A lack of liquidity

20 March 2008

Difficulties in securing dollar financing are set to restrict the amount of deals that come to the market this year

The pessimism that characterised the mood of project finance bankers last year is gone, and they are no longer battling against ever-shrinking margins and dwindling returns. The credit crunch has given bankers the opportunity they needed to start lifting prices again.

However, a whole new set of worries have descended on the industry. The credit crunch may have resulted in some upward movement in margins, but only because the cost of borrowing for banks has risen, reflecting the difficulty the banks are having in getting hold of dollars to lend for long-term investments in the Middle East. Some in the industry expect this to cast a long shadow over any deals that attempt to come to the market in 2008, and say it could put some sponsors off raising money at all this year.

Activity slowdown

“Some institutions are delaying their finan-cing because they will not get the pricing they could have got last year,” says Fahad Saeed al-Raq-bani, general manager, project finance, at investment vehicle Mubadala, based in Abu Dhabi.

Yet he insists Mubadala will be coming to the market for more financing this year than it did in 2007.

If so, bankers will probably welcome the deal flow. There was a noticeable slowdown in the market last year, after the Middle East and North Africa region emerged as the biggest project finance market in the world in 2006, with about $50bn worth of deals completed.

The slowdown in activity is noticeable from the slimming deal volume of the biggest advisers in the region. In 2006, the top five advisers raised $58bn; in 2007, it was $44bn. The outlook for 2008 remains murky, however.

Darren Davis, head of project finance at the region’s most prolific project finance adviser, HSBC Middle East (see box, facing page), predicts the GCC alone will account for $50bn worth of deals in 2008, and the Middle East will be the biggest project finance market in the world by the end of the year.

This advance will be driven by the shift away from Qatari projects and petrochemical deals towards vital infrastructure, he says.

Other bankers in the region disagree, saying new infrastructure projects will be unable to make up for the shortfall from the lack of Qatari and Saudi petrochemical deals. In short, there is a sense that nobody quite knows how the market will behave over the next 12 months.

“There is a renewed caution on behalf of both banks and borrowers,” says Mansoor Durrani, head of project finance at Saudi Arabia’s National Commercial Bank. “Deals will get done if they are priced correctly. But I am not sure if big ticket deals will get through the market.”

Project delays

“A lot of projects will either delay themselves or get shelved,” says Irfan Said, project and structured finance head at Samba in Riyadh.

“Liquidity that is available is definitely going to be more expensive than pre-crisis days,” says Rajan Malik, senior vice-president and head of syndication at Gulf International Bank in Bahrain. “What that means is that the project finance transactions that were in the private sector will likely be pushed back six to 10 months until the situation improves.”

Even the most bullish of bankers admits that some marginal deals may fall by the wayside. Others in the market say deals this year will be mainly relationship-driven, and banks will finance the projects of lenders with which they already have commitments in other areas, but will be less open to exposing themselves to new clients.

“I think we will see more deals being done in the nature of corporate finance transactions, rather than project finance deals,” says Said. “I see more merit in doing my budgets for raising money through advisory work or large corporate borrowing, rather than project finance.”

The $6.9bn raised by Citigroup for the Emirates Aluminium (Emal) smelter in December was the largest project deal completed in 2007. It was also a sign that dollars could be found for the right projects. Of course, it helps that the project sponsors, Mubadala and Dubai Aluminium, are owned by the governments of Abu Dhabi and Dubai.

Even this deal was not without problems, though a mooted $2bn bond issue for the project is yet to be raised. Raqbani’s only comment on the bond is: “All our options remain open and we will select the right funding sources for the project. We are in no rush [to issue the bond].”

Huge losses

Other deals that hit problems in the rocky market conditions in 2007 include Qatar Steel’s $1.3bn refinancing and a $1.2bn bond issue by Qatar Fertiliser Company (Qafco). “The Qatari deals were among the worst affected by the credit crunch as they tend to squeeze margins as much as possible, and banks just were not willing to drop prices that much,” says one local bank source.

The impact of the credit crunch fell first on international banks, which have been reporting huge losses because of provisions made against the fall in value of investments in structured products derived from US sub-prime mortgages. This resulted in a drying up of appetite for long-tenor project debt in the Middle East.

According to Durrani, this presented regional banks with the perfect opportunity to move into the deals they were turning away from. “Regional banks are in a much better position to compete with international banks because of the problems they face from the credit crunch,” he says. “But we have been beset by our own problems.”

The lack of dollar liquidity stemming from uncertainty about the future of the GCC currency pegs left local banks without the funding streams to exploit the opportunity presented to them by the credit crunch.

The result of this will be that international and regional banks will have to rely on each other more than ever before. “We would never be in the position to take on the international institutions,” says one Saudi banker. “What we can do is use our collective underwriting capacity to offer international companies either our sectoral knowledge or local distribution capabilities.”

