Iran Eurobond Oversubscribed As Economic Confidence Outweighs Political Uncertainty

VOL. XLV

No 28

15-July-2002

IRAN

Iran Eurobond Oversubscribed As Economic Confidence Outweighs Political Uncertainty

Iran issued its first bond since the 1979 Islamic revolution on 10 July despite a bumpy road to market which had seen Moody’s withdraw the country’s B2 grade sovereign rating as it bowed to US government pressure. While some had expected the US Government’s inclusion of Iran in its “axis of evil” and its continued sanctions against the country to hamper its attempts to tap the capital markets, the €500mn issue was €300mn oversubscribed. Nevertheless Moody’s ratings withdrawal, US censure in general, and the regulations banning US citizens from buying Iranian securities due to the continued trade embargo had, according to some, an undoubtedly negative impact on the issue.

The bond, which was issued by the Central Bank of Iran (CBI) on behalf of the country, was lead-managed by BNP Paribas and Commerzbank (MEES 3 June), with the syndicate including six co-lead managers (Arab Banking Corporation, Emirates Bank International, Gulf International Bank, the National Bank of Dubai, Qatar National Bank and Standard Chartered) and five co-managers (Arab Bank, the Arab Investment Company, Bayerische Hypo-und Vereinsbank, Credit Agricole Indosuez and Standard Bank London). The transaction volume reached the higher end of the €300-500mn originally targeted and the higher end of the targeted 3-5 year maturity. The coupon will pay an annual 8.75% and was priced at a 425bps spread over benchmark euro swaps. The offer had been tested at 350-400bps in the Middle East during the road show, but in more price-sensitive Europe was presented at a 375-425bps level because Iran specifically wanted to diversify and attract European interest, Alexis Plan, Head of Emerging Market Syndicate at Commerzbank, told MEES. “It was a book-building deal. The Iranians could have done the deal at a lower level and sold to the Middle East but they wanted to open up to Europe,” he said. He noted that after the issue prices climbed (from the initial reoffer price of 99.23%) and was being offered up to 99.75% suggesting that the demand was plentiful.

In a press release Commerzbank pointed out that the bond fulfilled Iran’s main objective of diversifying its investor base with 42% placed with European accounts, 5% with Asian accounts and the balance to investors in the Gulf and Middle East region. It was bought by some 80 different investor accounts, demonstrating widespread support with investors including commercial banks (41%), asset managers and emerging market funds (32%), insurance companies (17%) and retail investors (10%).

The issue was launched at a time of high market volatility when spreads of most emerging market sovereigns were widening substantially, and in spite of this difficult environment, it was placed quickly and successfully, noted Commerzbank. Furthermore, it was launched during the typically quiet summer vacation period and still managed to see heavy oversubscription, the bank added.

Mr Plan said that he was “very pleased given the different ways people view the political risk,” pointing out that the bond issue went ahead smoothly despite the largely negative press surrounding it. He said that the success of the issue was not only seen in the oversubscription, but also in the 5-year maturity. “Straight away investors were willing to go for the five rather than the three years on offer,” he said, noting that longer exposure to debt indicates greater confidence in the issue.

CBI Governor Mohsen Nourbakhsh mostly realized his hopes that Iran’s strong economy would deliver attractive pricing on the bond, despite the sub-investment grade of B+ (the same as the country’s sovereign rating) from international rating agency Fitch and the designation as a member of the “axis of evil” by US President George W Bush. While Iran saw a good appetite for the bond in the road show, it is unlikely to increase the size of the issue, although it is permitted by parliament to borrow up to $2bn, Dr Nourbakhsh noted. Iran’s bond issue is generally seen in investment circles as an attempt by the country to secure a benchmark for its debt if it needs to tap international markets in future, given that the country does not need the funds.

