Middle East Loans Roundtable 2008: Part one
IFR: In spite of the wider difficult market, Middle Eastern corporate loan volumes appear to have held up relatively well. How does the panel rate the health of the market?
Raouf Jundi, Bank of Tokyo-Mitsubishi: Driven by the growth of regional economies, the loan market in the Middle East is booming. There is strong liquidity but obviously at a different price, and coming perhaps from different areas. Europeans are still providing the bulk of the liquidity and the regional banks are happy to come in only if there is a local tranche. Occasionally local banks will lend in dollars, but clearly the cost of dollar funds for them is too high, but for local currency - dirham or Saudi riyal, etc - they can accept lower returns which are comparable to what the dollar returns are for European Banks.
Grainne Molloy, HSBC: There is significant liquidity for the right Middle Eastern names at the right price. Middle East banks themselves have been relatively unscathed by the subprime crisis, with a couple of exceptions, but the debt market has not been immune from the fallout of that crisis. Increasing funding costs of banks, combined with difficulty in accessing liquidity, has led to greater selectivity amongst the banks which in turn has translated into increased costs for borrowers.
From a currency perspective, borrowers have to be more flexible. Certainly there is dollar liquidity as we've demonstrated on a number of transactions – notably with Borse Dubai and its acquisition of OMX. That deal totaled roughly US$5.8 bn and was highly successful, securing an oversubscription in syndication which managed to tap various sources of liquidity. European banks have contributed substantially to liquidity in general and, on that transaction, roughly 40% came from European banks. Interestingly, roughly 40% also came from Asian banks who are playing an increasing role in the Middle East. Similar to other banks, however, Asian banks are also beginning to refocus on their own markets, and are therefore becoming more selective as their return requirements have increased.
Raouf Jundi: Tenor is important for Asian banks as well. Clearly they prefer the shorter end plus the higher yield.
Gilles Franck, Standard Chartered: Selectivity has become extremely important. Banks now look a lot more thoroughly into what is the value proposition. Pricing now needs to stack up to reasonable levels and ancillary business on offer has to be clearly defined, probably more so than in the past when there were promises on business that may or may not materialise. Credit committees now ask clearly what is the wallet or the shared wallet that borrowers can offer.
Rizwan Shaikh, Citi: While lenders are being selective on the basis of relationship and cross-sell opportunities, they are becoming relatively less credit sensitive. Arguably, the liquidity component in pricing has become more important than the credit component. This is especially true for the regional banks and is particularly relevant in sectors where banks have concentration issues, such as real estate.
Peter Bulbrook, Barclays Capital: This is true but the incredible volume of loan business that was transacted in the Middle East last year only 25 percent was actually placed with Gulf-based banks. Now, they are driving this price dynamic which seeks a return beyond their increased cost of funding, which is now on average north of 125bp or sometimes north of 150bp. So given the limited capital that have today they are clearly chasing yield. You can show them probably a whole series of different credits and different credit qualities, but price works for them, so if you have a premium price deal they will look at it pretty positively.
Declan McGrath, RBS: Sectoral issues are also important and there is different behaviour patterns within different sectors. There is a clear differential operating between the banks that are true relationship banks, be they local or non-local, versus banks that are chasing yield. A lot more banks are less focused on being relationship banks of major clients, primarily because they know that they are not going to get fed and so they are chasing yield. Certainly we have seen it out of Asia and certainly we have seen it out of GCC banks. Therefore the risk of the major underwriters has increased, and we are back to the days of taking real underwriting risk. This is because investors are now prepared to wait for large loans to break in secondary and take it up at a discount at 97.5 or so to get an enhanced yield if they think that the deal is not going to find take up in syndication.
IFR: If you look at pricing in the Middle East, it seems to have increased at a higher rate than other markets.
Peter Bulbrook: The wider GCC capital market issuance that we've seen at the close of last year and early this year has driven a price dynamic which has pushed out local bank expectations. A lot of the banks that have been investing in the sukuk and the corporate bond market in the GCC now take the spreads that they are able to achieve in three or five year dirham sukuk as to where they will commit balance sheet. That's the challenge for the loan market and that's where we need to look on a relative value basis.
