Borrowers weigh project financing alternatives

11 October 2015

In a new credit cycle with more cautious bank lending, developers are looking beyond cheap loans

Special Report Contents

With government coffers significantly lighter in 2015, structured finance to carry out priority capital investment projects is coming back to the fore in the Middle East and North Africa (Mena).

Developers and government clients are weighing the most cost-effective ways to finance projects as liquidity begins to tighten and banks become more cautious on lending.

 GCC bond issuance, and bank loan and deposit growth

GCC bond issuance, and bank loan and deposit growth

While competition between banks to lend and grow their assets remains high, the era of historically low interest rates and cheap finance is drawing to an end. An expected rise in US Federal Reserve interest rates could also narrow the gap between the cost of bank loans and bonds, prompting a revival of the latter.

The start of a new credit cycle comes at an inconvenient time for cash-strapped project clients and developers scrambling for work in slowing projects markets in the GCC.

“We are seeing the beginning of an increasing need to consider alternative financing,” says Karim Nassif, associate director at US-based Standard & Poor’s (S&P). “There is still liquidity available, but in six or nine months it might not be there, so we will see more interest in alternatives.”

Major projects will need todiversify financing sources and be innovative to secure the quantity of funding required.

Increased caution from international and regional banks could also drive more reliance on export credit agencies (ECAs) to push projects through.

Their counter-cyclical remit could push them to continue taking a prominent role in financing in the Middle East, as growth in their domestic economies looks fragile.

ECA guarantees will be especially important for less wealthy countries such as Egypt, to give international banks the confidence to lend despite the fiscal weakness of many government entities.

Bank loans

Era of cheap finance ending

The cost of securing funding from banks is expected to rise

Oman tourism

Oman Tourism Development Company plans to use project finance for a number of hospitality projects

Thanks to historically low interest rates, companies have been able to access very cheap finance from banks for the past few years, with banks competing to lend at wafer-thin margins to maintain asset growth.

But as liquidity starts to tighten, costs are expected to rise.

International banks, which have the deep resources and appetite for long tenor project finance, have returned to Middle East project finance markets in the last few years. But they will want to manage their exposure to the region and are not an unlimited source of lending.

“This year we are witnessing the beginnings of a tipping point; the end of a credit cycle in the boom years between 2011 and 2014,” says Nassif. “There is a weakening in the banking liquidity environment as commodity prices decline.”

Falling government banking deposits, by 14 per cent in the UAE and 3 per cent in Saudi Arabia, as well as slowing growth in consumer deposits, are also affecting banks, according to research by S&P. Banks will then have to rely more on increasingly expensive market funding.

Government borrowing could start to squeeze out the private sector, meaning banks are less eager to lend to it and pricing will rise. The very high liquidity when oil prices were more than $100 a barrel led to GCC banks offering extremely low rates on long tenors. But high competition will constrain pricing to some extent.

“Prices may be on the upside move, although there is still stiff competition between banks that may hold those prices for a while,” says a UAE-based banker. “The loss of $300bn of oil revenue annually means banks will have to tap the market for wholesale financing.”

Loan growth has already begun to slow slightly in Saudi Arabia as banks are more cautious in their lending.

Falling liquidity will have different effects across the GCC. Kuwait and Qatar have the most liquid banking sectors, so it could be years before the effects are felt there.

Riyadh-based Jadwa Investments believes that Saudi Arabia’s banking sector has enough liquidity to absorb government borrowing in the form of bonds, without crowding out credit to the private sector.

It estimates domestic banks have more than SR460bn ($122.7bn) in excess liquidity, in holdings of Saudi Arabia Monetary Authority (Sama) bills, deposits at Sama, and net foreign assets.

This dynamic is most apparent in Oman, which is comparatively less wealthy and its banks less liquid.

The Oman Tourism Development Company (Omran) has already announced its intention to use project finance for several hospitality projects, and other government clients are likely to follow suit.

“The local market is tightening and liquidity is reduced as the government slows spending,” says one banker in Oman.

“But the government… won’t cause any dramatic changes. The slowdown will be smooth to keep things moving.”

A rise in Federal interest rates in the US would also push up lending costs, as the dollar peg on most GCC currencies would require similar action from GCC central banks.

“The uncertainty around the potential rate hike is not helping,” says Nassif. “Projects and companies with long-term debt want a sense of sensible future rates to calculate their options.”

Export Credit

Counter cyclical lending supports projects in tougher times

Agencies accept financial exposure to help fund important infrastructure projects

The Sadara project will encourage further investment in the industrial development of Saudi Arabia's east coast

The Sadara project will encourage further investment in the industrial development of Saudi Arabia’s east coast

ECAs, which have a counter-cyclical mandate to support the private sector more in downturns, could prop up commercial lending.

ECAs stepped up their activities, especially as lenders, following the financial crisis in 2008. This situation has gradually become the new normal, but some ECAs are ready to step up another gear to compensate for more cautious commercial banks.

“Meeting increased demand depends on the specifics of each project,” says Tahir Ahmed, head of civil and defence at UK Export Finance (UKEF). “We have to operate commercially too, and the low oil price is part of our decision.”

Other important market players may not be willing or able to take on more exposure in the region, while the bankability of projects is just as important to ECAs as commercial lenders.

