Ratings: Rates and measures

06 September 2002

Meltdowns in the Americas have kept credit ratings agencies busy this year. Taking a view on Argentina's debt profile or assessing WorldCom's bond burden may have quickened a few pulses, but there has been no such excitement in the Middle East. By global and emerging market standards the region has historically been a backwater for the ratings agencies.

However, there are signs that this may be changing. The use of sovereign debt continues to rise - particularly in North Africa. Local bond markets are beginning to take shape and the banking community is becoming increasingly integrated into the global financial community. All these developments spell opportunity for international ratings heavyweights Standard & Poor's (S&P), Moody's Investors Service and Fitch, as well as the emerging market specialist, Capital Intelligence (CI).

For years, CI has provided the most comprehensive coverage of Middle Eastern banks. As the annual MEED report shows, this has not changed (see pages 29-30). Of the 117 banks surveyed, CI rates 111. Moody's has the strongest position in the market among the international agencies. It has expanded its coverage marginally over the past 12 months and now rates 64, or 55 per cent, of the financial institutions (FI) in the survey. The other two agencies have moved in the other direction: S&P covers 36 institutions, down from 43 a year ago; Fitch has reduced its coverage to 40 institutions from 52. In the case of the latter, the main driver has been the rationalisation of the coverage effectively inherited through the 2001 acquisition of Thomson Financial BankWatch.

S&P says it has trimmed its coverage of some of the smaller banks that attracted limited international interest. 'We have withdrawn some of our PI [public information] ratings in Tunisia, Morocco and Oman for this reason,' says S&P's Emmanuel Voland. 'But we have expanded our coverage elsewhere - in Kuwait, for example.'

In the short term, no sudden explosion in coverage is expected at any of the agencies. However, there is likely to be a gradual ramping up of activity. Certainly, the development of regional bond markets and the increased use of floating rate notes by regional banks will boost the need for ratings agencies' services.

As the table on page 28 shows, GCC banks are rethinking their approach to big ticket funding. In 2000, 13 financial institutions tapped the syndicated loan market for a total of $2,300 million. In 2001, five banks came for less than $1,000 million. So far this year, only three banks have taken syndicated loans and have raised a mere $650 million between them. However, the decline in popularity of the syndicated loan has been exceeded by the rise of floating rate notes (FRNs).

Unsurprisingly, the ground was broken in February by National Bank of Kuwait (NBK), which staged the region's first and, to date, largest and best-priced FRN issue. Hot on NBK's heels were Gulf Investment Corporation, Gulf International Bank and Emirates Bank International. Between them, a total of $1,300 million has been secured.

The banks' stated aim has been to diversify funding bases and stretch the tenor on the liabilities side of their balance sheets. The need for the latter has been exacerbated by regional banks' increased involvement in long-tenor project finance deals: concerns about asset/liability tenor mismatches are growing. While the FRN issues have in deal terms been successes, there are reasons to question whether the underlying objectives have been met. The bulk of the $1,300 million raised in the four offerings to date has come from the same balance sheets that would have absorbed syndicated borrowing: there might have been some diversification, but it is far from extensive. Equally, none of the FRNs have tenor greater than five years and five-year money has become increasingly accessible in the loan market. As the table shows, 53 per cent of FI syndicated borrowing in 2000 had five-year tenor and this rose to 85 per cent of the combined FI syndicated borrowings of last year and this year to date.

'At the moment, they are testing the water with the FRNs,' says Elizabeth Jackson-Moore, managing director for Middle East banks at Moody's. 'When you're dipping your feet you don't go all out for 20-year money. This is a gradual process.'

From the ratings agencies' perspective, the important question is whether this is the start of a new trend that will generate opportunities for them, or merely a temporary tributary flowing from the funding mainstream. The test is likely to come next year when a number of syndicated loans are due to mature. The banks will be confronted with the choice of whether to refinance with another loan or take the bond route. Most will make their choice based on the question of price.

'The wholesale banks are likely to carry on with FRNs,' says Voland. 'Given the high levels of regional liquidity, the commercial banks have no real need to do so. Some will continue to look at the diversification play, but only if they can get good pricing.'

Perhaps more promising in the long term is the development of regional corporate bond markets. The total number of local currency issues in the GCC can still be counted on two hands. But there are signs of change. The AED 1,500 million ($409 million) bond issue staged by Dubai-based carrier Emirates in the summer of 2001 might still be the only domestic issue in the UAE, but a number of others have been promised. In Bahrain, project finance deals for Bahrain Petroleum Company (Bapco) and Aluminium Bahrain (Alba) might both have bond components. Kuwait has seen the most activity, with United Real Estate Company, United Industries Company and Kuwait Investment Projects Company (Kipco) among others joining Burgan Bank in issuing local paper. A market is yet to open in Saudi Arabia but the passing of the Capital Market Law is expected to open the floodgates in what will end up being the most dynamic market.

'The local bond markets are still in their infancy but they offer excellent prospects,' says CI's Darren Stubing. 'GCC corporates are undoubtedly going to start looking to bonds. The numbers might be small now, but they will start growing over the next couple of years.'

Looking further ahead, Basel II, which will see radical changes to the BIS ratios for capital adequacy, is likely to further deepen the region's appreciation of the ratings agencies. From January 2006, banks in regulatory environments that adopt the proposed measures will make capital allocations linked to the credit risk profile of their loan books. These profiles can be built either by internal risk assessment systems or by the use of credit ratings.

'The high-end institutions will use internal processes, but this is only economical for large banks,' says Stubing. 'It is unlikely that any Middle East bank will have the resources to do this entirely internally. Some will combine internal systems with credit ratings and some could end up wholly dependent on ratings. This will eventually be a driver for the widespread adoption of corporate ratings.'

There are also signs that one of the old regional barriers to the agencies is crumbling. 'Overall, attitudes towards transparency are steadily improving,' says S&P's Voland. 'In markets such as Kuwait, levels are pretty good: IAS [international accounting standards] are adhered to and IAS 39 has already been introduced. At the other end of the spectrum is Egypt, where banks don't disclose NPLs [non-performing loans]. Transparency is still not that great in Tunisia, either.'

Progress might be slow but it is irreversible. The ratings agencies are hoping the same can be said of their contribution to the regional financial community.

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