Setting the scene
Gauging the mood in the international debt markets, identifying the drivers and influences of the Middle East markets and assessing the strength of recovery.
EuroWeek: Sentiment appears to be improving in the international loan markets. Will it continue?Raouf Jundi, Bank of Tokyo-Mitsubishi UFJ:There is a more positive mood in the market, and this should continue, barring any major shocks. We must remember that shocks in recent years have tended to happen in the summer, either during or just after. Dale Summerville, Calyon: I take a middling view. I guess no one really knows whats going to happen to the banking business and our syndicated loan business in particular. But after the near-Armageddon it is going to have to change.We can speculate on how it is going to change, but obviously the eight or nine years of free money are gone. The idea that we can transform short term deposits, which are not as prevalent today as they were, into loans and distribute them in the manner that we became accustomed to is not going be the model in the future. What that model is going to be is sheer speculation. What will be extent of the regulatory changes in the US? What will be the more fundamental changes in the way we do business? Im not saying we dont have a clue, Im just saying no one can say at this stage where we will be a year from now.
When you raze all the trees in the rain forest you dont just change the water table. You change everything from plant and animal life to planetary weather.
Clearly we have less capital to lend and we will lend it more carefully and that in itself will change the nature of our business. As bankers and syndicated lenders, we have been accused of being lemmings many times. I suspect we need to become the more intelligent species of lemming that doesnt go charging off the cliff into the sea and avoid the dangers of being either too optimistic or too pessimistic.
The overriding sense that I get is that we will proceed with cautious optimism. Optimism is needed to get markets going again its an ingredient that is essential to confidence and that is what is lacking.
Theres the debate of whether its a U-curved recovery or W-curved. Im probably in the W-curve camp.
Without going into detail, there will be at least one significant hard underwrite coming out of the wider MENA region soon. Whether this proves to be a one-off because of the specifics in the transaction, or whether it heralds the return of confidence in the region remains to be seen.
In any event, we ought to remain cautiously optimistic and move forward, picking up on opportunities as they come. Well continue trying to work in concert and perhaps we will all be a little less aggressive than we were a year or so ago.Grainne Molloy, HSBC: We are seeing improving sentiment and confidence in the bank market. This is off the back of improving economic data, a rally in the equity markets and record issuance of bonds across sectors.
We shouldnt forget, though, that volumes are still down sharply on the same period last year circa 40%-50%. The market remains driven by refinancings in fact, refinancings and forward starts constitute circa 50% of total volumes.
But deals are getting done, some are even being oversubscribed. The recent Saint Gobain transaction is a case in point it was 100% oversubscribed.
Will this continue and will we see a return of competitiveness? I think we will in some markets. But, by and large, banks will continue to be cautious.Jacco Keijzer, Royal Bank of Scotland: I would agree. We are seeing a return of positive sentiment. The housing market is showing signs of stabilizing but unemployment continues to rise and that will no doubt have adverse effects on consumer credit default levels and consumer expenditure.Steve Perry, Standard Chartered: Like Jacco, I agree sentiment has improved. Driving this improvement is the fact that we have had a sustained period during which there have been no additional shocks. The bond markets have obviously profited from the fact that collateralized loan obligations are no longer around and that institutions have to put their money somewhere, the bond market being one such suitable place. In terms of continuing the recovery, optimism is the key. All of us round this table have a big part to play in that if we as the market are negative, then this will feed the contagion and negativity will continue.
On the retail side of the market, that still seems to have slowed down in the region and that can help drive the recovery in our market the ability to syndicate.Jundi, BTMU: But there are signs that retail is coming back. There has been more activity in the secondary market and that will hopefully translate into a recovery of the retail market.Summerville, Calyon: Let me throw the first pebble into the pond and ask the question: how will the market come back and do we really want the retail market to return in force? If Im a corporate treasurer or CFO, Ive seen my company go through hard times and my syndicate is composed of my x number of relationship banks and a solid minority of tourists, generally from Asia, who at the first sign of a cloud on the horizon are gone. Trying to get a waiver out of these institutions, even in benign times, is a very different paradigm from dealing with my relationship banks. Now, in this ying and yang between wanting to diversify resources, taking advantage of extra liquidity, and wanting to make sure that ones basic funding is safe in tough conditions, my questions is whether people want the marginal retail participants back? Will this retail liquidity come back in the same way and will the overall model remain originate and distribute?Perry, Standard Chartered: I think it has to. All of us round this table underwrite deals and distribute debt. We cant do that without retail. We have all retrenched in recent years, lead banks are generally putting less money into deals which means that retail is actually more important than it was two or three years ago.Keijzer, RBS: A client may feel that all it needs is its five or six relationship banks and for the rest go to the bond market. Its nice and easy and it offers longer maturities.Summerville, Calyon: As long as its open. It can shut as quickly as it can open.Jundi, BTMU: The loan market is always there, it never really closes. It goes through smoother cycles whereas the bond markets can shut down overnight. What does a company that is reliant on the bond market do then? Retail has to come back because borrowers need an alternative, dependable source of capital. At the moment we are happy because the bond market is taking out the loans and we are being reduced that way. But are we going to be happy in the future to depend on the bond market all the time probably not. We will need to be able to control how we reduce our exposure. Im sure we are not all happy to retain large chunks of exposure so we need to have dependable outlets to sell down that exposure. The retail market is that outlet.Molloy, HSBC: The bond market is important not only because it allows banks to recycle their capital, but from a borrowers perspective, it provides access to a diverse source of funding and a longer maturity profile than is currently available in the bank market where the sweet spot is one and two year maturities. Will we see a return to the five plus one? I just dont think so.
