Banking & finance
$30bn: Bonds issued out of the Middle East in 2010
$650m: Amount borrowed by Qatar Aviation in November, priced at 125 basis points above the London interbank offered rate
$20bn: Total raised for projects in the GCC by late November 2010
$25bn: Projects due to be financed next year
As the year comes to an end, the otherwise optimistic mood about the region’s ability to steer through a global financial crisis is soured by news of a Dubai government-related firm having to launch a multi-billion dollar restructuring.
In that way, 2010 has ended much the same as 2009. This time though, the amount to be restructured by Dubai Group, part of Sheikh Mohammed bin Rashid al-Maktoum’s Dubai Holding, is about a tenth of the size of the Dubai World debt restructuring, launched at around the same time in 2009.
The region is now shifting towards using longer-term funding for its strategic plans
Dubai spectacularly brought the financial crisis to the Gulf in November 2009 when it announced it needed to restructure some $25bn of debt on the eve of a national holiday. In October 2010, history repeated itself when Dubai Group announced it needed to restructure an undisclosed amount, thought to be between $2bn and $5bn.
Although Dubai is still grabbing headlines around the world as it grapples with its self-inflicted debt problems, much has moved on in the region’s finance markets.
The latest Dubai restructuring was notable, but largely unsurprising. Lessons of the botched announcement in November 2009 had clearly been learnt, and investors had realised that Dubai is not symbolic of the whole region. The market had also expected further efforts by the emirate to renegotiate payments on its $109bn debt pile, and the speed with which Dubai World managed to reach a consensual restructuring agreement, setting a pattern for future negotiations, helped bolster confidence.
Debt restructuring of corporates in Dubai, Saudi Arabia and Bahrain is still ongoing though, and while confidence returns, most bank chiefs admit it will be shaky for a while to come.
Strategic changes to funding
The region is now shifting towards using longer-term funding for its strategic plans, rather than short-term funding.
In the past, the Middle East had overwhelmingly been financed by loans and equity capital markets. That has now changed as bank lending dried up and the region had to look for a new source of funding. The bond market has now become the financing source of choice.
Bouyed by a perfect storm of low interest rates globally, strong government balance sheets and a higher perception of risk in the region, international investors flocked to new bond issuance out of the Middle East. In 2010, about $30bn of bonds will have been issued, nearly as much as in 2009, when more than $36bn of bonds were issued.
The activity in the bond markets in late 2010 is expected to continue into 2011 with Abu Dhabi’s debt management office understood to already be at work, planning out the timing for many of the Abu Dhabi government-owned companies to issue bonds.
Qatar should also continue issuing new debt, and several Saudi banks are expected to issue in the next year as they try to boost their dollar liquidity and extend their funding profiles.
Project companies are also lining up debt issuance next year, which could be the beginning of a spate of issues used to directly finance infrastructure development.
As more issuance occurs and investors become more knowledgeable about the Middle East and discerning in terms of who to invest in, the opportunity for non-investment grade issuers will open in 2011.
Initially, they will have to pay more to borrow and be more opportunistic in the timing of their issues, but below investment grade issuers could be a key trend for 2011.
While the debt capital markets have been gaining momentum, other aspects of the finance sector were still dealing with the impact of the global financial crisis.
Lending slow in the UAE
Generally, banks are still accounting for their lax lending policies of the past few years and dealing with the impact of debt restructurings around the region. As a result, new bank lending to the private sector dried up almost completely as banks took measures to put aside more capital because of the growing number of non-performing loans (NPLs) they had to account for.
Banks in the UAE were particularly constrained by the fact that they had been allowed to get so overextended during the good times – in some cases having loan to deposit ratios of more than 140 per cent, despite Central Bank of the UAE guidelines that the ratio should be 100 per cent.
As the banks try to increase their deposit levels and slow lending to tip the balance back to where it should be, little is left for making new loans. The competition for new deposits to improve balance sheets is also pushing up the rates banks will pay customers for large deposits. That will further eat into profitability.
NPLs are expected to peak in 2011, meaning that bank credit should start to flow more freely by late next year. NPLs as a percentage of total loans is around 3.5-4 per cent, according to Markus Massi, managing director of Boston Consulting Group in Dubai. This could rise to as high as 7 per cent in 2011. “In 2011, banks will still be working on improving the quality of their loan portfolio,” he adds.
As a result, the loan market should also pick up as these issues are worked through. The last 12 months has been particularly barren as banks shied away from loan deals. Some of the region’s biggest corporates, such as Saudi Aramco and Abu Dhabi National Energy Company (Taqa), managed to complete syndicated loan deals, but mainly by drawing on relationship banks looking to make sure they are well placed with the region’s top-tier borrowers when growth returns.
As the effects of the financial crisis slip into history and international banks become more liquid, they will become keener on underwriting large loan deals for the region.
Financing for projects has shown some signs of recovering though. In 2010, several large projects managed to reach financial close, including Aramco’s Jubail refinery – a $14bn project being developed with France’s Total. That brings the total raised for projects in the GCC to about $20bn by late November, compared to about $25bn the previous year. The number could well be higher by the end of the year.
Next year could be an even more active one, with about $25bn of projects due to be financed in 2011. Another Aramco refinery could be financed, along with the Barzan gas project, phase two of Emirates Aluminium, and power projects in Abu Dhabi, Dubai, Saudi Arabia and Kuwait.
Aramco’s Jubail refinery deal is indicative of a key trend in the region’s financing market. Saudi Arabia is increasingly becoming reliant on its domestic banks to fund development projects, with international banks being unable, or unwilling, to match the low rates of local lenders. Saudi Arabian banks are generally sitting on large amounts of excess cash after 2009, when loan volumes actually shrank slightly.
Coupled with the pressure to start increasing profits after a year of falling income, the banks are fighting to lend to the most creditworthy borrowers. Saudi banks were able to offer riyal denominated loans to the Jubail project at margins significantly below the margin on dollar loans offered by international banks.
In August, a group of six Saudi banks lent the Power & Water Utility Company for Jubail & Yanbu (Marafiq) SR2.5bn ($670m) with pricing for the 15-year loan starting at just 85 basis points above the Saudi interbank offered rate (Sibor). Even at the time, bankers said lending was becoming too competitive and pricing was going too low.
Lending at that level is unheard of in the rest of the region. Qatar Aviation, which carries a sovereign guarantee from the state of Qatar, borrowed $650m from a group of regional and international banks in November, priced at 125 basis points above the London interbank offered rate (Libor).
As confidence returns to international banks, activity in the loan market will undoubtedly pick up. Some banks are already warming to the idea of underwriting large transactions again.
That will be good news for Dubai, which faces another tough year in 2011. Next year the emirate has to refinance or repay $19.5bn, according to investment bank EFG Hermes. If one of those deals goes wrong, it will be a significant blow to confidence in the emirate, which many thought had put the worst of its financial troubles behind it in 2010.
Caution reigns for banks in the Middle East
The key message for banks and borrowers, though, is that there will be no return to the kind of easy credit seen in the last boom. Banks have become more cautious and introduced more rigorous credit approval procedures. Name lending, where borrowers get loans based entirely on reputation, is a thing of the past.
Lenders are also much more wary of borrowers plying an obvious mismatch between using short-term borrowing to fund long-term plans.
Many corporates continue to struggle with the new credit environment, and labour under the mistaken belief that soon things will return to ‘normal’. However, the bubble of the last few years was the aberration rather than normality.
Banks will now start playing a more discerning role in tempering the ambitions of the region with the reality of what can be achieved. That promises to still be a painful readjustment, but a necessary one.