Monday, October 18, 2010

Dubai Sovereign Bond: "Pay to Play"


An article in the FT today reports that bankers were told that lead underwriters on Dubai's recent US$1.25 billion sovereign bond were told that in order to be considered they needed to make loans to the Emirate.  Supposedly a two-year loan for some US$300 million priced at Libor +300 bps.

A couple of observations.

First, this is a pretty standard request, particularly from a client having a bit of a problem.  Just as the good banker is taught to seek to increase his "share of a customer's wallet" in good times, borrowers especially those currently out of favor in the market look for their bankers to be understanding in more difficult times.  In both cases there's a lot of talk about the importance of relationships.  How strong they are.  Sentiments said with no doubt more sincerity than the average politician's promise.  But just as meaningful for that.

Second, Dubai's Sovereign Bond was "priced to place".   Dubai could not afford to have this transaction fail. With a bond, a low price means the interest rate was set higher than it needed to be.   Pretty much the same rationale as IPO pricing.  Under price the security by a bit so that the offer is successful.  And then  as the share rises in initial trading, you've got a good story for the company and the investors.    

I've seen estimates that Dubai's pricing may have been as much as 0.75% to 1.0% higher than required.  The underwriters who "sat" on a substantial portion of their allocations may not too far in the future have large capital gains - though probably not until after issuance of the DEWA bond.  If they've placed it with clients,  as some will have, then they will derive some relationship benefits there and can use those to secure additional business from those clients.    Just as the investment firm that can allocate IPOs to its customers gets something back.

For HSBC and Standard Chartered with major domestic operations in the UAE, being seen as a good friend is a useful thing.  If indeed SC's threat to move its corporate headquarters to the more tax and regulation friendly shores of Dubai is more than mere posturing, another good reason.

Finally, there's probably also a very hard headed calculation here - that it's going to be some time before Dubai regains full market access.  Amounts are likely to remain limited  and increasing only slowly.  Pricing will probably improve even slower.  As the thinking goes, there are opportunities for profit here.

And of course, there is one other factor in play:  banker and investor ADD.

Do bankers have short memories?

Excuse me, could you repeat that, I've forgotten what you asked. 

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