EuroWeek: Are we seeing the same recovery of risk appetite return to the Middle East market?Perry, Standard Chartered: There hasnt been a recovery so far and I dont expect one until next year. I dont think the drivers of the European market apply in the Middle East because you have a lot of reliance on the local, regional banks who have withdrawn into their home markets or because theyre going back to what they know best. For this market, improvement has to come from the banks first. They have to adjust and adapt themselves so that they can then get re-engaged in the market. Summerville, Calyon: I agree. There hasnt yet been recovery in the Middle East weve been pasting over the cracks. Theres still too much dead weight that has not yet really come to the fore. The regional banks must still have a lot of bad assets on their balance sheets that I suspect will come out, perhaps before the end of the year. How significant is that going to be and how much is that going to weigh Middle East banks down remains to be seen. This is more a cause for pessimism, I should think. Jundi, BTMU: On the borrowers side, theres clearly now a division of credit quality. The private sector is not in the best of conditions just look at what has happened in Saudi Arabia and Kuwait. The quality in this region is at the sovereign and quasi-sovereign level and they have access to funds. But those funds are mostly coming from the international banks. Many local banks had their loan to deposit ratios at beyond the 100% mark. Until they readdress their balance sheet structures and have a comfort cushion of deposits above loans I dont see them coming back in any force. They will support their domestic entities but I dont see them going cross-border until they get their balance sheets fixed. Its a question of access to funding.
EuroWeek: Jacco, would you agree that the key driver of the Middle East market is the health of the local banks?Keijzer, RBS: Yes, absolutely. But you also see political pressure for them to play in their local markets, to make sure they support local companies and entities. You saw that on Bourse Dubai and Dewa they had massive support from local banks.
EuroWeek: How dependent is the recovery of the Middle East debt markets on the recovery of the international banking sector?Jundi, BTMU: Totally. That is where the funding comes from at the moment. While the composition of the international banks have changed dramatically some have disappeared, some have withdrawn as a result of their problems they are still the main providers of capital for this regions market. Molloy, HSBC. Traditionally, around 60% of syndicated lending in the Middle East has been distributed to international banks. Its a similar story with the recent bond issuance out of the region a significant percentage has been sold into Europe and the US.
EuroWeek: So Jacco, despite the fact that you are based out in Dubai, you would agree that the local bond market is totally dependent on what happens in Western Europe?Keijzer: US and European investors are driving demand for bonds from the region at the moment, they are providing the liquidity. I would, however, expect that local firms will, over time, play an increasingly important role going forward.
EuroWeek: For much of last year, the GCC market seemed impervious to the crisis unfolding elsewhere in the world. But in October the market promptly collapsed. But does that mean that because it fell so quickly it will bounce back quickly? There is a theory that the GCC markets will recover first before other developed or emerging markets.Perry, Standard Chartered: I dont think so. In terms of recovery it will be a much shallower curve. The banking market here is dependant on banks getting their balance sheets in order and the oil price recovering which is a strong driver of wealth in the region. A higher oil price will result in an inflow of dollars into the region.Jundi, BTMU: We need to go back to the quality of borrower. For the sovereigns and quasi-sovereign entities the markets will recover very quickly. But for the private sector, a very important change needs to happen and that is full disclosure. Its clear that the international banks will not return to the private sector until there is full disclosure up to the levels of European standards.
The corporate sector
Assessing refinancing risk, quantifying lending appetite, identifying new pricing levels, reviewing latest developments of structures and analyzing prospects for M&A.
