BAHRAIN. Running a state budget deficit and facing a prolonged period of civil unrest, Bahrain is not in the same league for investors as the Gulf's wealthier oil exporters. But good timing and strong demand for regional assets in general mean a planned bond issue by the tiny kingdom is likely to go well.
Bahrain is sounding out investor appetite at roadshows this week for a possible issue of an international, conventional bond. Bankers said Bahrain's first conventional debt offering since 2010 would be open to qualified investors in the United States and elsewhere, and might be as large as US$1.25 billion.
Bahrain last tapped the international market in November with a US$750 million, seven-year sukuk (Islamic bond), which was largely sold to investors in the Middle East. The upcoming issue will not be able to count on interest from a deep pool of Islamic investment money in the Gulf, so it will be a tougher test of market confidence in Bahrain.
Bankers said Bahrain was eyeing a seven- or 10-year issue, which should appeal to institutional investors in the West, who have been showing interest in Gulf debt as a safe haven while the financial crisis has hurt other markets around the world.
"The timing is very good for Bahrain; this issue has been rumoured for a long time now and we are seeing GCC (Gulf Cooperation Council) credit markets trading at some of the tightest yields for years," said Thomas Christie, sales trader at Rasmala Investment Bank in Dubai.
"Combined with the fact that the market is very liquid currently and searching for yield, we should see any Bahrain issue do well."
With oil prices sliding, Bahrain's state finances may come under pressure. Brent crude oil fell to an 18-month low of US$91 a barrel on Thursday, from above US$120 early this year; the oil price which Bahrain needs to balance its budget jumped to $114 in 2011, the highest level in the Gulf, from just US$80 in 2008, the International Monetary Fund said in April.
The government's budget deficit shrank to US$83 million in 2011, the lowest shortfall in three years and well below a projected gap of US$3.3 billion, because oil prices were higher than expected. But with oil now sliding, this year's deficit may be larger than last year's.
Another issue for investors is protests by Shi'ite majority Muslims against the Sunni-dominated government, which have continued for over a year. They have not prevented the economy from resuming growth after a brief contraction early last year, but it is not clear how the political problem may be resolved in the long term.
For now, however, the signs are that investors will happily accept these risks. One positive is that the country's absolute level of external debt is still very low, at 14 percent of gross domestic product, according to Bahrain's bond prospectus.
Perceptions that Saudi Arabia's Sunni rulers will do what is necessary to support Bahrain's government, fuelled by a Saudi proposal in recent months for a closer union of Gulf states, are also important.
The bond prospectus said that although a US$20 billion fund planned by wealthy Gulf Arab states last year to aid Bahrain and Oman had not yet been capitalised, Bahrain expected to receive an allocation soon, which would come in addition to money already earmarked in its budget for priority projects.
Bahrain already relies on output from Saudi Arabia's Abu Safa oil field for some 70% of its budget revenue. Analysts have said Riyadh might give Manama more oil from the field if its budget runs into trouble.
These factors, along with a general tightening of Gulf bond spreads, have helped to cause an impressive drop in the cost of insuring Bahrain's debt against default over the last several months. Its seven-year credit default swaps were at 353 basis points on Thursday, compared to 394 bps at the end of last year.
Analysts said the need to attract conventional investors with the new bond, rather than Islamic investors facing a very limited supply of sukuk, meant Bahrain would have to be fairly generous in pricing the debt.
"They will have to price more competitively, given it's a conventional; a sukuk would probably be cheaper," said Raza Agha, senior economist for the Middle East at RBS in London.
The Bahraini sukuk issued last year was yielding 4.94 percent on Thursday, off a low of 4.78% hit on May 1, Thomson Reuters data shows.
Bahrain's 10-year, US$1.25 billion conventional bond issued in 2010 was bid at 5.64% on Thursday; yields have compressed about 27 bps in the last two weeks.
The new issue will need to offer a spread in the low 400 bps area over midswaps for it to interest investors, Christie said. Currently, 10-year midswaps are around 1.75 percent, he added, so this would equate to a yield of at least 5.75%.
Christie said he hoped the new conventional bond would create a more liquid benchmark for the sovereign, since the recent Bahraini sukuk was majority-held by local Bahraini institutions.
Dubai's CDS trade at a similar level to Bahrain's, so the performance of Dubai's US$650 million, 10-year sukuk since its issue in May is encouraging. The sukuk was bid at 5.74% on Thursday, having tightened more than 50 bps.
Bahrain is rated BBB by Standard & Poor's. It is unlikely to achieve a yield as low as most sovereigns with the same rating, because international investors demand a regional premium from the Gulf. But the comparisons still look positive for Bahrain; Russia, also rated BBB, issued a US$2 billion, 10-year bond in April which was yielding 4.00 percent on Thursday.
Lithuania, rated BBB, issued a US$2 billion, 10-year bond just weeks before Bahrain's last conventional issue in 2010. The Lithuanian bond, priced at 7.375% at the time, was yielding just over 4.50% on Thursday, according to Thomson Reuters data.
Bahrain's "current curve is attractive at current levels compared to other credits rated BBB," RBS's Agha said. "There is no question of any sovereign repayment difficulties given the close ties Bahrain enjoys with other GCC countries, particularly Saudi Arabia."
JP Morgan Chase, Citigroup Inc, Standard Chartered and Gulf International Bank are mandated to arrange the investor meetings, which will run until June 26.