Gulf Markets: The Liquidity Well Runs Dry

Euromoney, November 2015

There are two trends underway in the Gulf capital markets today, individually interesting but problematic in combination. On one hand, a low oil price is finally pushing sovereigns back to the debt capital markets, often for the first time in years, with spillover effects that will increase the need for external funding for everyone from the banks to private companies. On the other, both local and international liquidity for debt funding from the region is ebbing. Put those two together and you have all the ingredients for a crunch.

There’s no great cause for alarm: a region of double A-rated sovereigns with little or no debt is always going to find a willing audience when it really needs one. But there is a sense of a new reality dawning in the region’s capital markets, and it’s going to take some getting used to.

First, the supply side. It has taken a while, but finally, the impact of the oil price is being felt by the region’s governments as they discover a shortfall in meeting their budgets. “We were operating in something of a suspension of disbelief for much of the latter part of 2014 and the first half of this year,” says Andy Cairns, managing director, global head of debt origination and distribution at National Bank of Abu Dhabi. “As oil came down from $110 a barrel in June 2014 to sub-$50 today, there was seemingly no impact on market liquidity and pricing.”

It was a halcyon time for borrowers, and it couldn’t really last. NBAD itself, for example, printed a 5-year dollar benchmark in 2010 at mid-swaps plus 178; a similar transaction this February priced at mid-swaps plus 85, a 50% tightening in the spread. Refinancings, tenor extensions and upsized deals have been rife right up until this year’s Ramadan, such as the AED3 billion refinancing loan signed by GEMS Education in August, or the US$1.5 billion ENOC syndication, with a door-to-door tenor of nine years, signed in June. “The trend for the last several years has been of ever tighter spreads, covenant relaxation and duration extension on both the loan and the bond side,” with “increasing amounts of bilateral lending because the banks had supra-normal liquidity,” Cairns says. “It was a great time to be a borrower.”

And it’s over, for the foreseeable future at least. Oil at below $50 doesn’t work for countries who base their budgets on much higher levels. According to NBAD estimates, budget break-evens in the Gulf states take place at $48 per barrel of oil in Kuwait, $61 in Qatar, $76 in the UAE, $97 in Oman, $102 in Saudi Arabia and $109 in Bahrain. Most of them have significant sovereign wealth they can draw upon – and that’s clearly happening, with SAMA withdrawing mandates from external fund managers in Saudi Arabia, and ADIA believed to be providing funds to the state (see sovereign wealth fund article) – but eventually the debt markets are going to have to come into play.

“Clearly there are deficits in the region that will need to be funded,” says Iman Abdel Khalek, director of Middle East debt capital markets at Citi in Dubai. “Most of those sovereigns have access to ample reserves, to local and to international capital markets. I think they are going to be looking at a combination of these sources.”

The use of local markets is already well underway, most obviously in Saudi Arabia, which had been out of the debt markets since 2007 before starting a new bond programme in riyals which could raise the equivalent of $27 billion by the end of this year. Oman, too, has been active in local currency debt.

Sooner or later, they are likely to look to the international markets. “We don’t yet see the GCC sovereigns reaching out to the international debt markets, but that’s something they will consider when conditions permit,” says Amir Riad, global head of corporate finance and investment banking at Abu Dhabi Islamic Bank. Now – with volatile markets, bearish sentiment against emerging or frontier markets, a China slowdown and the spectre of Fed rate tightening – is possibly not the time. But they can’t wait forever.

In fact, sovereigns are already believed to be mandating international bonds. Bahrain and Oman are thought to have done so, and this is just the start. “This year we have had only one GCC sovereign issue: $1 billion from Ras Al Khaimah,” the UAE emirate, says Cairns. “Next year conceivably could be 20 times that.” And that’s not a number just plucked out of a hat. Consider this: if Qatar, Saudi Arabia and Abu Dhabi all come to the market next year, which is not unfeasible, they are unlikely to go for much less than $5 billion apiece. Then add Bahrain, Oman, Dubai, Sharjah and Ras Al Khaimah for a billion apiece. “Regional issuance has been averaging $40 billion per annum over the past three years,” says Cairns. “So to add $20 billion of sovereign supply is a massive increment.”

