Wednesday, 26 September 2018

After the gold rush

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At the start of the year, the boom that had turned the Middle East into one of the world's hottest loan markets looked like it was set to end in a spectacular bust. However, government support for some the region's most indebted borrowers has helped to steady sentiment, and there is hope that the market can now recover some of its previous poise. By David Cox.

With project financing and FI dominant until the early part of the 2000s, the Middle East was largely a backwater loan market. This changed dramatically as the region's largely state-backed corporates used debt to gear up their equity investments in what turned out to be something of a global shopping spree. And the growth rate was dramatic. From signing 54 loans for just under US$14bn in 2000, at the height of the debt boom in 2007 Middle East entities signed 162 loans worth close to US$130bn. Even as global markets slumped in 2008, loans worth nearly US$99bn were signed in the year.

However, hopes that Middle East's vast oil wealth could provide a base to enable the region's economies to decouple from the economic carnage spreading through the West were soon to prove forlorn. And just as the ascent of the market was rapid, so was its halt this year, with Middle East entities signing just 11 loans worth about US$7.7bn in the first four months of 2009.

The reasons for the sudden halt in activity were threefold. First, Gulf banks themselves were soon implicated in the credit crisis through their exposure to sub-prime instruments and failed institutions; second, a number of high-profile defaults in Kuwait led to wider concerns over transparency in the country; and, most seriously, third, the view that Dubai-linked entities had over-borrowed led previously keen lenders to reconsider their commitment to the state and the wider region.

That Dubai was the catalyst of lender concern in the Middle East is in retrospect not surprising. Dubai Inc's acquisition spree resulted in Emirate-linked entities owning outright, or stakes in, companies as diverse as P&O, Madame Tussauds and Nasdaq. A frenzy of largely unco-ordinated borrowing funded this binge, leaving Dubai with a debt pile that reached US$70bn at the end of 2008, translating into one the highest proportions of foreign debt to GDP in the developed world. Fears over Dubai's debt load were further compounded as the Emirate does not have the same resource wealth as other Gulf states.

After a US$2.5bn refinancing for Borse Dubai that only managed to close fully subscribed after state intervention, Dubai started to soothe the market's nerves with the announcement that the UAE Central Bank had subscribed to half of a US$20bn bond programme. While the move was not seen as a panacea for all the Emirate's woes, bankers said that as a public acknowledgement of Dubai's funding issues, the federation's public display of support provided a floor from which market sentiment could once again rebuild.

The move also meant that Dubai had more than enough leeway to cover its estimated refinancing requirement of US$11bn in 2009. Borse Dubai's difficulties had showed the tough task that once feted borrowers now faced in getting banks to maintain their lending commitments.

In syndication Borse Dubai raised about US$1.2bn from the market for the refinancing, leaving the Investment Corporation of Dubai to step in and provide the shortfall through two local banks. Although the facility missed its target by a wide mark, it did show that lenders were still willing to support the market – albeit in smaller volumes than previously. The performance of a loan for Dubai Civil Aviation Authority later confirmed this view when it closed the refinancing of a US$1bn ijara facility at US$635m in April. Here, as with the Borse, the remainder was made up by the government.

However, with the state successfully stabilising the market, lenders showed they were willing to support top tier borrowers in size, with a US$2.2bn loan for the Dubai Electricity & Water Authority (DEWA) key. The facility was a notable success, raising more than the launch amount in a market where other Dubai borrowers had missed their targets. Indeed, the facility offered a signpost to the likely direction of the loan market throughout 2009.

"Market sentiment has improved slightly throughout the year," said Steve Perry, regional head of syndication, Middle East and Pakistan, at Standard Chartered. "The success of DEWA's loan was very helpful in improving the mood and showed the market's propensity towards safe-haven credits with stable cashflows and business models," he added. "As a result, I expect industries such as telecoms and utilities to be the focus of much activity this year."