EuroWeek: There were genuine fears about refinancing in certain areas in the region. Are those fears receding?Summerville, Calyon: Yes and No. There have been a series of refinancings being driven by pure relationship considerations requiring lengthy discussions with individual banks by the borrower. We all cosmetized this and put a happy face on it, but they were not necessarily very successful syndications. But at least they were done and that is a positive sign. But by a large they were done for amounts much less than many of these prime signatories were hoping for (or indeed used to) and they were a lot more work than they had expected. So Im not terribly optimistic about the track record of refinancings although at least they can be done.
So the fear has receded but we have to ask the question why. Its because governments and central banks have been pouring money in which perhaps masks the underlying problems with the market.Jundi, BTMU: There was a time when it was uncertain that refinancings would get done. That was a worrying time. But support from central banks and governments have come through as expected and that has reassured bankers. Molloy, HSBC: State or quasi-state entities have successfully refinanced whether through the bank market or with help from the state. The fact that they have refinanced has made banks a lot more comfortable, in particular where the state has demonstrated support when needed. The worry is the likely appetite for second tier names, putting their ability to refinance in question. Having said that, these entities have been financed for the most part by a closely-knit group of relationship banks they were not widely syndicated at a retail level. So relationship banks will be able to take a view of whether they want to support their clients and help the refinancing effort.
EuroWeek: Is the recovery in the corporate sector happening because borrowers are finally accepting the increase in margins and fees and only now willing to come to market?Jundi, BTMU: The pricing levels in the Middle East that we reached before the crisis were converging with European prices. Top level borrowers in this region were tapping the market for sub-20bp levels for five years and even longer sometimes. The bounce back in pricing has been more severe than in Europe. The main reason for that is the lack of liquidity local banks have pulled back and there are fewer players globally so the availability of funding has shrunk. For a European single-A credit, pricing would be about 250bp all-in. For this region, pricing is definitely higher and that is a result of a much more severe shrinkage of liquidity. But banks are coming back because they are now getting the returns that they should have had all along.
EuroWeek: But are corporates coming to market because they have finally listened to you after nine months of you trying to convince them that the world has changed?Jundi, BTMU: Some corporates have yes. Fewer are in denial. Summerville, Calyon: I have spent much of the last nine months trying to convince borrowers that they had to get out of denial and recognize the fact that we are syndicating liquidity, not risk or pricing. We have been telling borrowers that if they can get it, they should take it.
Now the question is the expectation of what happens to pricing going forward. Sentiment is improving and sooner or later competition will reappear and there will be pressure on pricing. Who knows, by the end of Ramadan, we might be operating in a booming market again. I actually doubt it and I think this region has a few surprises and difficulties to come that will make banks careful with pricing.Jundi, BTMU: I actually dont think we will see a softening of pricing in this region and in Europe for a while. The loan market is slower to react than the bond market spreads in the bond market have tightened quickly but the loan market is much more stable.Keijzer, RBS: The last time we went through something like this was after the internet bubble. But five years after that we were back at the same pricing levels as before that crisis. Perry, Standard Chartered: Switching from corporates to the project finance market, it will be really interesting to see how the Shuweihat deal will go. Weve all seen the pricing on that one and the pricing on Al Dur which was at 295bp rising up over 50% over eight years. Now we are looking at a 22 year door-to-door deal starting at 225bp. This will be the real acid test of lender appetite for long term lending.Molloy, HSBC: In the past, to increase pricing on a deal was a sign of a failure. In this market it is almost expected. But I would say that we are now finally getting to the stage when banks and borrowers are agreed on where pricing should be. Having said that, perhaps we have a little further to go on project finance.
EuroWeek: What is the new corporate pricing benchmark? Is it IPIC?Keijzer, RBS: I think it depends on what you are looking for in size and tenor. IPIC is looking for size so it will have to pay an attractive margin but a borrower looking for a smaller transaction could probably get away with paying a lower margin.
It is impossible to say we have reached a general benchmark because there are so many variables.Jundi, BTMU: Compare two visible deals QTel and IPIC. QTel is a refinancing among existing banks, its a forward start and its priced lower than IPIC which is new money and its big.Molloy, HSBC: It is also worth noting that the IPIC transaction is structured to incentivise an early takeout, reflecting some of the big acquisition deals done in Europe and the US.Jundi, BTMU: Although the IPIC model is half US and half European. It doesnt have the same duration fee levels that you would perhaps find in the US.
EuroWeek: So are we now seeing the high water mark in terms of pricing on corporate deals in the Middle East?Summerville, Calyon: The sense I get is that banks seem to be satisfied with the general level of pricing seen today.
