IFR: Moving on to the FI market, as we've mentioned financial institutions were a huge source of loan volume in the past few years but we've seen only clubs and one syndication this year. What is the future for this market?
Raouf Jundi: There are two things. One argument is that the Russian FI market has remained open, so why is the Middle Eastern not there? Credit quality, in fact, in the Middle East is much better. But many of the banks had already been to market, so maybe the demand wasn't really there and as long as prices have gone up, the borrowers weren't willing to pay up.
Now we are seeing a few banks going back into the market. There have been some club deals, there is now the first, test for Bank Muscat in Oman, where the banks clubbed it, signed the deal, advanced the funds and have now followed up with syndication to see what the interest is from the market.
That will be a good test, because pricing has clearly gone up, the borrower has accepted it, we are seeing some interest, but the question is how much interest will there be.
Declan McGrath: A lot of FI funding has been done. Whether the FIs got the timing right by accident or design is another question. But a lot of the FIs got their timing right. For example, QNB signed a loan last year at LIBOR plus 19.5bps. However, in six or twelve months' time, when they need to come back to the market, you might see a little bit of resistance. But you will find that they will get done on a club basis. They will try to get the crew of banks in that they want to get in there and then try and see what they can raise in general syndication. Bank Muscat will be a great example to see how this tactic actually pans out when it gets out to the marketplace.
Gilles Franck: The FIs face the same constraints as corporates when it comes to considering the alternatives, which are the bond markets where the pricing has ballooned out as well, meaning there's little arbitrage between the markets.
Peter Bulbrook: The borrowing was very opportunistic last year and US$20bn or so was raised. But everybody that participated or had the relationship expected the next course of financing access to be the capital markets. However, that market is not there right now, not at the price they want to issue at.
The dynamic on these deals that have been clubbed so far is interesting and probably underlies why we have not seen increased debt capital market requirement. They are very focused on their benchmark spread, as would be any financial institution, but they have been willing to supplement the all-in requirement for funding, or all-in for lending, by some significant fee packages. Benchmark spread is probably the most sensitive issue for any FI issuer, so that has been a feature in clubbing these situations today.
Rizwan Shaikh: Raouf mentioned that Russia is seeing more issuance in the FI space relative to Middle East. A big factor driving this is that most of the pre-crisis issuance by Middle East FIs was three or five years. Russia, on the other hand, saw mostly shorter dated deals. So a lot of the Russian FIs need to come back to refinance the maturing deals and are having to pay out more. While the margins on some of these loans have been kept artificially low by paying higher fees, the all-in cost has gone up significantly for most financial institutions.
Declan McGrath: The size of the transaction is also key and you are unlikely to see US$2.5bn to US$3bn financial institution loans as new deals will be kept at lower levels.
IFR: How much relationship pull does an FI have?
Grainne Molloy: I think it comes down to price. Some of the FI lenders we speak to say, "We are not going to support our competitor at that price".
Rizwan Shaikh: The relationship groups for FIs differ from corporates in the sense that you have a wide group of correspondent banking relationships spread out thinly, which can be leveraged to get small tickets. Corporate bank groups tend to be smaller but they are able to concentrate their relationship in terms of cross-sell and therefore can extract bigger tickets. So invariably in corporate deals, you tend to find smaller syndicates compared to FI deals.
Grainne Molloy: Having a good rating helps with expanding the investor universe.
Declan McGrath: Large FIs will have certain relationships with an awful lot of smaller correspondent banks around the world. Protecting these relationships is actually quite important to the people who are involved in correspondent banking. So while it is a much smaller universe to deal with, they go to tremendous lengths to protect their business. But you are right, you won't see them with huge tickets either.
Peter Bulbrook: That's why these deals are being club run. You have your pocket of correspondent banks, very close historic relationships, and you have the complement of other relationships that do their capital and equity structuring. So the club is really what we have seen and I suspect that is the way it will go forward.
Declan McGrath: The rating point is very valid too, because actually in some ways, even though the traditional heresy of one bank lending to another bank - being lending to their competitor - gets taken away if there is a reasonable rating attached to it, it does give some diversification to their individual types of portfolios.
Peter Bulbrook: International banks looking to do business in the GCC have corresponding banking relationships and strategic relationships for business. This is a very key part of doing business in the Middle East and will always be important.
Raouf Jundi: When the capital markets do come back for these banks, in the longer term their funding will probably depend more on the capital markets than the loan markets. It's just a natural progression.
Declan McGrath: They will also want to make sure that they can get the longer maturities as far as they can, because they wouldn't want to get caught back in the same position they are currently in. With respect to some of these banks, going back to the point I made about evolution, the education, they are a lot smarter than they were, say, five or ten or years ago when we started chasing
them in the first place. So they are very knowledgeable about what's going on in the world and where to get their advantage.
