The three-month Emirates interbank offered rate was 1.54 per cent on 12 February, the highest level since July 2011
In mid-October 2011, Saudi Arabian Mining Company (Maaden) signed a $3.6bn financing deal for phase two of its aluminium project. The debt was priced at just 145 basis points above the Saudi interbank offered rate (Sibor), 20 basis points lower than the debt raised for phase one of the project a year earlier.
Comparing the two deals, no one would have thought the global financial crisis, which started in 2008, had taken a worrying turn for the worse. Despite all the factors that seem to point to deteriorating market conditions, pricing has generally been improving.
High levels of liquidity in Saudi banks have pushed down the pricing on loans as lenders try and put their balance sheets to good use. A similar trend is at work in Qatar and Abu Dhabi. Bankers often complain that pricing is too low, but this time they may have a point.
Pricing rationale behind loans
The question is how long pricing can keep falling before lenders stop agreeing to financing deals. “Typically, the rationale for doing loans at the kind of pricing Qatar Petroleum and Saudi Aramco get, is that these are key relationships for the bank and can generate a lot of other work,” says the head of project finance at one international bank. “That [rationale] is increasingly being questioned though, as the ancillary business you get doesn’t always make up for it and often there’s not much other business to share around a club of 10 or 20 banks.”
Pricing for local currency tranches is falling for two reasons. First, the banks are generally liquid and need to start generating profits after about two years of poor performance from provisioning against bad loans, following the bursting of the credit bubble in 2008-09. Second, local lenders are much more susceptible to political pressure from governments, which often have a stake in both the project and the largest domestic banks.
In Saudi Arabia, the volume of liquidity is so high that pricing is falling even without any political interference. So far, the banks are not complaining about pricing too much, as they are instead focusing on rebuilding their loan book after a period of stagnant growth in 2009. The competition for market share and book assets is pushing down pricing. This will continue to be the case throughout 2012, as Saudi banks have largely forced out foreign competitors by underpricing them. The kingdom will, therefore, be left untouched by the current global banking worries.
In Qatar, the opportunities to lend are generally few, but large in size, and banks fall over themselves to participate. Abu Dhabi looks to be the exception. With no deals completed there since the first half of 2011, bankers say the appetite from local banks is uncertain. Liquidity conditions, however, have been deteriorating, which is putting upward pressure on pricing.
The Emirates interbank offered rate (Eibor), a measure of liquidity in the UAE banking sector, has been rising since August and is expected to continue that trend for most of 2012. The three-month Eibor rate was 1.54 per cent on 12 February, the highest level since July 2011. The next Abu Dhabi project to seek financing will be the second phase of the Emirates Aluminium project (Emal 2), which is expected to start approaching banks for funding within the first quarter.
By the time Emal 2 is priced, it could have been more than four months since the last deal in the Middle East closed. The current turmoil in the global financial markets means that four months is a very long time in banking.
It is not just the lingering financial crisis that could push up bank lending rates. New banking regulations being introduced known as Basel three could also influence them.
“The current liquidity situation in the region has not yet been fully fleshed out,” says Jonathan Robinson, head of project finance at the UK’s HSBC. “There are definitely pockets of liquidity in places such as Qatar and Saudi Arabia, but there are also a lot of institutions that would not be described as liquid.”
Negative conditions in global financial markets
Liquidity among local lenders may also not be enough to arrest the impact of the declining number of European banks lending on project finance. So far, the signs are that pricing is coming down, although it remains elevated compared with pre-credit crunch levels.
New sources of liquidity, such as export credit agencies and Japanese banks, have shown themselves willing to step into the gap left by European banks. Even some US banks, typically shy of project finance lending, have shown interest in investing in regional projects.
Because of the negative conditions in the global financial markets, only the region’s largest and best-known sponsors are expected to try to raise money this year. More speculative projects, or ones sponsored by developers without a strong track record, will probably put their financing plans on hold.
That means that virtually all projects likely to seek funding during 2012 will be strategic in nature, have strong government backing and be key banking clients: everything they need to convince lenders that they deserve the best pricing available. As a result, bankers will continue to complain about low pricing this year.