Tuesday, 22 January 2019

International bank challenges

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Challenges for international banks operating in the Gulf Co-operation Council countries remain, but both borrower and lender are dependent on each other for future growth by David French.

International banks have played a significant role in the development of the GCC region in recent years. It was European, Japanese and American money, on the whole, that helped to fuel the boom years of the early part of the 21st century. However, the benefits haven’t all been flowing one way, with the growth of the Gulf region opening up many new opportunities from which international banks can generate business.

The middle part of the decade was a particularly frantic time for international banks involved in the region. Lending grew at a rapid pace, from US$23.2bn in 2004 to US$122.8bn by 2007. After lending just short of US$32bn in the first half of 2008, the collapse of Lehman Brothers saw Western banks reverse the policy of ploughing staff and resources into the region to return to their home markets.

Having binged on the cheap credit that these banks had provided in the proceeding years, many borrowers in the region found themselves in a quandary. Without the means to refinance maturities and other fundraising options closed to them, restructurings and defaults became more frequent.

Concerns over the ability of borrowers to repay, coupled with the more pressing issue to conserve capital, meant that bank lending fell by 75% in the first six months of 2009; compared with the same period in 2008. However, slowly, loan finance is returning for specific clients. These loans have, predominantly, been done on a club basis, with the few syndications in the project finance market.

So what are the features that are shaping international banks’ attitudes to the loan market? The most prominent is the more cautious attitude. While 2006 and 2007 saw banks falling over themselves to lend into the GCC, since the events of late 2008 banks have channelled their resources towards existing clients. While some slackening of attitudes has taken place since the depths of 2009, deals have mostly been restricted to refinancing existing transactions.

Some new names have surfaced – Qatar Aviation Leasing Company (QALC) completed its first ever loan in March, while Aabar Investments wrapped up its debut syndicated deal in August. However, both borrowers, with their strong ties to the Qatari and Abu Dhabi governments respectively, represent the fact that banks, on the whole, are still only willing to lend to certain types of borrower – the triumvirate of quasi-sovereigns, telecoms and infrastructure.

There have been deals done outside of these sectors: for example, Bank of Sharjah closed a US$150m loan in August, while a US$200m facility for Global Education Management Systems (GEMS) shows a hint of private sector lending returning.

Even allowing for the odd deal outside of these three areas, other markets remain off limits for the majority of international lenders. The Saudi private sector is one such market; Dubai is another. This is because, along with Kuwaiti investment companies, the most high-profile restructurings in the region involve Dubai government-related entities (GREs), such as Dubai World, and the two Saudi conglomerates: Saad Group and Algosaibi Group. Issues at these companies have meant that international banks have been unwilling to risk further exposure to similar firms and, as a result, have stopped lending.

Having been burnt by these events, approaches have changed. When banks were piling into the GCC region during the boom, the pressure to make money meant they were willing to accept a lack of transparency. Even if bankers don’t like to admit it, international banks were just as guilty of name lending as their local counterparts. Having paid the price for this mistake, international lenders are demanding much more openness from borrowers before they part with their cash.

The other consequence of the restructurings taking place, in particularly the ones involving Dubai GREs, is that banks are now more concerned with their distance from the assets and, in the case of quasi-sovereign entities, where the borrower sits in the overall structure of an economy. The immature legal structures in place in the region have made things more difficult for banks when things have gone wrong, with the framework to settle disputes, such as the seizure of overseas assets, non-existent or untested.

This, in turn, has impacted on lending decisions. When Mubadala was marketing its loan earlier this year, it had to drop plans to place the funds in a treasury holding SPV after pressure from banks, which were concerned about having an additional layer between them and the company.

Immature legal frameworks also raised another issue for international lenders on Mubadala’s loan. Conventionally, all facilities involving banks from outside the region have been covered by English law. In the case of Mubadala, the borrower originally wanted to use English law for the facility but UAE law for the guarantee over the SPV. While the point became moot once the SPV was dropped, it had been a significant bone of contention during negotiations.

