GCC Debt Smashes All Records

GCC sovereigns have raised a record $50.5bn in international bond issuance to date this year, smashing last year’s previous record of $37bn as they seek to cover their burgeoning budget deficits, according to data compiled by MEES.

Saudi Arabia has accounted for the lion’s share with $21.5bn, followed by Abu Dhabi with $10bn, Kuwait with $8bn, Oman also with $8bn and Bahrain with $3bn.

Less than three years ago, Saudi Arabia, Kuwait and Oman had never issued debt in the international markets but the plunge in oil prices since the end of 2014 sent their budget deficits soaring.

Indeed, while political relations have frayed throughout the course of the year, one front on which the GCC is united is that, for the first time, all six states have bonds outstanding in international debt markets.

With its sizeable $3 trillion pool of reserves and relatively low debt-to-GDP ratios, the GCC benefits from high credit ratings relative to other emerging market (EM) issuers. The region’s historically low level of debt issuance highlights the scarcity value of recent bonds.

Yield-thirsty fixed income investors are increasingly being drawn to higher-yielding GCC bonds. The US Federal Reserve gradually started to raise interest rates in the second half of 2016 but they remain at an all-time low while at the same time, bond yields are currently near zero or negative in many key bond markets such as the UK, Eurozone and Japan. The Bloomberg Barclays GCC index provided a 3.35% return in the first half of 2017 compared with a 1.38% yield on US treasuries, and 1.89-2.31% yields on 10-year to 30-year US bonds.

CORPORATE BONDS TAKE OFF

However, a new development this year has been the surge in domestic bonds; issuance of corporate debt on local currency markets has more than doubled from $8.93bn in 2016 to $17.23bn to date in 2017 (see charts).

With banks becoming more stringent in their lending practices amid tighter liquidity conditions, corporates are being forced to become more active in the bond market.

Indeed, the Gulf’s 56 leading listed commercial banks achieved a 6.5% growth in assets in 2016, driven by increased lending to the government and government-related entities (GREs), according to a June 2017 KPMG report on GCC banks, which also noted that their impairment charges rose by approximately 25% in 2016.

In its most recent report on GCC capital market issuance, published 14 November, international ratings agency S&P notes that it “sees an emerging trend in budget-constrained governments increasingly looking to their GREs to tap capital markets for corporate and project bonds.”

On 6 November Abu Dhabi Crude Oil Pipeline (Adcop), a wholly-owned subsidiary of state-owned oil giant Adnoc, issued $3bn of project bonds - one of the largest-ever Middle East non-sovereign bond offerings. The offering was “significantly oversubscribed by more than three and a half times, exceeding $11bn in orders” (MEES, 10 November).

Like other Gulf NOCs, Adnoc is looking to maintain its spending on capacity expansion in the face of constrained government revenues.

Meanwhile, on 26 October, state-owned Nogaholding which controls Bahrain’s key oil and gas subsidiaries, raised a 10-year $1bn debut bond which attracted order books of $2.6bn (MEES, 27 October). The issue was priced at 7.25%, slightly tighter than the initial pricing of 7.50% and follows the government’s raising of a $3bn three-tranche international bond in September (MEES, 22 September).

Other large noteworthy corporate issuances in 2017 have included Oman Oil Company (OOC) and state-led Petroleum Development Oman (PDO), Kuwaiti petchems JV Equate, Qatar Reinsurance and Saudi firm Acwa Power.

The most high-profile corporate issuance to date was the $3bn that state oil giant Saudi Aramco raised via its debut sukuk issue, part of the company’s plans to raise $10bn in debt ahead of its IPO slated for late-2018 (MEES, 24 March). The $3bn raised was in excess of the $2bn previously-touted.

SUKUK SURGE

Along with the trend of increased corporate debt issuance, there has been a huge uptick in GCC sukuk issuance for corporate and infrastructure financing. During the first nine months of 2017, issuance in this segment increased to $6.8bn, up from $2.8bn during the same period of 2016.

For a region that has traditionally been dominated by relationship-driven bank lending, these are significant developments.

CHANGING INVESTOR PROFILE:

“The syndicate loan market was very active in previous years, however this year bank lending has slowed as rising interest rates make bank funding less competitive,” Anita Yadav, senior director of global markets and treasury and head of fixed income research at Emirates NBD, tells MEES.

Until 2014, the biggest buyers of Middle Eastern bonds were the local banks buying mainly for their asset and liability management (ALM) books, with almost 80% of the bonds issued being held by local banks’ ALM books, small family offices and local private bank clients.

“In recent times, most large sovereign deals have been placed with international investors,” says Ms Yadav.

“Though some of this does get bought back by the GCC investors in the secondary market, overall we estimate that still a good 35-45% of the bonds and sukuk remain in the books of the international investors, particularly the longer tenured securities.”

Demand for GCC bonds with longer tenors has especially derived from insurance and pension companies.

FUTURE DEMAND

Looking ahead, GCC countries’ ambitious spending plans ensure a continued need for bond issuance.

The GCC faces high infrastructure project spending requirements which S&P pegs at $120-150bn annually (including transport-related projects) between now and 2019.

