The launch of Damac Properties’ five-year sukuk (Islamic bond) in early April is the latest in a series of issues by pure corporates in a market that has traditionally been dominated by sovereigns and government-related entities (GREs). Such was the demand that the Dubai developer was able to expand its offering by $150m to $650m and tightly price it at a 4.97 per cent coupon rate.

Neither investment grade-rated nor backed by the government, Damac is part of an increasingly diverse stream of firms that has been able to successfully appeal to a wide range of international investors. It is both a reflection of growing investor confidence in the economies of the GCC and an indication that regional bond markets are starting to mature.

There was a surge in corporate bond issuance at the end of 2013, when several companies, including Dubai-based GEMS Education (which issued a perpetual $200m sukuk) and Qatari telecoms firm Ooredoo (a five-year $1.25bn sukuk), made their debuts.

Increasing appetite

With strong economic growth forecast in the medium term, GCC corporates are expanding once more, eyeing new geographical territories and business areas. This comes with additional financing needs, which, together with favourable pricing conditions, is driving the interest in selling bonds.

“I think we will see continued expansion of corporates tapping into the bond and sukuk market”

Doug Bitcon, Rasmala Investment Bank

“We definitely see more corporates looking at the bond market, with a number exploring the possibility of obtaining a rating [seen as a requirement by international investors],” says Fawaz Abu Sneineh, head of debt capital markets at National Bank of Abu Dhabi (Nbad). “Some may not have embarked on that path before as they didn’t need to, but now we see especially larger companies considering it.”

Non-government-related corporates sold bonds worth more than $4bn in 2013. While that represents just a tenth of overall issuance in the GCC, the inclusion of new names is seen as an encouraging trend in a market that lacks diversification.

“Damac being a newcomer is a good thing for the market,” says Montasser Khelifi, senior manager, global markets at Dubai-based Quantum Investment Bank. “They have a different profile, but investors realised Damac shows promise as it operates in the rising Dubai real estate market and has a low debt level.

“We’ve also seen good performance in other companies – [Saudi real estate developer] Dar al-Arkan has had a good rally in its sukuk prices and [Sharjah-based] Dana Gas’ restructuring has had a positive effect on its ability to issue a new sukuk last year. Taken together, the developments are very encouraging.”

The low interest-rate environment, which means coupons on bonds have dropped, makes it an attractive time for corporates, as well as other types of issuers, to make a move. The region’s lower risk profile, reflected in a four-to-ten-fold plunge in credit default swap spreads compared with 2009, helps keep prices affordable.

Dar al-Arkan’s $450m sukuk last year illustrates this well. It carried a coupon of 5.75 per cent, which is nearly half the interest on its 2010 bond, when it launched a similar-sized offering with a 10.75 per cent coupon.

Reducing risk

The attractive pricing allows companies to diversify their investor base away from banks and lengthen the maturity profile of their debt. By staggering their maturities – carrying both short-term loans and longer-term bonds – firms will have a less risky profile and be in a better position when the need for refinancing arises.

It is not just low prices bringing corporates to the market. In some cases, companies have no choice other than to tap alternative funding sources to loans. While banks are still able to fulfil the majority of financing needs, they are generally less willing to sign long-term loans amid tighter regulation on capital, such as the international Basel III regulatory framework.

“I think we will see banks, including [those] in the region, looking to manage existing exposures rather than adding new ones,” says Doug Bitcon, head of fixed income funds and portfolios at Dubai-based Rasmala Investment Bank. “So far, 2014 has been a bit different, though, with a lot of banks re-entering and offering longer-dated syndicated and bilateral loans to borrowers.

“I think we will see continued expansion of corporates tapping into the bond and sukuk market, although this is going to take time. Rather than only having shorter-term bank facilities, a lot of firms are looking to turn out those liabilities and access the debt capital markets.”

For corporates and GREs with longer-dated assets, it makes sense to match those to maturities with the same profile. In addition, companies may prefer the ability for bullet repayment, allowing them to pay the raised amount at the maturity date.

Supported by steady issuance by GREs and sovereigns, bond and sukuk markets are continually broadening and deepening, with some issuers having launched innovative structures and notes with longer tenors. Lenders have also become more active players in order to strengthen their core capital.

Depending on the needs of the issuer and investor appetite, innovative structures could become more common, although it is expected traditional structures will also stay in demand.

“The bond markets for GCC issuers have continued to broaden and deepen, with the first corporate hybrid issues in conventional and sukuk format seen in 2013, for example,” says Christoph Paul, head of debt capital markets at US-based Morgan Stanley’s Middle East and North Africa office.

“The specific decision to raise financing via loans or the capital markets will remain a case-by-case assessment, driven by a range of factors including choice of maturities, volume requirements, covenant and pricing considerations, and diversification strategies of issuers.”

Saudi Arabia and the UAE top the tables in terms of issuance, with the former mainly confined to a domestic investor base as rates on local currency-denominated bonds are cheaper than issuing in dollars. Saudi Electricity Company is an exception. It issued a double-tranche, $1.5bn sukuk in April, consisting of a 10-year tranche priced at 4.25 per cent and a 30-year tranche priced at 5.5 per cent, and has been a regular issuer in dollars for years.

But while corporates and GREs more frequently use bonds to fund their operations, many have yet to feel the need to issue project-specific bonds.

At the Mena Project Bonds Conference in Dubai in April, organised by US law firm Latham & Watkins, bankers said they hope to see one or two project bond issues in the next 12 to 18 months. Project bonds, the final step in the establishment of a developed yield curve, can be a time-consuming process as they are not as easily executable as loans. Banks will need to have a thorough understanding of the project specifics, various construction phases and existing lines of financing.

But projects may need to include more alternative funding sources in the future if bank liquidity dries up. Smaller, non-government-related suppliers in particular may struggle to get loans, exacerbating the need for GREs to set a benchmark through bond issuance. Firms could look to a model similar to Abu Dhabi’s $2.7bn Shuweihat S2 independent water and power project financing, which consisted of loan, bond and export credit agency tranches.

Forecast demand

Looking ahead, different needs may drive corporates, GREs, financial institutions and sovereigns to the bond market. How soon they plan to tap that source of funding will also depend on their readiness to issue as well as global conditions.

“Globally, interest rates are ultimately expected to go up, but if done gradually, I don’t think that will halt issuance – it will just cost issuers a bit more,” says Nbad’s Abu Sneineh. “Some may choose to reassess their options, but the ones who want long-term financing will still do it.”

Sukuk are likely to remain a popular option as they currently offer better pricing than conventional bonds and attract both conventional as well as Islamic investors.

The main challenge will continue to be the firms’ ability to present their stories, however. Some still need time to satisfy the more rigid requirements that come with offering a bond, including producing audited financial statements and obtaining a rating. Unless they are publicly listed, it will take effort to become more comfortable with the higher levels of transparency.

But if they manage to do that, it could give them access to a much wider base of investors, and, in turn, help the region further deepen its capital markets.