Syndicated Loans 2005 - International banks target Middle East
International banks have flocked to the Middle East over the past year and this flood of liquidity has translated into a sharp reduction in funding costs for the region's borrowers. But for international banks, starved of returns at home, the Middle East offers good yield prospects. However, this environment is tough for local banks, which have been priced out of some syndications. But with corporate activity on the increase and huge demand for infrastructure funding, plenty more supply is expected. David Cox writes.
Buoyed by an oil price that has bounced around record highs all year, the Middle East is enjoying an economic boom. And with this comes a renewed confidence to invest in infrastructure and a new cycle of international corporate expansion. Accompanying this economic assertiveness, over the past year there has been an explosion in lending volumes with around US$32bn raised on the syndicated loan markets so far this year. And in a borrower friendly environment, the popularity of the region has meant a steady fall in loan pricing for corporate, financial and infrastructure names.
The unprecedented level of global liquidity that has caused funding costs to fall across all markets can explain much of the pricing fall in the Middle East. However, it is the entry of international banks or more specifically - European banks - that explains much of the sharp pricing reductions in the Gulf Cooperation Council (GCC) countries. For international banks the attraction of the GCC is clear: the glut of global liquidity has cut lending margins across the major European markets, while the sclerotic nature of much of the continental European economy means opportunities for big-ticket event-linked lending are thin. As such the Middle East offers plentiful supply and relatively good returns.
"There is increasing competition between the European Banks active in the region and the make up of syndicates is increasingly dominated by international banks," said Julian Taylor, managing director of syndications at HSBC. "Pricing continues to be aggressive in both the project finance and FI markets as seen on Qatofin and ADCB. However, returns are still relatively good at the hybrid and crossover corporate end of the market."
In the developed financial institution market, Abu Dhabi Commercial Bank (ADCB) is the latest borrower to benefit from these conditions. The bank mandated Banc of America Securities, Calyon, Deutsche Bank and JP Morgan to arrange a US$750m loan priced at just 27.5bp over Libor. Despite smashing through last year’s benchmark from Gulf International Bank, which put in place a five-year loan at 35bp over Libor, the deal was a huge success and by September looked on track to be increased to US$1bn.
Although an unambiguous success, when mandated there was considerable lender scepticism that ADCB would be able to raise such a large ticket at a price that was so through the previous benchmark. However, although on an absolute basis the pricing reduction looks sharp; when compared to international comparables the returns is well within market pricing. Once BBB+/Baa1 rated South Africa completed its US$1.5bn three-year and five-year loan at 22.5bp and 30bp for the longer tranche respectively earlier in the summer; it was clear that it would only be a matter of time before GCC borrowers, some with higher ratings, would start to demand similar pricing.
Moreover, for European banks that are faced with the option of lending domestically to BBB corporates at drawn returns in the mid-teens, a Aa3 rated bank paying a drawn margin of 27.5bp is still attractive: “Many of the region’s borrowers offer good returns based on their ratings when compared with Europe,” said John McWall, head of syndications at Arab Banking Corp.” We are seeing upwards of 80% of regional syndications dominated by international banks. Although this pricing environment is tough for many local banks, the region is buoyant economically and banks are recording very profitable business through their retail networks.”
Although cheap money may be tempting, the high oil price means most of the region's banks are highly liquid and have little need for external funding, with several pre-payments reported. And while European banks are happy to lend at these levels, the falling pricing environment is tougher for many local banks. Benchmark pricing is logically below the cost of funds of the region’s other local banks and many are being pushed out of the FI lending market. But for now European and international liquidity is more than plentiful and ADCB is still likely to be followed by other top tier financial borrowers who will look to take full advantage of European's willingness to lend cheaply.
A strong economy is feeding through to the corporate sector with many of the region's companies looking to expand internationally. And this upturn in corporate activity is so far providing a rich supply in the loan market.
"The primary purpose of corporate loans in the region this year has been for acquisitions," said Raouf Jundi, head of origination for Middle East and Africa at Bank of Tokyo Mitsubishi. "This reflects a recent phenomena that has seen Middle East corporates investing internationally and seeking to diversify into industries outside of oil and gas."
To fund its acquisition of CSX Corp’s international terminal business, Dubai Ports was the first borrower to test the market, when at the start of year it launched a US$1.45bn loan through sole MLA Deutsche Bank. With few precedents, pricing was always going to be tricky, but the margin of 90bp over Libor was seen as overly generous with talk of upwards of US$4bn raised. Facing an embarrassment of riches the lead took the highly unusual step (for an investment grade deal) and reduced the headline margin to 75bp.
Even if execution was less than smooth, the deal unambiguously showed the level of liquidity available for event linked transactions. Since then deals ranging from Mobile Telecommunications Company of Kuwait acquisition of Celtel through to Etisalat International’s acquisition of a stake in Pakistan Telecom have been funded through multi-billion loan financings.
With such demand for corporate sector, it is not just acquisition-linked loans that are attracting liquidity: "The hybrid sector that falls between project financing and corporate lending has grown significantly over the past year. These deals, many of which are property linked, offer a better yield," adds HSBC's Julian Taylor.
Etisalat’s US$2.1bn loan emphasised another of the year's trend: the growing importance of the Islamic finance market. The loan for the UAE based telecom is the largest to date in the Islamic financing market and shows how quickly the market has developed.
Again, as with much in the region, the Islamic market is developing in response to the high oil price. The market first emerged in the 1970s when the oil price was high, meaning the Gulf was awash with liquidity. A similar phenomenon today means the amount of cash invested in Sharia compliant accounts is estimated to stand at around US$500bn and is growing at about 10%–15% per year. These growth levels put the Islamic market as one of the fastest growing financial markets in the world.
Given these growth rates, it is hardly surprising that banks and borrowers are increasingly looking to take advantage. As well as Etisalat, Dolphin Energy, United Gulf Bank and Arcapita are among those to have completed successful loans.
But just as in the conventional market, the European thirst for assets is driving down prices, making some transactions uneconomic for Islamic banks. For example, not a single pure Islamic bank joined the recent US$1bn syndication for Dolphin Energy: "There is a lot of Islamic money looking for a home," adds ABC's John McWall, "However, this is not a market purely for Islamic institutions; both international and regional conventional banks are increasingly active in the sector."
A further consequence of high hydrocarbon prices is the huge investment into infrastructure and predictably the energy sector has dominated project lending with some US$26bn closed in project finance loans since last summer. The most high profile of these was the US$7.6bn package for Qatargas2 – the largest energy sector project financing to date.
As the nature of project finance means these deals are more attractive on a return basis than other forms of lending. But the charge of international banks here has meant that even in this sector local banks have found the returns too low. And while international banks are more than able to provide the necessary liquidity to the financial and less extent the corporate sectors, the size of the project finance means that the involvement of local banks is essential.
So far there have been no high profile market failures, although the RasGas 2&3 expansion deal came close. The US$1.675bn 15-year transaction paying 45bp to 65bp on the commercial tranche did attract enough liquidity, but not before pricing was increased by 10bp from the original plan with a larger bond component required. Tellingly, the loan only attracted four local participants, signalling to sponsors and financial advisers that pricing can only be pushed so far.
But with several billions required in infrastructure investment over the next year, project financing is likely to provide a rich vein of supply with Saudi Arabia tipped as the major new market.