I used to say in previous cycles that if you are lending at Libor plus 3% then you probably shouldnt be lending. Now, of course that 3% is probably around 5% or 6% or even higher. Right or wrong, the consensus today is that pricing in the 3% or 4% range is about right, for the very best signatures, at least in this region.
EuroWeek: So pricing is up and people are lending but what about underwriting? Is that returning on a consistent basis?Jundi, BTMU: Once we see the result of the current deals then confidence will return to the market. Whether or not that will lead to underwriting on a consistent basis is another matter. Perry, Standard Chartered: Im not so sure it will return on a consistent basis. As a bank, we will underwrite a deal for our core clients. From a market perspective generally, any client with consistent cashflows should be a candidate for underwriting. The DEWA refinancing Standard Chartered recently closed showed the way, in terms of banks being comfortable with the cashflows. The same for QTel although it was a forward start, banks liked the sector and the cashflows.
EuroWeek: But are there enough of you to do a big deal?Perry, Standard Chartered: The issue is not finding out if there are enough banks to underwrite a deal, its finding out if there are enough banks to come in as participants or to sub-underwrite. Banks have got so used to coming into club deals at the same levels, everyone with the same title and getting the league table status.
EuroWeek: Asset prices are still close to historical lows, for those with a bit of cash M&A looks good value at the moment. Companies in this region have a fair amount of cash which they could leverage but are banks willing to extend that leverage to make the M&A deal work?Keijzer, RBS: You need to step back and look at how attractive M&A opportunities are. M&A at high valuations were attractive as long as you could put significant leverage on it it didnt really matter how high the valuations were because leverage would still allow you to achieve your target returns.
Currently the valuation levels might be lower but the leverage multiples achievable in the market are considerably lower as well.
There is also the issue of one bank doing the underwriting so that the acquirer has certainty of funds and that banks get attractive fees on the bond takeout and advisory side. But my question is: what is there for the other banks what is their motivation? While valuations might be attractive, the case for increased M&A is dependent on more variables than valuation alone.
EuroWeek: But are you finding companies in this region still have the hunger to buy businesses overseas that we saw before the crisis hit?Jundi, BTMU: The companies that have a strong balance sheet and high profile have the ability to look at targets and they will get the support of the banks. The companies with the direct sovereign link or those with the strong and clean balance sheets are the ones that are most prolific at the moment looking at targets. Steve Perry, Standard Chartered: The issue that we are coming up against is that because valuations are improving target companies are beginning to say, hang on, we might be selling the company too cheaply. That, of course, impacts the buyer who is then faced with a more expensive purchase price and more often than not puts the whole deal on ice, waiting for valuations to stabilize.
EuroWeek: We mentioned QTel earlier, that it had a forward start structure. Is this structure the way forward for the region?Molloy, HSBC: QTel was the first in the region. Theres nothing to prevent forward starts being done in this region it is a way for the borrower to lock in liquidity at a future point in time, albeit at a cost from day one. There are some names in the region who would benefit from doing forward starts and so we may see a few more coming out in the near term.Jundi, BTMU: The forward start was a great product when it came out it gave borrowers that most precious commodity, commitments from banks, at a time when it was so scarce because of adverse market conditions. Companies were in danger of losing more than half their banks when faced with refinancing their facilities.
The forward start allowed them to secure these commitments for a longer term it was easy for banks to renew their commitment than enter into a new deal in return for being paid market prices on existing debt.
But todays market is quite different to that of January, February and March and Im not sure forward starts are that relevant any more. We have moved on.
The only entities that may benefit from the forward start are financial institutions who need to refinance. This has not been tested yet but if they want to extend commitments it might be a very useful structure to them.
EuroWeek: Dale, do you like the structure?Summerville, Calyon: We in the loan market, unlike those in the bond market, like to take things that are perfectly standard, call them different names, pretend that they are the most sophisticated inventions that any intelligent being has ever created and that it is just for you.
The forward start is, in fact, just renegotiating the terms of an existing financing. Fundamentally, you are simply taking an option on your existing syndicate and refinancing your loan early and hope that your relationship banks will value your relationship enough to get the deal through credit approval.
