Egypt may convert Gulf funds into bonds

Egypt could convert part of the $12 bn of loans and grants pledged by Gulf nations this week into tradable bond securities, a lawyer working with the Egyptian government said. The lenders in question – Saudi Arabia, the UAE and Kuwait - will then have the flexibility to sell the bonds to other investors, should they wish to.

Qatar already has that option: Egypt recently converted $3.5 bn of Qatari loans into bonds through a newly established $12 bn Euro Medium-Term Note program. The loans made by the other three Gulf nations might be given similar treatment.

“The contributions from non-Qatar states are certainly capable of being represented by notes issued through theprogram,” said James Healy, a partner at law firm Skadden, which represented Egypt in connection with the establishment of the program.

According to the program’s prospectus, however, funds raised in the form of notes must be used to finance the country’s budget deficit, something that may be less attractive for Egypt compared with the alternative of keeping the money on deposit in the central bank.

“Notes issued through the program have been authorized under the budget law and have to be used to reduce the budget deficit,” said Healy. “Egypt may have more flexibility if they leave the funds as deposits with the central bank, as these can be used to increase foreign reserves.”

While turning foreign loans into bonds reduces Egypt’s flexibility, the conversion brings clear advantages for the lenders, providing them with tradable securities and formalizing the terms of the loans under English law.

“The key advantage is the potential tradability of these securities, which would suggest Qatar might have considered trading them before maturity,” said Healy.

Earlier this month, Egypt converted $1 bn of Qatari loans into bonds under the program, which is led by HSBC and QNB Capital.

The new $1 bn three-year bonds were issued on July 1 at part yield 3.5%. The transaction follows a $2.7 bn 18-monthsenior unsecured deal that was issued in late May at a yield of 4.25%.

The conversion has another advantage for Qatar, as bonds provide extra protection in the event of Egypt defaulting.

Protection

The EMTN program documentation sets out that all bonds are subject to English law, and that creditors would have recourse to international arbitration courts in London.

While this doesn’t confer complete protection – arbitral awards can still be overturned by Egyptian courts in certain circumstances - the mechanism is useful when dealing with international aid, a Gulf-based analyst said.

“If you think back to Dubai in 2009, part of the support from Abu Dhabi was done by a mechanism where Dubai issued bonds to the UAE Federation,” the analyst said.

Unusually in the case of Egypt, the coupon on the second bond deal is on easier terms than the first, at 3.5% compared with 4.25%, despite having a longer tenor.

This may be partly because the second deal is smaller, but it could also be a sign that Qatar is trying to ease the burden on Egypt, said Souheir Asba, an EM strategist at Societe Generale.

“I would have a weighted average yield they want to get, but on the specific tranches they might decide to go a bit lower, depending on what they think is Egypt's ability to pay,” she said.

“Qatar wants a firm commitment from Egypt. They want to be sure they will get their money back and this is the best way to do it.”

True price

If Egypt was to issue a new three-year US dollar bond in the public market, it would probably have to price it at a yield of around 7.25%, a trader said.

In its last public bond issuance in April 2010, a 10-yearnote priced at 5.75% and a 30-year at 6.95%. They were trading at 8.4% and 8.97% on Friday.

Since 2011, Qatar has made deposits of $8 bn in total to Egypt. Of this, about $5.5 bn is expected to be converted into bonds, a source said, suggesting that a further $2 bn could follow when the political situation in Egypt stabilized.

The Saudi funds comprise a $2 bn central bank deposit, $2 bn in energy products and $1 bn in cash; Kuwait will divide aid into a $2 bn central bank deposit, a $1 bn grant and $1 bn in oil reserves; and the UAE will make a $1 bn grant and will offer a $2 bn loan, the three respective state news agencies reported last week.