IFR: Is that to suggest that the bond and loan market pricing is converging?
Peter Bulbrook: To a degree, but not entirely and there is not an exact measure between loan and capital market pricing anyway.
Raouf Jundi: It doesn't just apply to the Middle East and even Europe, where the banks - or the markets - have been saying that they will converge. They have never really converged. At one time either one is high or the other is high depending on where the liquidity is coming from.
Rizwan Shaikh: Convergence will depend on size. If you can get deals done within your relationship group, you can be significantly inside the capital market pricing. The moment you need to go outside your core group, you will see a lot more convergence between loan and bond pricing.
Peter Bulbrook: Across any loan market across the globe the relationship is the key to achieving subscribed deals and accessing capital from banks. I think it's a point that in the GCC we are in the infancy, in terms of loan market issuance and relationship development, particularly with the international banks. Clients have been issuing in a corporate context over the last two or three years in size but not previous to that. Clients have to be aware, and we see many that are, that successful deals come where clients have embraced their relationship banks, given them the right additional ancillary business and given the right income flows that support capital commitment.
Grainne Molloy: In the past, we have seen deals which although aggressively priced and structured, were successfully placed in the market on the strength of relationship. But as deals are increasing in size, due to Middle East corporates becoming more acquisitive and reflecting the growth of the GCC economies, there isn't sufficient ancillary business to go around. So while relationship continues to be a key element in the successful distribution of deals, price and structure are equally important; it's not just the one without the other.
Declan McGrath: The GCC is an evolving market, and borrowers are learning. There is an educational process that needs to go on both sides of the table and they have learned. Even the local GCC banks themselves, they are not hiring ex-pats from the foreign banks for no reason, they are doing it for all the right reasons and they are putting them in senior positions within those banks for all the right reasons.
IFR: Why has there not been a sort of feeding frenzy in the Middle East as there has been in Russia? Why does the Middle East look relatively quiet compared with Russia?
Rizwan Shaikh: It is really M&A driven. We've seen a drop off in both inbound and outbound M&A activity in the Middle East in the last six months, whereas there has been a lot of M&A activity in Russia which has driven volumes.
Grainne Molloy: A percentage of it is project finance related. We've seen a slow down in the growth of project financing in the region and that's not because the projects aren't there but rather, contractors and sponsors have reached the natural limit of their capacity. There is a huge volume of project financing to come, but if you look at the volume of project financing as a percentage of total financing, it has actually declined. Traditionally in the Middle East market, project financing was around 70 percent of lending activity. In the last year or two, project finance has accounted for 20 or 30 percent of total lending volume.
Peter Bulbrook: We also haven't seen significant FI issuance this year and we had about $20bn last year. A lot of the M&A either has been talked about but hasn't quite worked, or hasn't happened. There are some deals that have been delayed or have or have taken longer than expected.
Declan McGrath: I think world M&A has also decreased, partly driven by two sides of the table. The target client that somebody may be chasing, because the equity markets have taken a hammering, they may decide they are not prepared to sell at the price that's being offered.
Raouf Jundi: Also if you compare with Russia, the Russian economy is much more diversified, so there is demand from different parts of industries.
Gilles Franck: Russia traditionally relies a lot more on leverage than the Middle East.
Peter Bulbrook: Russia is quite unique, it is a much bigger economy, there are many more corporates that are looking for straight debt, as well as M&A.
Raouf Jundi: The Middle East is very much a hydrocarbon power, which is mostly project financed and there is a slow down in the project market for sure.
IFR: Because of the higher cost, are corporate and project borrowers still going to rely on leverage to the same amount or, given the amount of liquidity that must be in the region are they going to start funding through their own equity?
Peter Bulbrook: Some of the acquisition scenarios we have seen - and have seen successfully concluded - have been, relatively speaking, highly levered transactions. These have been from government owned entities that have been able to access bank and capital markets.
Declan McGrath: And with significant equity on the table as well.
Peter Bulbrook: The size and aspiration of some of the sovereign wealth funds and some of the other clients we work with mean they are still looking at big opportunities and they have realised that the wider financing markets need to see more equity in transactions.
Grainne Molloy: Some of the acquisitions being looked at are going to require not just the bank market but the capital markets as well.
IFR: Are sovereign wealth funds still actively hunting out opportunities?
Declan McGrath: There's no question that the sovereign wealth funds are interested in diversifying their asset base and they will look to continue to do so. It is a little bit more difficult for them at this moment in time. The pricing that would be required, or the pricing that they would be prepared to pay in terms of a premium, is not as much as the people who they are targeting would want to see in a lot of cases.
Peter Bulbrook: Sovereigns or their investment vehicles are strong in the traditional sectors such as hydrocarbons and other industrials and sectors where they already own businesses. That's where they are looking in terms of acquisition opportunities around the globe. So that is, businesses that make sense and can complement the group or the strength of the corporate activity they already have.
IFR: Islamic finance is something that has been spoken about for a long time now but it hasn't reached the potential in the loan market that was once promised. How important is that market now?
Rizwan Shaikh: The Islamic market volumes are healthy but they may be somewhat misleading as to the true size of Islamic content. There are a lot of deals structured Islamically as a way to tap into marginal liquidity. So you have to see through those volumes and see how much of the deal size is real, pure Islamic content and it is not as large. When doing big deals, every dollar of marginal liquidity counts, so by structuring a deal Islamically, if you can tap into incremental liquidity, then why not? While the documentation is a little bit more complex, it doesn't cost anything in terms of pricing.
