If 2011 began with optimism that a recovery in the regional banking sector was under way, 2012 is starting on a much shakier footing.

At the end of 2010, liquidity was slowly but steadily improving, economic growth was picking up pace and confidence was returning after the defaults and redundancies caused by the global financial crisis. As 2012 begins, many of these indicators are starting to reverse.

In its latest report on the Middle East, the Washington-based IMF predicts growth for most countries in the year ahead, but generally at levels slower than in 2011.

Activity in the bond and loan markets during the first 10 months of 2011 shows that momentum has definitely been lost. By November, there had been about $17bn of bond deals completed across the Middle East and North Africa (Mena) region. In comparison, $32bn of deals were done in 2010, and about $35bn in 2009.

Fewer loan deals

For the syndicated loans market, the reversal in activity has been even more pronounced. In 2011, there were 59 deals across the Mena region, raising nearly $25bn. That is less than half the $54bn raised in 2010 and is even less than the $39bn raised in 2009. Compared with the peak of the region’s economic boom in 2007, when 148 deals raised $124bn, it looks anaemic.

International and local concerns have put many potential bond issuers off trying to access the markets in 2011

The outbreak of anti-government protests around the region, which have resulted in the removal of four long-serving leaders, despite attempts to brutally suppress demonstrators, has spooked investors and hit economic growth. Coupled with that, the sovereign debt crisis in Europe has caused even more risk aversion among global investors. Financing conditions are also getting tougher because many European banks are struggling with their exposure to indebted nations.

The international and local concerns have combined to put many potential bond issuers off trying to access the markets in 2011. Even strong corporates such as the UAE’s Majid al-Futtaim Holding, Dolphin Energy and a project sponsored by Qatar Petroleum and the US’ ExxonMobil have had to put capital markets issues on hold.

A solution to the Eurozone debt crisis should restore some confidence among bond investors and enable some issues to take place in the first half of 2012, but as always with the bond markets, activity will rely on one brave issuer attempting to go to the market opening the way for others to follow. Until that happens, many corporates and state-owned investment vehicles may prefer to sit on the sidelines.

Negative sentiment for bond market in 2012

Unlike 2011, which started on a wave of optimism after a slew of successful deals in late 2010, next year will begin with a less positive sentiment. That could mean bond market activity takes a while to get going. If opportunities arise in the markets, however, the queue of potential issuers could start flooding to the markets; in 2010, Mena issuers booked $10bn of deals in each of the third and fourth quarters.

Europe’s troubles were not all bad news for the Middle East though. As a result of the worsening financial environment, many European banks have had to sell off their regional assets to shore up their balance sheets.

For regional banks, these sell-offs have provided an opportunity to boost asset books in the secondary market after a disappointing year in the primary market. That should help banks meet their budgets for 2011, but next year is unlikely to see such opportunities arise again. Unless the syndicated loan market recovers, banks will have a hard time booking this volume of business next year.

If European banks start to reduce their involvement in deals from the Middle East this will have a big impact on the region’s ability to raise funding.

“In the cross-border syndicated loans market in the Middle East, around 50 per cent of the financing raised comes from European banks,” says Vis Shankar, chief executive for Europe, Middle East, Africa and the Americas at the UK’s Standard Chartered. “If those banks have to deleverage that leaves a question of where that money will come from.”

Coupled with the potential pullback of European banks, local banks may be less willing to book new deals in 2012

Coupled with the potential pullback of European banks, local banks may also be less willing to book new deals in 2012. Early indications are that liquidity growth is starting to slow in the UAE and Qatar. This means financing conditions will probably get tougher before they improve.

The exception to this is Saudi Arabia, where banks are sitting on large deposits for which they are struggling to find a use.

As a result, when good-quality deals do come to the market, they tend to be flooded with offers of cheap money, as long as the deals are in Saudi riyals. This is pushing down the pricing on loans as banks compete for the chance to lend.

Bank managers in the country have been saying for most of 2011 that they think the downward trend is running out of stream, but prices still seem to be dropping. A test of this will come in early 2012, by which time Power & Water Utility Company for Jubail & Yanbu (Marafiq) should have agreed pricing on a 15-year SR4.5bn ($1.19bn) loan deal.

In 2010, it raised SR2.5bn in a 15-year deal priced at 85 basis points above the Saudi interbank offered rate (Sibor), providing a useful benchmark of attitudes towards pricing deals in 2012.

Transaction comparison for Saudi banks

Comparing the figures for syndicated loan market activity shows that Saudi Arabia’s banks are doing less deals, but they are generally bigger ones.

In both 2010 and 2011, Saudi and UAE banks did the same volume of business, but in the UAE the average size of transactions was substantially smaller. This indicates that corporates in the UAE are less willing to try to raise large sums, and that banks are less liquid and able to provide them.

In terms of project finance, 2011 was another disappointing year, with even Saudi Arabia recording only modest activity. Just a handful of projects reached financial close, most notably Masdar’s Shams 1 solar project in Abu Dhabi and Abu Dhabi Water and Electricity Authority’s Shuweihat 3 independent power project.

The only real sign of optimism was the success of the Barzan gas project in Qatar. This deal managed to raise commitments of $5.7bn for a bank tranche that only needed $3.9bn.

The most interesting aspect of this financing was not necessarily that it was oversubscribed, but that it attracted commitments from 31 banks, even during one of the worst periods of the European debt crisis.

It may be presumptive to draw too many positive conclusions about what this means for project finance in 2012.

Some bankers close to the deal argue that it shows lenders that had previously stopped doing project finance loans since the financial crisis of 2008-09 are returning and that new banks are also entering the market.

In truth, many of these banks are likely to only be in the Barzan deal as a way to get a foot in the door with the Qatari government. They will be keen to use lending on Barzan as an attempt to position themselves for other work in Qatar, especially given the country’s cash-rich position and its need for huge investment in preparation for hosting the football World Cup in 2022.

It is unlikely that banks such as the US’ JP Morgan, Bank of America and the UK’s Barclays will start to appear more regularly in project finance deals around the region. The role of other European banks that have traditionally played a large part in regional project finance is also uncertain. Several of them were unable to lend on the Barzan deal due to a combination of the low pricing being sought by the sponsors and the deal being done at the height of the European crisis.

Many of these banks are now selling off their project finance assets in the secondary market. Although this could give them the room to book new assets in 2012, it is still unclear if they can continue to be as supportive of the sector over the next 12 months as they have been in the past.

The major upside for banks in the region is that although dealmaking activity may not be as high as many would like, a slowdown in provisioning should mean banks are now writing off less of their profits to offset bad loans. Provisioning has been the main reason that profit growth has not been as positive as hoped.

The challenge beyond that will be where the growth comes from in an environment where few new deals are being done and general economic activity is threatened by the slowdown in the West.

Uncertainty ahead

Although the outlook may not be that favourable at the moment, the situation could begin to improve late in 2012, especially if markets start to believe that Europe has done enough to contain its sovereign debt crisis. The flipside is that a slowdown in the global economy hits the oil price, which in turn spooks regional governments and the private sector and leads to a slowdown in investment and knocks already weak confidence.

At the moment, 2012 looks like being another uncertain year, which is likely to mean that private-sector investment will be postponed until there are signs that a real recovery is under way. Until then, financing activity will struggle to regain any sense of momentum.