Theres no doubt it did serve a purpose and was undoubtedly useful for a number of borrowers who would have been sweating otherwise trying to refinance their maturing debt and wanted some certainty. But Im not so sure that it would work for financial institutions.Molloy, HSBC: To be effective, timing of approach to the market is key; a borrower needs to approach the market for a forward start sufficiently ahead of loan maturity. Approaching the market six months prior to the maturity of a loan is of limited appeal to lenders.undi, BTMU: A lot of European companies that had facilities maturing within a year were under pressure to get certainty on refinancing because otherwise the rating agencies would threaten to downgrade them. So they had to lock in commitments for longer than one year so as to maintain their rating. Summerville, Calyon: It proves the old adage that we as bankers constantly try to tell our clients: borrow when you dont have to. Because if you wait till you have to, you end up with weekend pricing, if you can raise the money at all.
The development of the bond markets in the Middle East
Interaction with the loan markets, advantages and disadvantages of the bond market, the importance of sovereign benchmarks, how the crisis has changed the bond/loan balance.
EuroWeek: Do you expect to see the bond market play a much bigger role in the region, just like it is in Western Europe where we have had record levels of issuance and it has, for some borrowers, taken over from the loan market as the core element of finance?Jundi, BTMU: Taking over is a strong word. The two products are very complimentary. Without the bond market opening in this region, trying to raise a substantial amount for IPIC, for example, would have been very difficult. Banks know that part of their commitment will be taken out very quickly but without the bond takeout in place we wouldnt have had such strong support in the loan market.
The bond market is a welcome addition to this region to support diversification of funding for entities and it is welcome from the loan side because it takes a bit of pressure off the loan market.
EuroWeek: When I say takeover I refer to what happened with Roche, which following such a strong take-up of its bonds dropped its Eu20bn loan facility and did the whole financing for its takeover of US rival Genentech in the securities market. Jundi, BTMU: Although its important to point out that Roche had an understanding with its banks that financing would be there if required and they had a strong balance sheet and rating to be able to issue Eu45bn. But of course it also sent a clear signal to the shareholders of Genentech that Roche was serious about buying them out. As a result, there were consequences that Im sure Roche had factored in beforehand.Keijzer, RBS: Alot of firms in this region are not ready for a bond. So, on the back of that there is no real danger of the bond market taking over from the loan market. There is no local high yield market and no real international market for regional issuers for mid-market companies. The number of companies that can access the market is still quite small so there are few companies in a position to issue a bond if they wanted to.
The market for bonds will develop but it is still early days.Perry, Standard Chartered: The bond markets can still be more expensive however there is a real opportunity to create a local bond market.Keijzer, RBS: They are quite close actually. If you look at QTel for example, today it is trading at around 360bp for a five year bullet whereas their two year forward start excluding fees is paying 250bp. That is only a 110bp differential which really is not that bad. Most of the bond deals recently have traded up thus creating a tight benchmark for issuers.Molloy, HSBC: Bahrain managed to price inside its CDS which reinforces the fact that the bond market is very competitive at the moment.
EuroWeek: Has the crisis brought about a permanent shift in the relationship between the bond and loan markets in this region?Summerville, Calyon: I would say yes, but its important not to exaggerate. The products overlap, but they also serve different functions and that differentiation will last forever.
There has been an expectation almost as long as I can recall that the loan markets would morph into something like a bond. That is why there is talk about investors and not lenders and issuers and not borrowers a language that I religiously maintain (call me old fashioned). So there has always been a harmony and an appropriate time for loans and an appropriate purpose and time for bonds. That will continue.
There is certainly in the short term a very strong correlation, because deals like IPIC are getting done because the bond market is open. But what happens when it shuts as it will surely do at times? Well be back to what works and well muddle through.Jundi, BTMU: Its really important to have both markets functioning. They wont be in synch all the time, for example, one of them might shut down for a while. But as long as one is open then there is a source of funding for the region.
EuroWeek: Is the bond market in competition with the loan market?Molloy, HSBC: Prior to the crisis, in certain sectors in project finance we saw bonds in competition with the loan product. But in the Middle East, the two should be as compatible as possible. The bond market is still developing but ideally it should provide diversity of funding and assist in the growth of the debt markets.Keijzer, RBS: The Federal Funding Law is currently being discussed within the UAE which would give the Central Bank a means to establish a local curve that can be used as local benchmark for borrowers. The UAE doesnt necessarily need the money but what it wants to do is increase the sophistication of the local markets and create an additional funding window for borrowers.
EuroWeek: We are seeing some banks combine bond and loan operations. Does it make sense for that to happen in the Middle East region? Jundi, BTMU: The model works differently for different banks there is not one best model. Working for a Japanese bank Im not allowed to market DCM as there is still a Glass-Steagall act in place in Japan where the commercial bank is separated from investment banking. Having said that, a lot of banks that can combine DCM and loans prefer not to.