Peter Bulbrook: In the world of Basel II, rating is a very key focus point in terms of how we weight banks. Traditionally we looked back at 20 percent weighted assets or 100 percent on non-OECD financial institutions, but rating and weighing of capital commitment is an incredibly important and probably fast developing feature in the loan market today.
IFR: How important is that rating to you now, because in Turkey we are still seeing banks put in place one year lines at 67.5bp?
Raouf Jundi: Turkey is a very special situation, because Turkish banks do offer substantial ancillary business. They can spread throughout all the relationship banks and that's why all the deals are clubs.
Declan McGrath: Rating and Basel II has made a significant difference. Just before the end of the year we looked at a bank that was 20 percent weighted on 31 December but on 1 January, under the new BIS II arrangements, it became 179 or 180 percent weighted, depending on what model you used. That's the degree of differential that can actually occur. Now, that's an extreme and it is exaggerated for emphasis only, but banks are paying an awful lot more attention to it.
Peter Bulbrook: It is a wider loan market feature and particularly interesting in terms of exposure in the GCC. Rated corporates will probably find greater favour in terms of capital asks from the international banking community. Many of us around the table are working with clients on rating assignments right now, there's a lot of corporates seeking ratings, and the benefit to them for that is not just access to capital markets, but it gives a much better, capital friendly dynamic around capital commitment to loan deals and that will help in size and it could well help in price as well. It is something to look forward to this year, and to see how many of these entities get rated and get that public investment grade rating.
Gilles Franck: There's a completely new dynamic now in corporate ratings because of this. Before one or two years ago, it was more tentative, more profile and capital markets driven, but the regulatory angle now obviously makes a big difference.
Declan McGrath: You have to bear in mind that you don't have to go back that long, just prior to the end of 2006 when there were a few deals, but not a huge amount on the corporate side done out of GCC. It really was 2007 where you saw the corporate transaction come to the fore, and there were lots of different reasons for it, including M&A activity, both inbound and outbound from the region. The concept of the sovereign support gets a lot more attention today than it did a few months ago.
Grainne Molloy: It's a function of the size of the deals that are now being done. The Middle East has seen a steady stream of smaller corporate transactions over the years as the smaller corporates who traditionally funded themselves on a bilateral basis sought to rationalise their funding through the syndicated loan market. The last couple of years have seen more acquisition facilities being done and the size of those facilities has increased.
IFR: Will those smaller deals continue to come?
Grainne Molloy: Yes, but borrowers must be realistic about the pricing levels they can achieve.
Gilles Franck: At the right pricing level there's definitely an opportunity for them.
Peter Bulbrook: They are the kind of deals that just work in a local price context and a credit story that works best for local banks largely speaking. I agree volume and opportunities are picking up.
Declan McGrath: Banks are starting to look at going further down, for want of a better expression, the credit spectrum within the region, to look for new potential clients.
Peter Bulbrook: Yes, this is the mid cap market within GCC and it is rapidly developing.
IFR: Moving to the infrastructure market, if banks can now lock in margins well into the 100bps for government supported credits over five years, what is the future of the infrastructure market with its need for 10 or 20-year plus tenors?
Raouf Jundi: The first problem in the project market is that capacity has not grown, whereas the size of the projects has grown. Where some of the liquidity has come from multilaterals like JBIC, we all know that JBIC itself is reducing its exposure. The way it's going to function will change later in this year and everyone is expecting that JBIC will provide less liquidity and that is an issue which the project financiers haven't really got to grips with yet.
Declan McGrath: For a long time people would look at the situation of lending for 20 years at LIBOR plus 65bp or 75bp, this continued because there was the availability of the liquidity for the number of the projects that were around at the time. The world is trying to increase its infrastructure, it is trying to do all the right things in some of the regions outside of the major western world, although, having said that, the US for example has US$500bn worth of infrastructure projects to do over the next ten to twelve years. But within the region the projects have got bigger and now that we are in this current so-called crisis, people are not prepared to put their money on the table for that kind of tenor at those kinds of returns. There has got to be something else that's going to make it worthwhile. I do think that some of the more significant projects will get done, they will have more equity coming into them, they will have more sponsorship support where they are of significance, whether it is roads, whether it is liquid natural gas or whether it's oil-based. You will see them get done, but it will be much more difficult to get people to be willing to provide 20-year money even for a US$10m, US$15m or US$20m ticket unless the pricing increases significantly.
Grainne Molloy: The Project Finance market will continue to play an important role in the growth of the GCC. Traditionally project finance has centered on oil and gas and petrochemical projects. This is now being extended to infrastructure. Banks continue to have appetite to lend the long tenors required by such projects, however, not unlike other sectors, project finance is experiencing a change in funding parameters.