DEWA also provided a new pricing point. The facility paid a margin of 300bp, which on a wider comparative basis looks competitive given that Dubai CDS was yielding around 565bp at the time of signing in April. Dubai is not rated, but state-owned global ports operator DP Word is rated A/A1.

On a wider market basis, European Single A rated credits are paying margins in the 150bp range, meaning Dubai is paying a very hefty country premium. As such, given the scale of this premium, which undoubted reflects in part fears about Dubai, bankers doubt whether DEWA will provide the pricing benchmark for the rest of the year. That said, it demonstrates that the market will provide support for decent credits.

While most agree that the pricing benchmark for the year's activity has yet to appear, few expect it to emerge from Dubai. After dominating so much activity in the region, the Emirate is likely now to take a back seat. While the bond programme means lenders are more relaxed over credit quality, there is still a clamour for more clarity over where, or if, the money has been deployed and which borrowers have been, or are set to be, supported.

Worries over transparency are also likely to mean that Kuwait will continue to be a very difficult market. These concerns follow last year's default by Global Investment House and Investment Dar's ongoing talks about restructuring its debt load. While these discussions continue, bankers said they had highlighted some of the difficulties of lending in Kuwait, where companies are allowed to release less information than those in other Gulf states, and then only in Arabic.

"Until there is a resolution on these restructurings, interest in Kuwait is likely to be limited to quasi-sovereign or intra-regional names such as Zain, the mobile operator," said one senior banker. In this situation, bankers expect most of the opportunities to come from the triumvirate of Abu Dhabi, Qatar and Saudi Arabia. All three have the benefit of strong domestic commodity bases and relatively modest borrowing records.

Already one the year's landmark facilities is being put together as the Bank of Tokyo-Mitsubishi UFJ, HSBC and Santander are co-ordinating a US$5bn loan for IPIC. Although US$5bn is a hefty sum in the current market, IPIC's status as the holding company for Abu Dhabi's oil interests makes it a fine credit whatever the wider economic climate. Indeed, IPIC's impeccable credentials are the type that banks will be looking for when loosening their purse strings.

"Sentiment is improving and while there have yet to be any landmark deals completed to test this so far this year, there are strong signs of returning appetite," said Raouf Jundi, head of origination, Middle East and Africa, at Bank of Tokyo-Mitsubishi UFJ. "There is a strong flight to quality inasmuch as lenders are looking for borrowers that are either quasi-sovereign or have a strong business profile with real income and growth potential," he added.

That said, few expect a return of large-scale syndications any time soon, with clubs expected to dominate. With the partial exception of Saudi Banks, few regional lenders are willing to lend outside their home country and cautious international lenders show little desire to expand their relationship client bases.

As in the wider EMEA region, to lend, banks require both a strategic relationship rationale as well as significant pricing. This means Middle Eastern borrowers – in keeping with the new European environment – must provide concrete evidence of ancillary business opportunities and how they intend to share them among their group before most lenders will agree to commit. In a market that the cream of international banking sought to court until little less than a year ago, for many Middle Eastern borrowers this new attitude is likely to come as something of a culture shock.

Moreover, constraints on banks' balance sheets and their continuing deleveraging means the bond market is expected to become increasingly important. Successful sovereign sales for Abu Dhabi and Qatar have been followed by a US$1.75bn bond from Mubadala, making it the first Gulf-based corporate to issue since the beginning of the credit crisis. The reopening of the bond markets is positive for the loan market as it offers an alternative take-out route given that demand among retail banks remains patchy at best.

Whether this means that the market will be able to move beyond club-style facilities to formal underwritings remains an open question. When asked, bankers say that while they are prepared to underwrite, they also require downside protection through high pricing and significant flex. This may be a paradigmatic shift from the easy days of the credit boom, but with depressed equity valuations meaning there are opportunities for corporate expansion globally, the potential for well-run borrowers to use the market for their long-term benefit is real.

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