MIDEAST DEBT-Turkey sukuk to test Gulf appetite to diversify

Thu Sep 13, 2012 3:42pm IST

* Yield on Turkish sukuk will be low compared to Gulf issues

* Could be some 100 bps below Bahrain sukuk

* Sukuk supply/demand imbalance may offset new-issue premium

* But Gulf investors increasingly keen to diversify

* Strong demand would be positive signal for other EM issues

By Rachna Uppal and Mala Pancholia

DUBAI, Sept 13 (Reuters) - Turkey's first-ever issue of a sovereign sukuk will test Gulf investors' willingness to leave their comfort zone within the region and settle for lower yields outside it - potentially signalling fresh flows of Gulf money into southeast Asian and African debt.

Turkey, rated BB by Standard & Poor's, held investor meetings for the dollar-denominated Islamic bond in several Gulf cities this week. The issue, which could raise up to $1 billion, is expected during the week starting on Sept. 17.

Traditionally, Gulf investors have tended to focus on their own region, where credit ratings tend to be high but geopolitical risks keep yields higher than would normally be the case for such ratings.

"Gulf investors tend to be comfortable with their regional geopolitical risk, which maintains yields above assets of other similarly rated EM (emerging markets) issuers," said Doug Bitcon, head of fixed income funds and portfolios at Rasmala Investment Bank in Dubai. "There is therefore less incentive to look elsewhere when investing."

When Poland issued a $2 billion, 10-year conventional bond this week, Middle Eastern investors showed little interest, taking just 4 percent of the debt on offer.

But the Turkish sukuk is likely to attract much stronger demand from the Gulf. One of its selling points will be the sukuk format; unsatisfied demand for sukuk from cash-rich Islamic investors in the Gulf has been massive this year. Ernst & Young estimates global outstanding demand for sukuk totals about $300 billion, while new issuance this year may not be much over $100 billion.

Also, as Gulf investors grow in size and experience, analysts detect an increasing desire among them to expand their debt portfolios into other regions - even if that means accepting somewhat lower returns.

"Gulf investors showed very strong interest in the recent eurobonds issued by Turkish banks (over the last several weeks), and this appetite should continue to the sovereign," said Apostolos Bantis, fixed income analyst at Commerzbank in London.

Bitcon said: "Following events in recent years, there is greater acceptance of the merits of portfolio diversification, which can have an opportunity cost.

"There is a clear supply/demand imbalance in the sukuk market and this new Turkey issue will therefore, in our view, be on the radar of most Gulf investors."

BROADENING HORIZONS

If Gulf investors prove willing to buy the Turkish sukuk in bulk, that will be an encouraging sign for their investment in other emerging market issues - conventional as well as Islamic.

Among upcoming issues, Indonesia has mandated banks for a sovereign sukuk issue that is expected by the end of this year, while South African officials told Reuters in July they were preparing to launch a sukuk, which would be the country's first.

In the immediate neighbourhood, Jordan said on Wednesday it was discussing the issue of a seven- to 10-year eurobond of $750 million-$1.5 billion, while Morocco plans to sell a $1 billion sovereign bond in October. Both countries receive official aid and diplomatic support from the Gulf, which may be a plus for investors from the region.

"A logical step for investors in the region who have so far focused on GCC...opportunities would be to expand their scope to North Africa, or Africa generally," said Chavan Bhogaita, head of the markets strategy unit at National Bank of Abu Dhabi.

"As regional fixed income investors mature and develop, it's a natural evolution for them to look at more deals in potentially different geographies or different formats as a means of avoiding concentration risk issues within their portfolios."

PRICING

Turkey has been a frequent issuer of conventional dollar-denominated bonds so it has a well-developed yield curve. For Gulf investors, increasingly comfortable with tenors beyond the traditional five-year sweetspot, a seven- or 10-year maturity could be most attractive.

Turkey's $1.5 billion, 7.5 percent bond maturing in 2019 was yielding 3.1 percent on Thursday. Its $2.5 billion 2022 maturity, issued at 6.25 percent earlier this year , was yielding 3.75 percent on Thursday, about 5 basis points more than its yield on the day the sukuk mandate was announced.

Some bankers think the price advantage to Turkey of issuing a sukuk, given the big supply-demand imbalance for Islamic debt, may at least cancel out the new-issue premium demanded by investors.

"I think it (Turkey's sukuk pricing) should be tighter than the conventional," said one fixed income analyst.

Such calculations show the Turkey sukuk may deliver much lower returns than comparable Gulf debt; the yield on a $750 million, seven-year sukuk issued in November by BBB-rated Bahrain, three notches above Turkey, is now around 4.03 percent.

NBAD's Bhogaita said Turkey would face a choice between minimising its borrowing costs with the sukuk and attracting a large number of Gulf investors, because it probably could not do both.

"Will they have to leave a little extra on the table to appeal to broader Gulf investors, or is the aim to attract a global, established investor community at the lowest cost of borrowing?"

Turkey is due to complete its roadshows on Sunday, through HSBC, Citi and Kuwait's Liquidity House, a unit of Kuwait Finance House. The sukuk would have an ijara structure, backed by real estate assets. (Editing by Andrew Torchia)