The Sukuk market, and fixed income market as a whole in the GCC, does not have the same feel it had last May. Whilst spreads are actually tighter than last May, this is not the sole reason for the formation of a bubble.
Firstly, in the sukuk world, there is simply nowhere near enough supply of sukuk to meet the ever-growing demand. If anything, this will actually worsen as we lose some names later this year, such as TDIC and GE.
Secondly, the economic back drop is very different to a year ago. Dubai has shown great strength, and in winning the Expo 2020, has pretty much secured economic strength for the next six to seven years. Having said this, we don’t see the market tightening any further from here for the short term, particularly with the summer months and Ramadan fast approaching. I expect that things will simply tick over and pretty much follow US Treasuries and US swap rates. I can see 10-year US Treasuries in particular range between a low of 2.50 per cent and a high of 3 per cent for the short to medium term. All of this should give some stability to sukuk prices over the coming months rather than a May sell-off, as we saw in 2013.
Although Dubai’s five-year CDS is currently trading 30 basis points (bps) inside of the pre-May 2013 sell-off (174bps), there are a number of factors to consider, notwithstanding the positive news flow out of Dubai in the past six months on the back of the Expo 2020.
The geopolitical turmoil in Russia and Ukraine has resulted in a flight to safety, which has led to US Treasuries rallying, and from an EM asset allocation perspective, investors have had to adjust geographic exposures accordingly.
Dubai credit has tracked US Treasuries higher, and credit spreads have also tightened due to idiosyncratic factors. A case in point is the recent rollover of Dubai’s debt to the UAE Central Bank ($10 billion; Dh36.73 billion) and Abu Dhabi ($10 billion) at 1 per cent, which reflects Abu Dhabi’s overwhelming support for Dubai. Bearing that in mind, if we then compare CDS spread differentials between Abu Dhabi and Dubai with that of Abu Dhabi and its GREs, Dubai’s CDS still looks relatively wide.
The caveat to that argument however, is Dubai’s concentrated exposure to the real estate market, which has performed very well of late. Emaar announced that first quarter profits were up 55 per cent year-on-year. This could be seen as a sign of overheating, however, the demand for real estate from residential buyers is much higher today than it was pre-2009, when speculators accounted for a large proportion of the demand. In addition, in the period leading up to the Expo 2020, the infrastructure build will require an inflow of foreign skilled workers, keeping the market buoyant.
As mentioned, the demand for sukuk remains stronger than supply and whilst bank funding remains relatively cheap in the region, issuers prefer to tap the loan market instead of bonds/sukuk. As we enter into a rising rate environment in the US with the Fed continuing to taper quantitative easing (QE) many issuers will look to enter the market by the end of the year, in order to lock-in relatively low rates.
The sukuk pipeline for this year looks promising, with a number of planned debut issues from sovereign issuers, such as the UK, Luxembourg, Senegal and Hong Kong. However, issuance to date has been rather light with transactions from Dubai Investment Parks (DIP), the Islamic Development Bank (IDB), Saudi Electricity Company (SECO) and Damac Real Estate coming to the market so far this year, all of which had been oversubscribed multiple times.
SECO and DIP are trading above reoffer price while Damac and IDB have sold off slightly. Damac, although oversubscribed at launch, has since traded down 1 per cent in the secondary market as the issuer took advantage of the demand by increasing the size from $500 million to $650 million and tightening the price from five-year US swaps +325bps to +310bps (therefore lowering the yield).
This is an opportune time for issuers to take advantage of low yields as dovish comments from the US Fed keep yields on US Treasuries low. However, as tapering continues and effects of bad weather get priced out of the US data, 10-year US yields could climb back towards the 3 per cent level.
— The writer is director of Fixed Income, Bank of London and the Middle East
