The regional project finance market has slowed this year, but infrastructure remains a key priority and banks are slowly getting used to long-term lending again.
The Middle East project finance market has suffered a series of blows since October 2008, when the global financial crisis reached the region. In late 2008, international banks began to baulk at lending to Middle East projects for long tenors at slim margins, as the banks’ balance sheets were battered following a global fall in asset prices.
$227bn – Value of Middle East project finance deals between 2006 and 2009
$2bn – Funding Saudi banks are expected to put into Jubail refinery project in 2010
In early 2009, the problems shifted away from international to Gulf banks, as regional company defaults on loan repayments left lenders worried about increasing their exposure to a region mired in its own debt crisis.
Despite project finance deals having been few and far between in 2009 compared with 2008, when $45bn worth of project finance was arranged compared with $15bn last year, several large deals were nonetheless completed. In late June, Bahrain’s $2.1bn Addur power and water project in Bahrain closed its financing.
In July, one of the year’s largest deals, the $4.1bn Dolphin Energy financing, was a refinancing of an existing project, leading many bankers to describe it as more of a corp-orate financing than a typical greenfield project financing deal.
The Middle East financing sector remains dominated by project finance, says Frank Beckers, head of project and capital advisory at Deutsche Bank. And the importance of project finance means the sector has shown signs of recovery earlier than other parts of the world.
“The bounce-back in activity in the Middle East project market has been better than in many other parts of the world,” says one London-based project finance banker.
Beckers says that between 2006 and the end of November 2009, project finance made up 43 per cent of all financing in the region. This compares with just 5 per cent globally, where the corporate loans and bonds market dominates. “This is partly because the Middle East is still at a much earlier developmental stage than the West, but also because there is a much greater belief in the efficiencies and risk-sharing principles behind public-private partnerships [PPPs] here,” says Beckers.
Despite this belief in the PPP model, in 2009, a handful of large projects were switched to government procurement as a result of the difficulties in the financing market. Most not-ably, this included the Ras al-Zour power and water project in Saudi Arabia.
In April last year, Riyadh scrapped private sector involvement in the scheme, instead implementing the project on an engineering, procurement and construction basis.
Financing on Abu Dhabi Water & Electricity Authority’s (Adwea) Shuweihat 2 project looked shaky throughout 2009, with speculation that it too would switch to being government funded.
But in October last year, a 22-year tenor for the $2.6bn financing was finally secured, demonstrating the enduring popularity of the PPP model in the Gulf.
The PPP model has also demonstrated its resilience in terms of the low number of restructurings of distressed project deals that happened during the 2008-09 downturn in the global economy.
Senior project finance bankers in the region say that their portfolios have remained largely free from problems. “With project lending, it is always clear where the risks are, who shoulders them, and where any support will come from,” says the London-based banker. “It is very different from a lot of the corporate, quasi-government or real estate lending in the region, which has become so problematic.”
In fact, some bankers say the credit crisis has had a beneficial effect on the project finance market. Cheap and easy credit conditions in the years leading up to the 2007 market crash enabled project sponsors to strip out creditor protection clauses, creating so called ‘covenant-light’ structures, which are higher risk for banks.
“In a way, it was fortunate that the crisis happened and put a stop to those [high-risk] sorts of structures before they ever really became widespread,” says the London-based banker.
“The bounce-back in activity in the Middle East project market has been better than in many other parts of the world”
London-based project finance banker
This year now promises a return to the huge project finance volumes recorded before 2009. In the first two months of 2010, Saudi Arabia’s $9.6bn Jubail refinery financing is scheduled to close, with another, similar-sized Saudi Aramco refinery also planned for 2010.
Indeed, the Saudi market is looking strong for this year. The Saudi banking system, which has been sheltered from the worst effects of the financial crisis due to the central bank’s strict limits on lending, is awash with local currency. Riyadh-based bankers say there has been so much cash in the local banking system, and so few opportunities to lend, that money is being deposited back with the Saudi Arabian Monetary Agency (Sama).
This has enabled the local banking sector to contribute to the successful long-term financing of projects such as Acwa Power Inter-national’s $2.5bn Rabigh power project in July last year. About $1.5bn of the project’s $1.9bn debt came from Saudi banks.
The local banks are also expected to put in about $2bn of financing for the Jubail refinery. The only downside of this liquidity is that it is only available in riyals, meaning developers may have to take on some currency risks.
But more important than a pipeline of future deals is the appetite of banks to extend loans over a long tenor. The economics of project development mean that long-term financing is essential to get the returns that private investors need to make it worth their involvement, says Ghazali Inam, global head of corporate finance at Arab Bank.
“Project finance is by nature long term, as long-tenor financing is critical to the economics of a project, as well as the economics of the project sponsors,” says Inam.
Typically, projects aim for financing of 15-20 years. The problem for banks is that project finance is generally a low-yield asset class, and while liquidity has been tight and returns higher on alternative investments – the shorter-term bond market, for example – project finance has not been an attractive way to deploy capital.
Several Middle East countries are also beginning to develop PPP markets, opening up the possibility of a much wider source for new deals. Egypt, Morocco, Jordan and Tunisia all have plans to launch PPP projects in 2010.
The deals in these markets, however, are likely to be much smaller in size than the multi-billion-dollar deals made in the wealthier Gulf states.
“As an adviser to the government or sponsoring authority, there is probably some value to be had [from deals in the emerging markets], but as a lender I am not sure if there would be the repeat business that you can get out of sponsors in the Gulf,” says one Dubai-based project finance head at an international bank.
So despite there being emerging market opportunities in the Middle East, project finance opportunities will remain greatest in the Gulf.
With Jubail expected to close early in 2010, and Riyadh’s power project PP11 also expected to be financed early in the new year, 2010 promises to be a significantly busier year for project bankers in Saudi Arabia and throughout the region.