In late 2007, as problems stemming from securitised mortgage deals in the US began to be revealed, and international banks started to acknowledge huge losses, banks in the Middle East were quick to proclaim that they were free from exposure to these kinds of products.
Although regional banks did have limited losses at that early stage of the crisis, as the problems began to spill over into other types of assets and other parts of the global economy, it became obvious to banks that they could not avoid the effects for long.
“There was a feeling that the Middle East would be able to go through this crisis without suffering,” says Jean-Christophe Durand, regional director for the GCC at French bank BNP Paribas. “But as we looked at the crisis unfolding globally, we noticed that it really started to hit the GCC at least six months after the rest of the world.”
Since the crisis hit the Middle East region, it has been the Gulf economies that have borne the brunt of the difficulties. While markets in North Africa and the Levant have also been affected, they were not as exposed to the real estate bubble as the GCC and, in many cases, their economies were less well integrated into global financial markets.
The collapse of US investment bank Lehman Brothers in September 2008 triggered panic in the global financial markets, and the subsequent stock markets falls and liquidity drought in the West leaked through to the economies of the Middle East. These factors, together with the sudden withdrawal of billions of dollars that had flowed into the region in the belief that Gulf countries would be forced into currency revaluations, an assumption that turned out to be false, led to a huge liquidity problem in the region.
As interbank lending rates in the Gulf rose sharply and interbank activity fell, GCC governments started pushing money into the system to encourage banks to start lending again. John Sfakianakis, chief economist at Saudi bank Sabb, estimates that in the six months to the end of March 2009, SR30bn ($8bn) was deposited in local banks by the Saudi government.
In the UAE, a fund of AED120bn ($32.7bn) has been made available by the government to shore up banks, along with facilities to swap dirhams for dollars to ease the problem of a lack of dollar funding.
While liquidity is returning to the market, however, the relatively high interbank lending rates show that more still needs to be done. “There is still a gap between Eibor [the Emirates interbank offered rate] and Libor [the London interbank offered rate], and banks are still paying to attract large deposits,” says Shayne Nelson, regional head of the UK’s Standard Chartered Bank.
Interbank lending rates have been falling. At the end of May, the three-month Eibor rate was 2.5 per cent, compared with 4.3 per cent at the beginning of January. But according to Nelson, in late May some banks in the UAE were still offering up to 9 per cent interest on corporate deposits in a bid to attract cash and improve their loan-to-deposit ratios. This compares with the 1 per cent base rate set by the Central Bank of the UAE.
The pressure to attract deposits has been particularly intense because many banks are exceeding the regulatory limits on their loan-to-deposit ratios, and so need more deposits to offset their loans. Around the region, government ministries have redirected funds back into their local banking systems to increase deposits.
While UAE banks are still trying to reduce their loan-to-deposit ratios, in Saudi Arabia the issue has largely been addressed. However, the kingdom’s banks are still reluctant to start lending again and are putting the majority of their liquidity back on deposit with the Saudi Arabian Monetary Agency (Sama), the central bank.
“Banks are behaving in a way similar to the consumer who sees the possibility of bad news ahead,” says Sfakianakis. “They are being risk averse and building up cash because of the uncertainty in the market.”
Research by UK-based bank HSBC shows that the average loan-to-assets ratio for Saudi banks is a relatively low 59 per cent, yet lending growth was close to zero in the first three months of 2009, demonstrating the banks’ reluctance to start lending again.
The emergence of liquidity problems in some of Saudi Arabia’s largest family companies in May and June, such as conglomerate Saad Group, has served to make the banks more nervous, both in Saudi Arabia and around the region.
“The third quarter of 2009 will be a very tough time for a lot of banks, as that is when we expect to see a lot of the liquidity problems in the private sector coming to a head,” says one banker at an international bank in the region.
Kuwait and Qatar have taken a different approach to propping up their banking sectors. Doha says it will buy QR15bn ($4.1bn) worth of real estate exposure from its banks by the end of June, allowing them to avoid having to write down their investments because of the fall in the market.
