Is tomorrow the big day?

Tuesday 18th October 2016

Is tomorrow the big day? Saudi poised to make its debut in international bond markets .....

ref:- "Saudi debt pitch focuses on youth and reform", The Financial Times, Markets and Investing, Analysis: Capital Markets

What's the big deal ..... it's just another sovereign bond issue, right? Not quite ..... Saudi Arabia's first ever international bond is due to be launched this week after Saudi delegates and their advisors complete the traditional "roadshow"  --  a tour of London, Los Angeles, Boston and New York designed to drum up investor demand. Word has it that the details of the long-awaited issue may be released as early as tomorrow. 

It's Saudi's position as the biggest player in such a sensitive and important part of the world  --  both geopolitically and economically  --  that has attracted such interest ever since the idea of tapping the international bond market was first mooted. Observers would point out that that the fact that it's happening at all is a measure of how much the precipitous fall in the price of oil has put the squeeze on Saudi finances that once seemed almost limitless. They'd be right too  --  the model of government spending that worked with oil at $120 per barrel patently does not work with oil at $50 or below.

Riyadh has been forced to make drastic cuts to public spending (by Saudi standards), has been burning through its admittedly huge foreign reserves and has already been raising debt to finance budget deficits of an order not seen since the 1990s. $63 billion has already been raised in local bond sales. Costly participation in conflicts in Yemen and Syria are also a drain on resources that $50 oil cannot satisfy.

But if there are good reasons why the Saudi economy has got to a position where it needs to borrow from the market, the roadshow delegates would point out there are also good reasons why the market should be prepared to lend: the size of the Saudi economy, the lack of external debt, its young population and the drive towards greater transparency. In fact one could argue that beyond the obvious raising of finance, the step into international capital markets is just a part of the comprehensive reforming programme that Prince Mohammed Bin Salman is applying to the Saudi economy. 

Also encouraging for investors must be the recent successful bond issues from Mexico, Argentina and most of all Qatar, with whom Saudi has most in common. Obviously, the search for yield at a time when developed markets offer precious little has played its part in their success, so what sort of yield are the Saudi bonds likely to offer? If you look at the Qatari issue, it paid a premium of 150 basis points above US Treasuries for 10yr notes, but after recent reverses in Treasuries the spread is less than that now at about 131 basis points. Saudi Arabia (A) has a lower credit rating than Qatar (AA) so should expect to pay a higher rate, but how much exactly will be influenced by the size of the issue. But say for example that the 10yr issue was set with a yield premium of 30bp over Qatar's , that would mean the Saudi 10yr would yield 3.40% (approx.). That would give it a yield premium of 161bp over US Treasuries  --  would that be enough to attract the buyers ? Or should they pay more to ensure good demand ? Tough decision ..... what the advisors decide now will set the tone for future trips to the well.

For what it's worth, the expectations are for an issue of 5, 10 and 30 year paper totalling anywhere between at least $10bn and $20bn. Saudi will of course not want to pay any more than it has to but it's important that the issue goes well ..... indications are that the process will be repeated each year up to a level of $120bn.

What sort of reception will the Saudi plans receive? Given the yield premiums on offer, probably pretty good. Demand is likely to easily exceed demand, they say. Like all good salesmen, the roadshow delegates have been keen to accentuate the positives, but for a few potential investors the fly-in-the-ointment might be the questions that they were less keen to answer : "What's the future for oil prices, especially with arch-rival Iran such a key player?" and "What's going to happen in the proxy way in Yemen?".