Declan McGrath: When credit crisis began in July and August of last year, there was more of a robustness about pricing out of the Middle East and Eastern Europe than there was in the rest of Europe and it was just a question of time until these regions caught up.
Grainne Molloy: For many local banks, the cost of funds is now significantly higher, particularly in dollars, ranging between 100bps and 170bps, and this is driving yield expectations. The other issue is the access to dollar liquidity and the desire to lend in dollars. There is uncertainty surrounding the dollar peg to GCC currencies with expectations that the local currencies will be revalued, resulting in limited desire among the local banks to lend in dollars.
Raouf Jundi: The Middle East reacted quicker to the price increases whereas only now we are seeing some of the equivalent European borrowers seeing their pricing going up. So, if you want, Europe is now catching up with what has happened in the Middle East.
Declan McGrath: There have also been a reasonable number of significantly sized loans as well, which has helped that process. But notwithstanding the fact that local banks prefer to fund in local currencies and not dollars because of the depegging issue, they do have dollars. They may not be using them, but they do have the dollars, which means they are taking a view as to what the outcome may be on the depegging issue and may be trying to protect the dollars they actually have.
Rizwan Shaikh: The dollar liquidity is there, but there is a wide range of assets chasing this liquidity. Investment banks, hedge funds and private equity, are all chasing regional petrodollar liquidity so the choice that banks have today in where they can deploy their liquidity is tremendous whereas the bank market does not offer the same kind of returns.
Declan McGrath: You will continue to see options for the other currencies – whether it is dirhams, Saudi riyals or Qatari rials – and clients will take the advantage. If a client is looking to do a dollar denominated transaction they prefer to access dollars, but they are giving the option to banks to lend in their local currency because of the concern over depegging. Whether that option continues once the depegging issue is cleared - and that may take quite some time because it is a political question - we don't know, but certainly today they actually have the options and they are taking them.
IFR: Is there a pricing differential between local currencies and dollars? Does it reduce a borrower's overall cost of funds or is it just an extra pool of liquidity?
Raouf Jundi: Indirectly it does, but local banks will not go into dollar deals unless the pricing is 50 to 100 percent higher. The main purpose of the local currency tranche is to increase liquidity and clearly if you increase liquidity then you are indirectly limiting the pricing.
Rizwan Shaikh: The logical thing one would have expected to see is a smaller spread on local currency tranches compared to dollar tranches, given the higher liquidity cost of dollars. But so far we haven't seen that. This can partially be explained by the fact that some deals have had to accommodate local currency tranches, instead of offering a dual tranche structure at the outset.
Peter Bulbrook: But we have to be careful in the sense that when we put loans to the market and to the wider investor base - whether it be a local GCC based bank, a European bank or an Asian bank - most of the loans that we work on have some form of global distribution. The spread is the credit spread, so it is difficult to differentiate between different currencies. The arbitrage is really the funding cost.
Declan McGrath: There is a play within the arbitraging of the funding cost, because there are other opportunities. But you are absolutely right, because the logical step that one would think about is, if I can do dirhams and I know that these guys' costs of funding in dirhams, or Qatari rials, or Saudi riyals are lower, why should I logically not take a cheaper margin?
Grainne Molloy: Local currency tranches, differentiated in terms of margin and tenor, were prevalent in the Egyptian market as a means of maximising liquidity, in particular for longer term transactions. That has since disappeared as the Egyptian banks, and their requirements, have changed.
Peter Bulbrook: That has changed because the financing requirements of Egyptian corporates - as we saw with OTH this year - have become global financing exercises for global businesses, meaning their requirements go outside of a local market context. Similarly the GCC today is not just a local market, it is a global financing market that sits front and centre on a global financing stage.
IFR: From the borrowers' point of view, if there is an actual requirement for dollars but they are forced to access local currency, how easy are currency swaps?
Peter Bulbrook: International banks have been committing dirhams to the dirham tranche trades this year and there is a significant arbitrage pick-up.
Declan McGrath: There is a significant chance now that they have to take the risk and costs of the swap.
Raouf Jundi: The swap market, though, is not as deep or as long, so I'm not sure how briskly they can hedge the requirements.
