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Cash-rich Islamic funds fuel wild Dubai sukuk rally

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Dubai 2014 sukuk yield plunges 235 bps since February; Fundamental factors support a rally; But some think euphoria has gone too far; Liquidity temporarily boosted by maturities; Approach of Ramadan may be spurring purchases

July 18, 2012 5:24 by



A spectacular rally in Dubai-linked Islamic bonds is pushing yields to record lows and influencing prices in the entire Gulf debt market. Some investors think the rally has reached excessive proportions, potentially setting bonds up for a partial pull-back when the euphoria starts to fade.

Dubai’s $1.25 billion sovereign sukuk, issued at a profit rate of 6.396 percent in November 2009 and maturing in 2014, was yielding just 3.2 percent on Wednesday, for example.

That is a yield plunge of about 2.35 percentage points since early February — an impressive gain for any credit and especially for Dubai, which until recently was seen as the ugly duckling of the Gulf because of its 2009 corporate debt crisis.

“Dubai Inc bonds have rallied significantly in the past few weeks and compressed spreads to ridiculously low levels,” a regional trader said, requesting anonymity because he was not authorised to speak publicly.

“The market has been overbought for a while and now it’s just trading on sentiment.”

PLAUSIBLE

Dubai-related sukuk have been surging across the board. Emaar’s $500 million, seven-year sukuk, issued at 6.4 percent last week, was bid at 5.78 percent on Wednesday.

There are some well-known and plausible reasons for the rally. Dubai’s property market, the source of its debt problems, has been stabilising and even picking up in some areas, while its state-linked firms have been moving aggressively to resolve their debt restructurings.

Dubai’s five-year credit default swaps, which represent the cost to insure against default, tightened to around 323 basis points this week, a nearly one-year low.

“Barring broader risk-off sentiments in global markets, the key to watch is whether Dubai CDS can break through the 300-320 bracket…that could well be possible if risk stays bid,” said Raza Agha, senior economist for the Middle East and North Africa at RBS in London.

In Emaar’s case, the company’s business appears to be recovering significantly; analysts polled by Reuters on average expect the big property developer to post in coming weeks a second-quarter profit of 516.3 million dirhams ($141 million), which would be a 106 percent increase on a year earlier.

SPECIAL FACTORS

Special, temporary factors also appear to be behind the Dubai sukuk rally, however, and the market could lose steam when these eventually fade.

One factor is an excess of idle funds, especially Gulf Islamic funds, searching for investment targets. This has been expanded by the maturing of several big regional bonds in the past few weeks.

“Several sukuk have matured recently, and the holders of that paper are now looking to redeploy that cash into new sukuk. This has helped to increase liquidity in the market even more,” said Nick Stadtmiller, head of fixed income research at Emirates NBD.

 

Earlier this week, Saudi Arabia’s Dar al-Arkan Real Estate repaid a $1 billion sukuk from cash and proceeds from land sales. Prior to that, two Dubai state-linked firms, DIFC Investments and Jebel Ali Free Zone (JAFZA), repaid their sukuk, freeing up $3.25 billion. Emirates airline also repaid a $550 million sukuk.

A second factor is the approach of the Ramadan holy month, which is expected to begin around July 20. Trading turnover tends to fall during that month, so investors are scrambling to get hold of bonds before that happens; the dramatic rally of the secondary market has made some of them desperate.

Although there has been heavy supply of new sukuk in the last couple of months – the government ofQatar issued a $4 billion sukuk earlier this month, the largest dollar-denominated Islamic bond ever seen – there is no sign that it has satisfied investor demand. Oversubscriptions have prompted diappointed investors to buy the new sukuk in the secondary market, bidding prices up further.

And the global financial crisis continues to encourage interest in the Gulf, which to many looks like a safe haven compared to Europe and the United States.

This factor is unpredictable, however. If the global crisis continues to worsen and oil prices resume falling, the Gulf could quickly lose its safe-haven image. And if the global outlook somehow improves in coming months, investors will no longer need safe havens as much.

Some analysts also note that Dubai’s economic, fiscal and corporate debt outlook, while improving, still carries risks. Sources told Reuters this month that Royal Bank of Scotland and two other banks had abandoned talks on restructuring Dubai Group’s $10 billion debt and threatened to bring unprecedented legal action against the investment vehicle of Dubai’s ruler.

“Debt refinancing will remain an issue for the next several years, but the progress to date bodes well for the process,” Emirates NBD’s Stadtmiller said.

“I would expect regional credit markets to be relatively stable if global risk aversion were to spike, but it would be a mistake to assume the local market would be immune to global problems.” (Editing by Andrew Torchia)



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