Dubai: Middle East corporate bonds are mispricing the effects plunging oil prices are having on the region’s finances, leaving borrowers vulnerable to a deterioration in market sentiment.
The average premium investors require to hold bonds from the Middle East and North Africa was 159 basis points on Friday, two points lower than this year’s high in June, JPMorgan Chase & Co. indexes show. That compares with 165 basis points on US investment-grade debt, according to the Bloomberg US Corporate Bond Index.
“The Middle East’s grossly mispriced credit spreads will eventually blow out to reflect the new economic reality,” Gassan Chehayeb, the chief investment officer at Texas-based Sancta Capital Group Ltd, a distressed-debt money manager, wrote in a note this month. The change in spreads since Opec’s decision to maintain oil output last year doesn’t take into account “the risk premium investors should demand given the deteriorating fundamentals,” he said.
With crude prices close to six-year lows, budget deficits in the six-member Gulf Cooperation Council will reach 13.2 per cent of gross domestic product this year — compared with a surplus in 2014 — as financial buffers in some nations are depleted, the International Monetary Fund said Wednesday. The pricing discrepancy that has left GCC spreads narrower than in the US since August reflects how Middle Eastern banks and institutions have favoured a buy-and-hold strategy amid a slump in bond issuance to a four-year low, according to Abdul Kadir Hussain at Mashreq Capital DIFC Ltd.
‘Overvalued’
Brent crude, the benchmark for about half the world’s oil, has slumped more than 30 per cent since Opec decided to hold production steady in November. It was trading at $47.99 a barrel at 12.16pm in Dubai on Monday. Saudi Arabia, the biggest Arab economy, relies on oil revenue to fund about 90 per cent of its spending, and the decline will widen its budget deficit to more than 20 per cent of economic output this year from 2.3 per cent last year, the IMF said on Wednesday.
The bonds don’t reflect the change in the region’s “risk profile,” said Hussain, chief executive officer of Dubai-based Mashreq, which runs the region’s best-performing sukuk fund, describing corporate debt as “overvalued.” A change could occur if “you have a lot of new issues which then come and reprice the market,” he said.
A 15 per cent decline in bond sales from the Middle East and North Africa this year to $30.3 billion (Dh111.29 billion) has helped keep bond yields depressed. Issuers held back sales in the summer to avoid the volatility in bond markets sparked by China’s slowing economy and expectations that the US. Federal Reserve was close to raising interest rates after leaving them near zero since 2008.
‘Pockets of Value’
The political situation in the Middle East isn’t helping. Saudi Arabia is leading a military coalition battling Houthi rebels in Yemen, a conflict that has killed more than 5,400 people since March and displaced nearly 1.5 million.
In Syria, Saudi Arabia is providing cash and weapons to allies fighting to topple President Bashar Al Assad. Russia’s entry into the conflict may have tilted the balance in favour of the government in the four-year war, which has displaced 7.5 million people. Daesh (the self-proclaimed Islamic State of Iraq and the Levant) extremists also hold sway over large parts of the country.
Some widening of spreads in the region over the past three months has created pockets of value as oil remains in a narrow range and credit risk is contained, according to Anita Yadav, the Dubai-based head of fixed-income research at Emirates NBD PJSC, the UAE’s second-biggest bank by assets.
UAE paper including from Abu Dhabi National Energy Co and Bank of Sharjah is oversold “and we also find value in Oman Electricity Transmission Co.’s 2025 bond,” Yadav said by phone on Tuesday.
Deficits
Saudi Arabia may run out of financial assets needed to support spending within five years if the government maintains current policies, the IMF said. The same is true of Bahrain and Oman, while Kuwait, Qatar and the UAE have financial assets that could support them for more than 20 years, the Washington-based lender said.
Investors are “still not fully pricing in the geopolitical risk in the region nor the cheaper oil,” Ahmad Shehada, executive director for advisory and institutions at NBAD Securities LLC, a unit of the UAE’s biggest bank, said by phone from Dubai on Thursday. Middle East spreads “should be about 20-30 basis points higher than the US and we will eventually adjust when governments start to cut spending and corporates start to report numbers that are not as expected,” he said.