It has gone through cycles where it has worked in some instances and then its gone back to being separate.Keijzer, RBS: We are starting to see DCM and loan markets being combined. I think it works like a charm you go and see a client and it becomes obvious that one product is not the way forward you can switch to the other products the team offers. Having said that you still need specialist loan and bond professionals within the team to make it work.Molloy, HSBC: We would agree with that approach, having recently created a single platform offering ECM, DCM and the loan product. It allows you to present a suite of solutions to your client.Summerville, Calyon: I have written internal papers justifying putting syndicated lending into a combined debt capital markets, so I do, despite being a loans guy, see the benefits of such a structure that has the two products working together side by side.
More importantly though, wherever I have seen such a structure work, it does so only because you have the right people. I can go talk very intelligently to a less sophisticated borrower or one that is getting up the learning curve about the technical and commercial aspects of bonds and general status of the bond market. But the more sophisticated the client, the more my five, 10, 15 or 20 minutes of bunkum on the bond market will wear pretty thin and thats where I should be bringing along the banks head of bond syndicate, who is in the market every day, every hour. The same goes for him I wouldnt expect him to go into a client and to sell a loan, and certainly not to attempt to structure one.
Whether or not youre all in the same business or product group, at some point you work under the same roof whether it is at the operational or client-facing level so its really down to having the right people in place who can work together and be aware of others markets and products.
EuroWeek: Steve: how is Standard Chartered set up?Perry, Standard Chartered: We are set up under the debt capital markets (DCM) banner but when we go to market a client we have an origination team drawn from people with different backgrounds be it securitization, bonds or loans supplemented by the product specialists. Standard Chartered is very client-centric, so we see the role of origination and syndications going hand in hand as very important. Its key to offer the right product to the client and ensure one department isnt selling a loan idea to a client if in fact the bond might be the better option purely on grounds of taking the fees to its own P&L. DCM is structured to avoid this.
EuroWeek: Weve seen a lot of sovereign bonds recently have they given impetus to the regional corporate bond market?Jundi, BTMU: That was the purpose of them issuing the bonds to open up bonds to the corporates. It was a very successful strategy because you immediately saw the Mubadala bond in Abu Dhabi after the Abu Dhabi sovereign bond. In Qatar you had the sovereign bond followed by QTel. Keijzer, RBS: Thats how Abu Dhabi could justify paying the spreads it did it was opening up the market and establishing the curve for its corporate borrowers.Jundi, BTMU: The sovereign bonds were also essential to help open up the loan markets.
Prospects for returning to market, the role of the bond market, the likely investor base, Turkeys example, the importance of ancillary business.
EuroWeek: Traditionally, financial institutions have been a mainstay of the Middle East loan market. Does the panel see the return of these borrowing institutions any time soon?Jundi, BTMU: Firstly, there is an issue of refinancing for this sector. A few deals are coming to maturity quite soon and it will be a challenge to get them done in the loan market. Whether forward starts work is not clear at this stage.
That said, financial institutions should be looking at the bond markets thats where international banks get a lot of their wholesale funding from and it should be no different for the Middle East institutions. But at the moment those markets are not really open for FIs.
Wed like to see them back but before they do we need to have a clear view of their restructured and cleaned up balance sheets. As I said earlier, many banks had loan to deposit ratios at or in excess of 100%. We need to see those ratios lower before they can access the loan market again, even if they are sovereign FIs.Perry, Standard Chartered: Id like to see financial institutions return but the conundrum is what is going to trigger that. Balance sheet tidying up is one thing.
Another interesting point is that liquidity provisions have fallen off quite substantially in recent months which indicates that banks are starting to trust each other again and are starting to lend to each other.
I guess the key factor will be who will be the first to go to the market and how successful will that deal be. Its like everything in this market right now the first one to come back sets the benchmark.Keijzer, RBS: Theres also the important question of whether the funding cost is acceptable for the issuing institution when compared to the amount of money it can make on the other side by lending it on. Thats always the difficulty for banks if you can only borrow at 3% but you have to lend it on at 2.5% it of course doesnt make sense to borrow.
In Europe and the US banks raise their capital predominantly from sources like money markets and the public bond market.
Im doubtful that banks will come back to finance local institutions once the sector recovers to the extent weve seen before the crisis, although it can never be ruled out. The expectation is that the bigger ones with government ownership and decent ratings will certainly head off into the bond markets for their funding once they are in a position to borrow money again.