The problems with raising dollars will continue to push prices up across the region, and could lead to some advisers experimenting with local currency tranches, or other international currency tranches. These are intended to tap the liquidity in currencies such as the Saudi riyal, or sidestep the dollar problem by supplying funding in euros and yen, rather than solely dollars.

“You could see some local currency tranches, but there is still a problem that a lot of local currency funding comes from deposits, which is very short-term money,” says Darren Davis, head of project finance for HSBC Middle East. “It is unlikely that local banks will want to expose themselves to the mismatch that would arise if they turn that short-term money into a 20-year dirham loan.”

Market appetite

Raising financing in euros or yen would help contractors as it would better reflect the currencies in which they pay for their supplies. However, it would leave banks supplying the funding needing to hedge their exchange rate risk.

Banks are nervously waiting to see how the first big deals of this year fare. Syndication of the $1.89bn commercial bank portion of the $3.9bn Ras al-Zour petrochemicals complex, which began in early March, is being looked to as a bellwether for market appetite for Middle East project debt. The deal is expected to close in April. “Caution has set in, and I think it is infectious,” says Said. “Everyone is waiting to see what happens next.”

The other key element in 2008 will be the reintroduction of market flex clauses, which enable underwriters to vary the margins on syndicated debt to make it more attractive for banks. By mid-2007, this had virtually disappeared from project deals in the Middle East because of the competition between banks to lend and the financial strength of the project backers. “We are no longer in an era when we are financing a long stream of ‘cash cow’ projects,” says Davis.

Market flex looks set to return as banks remain wary of being unable to syndicate debt and having to keep it on their own balance sheet. All this will make Middle East project finance deals a lot more sophisticated than they were a year ago.

The growing maturity of the market will put additional pressure on advisers to devise structures that incorporate a greater diversity of investors, with better protection for them, and take greater account of the difficulty contractors have in bidding prices for contracts in such an inflationary environment.

Governments and sponsors are only beginning to realise the market changed quickly last summer, and the huge returns seen while the oil price was high and debt was cheap may have come to an end - especially as the project market moves more into the infrastructure sector and away from projects that rely on cheap government feedstock to earn fat returns.


The main advisers

Once again, HSBC has emerged as the most prominent financial adviser for projects in the Middle East following its top ranking in MEED’s 2007 survey of the previous year. The bank acted as adviser on 11 deals and helped sponsors raise more than $15bn, giving the bank a market share of more than 25 per cent, far ahead of the competition. One of the most noticeable things about the table is the similarity it bears to the biggest advisers of 2006. HSBC, Citigroup, The Royal Bank of Scotland (RBS) and BNP Paribas all continue to occupy the top four positions.

The dominance of HSBC is also clear from the number of deals it completed in 2007. RBS, with four deals completed, still acted on less than half the number of deals completed by HSBC.

The dominance of international banks leaves little room for regional players to build a presence in the market. Banks such as Riyad Bank, Banque Saudi Fransi and Arab Banking Corporation have been squeezed out of the top 10 in favour of more international institutions. Inter-national banks also have a much higher average deal size than local banks, with the top seven banks all working mainly on deals worth more than $1bn. Regional banks tend to be working on deals below that level.

“The problem for regional banks is resources,” says one Dubai-based banker at an international firm. “If an international bank is hired by a project sponsor, they know they are getting 150 to 200 project finance people working on a deal. If someone from that team moves on, there are still plenty of resources to get the deal done. Even the biggest regional banks have only half a dozen project finance people, and that means there is a greater risk going against them.”

Mansoor Durrani, head of project finance at Saudi Arabi’s National Commercial Bank, agrees that local banks lack resources to challenge properly the huge teams at international banks. “International banks have global teams so they can afford to have sector specialists,” he says. “We specialise in the Saudi market. We could not afford to have someone devoted to metals deals, for example, because there are not that many going on here.”

Sponsors who force banks to partner with local institutions, which is a model used for several Saudi projects, should help local banks to obtain experience on huge deals, says Edilberto Mendoza, structured finance senior manager at Saudi Hollandi Bank. “Local banks can compete with international ones, especially on some deals that need local expertise,” he says.

The other big problem for the home-grown institutions is the inertia in the market, and the kudos attached to the established banking brands. Hiring an international bank as a financial adviser is usually easy to agree for the board of a project sponsor, while hiring a local bank can require more justification of the decision to get enough support.

Ernst & Young, at nine in the table, would have performed better if it had not been for the collapse of the $1.3bn Qatar Steel refinancing. Arab Banking Corporation, at 10, would also have fared better had the huge Saudi Kayan petrochemicals project financing not been held up by Saudi Basic Industries Corporation’s (Sabic) diversion of funding into the GE Plastics acquisition.

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