued by borrowers whose carbon footprints are too high (in November, for example, Sweden’s Riksbank ditched its investments in Australia’s Queensland State and Canada’s Alberta Province), may be the impetus required to bring green financing into mainstream markets.
“We are seeing an increasingly disciplined approach to issuance: wider adoption of MTN programmes, separation of investor marketing and transaction execution and greater disclosure. This improved transparency will be key as we see more regional ESG fundraising,” says Cairns at FAB.
So far, only a handful of green bonds have been issued in the region: a $587m green bond issued by National Bank of Abu Dhabi (now First Abu Dhabi Bank) in 2017, the double green sukuk issuance by MAF in April and then October. At the time of writing, Jeddah-headquartered Islamic Development Bank had mandated banks to do the region’s third green sukuk. A little further afield, Egypt is working on a green bond, as are Tunisia and Morocco, the latter having issued a small green bond in November 2016 in local currency via its sustainable energy agency, Masen. Casablanca Finance City followed in September 2018 with its own Moroccan dirham green bond.
But the appeal is growing as issuers become aware of the untapped international investor base committed to ESG investing. “The more people you can appeal to on an issuance the better, and doing a green sukuk enabled us to access a wider investor base than a vanilla sukuk or bond,” says MAF’s Arentz.
Ali Ahmad, head of capital markets FIG, Africa and Middle East at Standard Chartered in Dubai, believes that companies are likely to drive issuance in 2020, though many banks are developing ESG frameworks and could also be candidates to issue sustainability-linked and green debt. “There is greater appetite from international investors now for green debt,” he says. “Increasingly funds when presented with identical vanilla and green bonds will select the latter, while the issuer gets the benefit of investor diversification and publicity points.” GC