“We are not doing this for the budget. Because of the oil price we are running a surplus in the current account and the budget. This is to fund development projects and set a benchmark,” Dr Nourbakhsh explained, noting that “Iranian crude prices are currently at $23/B, which is above the $17/B forecast for the fiscal year ending 20 March.” (Iran’s Oil Minister, Bijan Zanganeh, had previously said the oil price assumption in the 2002-03 budget is $19/B - MEES, 11 March.) Dr Nourbakhsh said that bonds similar to that issued by Qatar’s Ras Laffan LNG project could be the next vehicle open to both private and state companies such as the National Iranian Oil Company (NIOC). This would allow entities to tap capital markets instead of relying on Iran’s complicated buy-back vehicle, which in some cases has been subject to investigations that have resulted in contract delays. Commenting on the Eurobond CBI Vice-Governor Mohammad Mojarrad said that it will open the door for Iranian corporates including airlines, telecommunications and oil and gas companies. Mr Plan said that he expects continued interest in Iranian debt despite US pressure on the country, noting that such issuances are interesting for diversification purposes because there is “very little Middle Eastern paper out there.”

The successful bond issue is likely to add momentum to reformists’ attempts to open up the country to foreign investment, after Dr Nourbakhsh’s previous efforts were stalled by conservatives over the conflict between paying interest on loans and the Islamic prohibition against usury. In addition to the bond, also testament to reform attempts is the planned launch of a new fund (EFG-Hermes Persepolis Fund) which will allow foreigners to invest in the Tehran Stock Exchange (MEES, 8 July).

Despite these positive developments, however, Iran still faces problems, stated Fitch on 10 July when it announced it had assigned the Iran Eurobond a B+ rating (with a stable outlook), which predictably is the same as the sovereign rating assigned on 10 May (MEES, 20 May). Fitch said that Iran’s rating is constrained primarily by the interaction of complex international and domestic political developments as tensions have heightened across the Middle East in recent months. Moreover, Fitch also pointed out that deteriorating US relations are a significant element of Iran's international risk profile.

It noted that while the country has rating strengths, it also faces serious weaknesses given that state control extends to most major industries, including banking. The role of the state is also evident in an extensive subsidy system that costs the government an estimated 20% of GDP annually, although exchange rate unification should reduce subsidies and increase fiscal transparency.

The oil sector generates 80% of export receipts and 50% of government revenues, exposing the economy to oil price volatility despite the presence of an Oil Stabilization Fund (OSF). Diversification efforts have yielded few results and are not likely to succeed in the absence of foreign investment and mounting demographic pressures show the need for large-scale employment generation, which does not appear forthcoming, warned Fitch.

On the plus side, Fitch notes that as one of the world’s largest oil producers, Iran’s economy has benefited markedly from higher prices over the past two years. In 2001 GDP grew by about 5% and the current account and fiscal surpluses were 5.1% and 3.4% of GDP, respectively. The current account has been in surplus for seven of the past eight years, leading to a continual accumulation of foreign exchange reserves, the establishment of the OSF in 2000 and a steady reduction in gross external debt. Foreign exchange reserves of about $15bn and an estimated OSF balance of $9bn provide a sizeable short-term cushion. As a share of GDP (7%) and foreign exchange receipts (27%), Iran’s external debt compares exceptionally well not only to its rating peers, but in fact to all sovereigns rated by Fitch. Its position as a large net external creditor is also one of its fundamental rating strengths, comparing favorably with other sub-investment rated sovereigns.

Fitch noted that domestic political risk centers on active debates between reformers and conservatives, who are contesting the degree to which political, social and economic liberalization should be fostered within Iran. However, the ratings agencies stresses that Iran has had ongoing international commercial relationships in which debt payments have not been affected by domestic politics. Fitch does not judge domestic political risks to be a threat to the regime at present, but believes that reforms could be caught up in broader debates.

Moody’s withdrew its sovereign rating of Iran (to which it had assigned a B2 rating with positive outlook) on 3 June stating that it had made the decision due to “US government concerns that such ratings could be inconsistent with US sanctions on Iran.” (MEES, 10 June). It noted that it had responded to the concerns and if these could be satisfied, it would anticipate issuing updated ratings. Moody’s had first rated Iran in 1999, but that rating was unsolicited. Standard & Poors was mandated to carry out a sovereign credit rating for Iran in October 2001 (MEES, 10 September 2001) in preparation for the Eurobond issue, and while it has applied for an export license from the US’ Office of Foreign Asset Control, it has yet to assign a rating to Iran.