Rizwan Shaikh: Although this issue is starting to ease, most counterparties are on the same side of the hedge, which makes hedging large amounts or long tenors difficult and expensive. However, many companies operating in GCC with local currency revenues can take the view that even if local currencies do depeg from the dollar, they benefit indirectly anyway, so it is not critical for them to raise dollars or swap local currency debt.
IFR: What if somebody were to buy European assets? If a corporate borrower was to buy, say a telecom asset, in Europe and pay in euros would that be a problem?
Raouf Jundi: This has been done earlier through a euro club deal for an important corporate in the region. There were European banks and European banks preferred the euros to dollars in any case, because even they have a difference in funding costs. The deal went very well and the currency was not an issue.
IFR: Would that be cheaper for them?
Raouf Jundi: I don't think it is a difference in pricing.
Declan McGrath: The size of the transaction is key here. With the really big deals you may run into a little bit more difficulty than you would with smaller deals.
Raouf Jundi: We have had comments from regional banks who said, "We prefer to fund in euros or even in yen rather than US dollars", because there is less of a premium.
Declan McGrath: There's quite a few European banks, second tier names, which are having difficulty funding dollars just like the GCC banks.
Peter Bulbrook: We have seen that as well.
Gilles Franck: These transactions get done up to a point, but it is never going to be the big volumes.
IFR: Seven year tenors have been mentioned. They have more or less disappeared from Europe now. Are they possible in the Middle East?
Peter Bulbrook: It's the optimal tenor horizon that garners the most market liquidity. And present experience suggests that's probably optimal around three years right now or one to three years, and that's not so different from the wider EMEA market anyway, even for investment grade in Europe.
So five plus one plus one, and seven year tenors are probably something that we will not revisit soon on a wider EMEA basis. We might see five years for the strong relationship transactions that are maybe just clubs or relationship held positions.
Declan McGrath: There is a real differential between corporate clients, for example, who have got their ten, twelve or so very close relationship banks that have been feeding them for the last three or four years. However, just before that they got rid of the other banks that made up their syndicate group because they weren't able to provide them with enough ancillary business.
Now, for a certain size of deal, they will get the deal done and they will get the five years that we have just talked about. However I do think that in the last two cycles where there have been seven year tenors and where pricing was very fine, what clients are now saying is, "Okay, we can see pricing is going up but, guess what, we are not moving, we are going to keep that seven year deal there at Libor plus 15 basis points", and so the banks are saying, "Right, well, we are not going to get caught in the same way again".
Peter Bulbrook: You have to remember as well that the volume of liquidity that has poured into the Gulf has come from European and Asians banks. We have all been experiencing extensions now on cheap seven year deals and in a capital constrained world that doesn't quite work today; so not too many banks will be suggesting that the best access to the market or balance sheet is through seven year commitments.
Declan McGrath: But there are clients who are still looking for seven and ten year deals for specific purpose-related transactions. They are still trying, but they are coming up against a brick wall with the banks because the banks are just not prepared to do it.
Grainne Molloy: To access Asian liquidity you need to aim for their sweet spot which is certainly not five years but is more likely between one to three years. If you look at the average tenor of deals done this year so far, you will find that it is probably about two to two and a half years in terms of average maturity.
IFR: Given the amount of "Dubai Inc." paper to hit the market in the past few years, how are lenders coping with concentration issues?
Peter Bulbrook: It is a question that comes around every week at the moment. It is an interesting one to solve. The background to a lot of the concentration around "Dubai Inc." is that a lot of the financing has been transacted on a very short-term basis largely with the expectation of being bridged to capital markets, which really for the best part since December, just hasn't been there or hasn't been there at the right price for the issuers to take these bridged positions out. By the time we get to the end of Q3 or Q4 this year there's circa US$20bn of short-term paper, whether that be syndicated or held on banks balance sheet that needs to be refinanced.
So the questions will be: Is there is a wide enough market capacity in dollars? Can you syndicate that amount paper? And on what terms and what price?
