* Tight pricing followed by secondary market
* Investors place primary market orders expecting them to be
* So underlying demand shrinks at final pricing
* Domestic, global factors behind divergence
* Saudi Electric bond may repeat pattern
By Rachna Uppal and Mala Pancholia
DUBAI, March 21 (Reuters) - Bond and sukuk issues from the
Gulf Arab region in the past few weeks have drawn huge investor
order books but then performed poorly in the secondary market -
a sign that some of the orders are not as solid as they appear.
In order to ensure they obtain part of a new issue,
institutional investors are bidding for larger amounts than they
actually want, because they assume their bids will be cut when
the issuer decides on allocations, traders and analysts say.
The heavy bids are causing the pricing to tighten
dramatically in the primary market, setting the bonds up to fall
in the secondary market when it becomes clear that underlying
demand for them at the final pricing is not as great as the
order books suggested.
This phenomenon can happen in bond markets around the world
but it has been particularly acute in the Gulf during recent
weeks, partly because of global trends and partly because of the
nature of the Gulf's investor base, which is cash-rich and
heavily focused on bonds from within the region.
"The secondary market performance of deals in 2013 suggests
that order books were probably inflated," said Doug Bitcon, head
of fixed income funds and portfolios at Rasmala Investment Bank
"One only has to look at the performance of the recent DIB
Tier 1 deal to realise that a large portion of the $14 billion
book was fluff."
Dubai Islamic Bank issued a $1 billion perpetual,
hybrid sukuk this month to boost its Tier 1 capital. It was only
the second such deal from the region, and arranging banks said
the order book totalled a massive $14 billion.
On the back of that, pricing tightened spectacularly from
initial guidance in the 7.0 percent area, which was considered
generous to investors, to 6.25 percent. Private banks, which
were given a 50 basis point concession on the pricing, took 32
percent of the paper.
The sukuk has performed sluggishly since
then, and was bid at 99.85 cents on the dollar on Wednesday
afternoon, according to Thomson Reuters data. During the same
period, many other emerging market bonds have performed well.
In some cases, Gulf order books this year have been so large
that issuers have been able to price their bonds at no premium
to their existing yield curve, or even inside the curve - once
again, setting the issues up for weak secondary market trading.
The Dubai government's $750 million, 10-year sukuk
issued in January got an order book of $11
billion. It priced at 3.875 percent, well inside guidance of 4
percent and about 12.5-17.5 bps inside Dubai's outstanding 2022
sukuk. It has traded below par since then.
"The recent deals have priced so aggressively that there is
little left on the table for short-term performance in the
secondary market," said Daniel Broby, chief investment officer
at Silk Invest asset managers in London.
There are domestic and global reasons behind the sharp
contrast between primary and secondary market performance.
Although Gulf investors are showing signs of putting more money
into bond markets outside the region, they traditionally focus
closely on issues from within the Gulf.
They are flush with cash because of high oil prices and
solid economic growth, and bond supply within the region - at $7
billion of internationally sold U.S. dollar bonds and sukuk so
far this year - has struggled to keep up with demand.
This is a recipe for tight pricing in the primary market, as
investors submit large bids to make sure they are allocated a
minimum amount of paper.
At the same time, the long-term outlook for bond markets
worldwide has weakened this year because of higher U.S. Treasury
yields and strengthening equity markets.
These factors have convinced many institutions that the long
bull market in bonds may have ended, making them reluctant to
bid prices up beyond levels seen at issue.
One sign of the changed mood is that trading volumes in the
Gulf's secondary debt market, which surged last year, have
declined since the start of this year, according to anecdotal
evidence from traders.
There is no sign that the primary-secondary divergence will
change any time soon. A dollar sukuk from Saudi Electricity Co
is due to price after roadshows end next week, and
because it is a rare dollar bond from Saudi Arabia, primary
market demand may be extremely heavy. The company's last
international foray, in 2012, drew a $19 billion order book for
a two-tranche, $1.75 billion deal.
"If the new issue comes to the market 50 bps cheap to the
existing curve I will become very excited," said Rasmala's
Bitcon. "Unfortunately the chances of that are similar to the
probability of snow in Dubai over Christmas."
(Editing by Andrew Torchia)