And what’s interesting is the spillover effect towards other issuers. In fact, banks and corporates have been reasonably active issuers over the years of abundant liquidity, and are not obviously strapped for cash, but nevertheless the changing economics at the sovereign level will trickle down from there. “The GREs [government-related entities] are going to have to borrow, as they are no longer going to have cheques written to them by the government,” says Cairns. “Then the financial institutions are going to have to borrow, because they will no longer be benefiting from the deposits they had,” since the governments will be withdrawing their deposits because they need them to maintain their spending plans. “Then the corporates are going to have to borrow, because they aren’t going to be benefiting from the cheaper bilateral loans from highly liquid banks. It all points to increased pressure on funding.”

This would all be quite encouraging for the region’s debt markets, and certainly its investment banks, were it not for the other side of the coin: at exactly the time that the region needs more funding than ever, liquidity is diminishing.

“Over the summer, a repricing exercise took place,” says Aziz Ata, managing director and head of DCM for MENA at HSBC Bank Middle East. “Spreads have widened, not only in the GCC but in emerging markets globally.

“Are there no buyers from the region? Absolutely not. But the quantum and the strength of the buyer base has obviously been affected.”

A clear example of diminishing liquidity could be found in National Bank of Abu Dhabi’s second-quarter results announcement in July, which disclosed Dh37 billion (US$10 billon) of outflows of government deposits in the first half of the year alone. While the bank did attract new deposits to offset that outflow, the overall deposit position still shrank 3.1 per cent year on year overall. Announcing the result, CEO Alex Thursby spoke of “a major dollar liquidity squeeze in the UAE and the region due to lower oil sales and dollars moving to different markets.”

Seeing this coming, several smarter credits have used the syndicated loan markets in recent months in order to grab liquidity while they can. Qatar National Bank closed its biggest ever syndicated loan in March, a $3 billion, three-year unsecured term loan and its first since 2012. Then, in September, First Gulf Bank – which also last issued in 2012 – signed a $1 billion three-year term loan, followed shortly afterwards by Union National Bank, another Abu Dhabi institution, which raised $750 million in its first loan for nine years

Partly this was to meet new UAE liquidity requirements from the central bank, and to get ahead of Basel III regulations, but also something else was happening. “We are seeing financial institutions make pre-emptive strikes to capture that liquidity,” says Cairns. “We are seeing a high level of inquiry from regional banks looking to secure access to liquidity through the loan market, which is something we haven’t really witnessed for the last several years because banks have benefited from abundant, cheap and sticky deposits.” Secondary bond levels are “materially wider” than pre-summer, Cairns says, up to 95 basis points for senior financials. Also, those syndicated loans being closed today were mainly negotiated pre-summer; it is only the next round of loan financings that will give us an accurate gauge on how much wider the market now is.

But with banks themselves struggling for liquidity, picking up loans – particularly the sort of easy bilaterals that existed among long-familiar relationship banks in the region – is not as easy as it used to be either, which brings us to the debt capital markets. And here, it’s hard to get a read on liquidity, because at the time of writing there has been absolutely nothing to assess since NBAD’s bond in June (barring the special case of Etihad affiliate EA Partners, which isn’t really pure Gulf exposure).  “It’s hard to make an assessment on liquidity now, because we haven’t seen an issue since the summer to show it,” says Ata at HSBC. “When the primary market starts turning its wheels we will have a better sense of secondary market trading.”

We do have some sense, though, because of a deal that failed to make it to market. In September, Abu Dhabi Commercial Bank set about trying to launch a six-year bond deal, of unspecific size but a benchmark, with price talk at 155 basis points over mid-swaps, through Barclays, Bank of America Merrill Lynch, JP Morgan and ING. But after beginning marketing, it pulled the deal.

