Middle East Capital Markets Roundtable: Part II
IFR: Simon, do you concur with that? There are a lot of restructurings in play around the region, and there’s always talk of potential future restructurings. How seriously should we take this when looking at the overall picture?
Simon Williams: I don’t think it will be difficult for Abu Dhabi entities to get access to refinancing. I think it should be relatively straightforward. I guess what I’m very aware of is the whole Gulf debt market is a relatively new phenomenon. Five or six years ago, there was no such thing as a Gulf bond. We’ve come a long way in the last five or six years and I think this is part of the maturing process, understanding how to manage debt and debt flows. The fact that we’re talking about maturities in 2012 in mid-2010 whereas we were talking about the maturities of last year far later in the game is part of the process of coming of age.
I agree with the point made earlier that there has to be a real deepening of the local and international debt capital market over the next three, five, 10 years and beyond. This region has massive capex needs. Capex projects are very well founded but the local banking system simply can’t fund them. There has to be access to other forms of long-term funding and I think debt capital markets will be central to them.
IFR: That speaks to one of the points you had mentioned, Robert, in your earlier comments about the development of a domestic currency bond market. Where are we in that process? Will it be regional or will it be country by country and will there be interest internationally?
Robert Mohamed: I think in all honesty you’ve got to look at the individual GCC countries and how far advanced they are in terms of currency (obviously they’re all pegged to the dollar anyway). But I think there is potentially huge prolific demand with the UAE and Qatar as well.
How far we go in terms of currency diversification is an issue: you’ve got to look at demand for the Dirham outside the UAE (which is clearly limited) and the same thing with the Qatari Real. But what is clear is that economic growth within the region is inextricably linked to massive infrastructure spending.
Now in my view banks will continue to lend if there is some clarity in terms of being able to recycle that over the longer term and that’s where the debt capital markets kick in. You’re seeing more and more potential opportunities to recycle capital very quickly. And that’s one of the clearest mechanisms available to banks generally. There is, without any doubt, a drive towards moving away from traditional lending and looking at ancillary business. The regional banks are probably a few years behind what’s already happened in the international sphere, in terms of diversifying your income stream away from traditional bank lending. So that process will continue unabated. Of that I’m absolutely certain.
IFR: Steve are you seeing borrowers now moving away from the core lending product and into perhaps more progressive forms of financing like debt capital markets and other things? Or is the syndicated loan both for projects and general corporate still central to a lot of financing strategies?
Steve Perry: I think the loan and the bond markets basically sit well together. If you look at the bond market in the last month or two, it disappeared, so if you just relied on one product, you’d get stuck pretty quickly. The Sukuk market is very liquid so you know you’ve got that option. A lot of us have been looking at bridge to bonds.
The straight loan refinancings and the straight bonds live hand-in-hand; they both survive off each other. I’m not so sure about the local currency markets, though. I’m not entirely convinced they’re going to take off in a big way, only because the petrodollar is so important in all the economies, so how does your local currency really add value to that?
Robert Mohamed: I totally agree. I think what is also very important is that there is a clear need to diversify the income stream away from hydrocarbons. I think what you’re seeing in Abu Dhabi, for instance, is nothing short of a very loud and visible attempt to move the income stream away from hydrocarbons and looking at specific industry sectors. The creation, for instance, of the Debt Management Office has introduced a new thought process into the issue of contingent liabilities on the part of the sovereign and also it’s just going to police borrowings by government-related entities in a much more methodical way. That’s never been done before within the region.
Our hope is that that mandate extends out to other GCC countries, because there is a clear need to borrow in the market. Historically, if you look at the investor base within the region, five years ago, 60%-70% of the bond investor base was banks, whereas now we’ve got to look at asset managers, hedge funds and other players as they exist in the international market and get them to be much more proactive, to push out that five-year sweet spot to a longer duration. One of the biggest impediments at the moment to the GCC fixed-income investor is the lack of a pensions industry. The lack of a longer-term asset business will always prevent you from going out beyond five years.
Qatar’s sovereign longer-dated bond in November last year was probably the first real attempt to push out that duration curve. I’m sure there will be some other GCC country looking to do the same thing, hopefully sometime this year.
IFR: Jonathan: when you talk to investors about this region, what are the kinds of issues and questions you get? Are there themes that tend to be recurring?
Jonathan Segal: Yes. One of the first themes is: how do I look at a region which in many cases at the sovereign level is Double A or Single A? Do I think of that in a context of an emerging market? Clearly, for the most part - with the exception of Dubai, - balance sheets in the region are strong and that’s a key factor behind the strong ratings.