Gilles Franck: It is interesting that the Qatari's in particular in the last few years had already tried to address a potential disconnect between the size of the projects and the available money in the bank market. They added capital markets tranches to bank tranches, to some extent arbitraging pricing differentials. Obviously what they had not foreseen is that the bond market might become so expensive and so, for now, the dual tranche structures have been dropped again. But the capital markets will definitely be there for project finance, at what institutional investors consider to be the right price.
Rizwan Shaikh: Infrastructure is in vogue these days with alternative investors e.g. infrastructure funds, multilaterals and other institutional investors, who are going to become increasing important for financing infrastructure projects. Many infrastructure projects, such as airports, used to be financed in the securitisation market which is now pretty much shut. This may lead to the re-emergence of the mini-perm structure, where banks provide five or seven year financing, with the expectation that capital markets and other sources will return in time for refinancing or de-leveraging to some extent. We used to see mini-perm structures some time back, although they have more or less disappeared in the last few years.
Grainne Molloy: Infrastructure projects in the Middle East have tended to be funded directly by the government. There is appetite from the bank market to lend to such projects as has been demonstrated by recent deals which have been structured on a similar basis to the PPP/PFI model adopted in Europe. Although a slow growth market segment, this remains nonetheless a significant area (as the infrastructure lags behind the development of the economies) requiring substantial financing.
Declan McGrath: If you had gone to a project financing group, sponsor, bank, prior to, say, August of last year and you mentioned the word "flex" you would have been thrown out of the room. Now you will not see a being deal done on the project financing side without it being discussed. It's there, and again, for all the same reasons that we are in the current markets that we are operating in.
Raouf Jundi: For a project, you could be sitting on the underwriting for months and months and months, and the market is changing so quickly so flex has become much more important. The banks prefer not to have a cap on flex and if there is a cap it must be quite a wide cap.
Declan McGrath: It must be a big, wide cap.
Grainne Molloy: Due to the nature of the bidding process - arrangers are often required to hard underwrite PF deals, making the requirement for flex all the more important.
Rizwan Shaikh: And with 20-year deals, if you get pricing wrong by a few basis points, you can be under water quickly. So while some banks may contemplate limited flex in short-term deals, longer dated project financings will be much more challenging.
Declan McGrath: The other interesting point is that, for a period of time up until the present crisis started, the majority of people who were doing project financing transactions were banks at the top of the table that were prepared to underwrite project financing deals. They were prepared to put reasonable amounts of money on the table to take large holds as they were building up their own asset portfolio. Of course that's fine if you think that you can fund and you can offset the funding costs that you are getting paid out in the open marketplace, but of course that's not the case today. Most of us around the table are paying an awful lot more for our funding anyway, depending on which day of the week it is, than we were and therefore the critical direction that credit committees and portfolio managers and your executive are directing at you is: you've got to make sure that you are giving real value return on the capital that you are actually expending. That's really what's driving a lot of the areas that we are actually seeing.
Grainne Molloy: Within project finance, the opportunity for revenue upside is compelling because of the derivative income that banks can earn, particularly at the senior level.
Raouf Jundi: The issue in the project finance market is really capacity. Project sizes are getting bigger, but the banks lending to them are not and sometimes shrinking and, multi-nationals such as JBIC are also reducing their exposure. So there is a real issue and I'm not sure how that's going to be addressed.
IFR: Do you think we might see more leverage structures as much as that level of pricing would appeal to institutional investors?
Peter Bulbrook: Quite potentially for institutional and specific industry fund investors.
Raouf Jundi: There are some funds being set up purely for the infrastructure market.
Rizwan Shaikh: We have already seen capital markets financings for projects in Qatar. There are structures available to tailor the amortisation profiles to match project cash flows. In fact, you can get longer duration in capital markets than the bank market. So that alternative is certainly available for better rated credits, at a certain cost. In terms of leverage structures, with the growth of infrastructure funds who are mostly interested in equity like returns, you may see equity substitutes /mezzanine tranches appearing in projects capital structures.
Peter Bulbrook: Certainly in a limited bank market. It's going to be a market that's going to develop or need to develop pretty quickly. It's going to have to be pretty dynamic in considering all of this possible tranching, because bank market capacity alone will not fund the US$1 trillion worth of infrastructure type projects that are pending.
Raouf Jundi: The capital markets will not provide the real solution. Although some deals have been structured for the capital markets, capital markets have to fund everything on day one, which is costly, whereas in the loan market the project draws over a period of three years.
Secondly, traditionally in project structures there are waivers almost every week. You can't go to 5,000 bond investors and ask them for a waiver, it's not practical.