It is fair to say this deal has riled a few people in the UAE, feeling that it made a bad situation worse through questionable timing and execution. Why launch it in the week of Eid, for example, when people were already leaving to go on holiday, making the timing tight? Why launch a six-year maturity? “When things are tough you make it as easy as possible for investors,” says one banker, not quoted elsewhere in this article. “You give them a five year so they can reference it against every other five year: that’s where the regional appetite is. And most importantly, if you want to sell something to somebody, you sell it when the audience is in their seat, not disappearing for Eid.” Another adds: “Frankly speaking, ADCB has set a bad example. If the ADCB trade had been successful, by now you would have had five or six trades in the market, easily.” So it damaged sentiment? “Well, I can’t say no to that question. It furthered the fear factor.”

All are keen to stress, though, that ADCB’s failure to get its deal away is not necessarily representative of the entire market. “The story, in my opinion, is that the ADCB situation was more a function of poor transaction timing and tenor selection than it is an indication of the regional bid no longer being there,” says one banker. “The regional bid is still there – less than it was 12 months ago, but it’s still there.”

In fairness, ADCB may not have put the market back too far: at the time of writing, Qatar Islamic Bank was preparing a roadshow for a dollar Regulation S benchmark senior sukuk issue, through Barwa Bank, Citi, HSBC, Noor Bank, QInvest and Standard Chartered. Assuming that goes OK, most banks report a strong pipeline. The question then becomes what they’re going to have to pay, and where they’re going to get the money from.

Sovereigns won’t have a problem. “Sovereign issuers would be well received because there is a scarcity aspect here,” says Riad at ADIB. “They have not been repeat issuers, they are strongly rated governments, and they will be able to access markets at optimal pricing, though spreads will be wider than, say, a year ago.” Khalek at Citi agrees. “We would expect a very strong reception” for a GCC sovereign issuer in the international markets, she says. “Some, like Abu Dhabi and Qatar, haven’t been to the market for a number of years. The market would welcome an issue from either of those sovereigns.”

Further down the curve, though, things may be a little trickier. “Regional banks, who are an important consideration for local issuers in the capital markets, are going to be more selective in terms of where they deploy their liquidity,” says Riad. “And we should not forget the emerging markets fund outflows, which over the last five weeks have been around $11 billion. So while we don’t see any investor pools exiting, they are cautious.”

In such an environment, the power of long-standing relationships – an unspoken agreement that banks will buy one another’s paper – may be tested. “Regional bids will continue to support regional names, but at a lower quantum,” Riad says. “People will prioritize certain deals over others, based on pricing, expectation and other things. In the regional space relationship angles are important, but not to the extent that they become a standalone decision. It has to be combined with reasonable economics.”

Cairns expects to see “a bifurcation between top and second tier regional credit. Liquidity pressure is a regional phenomenon, not a global phenomenon: bankers in New York and London are not experiencing it. Top tier credits have international counterparties so will have greater access to offshore liquidity.” He also notes that, since the FIG/corporate issuance split today stands at about 85/15, there’s much more room in investor portfolios for more corporate deals than bank issues. Just as well, then, that in the main don’t have an urgent need for more capital. As Riad says: “”Banks here are extremely well capitalized compared to 2008. There isn’t going to be a rush of banks going out and issuing new instruments, both as a function of growth expectations in their loan books and the state of the overall economy.

Even if liquidity is tight, not everyone is going to have a choice. Granted, GREs aren’t going to be quick to issue – “not many are going to be in a growth mode in the coming year or so,” says Khalek – but what about expiring issues? “There are quite a few redemptions coming, and that’s going to be a driver of new issuance,” says Ata at HSBC. Still, he sees little reason for alarm. “Frankly, yes, spreads are wider than they were before the summer, but if you look from an all-in yield perspective, you are not worse off. We just need one or two deals in the market being executed well and sentiment will pick up significantly.”

Not the end of the world, then, but a more bracing market to deal with than the easy years of apparently endless liquidity.  An environment in which issuers might just have to pay up a bit for a change.

Cairns sees it like this. “Let’s see this as the new normal, as opposed to the supra-normal liquidity that we have benefited from for the last few years,” he says.

“The sky isn’t falling in, but we have to accept the obvious: that most regional money comes from hydrocarbons and if the price of oil is 50% lower, it’s going to affect regional liquidity.”

ENDS