The government had already invested directly in the banks’ equity in January, and bought their local equity investment portfolios to avoid banks having to book losses on these too.
In Kuwait, the government approved in February a $5.2bn stimulus package to encourage banks to start lending again by providing government guarantees for loans, although this plan has been delayed by Kuwait’s fractious parliament.
In general, bank profitability is expected to remain robust, if not as high as in previous years. Regional banks are expected to be able to capitalise on expansionary government budgets to continue to develop infrastructure projects, which should enable them to secure revenue streams. The key challenge for banks wanting to maintain their profit levels will be their ability to deal with non-performing loans, the extent of which will largely depend on the magnitude of the real estate correction.
Although it took some time for the financial crisis to have an impact on the operations of the local banking sector, it hit the financing plans of major projects around the region much earlier.
The first impact of the banking crisis on the region was perhaps the financing for the $11.6bn acquisition of the US’ GE Plastics by Saudi Basic Industries Corporation (Sabic). In August 2007, Sabic had to cut the size of the bonds programme to fund the deal by about 50 per cent, to $1.5bn, and delay the fundraising for its Saudi Kayan petrochemicals project.
The main difficulty in this area of the market is the reluctance of international banks to commit to long-term funding, and the difficulty in the domestic market of securing long-term loans denominated in dollars, which prevents many local banks from participating aggressively in project finance deals.
Project finance activity has fallen, and although some large deals have managed to secure funding, it has been difficult. The Shuweihat 2 power project being developed by Belgium’s Suez Energy in Abu Dhabi was expected to secure long-term funding by mid-July, more than a year later than planned, after being forced to raise $900m in short-term financing in December 2008.
The project finance market exemplifies the wider changes that have occurred in the Middle East for corporate fundraising. “It is very important now to go out to as many sources of liquidity as are available to get deals done,” says Michael Crosland, head of project finance advisory at the UK’s Royal Bank of Scotland.
The syndication market is all but closed and banks have no desire to take on the risk when they are not able to sell on their exposures in the secondary market. Instead, deals are being financed as large club loans, with conventional and Islamic banks, export credit agencies and bond markets all being accessed in multi-currency tranches, to gather as many different investors as possible.
The closing of Shuweihat 2 and deals such as the $3bn refinancing of debt by Abu Dhabi-based Dolphin Energy in April have restored some confidence to the regional financial market. Adding to that has been the successful sovereign bond deals by Abu Dhabi and Qatar in April, which each raised $3bn, proving that international investors still have an appetite for Middle East debt.
These deals also demonstrate that pricing has not risen as much as the margins would suggest. Margins have typically risen from 50-100 basis points above Libor in late 2007 to as high as 400 basis points above Libor on some deals now. However, the rapid fall in US interest rates, to which many Gulf currencies are tied, from 5.25 per cent in August 2007 to 0.25 per cent by December 2008, means the total cost of servicing debt has not changed much.
A combined total of $9bn was raised in bond sales by the Abu Dhabi and Qatari governments in April, UAE-based Aldar Properties in the same month and Abu Dhabi state-owned investment company Mubadala Development Company in May. However, by the beginning of May, there were signs that the appetite for Middle East debt was starting to dry up.
The Aldar transaction was trading below its offer value shortly after the deal was launched in late May, which some traders took as a sign that demand was falling.
The successful sale of a $10bn bond by Dubai to the Central Bank of the UAE in late April had given investors some reassurance, but Dubai government-linked firms still have large levels of debt. Among the debts that remain a concern for international investors with exposure to the region is a $3.5bn Islamic bond (sukuk) of Dubai-based real estate developer Nakheel, which needs to be repaid in December 2009, and is likely to prove hard to refinance.
How the Dubai government handles this will have an impact on the whole region. Investors see the Nakheel debt as a test of whether the assumption that regional governments will support local firms will be fulfilled in practice. If not, it would have serious consequences for any company in the Gulf trying to raise cash from international markets.
Any failure to adequately compensate Nakheel’s investors would undo all the work that has been done to restore confidence in the Middle East in the first half of 2009.