Tapping the markets: Bonds

The kingdom of Bahrain (rated “BBB-”) has developed into a seasoned and popular issuer, tapping local and international capital markets in 2015 for a record amount of debt. Bahrain raised 800m in Bahraini dinars and 1.5bn in US dollars, as the kingdom sought to strengthen its economy and finance its growing deficit, which is estimated to reach 12% of GDP in 2015 amid falling oil prices. The timeline of the funding was well planned, as the kingdom, acting through the Central Bank of Bahrain, issued its debt across multiple tranches. These ranged from two-year to ten-year papers, with the government responding positively to regional demand for medium-duration maturities in light of a potential rise in interest rates. The new issues proved to be successful as measured by their oversubscription and subsequent positive performance in the secondary market; a remarkable feat given that liquidity had dried up in the GCC due to lower oil prices and that market sentiment was affected by the uncertainties surrounding a rate hike.

In Demand

To put this into perspective, Bahrain had to increase the size of one of its issues by BD100m ($263.5m), around 66%, to accommodate excess demand. Most of the Bahraini dinar debt was absorbed by Bahraini institutions, including locally-domiciled banks and insurance companies, as well as funds; with some demand from Saudi and, to a lesser extent, the UAE. It was the first time that local bonds and sukuk (Islamic bonds) were listed on the Bahrain Bourse in order to increase liquidity and improve market sentiment. The minimum issue size was lowered to BD500 ($1320) to encourage retail investors to participate in this asset class, where a majority of the issues have a nominal minimum size of $200,000. This also changed the dynamics of trading local bonds, with traditional “buy-and-hold” investors becoming more active. Given that over BD4m ($10.5m) of Bahraini debt was traded on the Bahrain Bourse in 2015, it appears that the government’s efforts to stimulate a more liquid and transparent market are proving to be effective.

At the same time, the government was successful in establishing a well-covered yield curve, thus complementing the thriving BD1.6bn ($4.2bn) Treasury bill market, and giving other Bahraini borrowers a benchmark. This proved useful for local corporates such as BBK and Ahli United Bank, which issued US dollar-denominated debt in 2015, with Aluminium Bahrain (Alba) a likely candidate for 2016. Earlier, Bahrain Commercial Facilities Company borrowed BD20m ($52.7m) in a rare Bahraini dinar bond issuance for a corporate entity in 2014. Previously, without a developed domestic bond market, most borrowers had few alternatives to bank loans, and were forced to pay high premiums to access international capital markets. The issues also gave local pension funds the opportunity to invest in Bahraini bonds.

Debt Ceiling

Nevertheless, Bahrain’s borrowing amid a low oil price regime has begun to challenge its investment grade rating. The 10-year credit default swaps rates on Bahrain, for example, soared from 220 bps to 370 bps over the space of just one year. Debt- to-GDP stands at 53%, and Bahrain’s budget for 2015 includes a deficit of BD1.5bn ($4bn), with a further BD1.5bn ($4bn) expected in 2016, representing 12% and 11% of GDP, respectively.

However, the kingdom has been proactive in addressing the challenges through policy responses that included cutting subsidies on meat, as well as pension reforms, while Bahrain’s parliament called for a debt ceiling of 60% of GDP. The kingdom still has ample room to continue improving its credit profile through further subsidy cuts before more stringent measures are implemented. We thus expect Bahraini bonds to generate positive returns in 2016, albeit running below their yield to maturity. The following year should be slightly better, with Bahrain generating above-average returns over a five-year period.