Gulf firms opt for bonds over bank loans

04 September 2009

Islamic Development Bank is latest to issue a bond as international banks remain reluctant to lend.

Saudi Arabia’s Islamic Development Bank is launching a bond with the aim of raising up to $1.5bn, in the latest sign that Middle East corporates are turning to inter-national debt markets rather than banks to raise capital.

Companies in the Middle East & North Africa (Mena) issued $18.9bn worth of bonds in the first eight months of 2009, compared with just $12.5bn in the same period in 2008.

By contrast, the value of loans has fallen steeply over this period. In the first eight months of 2009, the banks lent just $22.8bn, compared with nearly $69.6bn in the first eight months of 2008.

Many banks are reluctant to lend despite central banks around the world cutting interest rates to encourage lending.

“In 2006-08, banks were lending aggressively as they tried to capture market share,” says Nish Popat, Dubai-based head of fixed income at Dutch fund manager ING Investment Management.

“Now banks are being much more selective about the terms on which they lend, and thinking more about the capital cost of each loan they make.”

The withdrawal of banks from lending has led borrowers to seek money from different sources, leading to a dramatic increase in bond issuance.

The Abu Dhabi and Qatari governments kickstarted the bond market when both raised $3bn in late March. State-backed companies with close ties to their respective national governments followed suit with their own bond issues.

The same month, Abu Dhabi’s Tourism & Development Investment Company and Mubadala Development Company raised $1bn and $1.8bn respectively.

“Banks have been constrained by the need to boost their liquidity and capital ratios,” says Adel Afiouni, head of the global market solutions group at Credit Suisse. “On the other hand, low-risk bond funds [in developed markets] and prime-quality bond issuers attracted strong inflow and appetite from investors seeking a yield pick-up over zero-rate deposits.”

In their eagerness to invest in the nearly $20bn worth of bond issues in the Mena region so far this year, investors placed orders for $40bn, says Popat.

The loan markets have suffered by comparison. Kuwaiti telecoms company Zain managed to raise $2.5bn in July, but the deal was a challenge to complete and some banks that originally planned to lend dropped out despite the high margins on offer.

In April, Dubai Electricity & Water Authority managed to secure a $2.2bn loan, but Dubai Civil Aviation Authority failed to raise $1bn from the loan markets and had to instead secure a $350m equity injection from the Dubai government.

While the banks were slow to start lending at the beginning of the year, activity has begun to pick up, says Afiouni. “The situation [in the loan markets] is already improving,” he says. “Banks are more liquid and oil prices much higher than in the first half of the year. However, banks will remain selective in their lending until a clear picture of economic recovery emerges, and will favour large corporates with solid balance sheets or strong government support.”

“There is some degree of confidence creeping back into the [loan] market, and pricing seems to have stabilised at the moment,” says Hussain Hussain, director of Royal Bank of Scotland’s corporate debt origination team.

Once the banks’ confidence improves, loans are expected to overtake bonds as the most popular form of capital raising.

For bond markets to remain the largest source of corporate finance, two things need to occur. First, companies need to appreciate the importance of having multiple sources of funding. Second, a regional investor base has to develop. Investment funds, pension funds and insurance companies are crucial to developing sustainable bond markets.

The strong performance of bonds in the secondary market proves investors have a strong appetite for further Middle East bond issues, according to Hussain.

The bond deals completed this year were overwhelmingly arranged by international banks, with the top 10 including just one regional bank, Saudi Arabia’s Samba, which has worked on two deals.

In 2008, the top 10 included several regional banks. “International banks are in the flow of fixed-income business on a continuous basis, and are able to provide issuers with real-time knowledge of market appetite and investor views when advising them on their deals, which is extremely important in recent volatile markets,” says Hussain.

The UAE remains the biggest issuer of bonds and loans.

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