What distinguishes the Gulf and some other emerging markets from the developed markets is the relative immaturity in the use of capital markets, the relative lack of transparency, and access to, and in some cases the lack of understanding or immaturity of the legal systems or the lack of transparency around democracy (at least from a Western perspective), all of which makes analysis more difficult.
It’s those soft issues that are most on people’s minds and most holding back international investors from allocating more capital or allocating more finely priced capital to the region. The shift over the past three or four years has been away from, in the first instance, being worried about geopolitical risk in the region. That was certainly one of the top two or three investor concerns in the Gulf three/four years ago. But I think that notwithstanding some slight increase in questions about that due to the current situations around Israel, Gaza and Iran, the general trend is to be more sanguine about the geopolitical risk and understand that the entities that are coming to the market have positioned themselves neutrally in the Middle Eastern debate.
So it’s really transparency, it’s lack of a track record of information and consistency of policy in some cases and apprehension about how robust the legal systems are or how predictable the political systems are.
IFR: Anecdotally, we understand that there’s been a flood of distressed investors looking at opportunities in the Gulf, particularly in situations where original investors have taken a write-down. Have any of you has seen the distressed community come into the Gulf to pick up cheap assets? If so, do you think this is a positive development, on the basis that if a distressed buyer is coming in, there’s an inferred assumption that they think the market has hit some kind of bottom?
Steve Perry: Well, we’ve seen a few things happen in the last week or so with Dubai. But I think anywhere in the world distressed buyers are looking at pockets the same as everyone else would. I think visibly the situation that this region has been in the last 18 months has made it a prime candidate for distressed buyers to come in. In fact the banks that haven’t got a presence here, which just dabbled, are not going to be worried about selling at say 50 cents on the dollar because they want to get out.
There’s always going to be the volume there for distressed to make a business out of it, but I don’t really see it as being sustainable because basically this region will recover and it will recover pretty quickly; certainly more quickly than the Eurozone. So the distressed funds may flock back to Europe.
Robert Mohamed: If you look at where distressed buyers are actually concentrating their efforts, it’s because they see value. And they’re not going to present themselves in any particular part of the world unless they believe in the underlying core asset and they see some richness there, even if that’s over two years, five years or 10 years.
Generally, distressed buyers take up a medium to longer-term view. So there’s definitely upside and I think the prolific activity we’ve seen is probably a reflection of the underlying sentiment within the whole region. The infrastructure in Dubai is second to none and by default it’s going to reverse itself very quickly and much quicker than anywhere else within the GCC.
Farouk Soussa: Maybe if I could add just a couple of points. One just for the record is that it’s a very positive dynamic having distressed buyers in the market because it puts a floor to valuations. But beyond that, there are a couple of points to make. First there are more distressed assets out there given the volatility, there’s been in other areas - particularly assets in Southern Europe, which are competing with Dubai for being undervalued significantly. I think that will obviously have an impact on the flows into the [Gulf] markets.
But another thing is that in a market like the Gulf as a whole and Dubai specifically, where as Jonathan said transparency isn’t all it should be, my impression is that a lot of the distressed buyers are coming in and taking a view on moral hazard, more than anything else. They’re not looking at fundamentals and examining cash flow, economic prospects etc in great detail. Ultimately what they’re looking at is to see whether or not the issuers within the region (which by-and-large are government-related entities) will or will not be bailed out by governments in the region.
After what happened with Dubai World, the perception of the implicit guarantee by governments took a real bashing and spreads and CDS widened on all manner of GREs. And we haven’t seen them narrow to the point of the sovereign, so there’s still a perception that there’s a very good reason to distinguish between sovereigns and sovereign-owned entities. As distressed investors come in, they’re taking a punt on that spread being too wide. So they’re looking at moral hazard plays more than fundamentals. And that perhaps is not quite as positive a dynamic.
IFR: I guess infrastructure is an area we should spend some time on given the amount of it in the Gulf region. Simon: is the infrastructure market back on track? It did dip a little bit during the global financial crisis. Some projects had been deemed uneconomic because the cost of financing was too high. Is the infrastructure market picking up again? Do you see positive signs there?
Simon Williams: I do. I think the underlying argument for that infrastructure spending is still very strong. Farouk talked about utilisation rates in Dubai and the quality of the infrastructure here and I think he’s right. I’m not sure necessarily on the timing. I’m not sure we’ve gone through that transition process yet but certainly the infrastructure here will be productive.
I look around the region; I look at the infrastructure plans that were drawn up between 2005 and 2008. Many of those projects are very well placed power and water projects, airports and roads. I think what we’re looking at is compensating for the under-investment of the previous couple of decades. We’re also recognising the fundamental change that comes in this region with oil being worth US$70 a barrel in a bad year, not US$7 and being worth US$150 in a good year, not US$25. I think that fundamentally changes the region’s economic proposition but also fundamentally changes its infrastructure needs both in terms of quantity and quality.