EuroWeek: So you will be recommending that your financial institution borrowers go into the bond markets in future?Keijzer, RBS: The bond market is the more natural place for them. They get the longer term funding which gives them a better asset-liability management match the times of borrowing short and lending long are hopefully behind us.
EuroWeek: So where will the investors come from that will buy these bonds?Keijzer, RBS: Its a fair question. Weve seen some local currency trades for FIs recently but when was the last large dollar FI deal? Perry, Standard Chartered: Weve seen a couple of them get close but instead they clubbed them in the loan market.Jundi, BTMU: The last one I think was the National Bank of Abu Dhabi which was done just days before Lehman went under.
EuroWeek: But if you were to launch a dollar bond would you sell it here or internationally?Keijzer, RBS: For an FI borrower we would probably emphasize the local bid a bit more than on a corporate transaction. But we would aim and take them as wide as possible to establish a 144a structure. Furthermore, we would take them to the US and Europe on a non-deal roadshow in order for them to receive investor feedback. If the feedback is positive enough then we would try to issue.
Another important point to make which may explain why we havent seen many Middle East FIs in the debt markets is that there are no government guarantee schemes in the region. As a result, banks in this region have not been able to issue as their Western European or US counterparts have been able to in large volume since around October last year. The authorities decided to pump money in directly.Jundi, BTMU: In todays market the only FIs able to tap the loan market have been the Turkish banks. This is because the ancillary business that they provide has been consistent and substantial.
The FIs in this region have not traditionally provided a lot of ancillary business and in todays market ancillary business has become a key part of a banks decision to lend to a borrower.
Turkish banks have developed a superb system in looking after their relationship banks and they have benefited from it.Perry, Standard Chartered: But have the Turkish banks not also benefited from the cross-ownership by foreign banks?Jundi, BTMU: Not necessarily. Traditionally, even before they were owned by the foreign banks they always had strong support from the European syndications market because of the ancillary business that they provided and the strong relationships they worked on with their foreign creditors.Molloy, HSBC: Lending opportunities in Turkey have mainly been to FIs with limited syndicated lending to corporates. That obviously also helps.Jundi, BTMU: It is the only FI market that has remained open during the crisis.Summerville, Calyon: But there is also the element of pure pricing in all of this. Ancillary business is of course very important, but Turkish banks have shown themselves to be very inflexible when it comes to pricing. It is true that the Turkish Treasury has not built up an extensive yield curve, which would provide benchmarks for domestic markets, as well as swap and rate support to domestic borrowers, corporate and FIs. And maturities tighten rapidly on Turkish FIs in any crisis. That said, most Turkish FIs would probably readily forego an extension of maturity so as to keep their pricing down to what they see as acceptable levels. Perry, Standard Chartered: Banks that lend into Turkey have been doing so for many years so they are pretty experienced and know what to expect.
Discovering the depths of the liquidity, strengths and weaknesses versus conventional finance, its role in syndicated loans (more than just an add-on), the possibility of standardisation.
EuroWeek: How deep is the level of liquidity in Islamic finance? Has it been hit as hard as the conventional sector? Perry, Standard Chartered:Similar to the loan and bond products, conventional and Islamic are very much complementary. It opens up pools of liquidity you wouldnt have otherwise.
I wouldnt say the Islamic banking sector has been hit as hard as the conventional sector and now that the tap has been turned back on slightly many of the Islamic banks are now looking very carefully at some of the deals that we are putting out there they are quite interested in the new pricing levels.
Certainly on all the deals that we look at now, we tell the borrower that we will look to tap every pool of liquidity available to us bonds, loans, conventional, Islamic.Keijzer, RBS: It was interesting to see that a lot of the recent Islamic tranches were actually being bought by conventional investors. Molloy, HSBC: Yes, thats what happened. When we started to see Islamic loans emerge, they tended to complement a conventional loan. For example, in project finance transactions, we saw the bulk of the deal placed in the conventional market with an Islamic tranche as a top up. But then it gained momentum and not just in the Middle East but other parts of the emerging markets with both pure Islamic banks and conventional banks participating. In fact, the conventional banks were instrumental in reducing pricing in Islamic financings.
In the current market, Islamic finance is seen as an additional source of liquidity.Perry, Standard Chartered: On the borrower side, the Islamic finance route was always going to take time getting to grips with new documentation. As time has gone by, Islamic finance has moved towards a more standard approach and subsequently got better. This is because Shariah boards have now seen the types of transactions. Structures are consequently far more common and created to more universally accepted standards. It has simply become easier to execute Shariah-compliant deals.
