Dollar financing to return to the region

30 May 2008
Drying up of local currency liquidity is increasing the cost of dirham-denominated debt.

Bankers are anticipating a revival in appetite for dollar-priced corporate debt from the region before the end of the year.

The return of the dollar will be a relief for large companies, which have increasingly been turning to issues in Gulf currencies to access cheaper finance. With prices on dirham-denominated debt starting to rise as local currency liquidity dries up, such debt is becoming less attractive.

“The dirham market is starting to be more discriminatory and we are seeing the range of prices expand,” says the head of investment banking at one international bank.

“The market is starting to come back into some sort of equilibrium and the spread for dollars has come down. At the same time, the dirham liquidity pool has been pretty well accessed by now.”

The twin factors of a rise in local currency costs and a reduction in the cost of dollar-denominated finance are expected to convince some companies that the time is right to return to the dollar market.

“What I expect to begin to see is dollar deals coming back to the market after September and the summer lull,” says the director of debt capital markets at one international bank.

“What the market needs over the next few months is for someone to take the plunge and do a dollar deal, which will establish a pricing indication for everyone else to work off.”

A large number of deals have come to the market this year in local currencies rather than dollars, which were favoured in previous years. Although there have been swings in demand for different currencies in the past, the situation this time has been far more extreme because of the global credit crunch.

The trend has been particularly evident in Saudi Arabia and the UAE. Dubai Electricity & Water Authority (Dewa), Dubai World, Jebel Ali Free Zone Authority (Jafza) and the government of Dubai have all completed dirham-denominated debt issues since the start of the year.

Saudi banks are also putting pressure on financial advisers to structure deals in riyals, such as the SR5bn ($1.3bn) Saudi Basic Industries Corporation sukuk, which was launched in April.

The increasing demand for local currency finance is pushing up the price of such debt.

“A lot of these large dirham deals are competing with the whole country for that liquidity,” says the director of loan syndications at one large UAE-based bank. “If banks are already maxed-out to certain borrowers or sectors, prices will start to rise.”

The prospect of a return to dollar financing has raised some concerns, with bankers fearing a rush of companies approaching the markets at the same time.

“There will be a real challenge managing the number of mandates that banks have once the market starts to get back to normal,” says the Dubai-based banker. “There are a lot of mandates that banks are sitting on waiting for the market to return.”

In a bid to prevent such a rush, and to stop government-backed companies from undermining each other’s deals, the Dubai government’s finance department has created a debt management office.

The department, which was created in February, will co-ordinate the financing plans of the various state-owned companies and ensure that the debt is priced as low as possible.

At the moment, some deals are being priced far above the 53 basis points over the Emirates interbank offered rate (Eibor) that was established by the government of Dubai’s $4bn dirham-denominated bond issue in April.

This is despite the fact that the debt of state-owned companies essentially represents the same level of risk as lending directly to the Dubai government itself.

The current Dewa sukuk has been priced at 125 basis points over Eibor, more than twice the level of the government of Dubai’s transaction earlier this year, despite the fact it carries similar risk.

If it goes through at this level, the pricing would be the same as the dollar-denominated deal that Dewa abandoned in November 2007 because of high pricing.

Nakheel’s recent AED3.6bn ($980m) transaction was priced at 225 basis points over Eibor, although this was partly because it constituted exposure to the Dubai real estate market, which is seen as more risky.

Bankers are now watching the $5bn Dubai World refinancing for an indication of where the market is going. The deal is being structured with both dollar and dirham tranches of various maturities and should give an indication of the general sentiment in the market.

However, the biggest hurdle to the reopening of the dollar market will be local banks, which have not raised any dollar funding of their own for about 12 months.

Until they address this shortfall, they will not be able to do any large-scale lending in dollars. Most banks had typically been tapping dollar funding markets twice a year until the credit crunch led to a massive increase in debt costs.

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