Loan market gets tough
The global capital markets crisis caught up with the Middle East in September. Ouida Taaffe reports on the impact this will have on the loan market.
A region with billions of petrodollars would not seem an obvious place for lending banks to look for clients, especially not clients paying more than similar entities in other, more developed parts of the global market, but the Middle East is in growth mode and needs to pump in cash.
It's nice to have money bubble up out of the ground. Even if the value of the dollar has suffered and remains under pressure, oil is still a very attractive source of export income. However, oil reserves will not last forever, which is why furious investment in the future is so important to the Gulf states. The lending environment that supports large-scale capital investment is, however, far from benign.
"The loan market in the Middle East is more challenging now than it has been for quite some time," says Mark Waters, head of debt capital markets, the Middle East, at BNP Paribas. "There are three factors in this: rising pricing, lack of liquidity and limited investor appetite for longer tenors."
The most recent earthquakes in the wider capital markets – the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch and the bailout of AIG, and the continuing uncertainty they represent – have also not left the Gulf unscathed. Bankers say that the full extent of the impact on the lending market is not yet clear.
However, there will be a negative knock-on effect as CDS levels for banks and corporates rise, pushing up the cost of funds at financial institutions and, by extension, the cost of the loans they make. Banks are already going through repricing exercises on those deals in the Gulf that have not yet been launched, they say, bringing the fees and margins into line with what the market now demands. It is expected that premium pricing will be required to attract funding.
This does not mean, however, that no borrowers in the Middle East can push against the current liquidity restraints. There are always companies that represent particularly strong business prospects for lending banks.
Orascom Construction Industries (OCI), the Egyptian conglomerate, and the Investment Corporation of Dubai (ICD), for example, are both in the market with sizeable loans. In OCI's case, it has mandated Arab Bank, Banque Misr (bookrunner), Barclays (bookrunner), BNP Paribas, Citi (bookrunner), National Bank of Abu Dhabi (bookrunner) and Piraeus Bank to arrange a five-year US$1bn facility with an all-in of 172bp. ICD has mandated Barclays, Citi, HSBC, JPMorgan and RBS on the conventional side and Dubai Bank, Dubai Islamic Bank, Noor Islamic Bank and Standard Chartered on the Islamic side on a US$6bn loan rumoured to have a margin of just 125bp.
However, many corporates in the Middle East cannot fall back on a large group of relationship lending banks, or point to a track record or providing lucrative ancillary business.
"The Middle East is still a relatively young loan market compared with Europe," says Raouf Jundi, head of origination, the Middle East and Africa, at Bank of Tokyo-Mitsubishi UFJ. This – at least by some standards – shallow interaction with international lending banks is, of course, further compounded by the systemic lack of liquidity. Banks that are capital-constrained will support their best customers and otherwise look for the best short-term returns.
"There is a very transactional approach to the market these days," says Waters. "Outside of the relationship bank pool, most banks are purely focusing on return and, to a lesser extent, whether there is the potential for any business development."
In theory, of course, the willingness to lend at a competitive rate is a reflection of risk, which could suggest that the Gulf states may be quietly considered to harbour more lending hazards than meet the eye.
"Is there anything wrong with the fundamentals of state-backed entities in the Middle-East? No," says Mohammad Kamran Wajid, DGM and global head of the financial institutions division at Emirates Bank. "Any geopolitical shock might dampen sentiment in the short-term, but the perception that the companies themselves could be over-extended is misguided."
It could, of course, be argued that Gulf companies face a particularly stiff inflationary headwind that makes them less attractive clients. Many countries in the Gulf suffer from high inflation, much of it imported through dollar pegs. However, oil revenues are also high and these tend to keep local corporates in rude health. Banks say that Gulf corporates borrow not because they are financially pressured to do so, but because it is financially efficient.
"Any approaches to the loan market will be to add some leverage to very strong balance sheets, to extend their maturity profile and to diversify their pool of relationship banks," says Waters.
As an example of the gearing principle of lending, there is an expectation that a number of private equity acquisitions from the Gulf in Europe could take shape this year, some of them large – though, if the deals go ahead, the equity cheques involved will be well over 50%.
Such transactions, which would still involve borrowing large dollar sums whatever the equity stake, inevitably mean turning to international banks. Local banks, which had reduced their dollar reserves to avoid any losses that might have resulted from de-pegging, not only face a shortage of dollars, but also a higher cost of funds than international players, which obviously makes them reluctant to commit to syndicated facilities. Like the international players, they will support their own long-term customers first, generally with bilaterals, which can have an attraction for corporates that would rather not advertise just how much they are paying for their funds.
The difficulty of finding a wider retail syndicate in the Middle East means that loans are priced right down to the last dollar. Where a strong corporate in Western Europe could expect to fund well inside its CDS level, this is not the case in the Gulf.
"Loan pricing in the Middle East is getting closer to CDS levels as the scale of transactions increases and borrowers' seek to tap the largest possible investor base – a good segment of which will be looking at investing on a relative value basis," says Peter Bulbrook, managing director and head of European and Middle Eastern loan origination at Barclays Capital
However, this should not suggest that the loan market in the Middle East is in particularly poor health. "The differential in loan pricing between the Middle East and Europe is partly due to the fact that the Middle East reacted very quickly to the credit crisis," says Jundi.
The relatively high prices on offer for corporate loans in the Gulf, and the entrée such facilities represent to future business – particularly in a global financial market that is rocking following the failure of major investment banks – do have appeal for many lenders.
Further, banks have worked to make loans attractive to as broad a syndicate as possible – offering Islamic and local currency tranches tailored to local bank needs. Furthermore, the Gulf, with the exception of those borrowers based in Dubai, is not faced with the problems around tightening country limits that affect borrowers in, for example, Russia.
"Country limit constraints are not an issue for lenders to most GCC states. Indeed, lenders have experienced a scarcity of paper originating from some countries in the region," says Bulbrook.
So-called Dubai Inc lenders find themselves in a different category because the Emirate, on a back-of-the-envelope calculation, has borrowed more than US$70bn in the syndicated loan markets over the past two years. Given that the underlying creditor for much of this is the state of Dubai, banks are now starting to reassess the extent of the exposure they are willing to have to one entity. Some are predicting a dislocation.
"One key shift in the dynamics in the ME will be the emergence of a two-tier loan market in the region: one for Dubai Inc names and one for all other GCC names," says Waters, who believes that "the strong deal flow for Dubai Inc names plus the additional requirement going forward will place a huge strain on market liquidity. I believe [it] is already having an impact on banks in terms of their available lending/country limits for such names. As a result, I would foresee some pricing premium in order to attract the required liquidity from the market."
Challenging though the market looks going forward, it is not all bad. Lending to Middle Eastern corporates is also not as narrow a business as it might appear. They are often acquisitive – particularly in overseas markets as they seek to expand – and many have requested ratings with a view to tapping the bond market, which gives banks greater comfort both in terms of where such clients will fit within their Basel II lending model, and in terms of refinancing.
"There remain a lot of potential mandates across the region being worked on by banks and I see many new opportunities being presented through to year end," says Bulbrook. "Bahrain, Abu Dhabi, Qatar and Saudi Arabia are all likely to see sizeable deals for the remainder of 2008, although the likelihood is that the wider syndication of these tansactions will be 2009 events."
Further, though banks may not be keen to extend credit anywhere in the global markets at present, they will always prefer good risks to bad. Cynics suggest that banks are institutions that offer to lend umbrellas when it is not raining and whisk them away when it starts to get wet. Given that the Gulf will see sunny economic weather for some time, at least in terms of oil revenues, banks may be expected to continue to lend money in the Gulf.