* Qatar's first sovereign sukuk in nine years
* Plans 5- and 10-year tranches
* Price talk at MS+135 bps for 5-yr, MS+175 bps for 10-yr
* Size not yet set, but demand seen very high
* Outstanding conventional bonds tighter since issue
By Rachna Uppal and Mala Pancholia
DUBAI, July 10 (Reuters) - Qatar is returning to the international Islamic bond market this week after an absence of nearly a decade, and initial price talk indicates it is leaving enough on the table to entice a huge investor pool - and possibly print the Gulf's largest dollar-denominated sukuk this year.
The Gulf Arab state plans to issue a two-tranche sukuk, with early price talk in the area of 135 basis points over midswaps for the five-year portion and 175 bps over for 10-year paper.
This equates to a profit rate of about 2.22 percent for the long five-year tranche maturing in January 2018 and about 3.4 percent for the long 10-year paper maturing in January 2023.
The initial pricing guidance is wider than some in the market had expected, given heavy global demand for high-grade Gulf paper and strong demand for sukuk among idle Islamic investment funds.
Qatar may be aiming to maximise orders for the sukuk, which would allow it to make large allocations to global investors and particularly Islamic investors in southeast Asia. Allocations for big Gulf deals last month, including Bahrain's 10-year, $1.5 billion sovereign bond, showed investors from outside the Gulf were increasingly muscling in on new issues.
"Indicative pricing is a couple of basis points cheap to the existing conventional curve," said Doug Bitcon, head of fixed income funds and portfolios at Rasmala Investment Bank in Dubai.
"Bearing in mind that sukuk typically trade inside conventional paper as well as expected demand from regional banks, the indicative pricing is attractive."
Qatar, the world's top liquefied natural gas exporter, normally doesn't issue small; it printed a $5 billion, multi-tranche conventional bond last November, and prior to that a $7 billion bond in 2009. The sovereign has not issued a sukuk since 2003, when it priced $700 million of seven-year paper.
The amount of assets made available to back this week's sukuk suggests Qatar could issue up to $4 billion of paper, though it has no obligation to do so and many in the market expect a smaller amount.
This year's largest dollar sukuk issue so far is Saudi Electricity Co's $1.75 billion deal in late March, which Qatar looks able to exceed easily if it chooses.
Several market sources said they expected Qatar's pricing guidance to tighten before launch.
"They (Qatar) will tighten at least 10 bps...What they are doing is showing generous guidance to get the orders in," said a fixed income trader at a regional bank.
"Then they will tighten and print big," he said, predicting Qatar would issue between $2 billion and $3 billion.
Biswajit Dasgupta, head of treasury and trading at Invest AD, said: "We expect that they'll look to build a really large order book and then tighten the pricing. The market sense is that final pricing will be more or less in line with the current curve for the 2017 maturity, with the sukuk premium making up for this issue's longer duration.
"We think Qatari banks will be the biggest bidders, although the combination of a high credit rating and the sukuk structure will probably receive decent demand from some Islamic investors out of Asia."
Qatar's outstanding conventional bonds have tightened since issue in November. The $2 billion, 3.125 percent five-year portion of its last bond was bid at a yield of around 2.2 percent on Tuesday morning, according to Thomson Reuters data. The $2 billion, 4.5 percent 10-year tranche was at 3.23 percent.
That means the sukuk's indicative pricing is now roughly in line with the conventional bond for the five-year tenor and nearly 20 bps wider for the 10-year - implying there may be more room for the 10-year to tighten in subsequent price talk.
The sukuk will have an ijara structure, a rental or lease arrangement, according to the prospectus. In a common form of ijara, the originator sells assets to a special-purpose vehicle which issues sukuk certificates to obtain funding to pay for the assets.
According to a ratings release on Monday from Standard & Poor's, which has rated the potential sukuk AA, on a par with its rating for the sovereign, the underlying assets will be state-owned buildings and land in Qatar.
The Islamic debt market has been resilient during the latest phase of the euro zone crisis and most regional deals so far this year have been in the form of sukuk. Unrated Dubai issued a two-tranche $1.25 billion sukuk in April, following Saudi Electricity Co's issue.
Both those deals were considerably oversubscribed; they carried a 10-year portion which attracted long-term institutional investors while at the same time catering to the regional sweet-spot with a five-year tranche. The Saudi Electric sukuk attracted orders of at least $15 billion, partly because of its rarity as a dollar-denominated, investment-grade issue from that country.
Saudi Electric's 2.665 percent five-year tranche was bid at a yield of 2.40 percent on Tuesday, while the 4.211 percent 10-year portion was yielding just under 3.5 percent, according to Reuters data.
Qatar has hired HSBC Holdings, Deutsche Bank , Standard Chartered Plc and local lenders Barwa Bank and QInvest to arrange its deal. (Additional reporting by Regan Doherty in Doha; Editing by Andrew Torchia)