I’m also aware as I go around the region that policymakers are still committed to those plans, but perhaps the timing is changing a little. Five-year plans are becoming 10-year plans. Some of those artists’ impressions are perhaps having a little bit of the shine taken away from them. I look at this region as a post-boom story. In no sense have we gone bust, but I think we’re perhaps looking at some of the excesses that we allowed to come into our planning during those good years and taking a fresh look. And I think that’s absolutely right.
I think the infrastructure story is very strong and it’s real. These are not vanity projects; they are urgently required capital projects. You name it, the identifiable projects are there. But then it’s also absolutely right that policymakers step back and say: “Okay in this changed environment and this changed global environment where do our priorities lie? What do we have to do now? And what should we be looking to do further down the line?”
IFR: From a financier’s standpoint, Steve, do you agree that the vanity projects have been shaken out and we’re back to the key ones. And how do you look at this from a financing perspective?
Steve Perry: I think you probably have to differentiate between Dubai and the rest of the GCC for one thing. I think Dubai has focused on stuff that it can do without for the time being. It has pushed it, as Simon said, eight to 10 years out, rather than doing it next year.
I think if you go outside of Dubai, everybody’s looking at improving their infrastructure and therefore doesn’t really take any real notice of what’s happening in Dubai. The way I look at it is that Dubai could have funded a lot more of its projects off non-recourse or limited recourse rather than doing it all on their own balance sheet. Had they done that they might not be where they are today.
Now Abu Dhabi has taken a different tack. They’ve always gone for a very liberal process of PPP, and project financings, keeping it all off balance sheet. And they’ve reaped the rewards for that. One project I think will be very important for the region is the GCC rail project, which is going to link up the whole of the GCC. They’re looking at a complete network, so people won’t have to rely on the airports all the time.
IFR: But is this project out there as a deal?
Steve Perry: Yes. Some of the portions are already being bid at the moment.
IFR: What’s the timeframe?
Steve Perry: It all depends where the various parties see it. There are several phases; it’s not all being done at once. It’s probably not being very well managed in terms of inter-governmental co-operation.
Robert Mohamed: Abu Dhabi has always maintained a very conservative approach in terms of its infrastructure spending and its infrastructure build-out. And I think all that’s probably happened over the last, you know year or so is that infrastructure plans have been redrawn, refined and redesigned in terms of the essentials as opposed to the non-essentials.
Non-essentials are being put on the backburner and the government is focusing on the hardcore infrastructure stuff - the power, the utility stuff. They want to get that driving because that in turn will contribute to economic growth. And as trade flows reverse over the next few years to the point where Asia is in the driving seat, the Middle East will probably be the cornerstone of a new global trading hub.
IFR: In terms of the way project financing will be structured, we’ve typically seen big international portions and small domestic currency tranches. There was also a trend towards Islamic tranches. What themes do you see developing in how projects are financed in terms of deal structures?
Steve Perry: The issue with project finance is it’s long term debt financing and a lot of banks have moved away from that because of their liquidity costs etc. So again as I was saying earlier, similar thing with project financing: you’ve got 10 to 15 core banks that do project financing in the region. That includes some of the regionals like NBAD or Arab Bank. They’re still in the game provided the pricing makes sense and the deal makes sense. In terms of the structures, I think we’re become more reliant on ECAs to fill the gap. Whereas before people saw that as a bit of a slow cumbersome way of completing financings, now they’ve become a little bit more important. Islamic has always been an option but in the end it’s left and right hand.
Robert Mohamed: It’s also very important I guess to look at historical PF economics. That’s part of the contributing reason for the pain we went through in 2008. A lot of banks actually took huge proprietary positions in PF transactions, booked the interest income and just used it as a safe return. When the whole thing suddenly reversed, everybody was nursing fairly prolific losses.
I think project finance will come back but I think capital needs to be shored up in a very prolific way because banks are increasingly becoming much more focused on economic return on capital, and whatever way you look at it, unless the returns are there on the project finance side, the economic returns aren’t there over 20/30 years. The Dolphin project bond of last June was 10 years with an average life of six years. Demand from within the region was nowhere near as prolific as it was in North America or Europe. And that is from a very safe industry and a strong gas story.
Steve Perry: One thing I was just going to add is that we don’t really know how Basel 3 is going to come out and affect risk weightings on project financings. My view is it’s probably going to be a little bit kinder to project financing because historically there’ve been no defaults. No-one’s lost any money because ultimately in the GCC and surrounding areas the structures are very safe. So I think when Basel 3 starts being enacted, the actual net capital usage that’s applied to those things might actually be relaxed a little bit.
Click here for Part three of the Roundtable.