However, the market has increased. We've seen new Islamic institutions coming up, so the proportion of Islamic placed paper has increased. While the documentation is a little bit more complex, it doesn't cost anything in terms of differential and pricing or anything else to incorporate that. So where you have some capacity concerns you would rather structure something Islamically, because all the conventional banks are now so used to these structures they don't really care to a large extent, except for some smaller investors in Asia who may have some concerns.
Raouf Jundi: It's definitely a growing market, but expectations were perhaps unrealistic. It was never going to become 50 percent of the world market, because clearly there's more money globally in the conventional banks rather than the Islamic banks.
Declan McGrath: That's very fair. The expectations that were suggested at the time that it first came into vogue were totally and completely unrealistic. However, the sukuk market is certainly thriving. The loan market is almost certainly increasing in terms of size and, as has been said, if getting that last $150m to $200m of liquidity may very well be the piece you need to complete your deal successfully, people will chase it.
IFR: Do the clients care whether a deal is structured Islamically or not?
Peter Bulbrook: That's probably the key point, certain clients will insist or require that their financing is on a Shariah compliant basis and the bank market has accommodated this pretty well. There are lead banks that can structure and distribute this paper and there are now plenty of investors that can buy Shariah compliant paper too.
Grainne Molloy: Islamic structures were originally introduced to the project finance market as an important additional pool of liquidity. As the conventional banks became more active in the Islamic market generally, the pure Islamic institutions found themselves at a disadvantage in terms of tenor and pricing. However, as a result of the credit crunch, conventional banks have increased their pricing and reduced tenor, leading to a narrowing of the gap with Islamic institutions. This convergence will lead to further growth in this market. In addition, in certain jurisdictions, a Shariah compliant product is what the borrowers require.
Gilles Franck: I think Islamic banks will continue to play a particularly important role in regional transactions or sectors that conventional banks or rather international banks are either full on or more uncomfortable with. Real estate is one of those as is the second tier corporate market.
Raouf Jundi: The Saudi market is probably the most important, because there are implications for publicly quoted companies in terms of their share price, support, et cetera.
IFR: Is there a maximum deal size in the Shariah compliant market?
Rizwan Shaikh: Deal size is not a real constraint as most Shariah compliant deals have conventional banks participating also so the deal sizes are constrained by the overall market capacity for a particular issuer. In a sizeable deal, say US$2bn+, pure Islamic content may be 25 percent of that.
Declan McGrath: If you were looking for a guide as to how you might get larger percentages in Islamic and Shariah compliant financing, what they don't have at the moment is a kind of regulatory body at the top that decides what is Shariah compliant. There are so many degrees of difference in Shariah compliance depending on which jurisdiction you are in - whether you are in Saudi Arabia or whether you are in Qatar - and they have individual scholars and these individual scholars have different opinions and one may agree and one may not agree.
There is talk that there are attempts to formalise or standardise an opinion set of various scholars so that they can get an overall regulatory position. Now whether that happens or not, I don't know. If they did it I think that would be good and that it would certainly help in the evolution of the market.
IFR: Are there any clients who would say, "We don't want the money if it isn't Shariah compliant"?
Rizwan Shaikh: There are definitely issuers who have a preference, or in certain cases, requirement to have all or a portion of their borrowing Sharia compliant. That has really driven the growth in this market. It is estimated that Islamic assets today are about $500bn, which is a growth of about 30 percent over last year. So it is a pretty rapidly growing market.
Peter Bulbrook: The product certainly sits well in acquisition finance structures, where we have seen Islamic loan structures and conventional structures that work well together. We've seen it before and that's going to be increasingly important as financing asks continue to grow.
Gilles Franck: There's hardly any situation where you lose some liquidity by adding an Islamic tranche. So you can only gain from it by getting the additional dollar.
IFR: But how much now is actually taken up by Islamic banks rather than European or international banks?
Gilles Franck: I think it is very dependent on whether it is a 50bps priced deal or a 150bps priced deal.
Declan McGrath: There are still significant question marks around the product. Whereas some people may be passing judgment in terms of scholars as to whether or not it is Shariah compliant, there are others who say, "Actually, it is not Shariah compliant". The degree of requirement from those Islamic banks dictates whether or not they will do the transaction. With some of them it has to be really the way they want it, otherwise they won't play.
IFR: What pricing levels do Islamic investors now require?
Declan McGrath: It depends on the tenors as well.
Gilles Franck: They don't like to go long.
Grainne Molloy: It is probably pretty similar to where conventional banks are now.
Raouf Jundi: I think the conventional lending price has gone up to where it now satisfies the Islamic lenders.
Rizwan Shaikh: Unless it is a really tight relationship-driven club situation, pricing generally across the board is now pretty much aligned for conventional and Islamic investors.
Raouf Jundi: There are some conversions between the Middle Eastern model and the Malaysian model in Islamic financing, especially with many Middle Eastern banks now acquiring stakes in South East Asian banks. The Malaysian model has been more relaxed, in terms of regulations, but there is some movement towards convergence, which will continue.
Click here for Part Three of the Roundtable.