Ultimately, until there is a history of case law that bankers and lawyers can chart and base their arguments on, there is always going to be an element of doubt over local law. A legal process that takes days or weeks, rather than months or years, would also be beneficiary.

The negative impact of GCC restructurings has also extended to other banks. Prior to 2008, Asian banks were a big part of many syndications but, having been burnt by the likes of Dubai World, they have all but withdrawn from the market – deals for Qatar Telecom and ETA Ascon saw limited Asian representation. Their absence is a big part of why the syndication market has failed to regain momentum lost in mid-2008.

Local banks have also been missing from internationally organised deals. While not a consequence of the restructurings, the pricing levels that have been seen in 2010 facilities have been beyond their reach due to higher dollar cost of funding.

Like the disappearance of Asian banks, the lack of local institutions further diminishes the pool of liquidity available to borrowers and places more emphasis on the international banks. The QALC repricing, completed in October, was a case in point, where the halving of margin from 250bp to 125bp saw many regional banks drop out and internationals take on the additional burden.

Finally, the consequence of international banks restricting who they will lend to has created a situation where lenders are complaining that they don’t have enough good quality deals. With most banks looking for the same types of client, a well-structured facility from a good name sees banks flood in. If borrowers extend the loan, as IPIC did, this will help. However, if they don’t, as in the case of the original QALC deal, this results in significant scale-backs; to the frustration of banks.

So what does the future hold for international banks? The key point is that, in the GCC loan market, the fate of internationals is intertwined with that of their local counterparts. The practices of local institutions are more important in shaping internationals’ attitudes than vice versa as, like when they enter any market, Western banks have had to mould the dynamics of their offering to attract business and not just try to imply strictly Western standards.

This is why international banks were hit by the problems of name lending to family-owned conglomerates. However, if local banks return to name lending, internationals could be forced into following suit – despite the huge losses they’ve taken – as their offerings will look uncompetitive as a result.

A “race to the bottom” doesn’t look likely. Locals have also suffered heavy losses and, more importantly, are taking a bigger role on the world stage. This means they are adopting the Western standards required to be part of the international order. We are already seeing their increased prominence: the appointment of Qatar Islamic Bank as sole bookrunner on the internationally sold deal from Qatari Diar in 2009 was regarded as a watershed moment.

This extension into the realms once considered the domain of international lenders is also impacting on their ability to secure ancillary business. Competition for roles on revenue-generating work, such as infrastructure advisories, was already tough and internationals would often complain if clients were seen to be favouring the same bank or banks.

However, local institutions are now muscling in on this territory. Now, it is not uncommon to see big regional names mandated on international DCM issues. Meanwhile, locals are also building out project advisory teams, with the appointment of National Bank of Abu Dhabi as financial adviser to the Abu Dhabi Ports Company project a sign of this trend.

Coupled with this additional competition is the reality that auxiliary business opportunities in the Gulf are rare. The development of GCC bond markets is still well behind many other areas. Meanwhile, even though many hundreds of billions of dollars are being invested in infrastructure projects in the region, companies – even the large quasi-sovereign entities – only have the capacity to work on a handful of projects at any one time.

Therefore, if ancillary business is not forthcoming, it will be harder to convince credit committees to take further exposure on to their balance sheets. Banks will have to decide whether they can live with the small revenue-generation of syndicating loans – and hope the relationship will pay off in the end – or withhold further lending until the borrower can promise something more.

Ultimately, while there are issues, internationals are not going to abandon the GCC region. A balance between the needs of borrower and lender is needed, though, as both are interdependent. Local banks have come a long way but do not yet have the clout to replace what internationals have to offer the GCC countries. At the same time, while the Gulf remains a small part of their operations, Western banks have made a sizeable investment in the region and won’t want to cast aside relationships with cash-rich clients lightly. While their relationship might not be perfect, GCC borrowers and international banks will be profiting from each other for a long time to come.

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