Declan McGrath: There are some clients in the region who refuse to pay the price that is being demanded by the banks. They are not saying that they don't recognise that there is a fair price to be paid for a transaction, but certainly I have seen a couple of clients relatively recently who have said, "Okay, thank you, we know it is maturing, we will repay it, thank you very much but we are not going to renew it, even for two or three years, at the price you are suggesting".
Raouf Jundi: These clients are betting on the markets moving back in their favour in the short-term, which probably is not going to be the case. Sooner or later they will realise that they need to come back to the market and they will have to pay up.
Declan McGrath: A number of these loans were put in place on the basis that they will be there for the shorter term. Where and how long the volatility is going to last in the capital market where they would be expecting to place the longer maturity dated paper is an open question.
Peter Bulbrook: It is an interesting sales challenge when you are underwriting and distributing loan paper today in terms of being credible with your refinancing story for an investor that is buying short-term paper. This is because the last thing that an asset play investor wants to do is put a position on and be expected to roll, unless of course they then, at the roll point, command a higher price, which is not really where the clients want to see their funding cost and their financing exercise driven towards. So we are at a delicate balance right now to see where this capital market opens once again in sufficient size to be able to take some of the pressure away from the bank market.
Rizwan Shaikh: Capital markets do - as we have seen in the last few months – provide windows of opportunity even in current markets. The issue here with a lot of borrowers is accepting the levels at which they are open. Frequent issuers like Gazprom, VTB and others from the region who had strategic deals to finance, e.g. VimpelCom and KMG have issued record breaking jumbo bonds over the last few months. So the capital markets certainly remain accessible for solid credits, but the borrowers need to reconcile with the fact that they are available at a different level. When banks start seeing that they are being left to hold paper at sub-market levels because issuers don't want to pay capital markets levels, they will look to gradually reprice that paper until the disincentives for accessing capital markets disappear.
Peter mentioned earlier there is US$20bn of short-term paper which is maturing before Q4, but if you look at the other natural maturities for longer dated deals that mature this year, that number adds up to close to US$40bn. That's a lot of refinancing to be done and clearly that is going to come at a cost and to the extent issuers get practical about accessing the capital markets, it will help reduce pressure on the bank market.
Raouf Jundi: The same borrowers are also in a phase of growth. So unless they can offload the bank paper into capital markets, they will not be able to increase their overall funding.
Rizwan Shaikh: Banks are becoming a lot savvier in structuring bridges. You don't get bridges approved today without having serious discussions with borrowers on take-out strategies and incentives for going to markets. You will see a lot more protection and bells and whistles on these bridges which ensure that banks are not left holding them at a submarket level.
Peter Bulbrook: The opportunity is there, we have seen the wider debt capital markets within GCC grow tremendously over the last three to five years, so that issuers can access not just the traditional loan markets, they can issue in Islamic loan form, in the conventional capital markets, sukuks or convertible. All the tools are there for clients to use and they have been used successfully before.
Declan McGrath: In a lot of the cases where you have these bridges, the get out will be if they don't issue in the bond market, then there is an increased price to pay of significance and a structural change if that's what's required in order to get it restructured. Even for project and export finance type transactions that may be planning bond issues, you can get your full flex-pricing, or structural pricing in order to be able to take it out at the end of the period. We have actually seen a couple of situations like that.
Peter Bulbrook: Capital comes at a cost. So when banks book loan positions and put them through portfolio, the immediate measure or relative value play is, for example, the CDS. If you look at the CDS plays in some of the GCC names, it is incredibly high, considering where they issue in the bond market.
So if we just continue to keep soaking the loan market with exposure and capital, more and more we have seen the price getting near to the CDS levels or in fact the price they would issue in the capital markets anyway.
Gilles Franck: The bond space has ballooned because there was so much foreign participation in those bonds in the last two or three years and everyone thought, "Well, there's always going to be a backstop in the Middle East if I need to sell", and no-one ever thought that there might be a dollar shortage in the Middle East; suddenly there was no-one to sell these bonds to. So it has nothing to do with credit or anything. Now the loan market looks at those references as well and says, "Hang on, why should I go so much below that?" So there is a balance to be found. I am pretty confident that the capital markets will be there again for refinancings at levels that will be market levels and the question is who is going to take the first step?
Click here for Part Two of the Roundtable