It is a well-known fact that the GCC region, as with the rest of the commodity complex globally, has seen a deterioration in its fiscal landscape resulting from the self-inflicted crude supply glut and as such is tapping the bond market. We have seen a number of attractive new issues from the region, in particular the Emirate of Abu Dhabi. As regular readers are aware, our Net Foreign Asset (NFA) model assigns Abu Dhabi a 7 star rating as it possesses a NFA as a percentage of GDP well in excess of 100%; our forecasts calculated that its rating will remain at 7 stars into 2020 and beyond.
Abu Dhabi is hugely dependent on oil, ~55% of its GDP and around 80% of government revenues are generated from crude oil. The government is however well prepared to weather the continued drag from oil prices, for one Abu Dhabi has huge stores of hydrocarbon resources, which were accumulated when oil prices were high and according to the IMF, the Emirate’s estimated break-even oil price is around $58pb for 2016, one of the lowest in the region, and certainly in the world; Brent is priced at ~$47.75 today. The government also has many years of fiscal surplus accumulation and was prudent in its budgeting of proceeds from oil; which we believe will moderate the effect of the downturn and volatility of crude prices on the country’s exceptionally strong fiscal and external buffers.
Lower crude prices forced the UAE’s federal government to push reform efforts, which Abu Dhabi benefitted from; being the largest contributor to the region's budget. All subsidies, particularly petroleum, have either been removed or reduced since 2015. Diesel has been deregulated and prices went up in March this year, and a water tariff for expat consumers was introduced. Electricity tariffs have also increased by as much as 100% in some cases. In many other oil export dependant economies, say in the LatAm region, these measures would have a profound effect on the population, this is not to say that there hasn’t been any backlash from those residing in Abu Dhabi, but with a high income per capita ~$100,000 these types of reforms are more manageable. All in all this will no doubt increase the government’s non-hydrocarbon share of revenue.
So in an effort to establish its own USD benchmark yield curve, Abu Dhabi announced a $5bn two tranche deal, 5-yr and 10-yr; its first bond sale in seven years. The bonds were 3.4 times oversubscribed. Rated AA by S&P and Fitch, we added the 3.125% maturing in 2023 to our portfolios. The 10-yr bond was issued at a spread of 125bps over Treasuries and thus looked attractive to us; our Relative Value Model calculates that a similarly rated bonds with the same duration effectively trade around +65bps, the bond therefore provides ample spread cushion, around 3 credit notches. Since issue, just over two weeks ago, the bond has rallied over 2.5 points, tightening to a spread of ~113bps; the bond remains fairly attractive.
Also from Abu Dhabi was strategically important state-owned investment and development vehicle, Mubadala, which diversifies away from hydrocarbon assets. Rated AA, in-line with the sovereign, the company issued a $500m 7-yr bond, which was also massively oversubscribed, the order book was in excess of $5bn! We added the bond to our portfolios at the issue spread of +134bps over Treasuries, which offered an expected return and yield, by our calculations, of around 7% with a 3.6 notch cushion.
We will look to rotate out of these holdings into more attractive issues when they reach “fair value”, but we are happy to hold at these levels as we expect both new issues will be tightly held locally, given the lack of bonds outstanding in Abu Dhabi. Do we remain in favour of highly rated issuance from the GCC region?… Yes we Abu Dhabi do!