Saudi Arabia’s ‘Vision 2030’ program has huge infrastructure needs, but there are also sizeable infrastructure projects taking place in Qatar in relation to the 2022 football World Cup, as well as those relating to the Expo 2020 Dubai, whilst other GCC countries such as Bahrain are looking to promote infrastructure as a way to boost economic growth.

In terms of major corporates, Aramco, Saudi Telecom and Saudi Electricity are all expected candidates for issuing in 2018.

“I expect between $70bn and $100bn of new issuance in 2018,” says Ms Yadav. “The sovereign issuance will mainly be in order to fund their ongoing budget deficits.”

Prevailing depressed economic growth means that GCC countries’ budget deficits and fiscal reform programs show no sign of abating in the near future.

In mid-October, the World Bank lowered its 2017 GDP growth forecast for the GCC to 0.7% from 1.3% previously, citing slower oil price recovery and production cuts linked to the Opec agreement.

While it expects growth will then improve in the next two years, with regional growth expected to average 1.9% in 2018, followed by 2.7% in 2019, this still falls substantially short of levels seen prior to the oil price drop in 2014 and the 4.5% average seen before 2011.

The IMF in its latest Middle East regional economic outlook, released 31 October, reckons that Saudi Arabia will need an unlikely jump in the oil price to $70/B in order to balance its 2018 budget. And this is without factoring in the latest Saudi plans to boost spending next year (MEES, 3 November). The $70/B break-even oil price is, however, down from $96.60/B in 2016.

Meanwhile, in its 15 November report on Kuwait, the IMF notes that the country’s gross financing needs will remain large; it forecasts that a fiscal deficit of about 15% of GDP annually will generate cumulative financing needs of some $100bn over the next five years, although this is based on seemingly-conservative oil price assumptions of $49/B in 2017-19 rising to $52/B over the medium term.

Bahrain’s two-year budget for 2017-18 projects a deficit of $7.1bn, with total spending of $19.3bn and total revenue of $12.2bn.

Bahrain is the only GCC state that is rated junk by all three major credit rating agencies, so it will have to be generous in its future debt pricing; all three agencies have negative outlooks on Bahrain.

“Key drivers of issuance are the availability of capital and the expected continuation of low growth in the Gulf and a tempering of austerity measures in cuts to subsidies,” Karen Young, Senior Resident Scholar at the Arab Gulf States Institute in Washington, tells MEES.

“If governments ease up on expenditure cuts, there will be budget deficits, particularly with oil prices somewhat flat or below $60/B, and these will require external finance. The worst-case scenario for the debt profile of the region would be some problem in repayments starting in 2021 or 2026 [when many bonds are set to reach maturity], and, of course, any threat to currency stability.”

As far as corporates are concerned, S&P Global expects their refinancing needs will also remain significant, with $23.6bn in terms of capital market financings coming due ($11.9bn of corporate sukuk and $11.75bn of corporate bonds) between 2017 and 2019.

POSSIBLE HEADWINDS

But there are other factors that may weigh down on the future attractiveness of GCC bonds.

On 1 November the US Fed held its benchmark interest rate unchanged at 1-1.25%, but it is widely expected to hike the rate in December.

Yields from Gulf countries, all of whose currencies are solely pegged to the greenback bar Kuwait’s which is pegged to a basket of currencies, are likely to rise in tandem.

Kuwait, Saudi Arabia and Abu Dhabi have this year all issued bonds priced off US T-Bills.

And it should come as little surprise that widespread geopolitical uncertainty will have a bearing on future investor appetite.

“The most unpredictable and significant risk factor is political risk, most notably the increasing tensions between Saudi Arabia and Iran playing out in Bahrain, Iraq, Lebanon, Qatar, Syria, and Yemen, charges of corruption against ministers and leading business figures in Saudi Arabia, and the ongoing trade embargo of Qatar,” noted S&P Global in its 14 November report (MEES, 24 November).

Qatar is the one notable absentee from GCC dollar debt issuance this year – the last time it tapped the international bond markets was in May 2016 when it issued $9bn to partially cover its fiscal deficit. It has sat on the sidelines ever since its GCC neighbors Saudi, Bahrain and the UAE severed diplomatic ties with it in June and it became subject to trade embargos with several Arab countries.

Around 85% of the GCC ratings actions that S&P Global has taken this year have been negative. Most of those have been linked to Oman and Bahrain, the sovereigns with the region’s highest budget deficits, and Qatar.

However, the regional dispute did not seem to have deterred investors from participating in Bahrain’s $3bn international bond issue in September; its largest ever bond which was met with order books in excess of $15bn. (MEES, 22 September).

“Political risk in the Mena region could certainly change the risk and yield profile, but, conversely, it could also increase government revenue in a rise in oil prices, so there is some protection built in for the larger economies like Saudi Arabia and the UAE,” says Ms Young.

“Debt financing is becoming a staple of GCC budgets. I think we can expect more Saudi issuance, especially in sukuk. Bahrain will need to issue more debt next year, as will Oman. In short, while there is market appetite for long term sovereign debt, Gulf states should take advantage of the availability.”

While 2017 has been a bumper year for bonds and it has attracted significant international investment, in many respects the Gulf bond market remains in a nascent state, particularly with regards to its share of the investible universe.

According to JP Morgan Credit, the GCC currently represents 15% of the stock of EM debt and 10% of the flow, so there is significant room for investors to increase their allocations.