The Banker Middle East – “Quality by Association”

By 10/02/2010

The Banker Middle East – “Quality by Association”

From The Banker Middle East

2009 could be described (rather cynically) as a thrilling year for all those who have been involved in the conventional and Islamic bond industry. Roller coaster ride might be another way of describing the stomach churning events of the past year. Spreads on Credit Default Swaps (CDS) widened and narrowed with alarming regularity, while investors have been demanding even bigger yields.

At one point in early 2009, five-year CDS spreads on Dubai debt (at 960/1025) were even wider than Icelands (at 915/1015) although they have narrowed significantly since then, even allowing for the spike in November 2009 when they went from 318 basis points to 428.7 basis points while the price of credit default swaps for Dubai Government debt rose to 630 basis points on 12 February 2010 (a figure last seen in November 2009) on concerns over the state of Dubai Worlds restructuring predicament and from the fall-out over Greeces sovereign debt woes.

Moodys said it expects an increase in corporate issuance among high-quality issuers as companies replace shorter tenors with longer maturities, and reduce their historically heavy reliance on rollover bank lending while continuing with their investments. The spectre of a Sukuk default, once dismissed as unthinkable (like the Titanic was unsinkable) by the proponents of Islamic finance who constantly declared that it was safer than conventional finance because of its aversion to risk, was one of the major features of the Islamic finance landscape in 2009. Three Sukuk, two of them Gulf-based, went into default. Is another on the way?

In previous years, the number of publicly known corporate defaults in the region had been negligible and the Gulf Co-operation Council (GCC) demonstrated a highly interventionist and creditor-friendly track record,” said Raffaelle Semonella, an Associate Analyst for corporates at Moodys in Dubai.

However, by the end of 2009, a number of high profile-defaults had started to change this picture. A sharp deterioration in corporate credit quality due to a combination of weaker fundamentals and sovereign support uncertainty led to a substantial downward ratings migration, with a total of 34 rating actions of which all but two were in a negative direction. The average rating in the Gulf migrated from A1 in 2008 to Baa1 in 2009, said Philipp Lotter, Dubai-based Senior Vice President in Moodys Corporate Finance Group.

Until recently, conventional bank debt used to dominate the market across the different maturities. The rise of Islamic finance has led to a decrease in conventional debt issues, especially within short to medium-term markets. Conventional bank debt though continues to dominate the long term market. This is due to the fact that Islamic investors have more appetite for short and medium term debt of three to ten-year tenors. As the Islamic financial market continues to grow, longer tenors could be achievable in the foreseeable future,” Brad Kim, Moyn Uddin, Elie Semaan and Kacem Bouhitem of Macquarie Capital Advisers (Dubai) wrote in a book titled, “Investing in the GCC Markets-New Opportunities in a Changing Landscape.

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