Saudi sets record with mammoth $17.5bn bond issue

Saudi Arabia conducted the largest-ever emerging market bond sale on Wednesday, selling $17.5bn of debt in the government’s first international offer while attracting investor orders totaling almost four times that amount.

The huge demand, larger than many market participants had expected, was partly due to ultra-low global interest rates and funds’ frustration with a lack of high-yielding assets around the world.

But the sale was also a success for the world’s top oil exporter in its efforts to convince investors that it can cope with an era of low crude prices and ultimately reduce its dependence on oil.

London-based Capital Economics estimated the U.S. dollar issue would finance around a third of next year’s state budget deficit and almost all of the kingdom’s current account gap, meaning its foreign exchange reserves were unlikely to fall much further in coming years.

“This should dampen any lingering concerns that the riyal will be devalued. The government’s debt-to-gross domestic product ratio will rise as a result of the bond sale but, given its low starting point, it is hardly on a worrying path,” Capital Economics said.

The issue eclipsed the previous record for an emerging market sovereign bond sale, a $16.5 billion issue by Argentina in April. A source familiar with the offer said order books totaled $67 billion, coming close to the $69 billion record set by Argentina.

In the days before the sale, senior Saudi officials held a series of meetings with top investors in London and the United States to describe ambitious economic reform plans that include sharp cuts in state spending and a drive to develop non-oil businesses.

REFORM PLAN

The successful bond sale may be a good omen for another part of the reform plan; an initial public offer of shares in state oil giant Saudi Aramco. Expected to take place in 2018, that offer could raise tens of billions of dollars.

The bond sale was also helped by a rebound of oil prices above $50 a barrel in recent weeks from around $30 early this year, after Saudi Arabia changed course and decided to support output cuts by OPEC. It had refused to do this for two years in order to win market share back from U.S. shale producers.

Riyadh ran a record budget deficit of $98 billion last year – 15 percent of GDP – and is struggling to cut the gap this year. It turned to the international markets to finance part of its deficit this year after domestic investors, starved of petrodollars, began finding it hard to buy government bonds.

The Saudi issue is expected to set a benchmark for the kingdom and pave the way for further international issues by the government in coming years, as well as bond sales by a string of big Saudi companies.

Mohieddine Kronfol, chief investment officer for Middle East fixed income at major asset manager Franklin Templeton Investments, said the debut issue would invigorate Saudi financial markets.

“Not only could the bond help develop the Kingdom’s debt markets by introducing a more sophisticated type of investor, but there are also positive ripple effects for Gulf Cooperation Council fixed income as well as more global investors to take a closer, and longer-term, look at the region.”

The bond was priced more cheaply for Saudi Arabia than many investors had expected. A $5.5 billion five-year tranche was launched at 135 basis points over U.S. Treasuries, a $5.5 billion 10-year tranche at 165 bps over, and a $6.5 billion 30-year tranche at 210 bps over.

Bankers were particularly surprised by the pricing of the 30-year tranche, given uncertainty about the future of the energy industry in coming decades.

“They’ve managed to price it really tight – 210 bps is 25 bps inside initial guidance which is a massive drop, and clearly indicates that demand has been overwhelming on the 30-year,” one said.

When Qatar, which is assessed higher than Saudi Arabia by credit rating agencies, issued $9 billion of bonds in May, it sold the debt at 120 bps over Treasuries for a five-year tranche, 150 bps over for 10-year paper and 210 bps over for a 30-year tranche.