Agencies take aim at the Middle East

22 December 1995

GULF bankers are no strangers to challenges and change. In recent years they have survived two Gulf wars and seen the region's surpluses turn into deficits. They have had to cope with ever more demanding customers, the introduction of new technology and life on leaner margins. This year has brought developments which are set to change the financial landscape once again.

Firstly, corporate finance departments have assumed a far more prominent role and completed some ground-breaking project finance deals. And the Middle East - for so long ignored by the world's ratings agencies - has become the latest focus for their attention.

Regional bankers are monitoring the movements closely. 'There is an increasing tendency to go for project finance-type arrangements, rather than old sovereign borrowing or direct funding,' says Middle East regional manager of The Chase Manhattan Bank, Mahmoud Difrawy. Chase and Citibank were underwriters for one of the biggest loans of the year, the $700 million syndication for Saudi Petrochemical Company (Sadaf). The deal, which was arranged by Gulf Investment Corporation (GIC), was signed in November after being well oversubscribed.

The Sadaf loan also stood out for being the first such borrowing in Saudi Arabia to be governed by English law. This, says Difrawy, ensured a strong response from international banks. The next major prospect is also coming from the kingdom in the form of the GIC-advised $500 million syndication for the Ghazlan power station expansion. More loans are anticipated in 1996 from subsidiaries of Saudi Basic Industries Corporation (Sabic).

Similar opportunities are emerging elsewhere in the Gulf. The financing of the Equate petrochemical project in Kuwait moved ahead in 1995 and included a $100 million syndication, for which National Bank of Kuwait, JP Morgan and Chemical Bank acted as advisers. In Bahrain, GIC is advising Gulf Petrochemical Industries Company on a $110 million loan to part-finance a new urea complex. In 1996, bankers will be trooping to Qatar as the country's two major gas projects seek financing. And in Oman, a range of opportunities is emerging as the government seeks to finance private utility schemes, such as the Barqa power station, and its own gas development projects.

The shift to non-recourse project financing opens the way for further deepening of the regional financial market. The next step will be issuing corporate bonds, which will offer companies a cheaper source of funds than a syndicated loan. One regional banker estimates that a corporate bond will be 10-15 basis points cheaper than a syndicated loan, as the rating process that must precede a bond issue ensures greater transparency and improves perceptions among potential buyers.

The London-based ratings agency IBCA has helped advance the process by setting up a regional joint venture, the Inter Arab Ratings Company (IARC), in Bahrain. The new holding company plans to open country offices throughout the region to rate local firms.

If corporate bonds are to win wide acceptance in the region, Middle East companies will have to be ready to expose themselves to the intrusive process of obtaining a rating from agencies such as IARC. This could entail a cultural revolution for some companies and there is likely to be resistance until the process is seen to make sense by reducing the cost of funds.

Ratings arrive

It will take time to develop a market for such bonds as well. Difrawy says the growth of the corporate bond market will only come 'as and when the public becomes comfortable with the availability of information and the liquidity in the market'.

While a flourishing corporate bond market may be some years away, the rating agencies are looking more closely at the banks themselves. At the start of this year, the only agency with an active presence in the Arab world was the Cyprus-based Capital Intelligence. Now it has been joined by Standard & Poor's, Moody's Investors Services and Thomson Bankwatch, as well as IBCA. Moody's has gone as far as opening a Cyprus office to cover the Middle East.

However, the region's bankers are responding with caution to the rating agencies' sudden interest in the area. As Robin Munro-Davies, managing director of IBCA, explains: 'Rating is a two-edged sword that will benefit strong institutions, but will be a disadvantage to weaker ones.' Only a good rating ensures broader access at a cheaper price to funds in the interbank market, which is the main reason that banks will seek a rating.

The usefulness of a rating also depends on how much a bank has to rely on the international interbank markets. 'In the local market it is much less important, but the moment a bank moves outside that market then a rating becomes helpful if not crucial,' says Munro-Davies. A rating will carry more significance in less wealthy regional markets than in Saudi Arabia, Kuwait or Abu Dhabi. 'There they tend to be net placers rather than borrowers, so they are less sensitive to a rating than others.'

But ratings are likely to become increasingly important for institutions such as the offshore banks that depend on access to international capital. For example, Bahrain International Bank (BIB) tapped international markets in 1995 with a $60 million floating rate note that was oversubscribed; it was also one of the first institutions in the region to receive a rating from IBCA. It is difficult to quantify the relationship, says Munro-Davies, but in such issues a rating gives investors greater comfort.

A rating is not yet a pre-requisite for a successful issue, however. In November, Gulf International Bank raised $300 million from a syndicated loan, $100 million more than was planned, despite not being rated by an international agency. Nevertheless, if such institutions are to become the conduits for capital flows into the Middle East - for their own use and to finance new projects - a rating is likely to become an essential requirement. Scenting the latest challenge to land on the desks of Gulf bankers, the rating agencies have arrived. And they are in the Middle East to stay.

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