“If no commercial banks are lending in the region we support counter-cyclical business, and when we have to co-finance we act very closely with them,” says a senior manager at another ECA. “It is difficult to say where we are in the cycle, and loan pricing is still very aggressive.”

Since 2008, several megaprojects progressed thanks to direct lending from ECAs, including Sadara Chemicals in Saudi Arabia. Led by US Exim Bank with a $5bn loan, $7bn of the $12.5bn financing package was extended by various ECAs from Asia and Europe.

The Japan Bank for International Cooperation (Jbic) has underpinned Japanese firms’ success in winning independent water and power project (IWPP) contracts in the GCC.

These include the $3bn Facility D in Qatar, which will involve both Jbic and South Korean ECAs, and is expected to reach a financial close before the end of 2015, and the 2,000MW Sur IPP in Oman, for which Jbic extended a $697m loan in 2011.

Meanwhile UKEF has been active in the construction sector, providing a $110m loan to Dubai World Trade Centre to finance an expansion project, with the contract awarded to the UK’s Carillion Construction.

But ECAs have neither the capacity nor the mandate to take on the lion’s share of project finance, and play more than a supportive role.

“With direct lending, UKEF is not competing with commercial banks, but enhancing the partnership and complementing the commercial sector,” says Ahmed.

“We are not trying to squeeze out banks – we are a syndicate lender, combining direct lending and guarantee tranches, and we need banks to act as agents.”

A reduced project pipeline as regional governments rationalise spending could even mean less project finance deals. Less appetite from private investors and lenders could delay deals, meaning the expected increase in ECA lending may not materialise.

“Oil prices are cyclical whereas ECA funding is long-term,” says Ahmed. “The type of contract we support takes years to be awarded. Some projects are cancelled while others continue, and overall we are seeing more interest.”

Egypt is one country where demand for ECAs has boomed in the last year.

The planned investment drive is heavily reliant on ECA and development bank support to finance its infrastructure projects, as government clients have lower budgets and often run deficits.

Guarantees from Germany-based Euler Hermes were an important factor giving banks confidence to lend $3.7bn towards a $9bn gas and wind turbine order from Germany’s Siemens.

“There is a lot of work in Egypt,” says the ECA manager. “Many infrastructure projects are coming up there, it’s one of the most active countries.”

Egypt is close to securing about $1.4bn from China Exim Bank for its 70-kilometre Light Rail Transit network in Cairo. The loan will cover construction and a $110m tranch for a 10-year maintenance contract.

Negotiations are on-going with a China-based contractor for the main construction award, which is expected to be made imminently. “We hope that it will be within a month or 1.5 months,” said Sameh Refaat, vice chairman for Egypt’s National Authority for Tunnels.

The Egyptian government has also secured loans to fund the development of Line 3, phase 3 of the Cairo metro. The €940m loan includes €600m from the European Investment Bank, €300m from teh French Development Agency and €40m from the European Commission.

But while ECA’s can facilitate the import of capital goods and equipment, they cannot insure long-term contracts such as power purchase agreements.

This limits the support they can give to long-term renewables projects, whether under feed-in tariff or build-own-operate schemes. This is where development bank support is irreplaceable.

Bonds and sukuk

Issuances fall $8bn in a subdued market

But as rates for loans rise, debt market may become more attractive

Shuweihat water and power plant

Shuweihat IPP in Abu Dhabi was refinanced via a bond issuance in 2013

While sovereign bond issuance has emphatically returned this year, corporate bond issuance has been subdued.

Corporate and infrastructure bond and sukuk issuances in the GCC fell 58 per cent year on year by the end of August 2015, according to S&P.

The drop from over $15bn of issuances between August 2013 and 2014, and around $7bn the following year was linked to lower oil prices and slowing government spending.

“When you compare the yields and pricing on corporate bonds, we don’t see an increase in aggregate pricing of more than 20 basis points,” says Nassif.

“This doesn’t account for the decline so there must be other reasons; a combination of a weaker climate and GREs [government-related entities] consolidating their balance sheets and cutting capex.”

The last real project bond in the region was Sadara Chemical’s $2bn sukuk in 2013.

This is excluding refinancing bond issuances, such as Shuweihat IPP in Abu Dhabi in 2013 and a potential Fujairah IPP 17-year bond.

The drought was related to the higher levels of bank liquidity and willingness to lend, which led to companies exploring then discarding the bond issuance option.

As loan pricing creeps up, borrowers may find debt capital markets more attractive.

“It’s about what the most realistic way to get funding is,” says Nassif. “Entities operating at bigger levels, ie $1bn plus projects, have to be seriously considering bonds due to declining banking sector liquidity and limits on single borrowers.”

Some corporates and GREs may also be forced to refinance older debt. S&P estimates that $14bn of corporate and infrastructure debt will be due in 2016, while $25bn of bonds and sukuk will mature between 2016 and 2018.

Other potential refinancing issuers include the Abu Dhabi National Energy Company (Taqa), Dubai Electricity and Water Authority (Dewa), and the Saudi Electricity Company (SEC). They may also be pushed towards alternative sources of finances by banks’ limits on exposure to GREs.

More Omani GREs could look to debt capital markets to carry out infrastructure projects, especially in the utilities sector, to relieve pressure on government finances. The Oman Electricity Transmission Company successfully issued $1bn in international bonds in May 2015.

However, there are still disadvantages to issuing debt, as the weakening global and regional economy will discourage both GREs and smaller corporate issuers.

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