EuroWeek: But just picking up on your point about Islamic finance not being as badly hit as the conventional community, do you expect Islamic finance to emerge from this crisis in a stronger position and be a more important factor in regional finance?Jundi, BTMU: Its not clear how exposed Islamic banks have been to the property sector and their lack of activity more generally hints at the fact that this may be an issue. So I would almost suggest that your question should be looked at from the opposite end, i.e, will they emerge from the crisis as weaker players? As you saw with the Dolphin transaction, an Islamic tranche had been in place but it fell away as all the money went into the conventional tranche.
Borrowers still view it as more complex to set up and if they can avoid it and get all their money from the conventional side then they will do that.Molloy, HSBC: Similarly, the Nakilat transaction oversubscribed the conventional tranche, eventually raising circa $1.5bn on a deal size of just under $1bn. Therefore, there was no need to tap the Islamic finance market at all. Keijzer, RBS: Lets not forget that before the crisis Islamic finance had just started living up to its potential as a major source of liquidity. There was a lot of hype about it talk of the $4tr deposit base that we could dip into but compared to conventional deals from the region it is still developing. Molloy, HSBC: Its growth, however, depends on regulation. The lack of a standardised approach across Shariah boards within the region to some extent limits the growth of the product.
On the sukuk side of the equation, increased regulation could stymie its growth as scholars begin to voice their concern about the structure of these transactions and raise doubts over whether they are truly Shariah-compliant.Perry, Standard Chartered: But unlike commercial banks there are more Islamic banks springing up and have become much more active. I see it as a very positive story and should add an important source of liquidity to the local market.
EuroWeek: What are the chances of a more standardised approach?Summerville, Calyon: Standardisation is actually proceeding apace. There are Islamic solutions for swaps now, for example, and there all sorts of ISDA type of agreements being set up.
I used to be very skeptical about the chances for significant, or at least rapid, standardisation given the vested interest of the scholars; what would their motivation be to set up a standardised or an LMA-style approach to things and thus, to large extent, put themselves out of business?
But the market and market trends are much stronger than that. Likewise, its just as much cultural and social as it is economic, with the eternal debate between the ancients and moderns. With all this in mind, standardisation will surely proceed.But as Jacco was saying, we should not get carried away with the hyperbole. Increased standardisation has and will continue to add extra liquidity to the market, but it will not, at least for the time being, transform our retail markets into highly liquid and competitive markets.
Charting its recovery, gauging the level of confidence, appetite for long maturities, observing movement in pricing, where the bond market fits in and the role of the non-bank investor.
EuroWeek: Is confidence returning to the project finance sector?Jundi, BTMU: Its not clear what structure will come out as acceptable to the market in the immediate future. Will there be a project finance market? Yes, there will always be one there is a real need for it.
One of the problems is, of course, the tenors because most banks are not comfortable committing their balance sheets for such a long time.
Various structures are being tested, such as cash sweeps and mini-perms and the like but I dont think we are at the stage where we can see which way the structures are going to go.Perry, Standard Chartered: From the way the Dolphin transaction went we are encouraged by the progress the sector is making. Dolphin was 50%-60% oversubscribed which has got people buzzing that maybe the market is returning after being effectively shut at the end of last year.
I disagree a bit with Raouf on the subject of tenors. A lot of the banks I have been speaking to seem quite happy to contemplate longer tenors because the LPs have come off in recent months. The only thing that was making banks struggle last year was purely from a black box economic perspective where their LPs were, say, 180bp. Now they are back down to, say, around 60bp and that makes a big difference.
I think banks do not have a problem with tenor theyre much more focused on pricing. It will be interesting to see how the next couple of deals pan out. The deals will tell us whether long term project finance lending is back in vogue or still very unpredictable.Molloy, HSBC: During the course of last year there was a knee-jerk reaction to long tenors resulting in the introduction of mini-perm structures to the region. The jury is still out as to whether this structure really does work. By and large, banks look at any project on the basis of the underlying repayment profile, which, given the nature of the product will inevitably be long tenor. And so your ability to accept a mini-perm structure will depend on your view of the refinancing risk.
The reluctance of banks to underwrite in the current market presents project finance with a significant challenge. For example, in the power sector within some jurisdictions in the GCC, bidders are required to have fully underwritten financing in place as part of their bid, whereas in others this is not a requirement, for example, Bahrain.
But I agree with Steve that the nature of this market requires project financing. Traditionally it has been predominantly an international bank market and will continue to be so, although the number of banks with appetite for the tenors required has contracted somewhat.
EuroWeek: Surely the time has come for the bond markets to play a bigger role in the Middle East project finance given the problem some banks are having with tenors?Keijzer, RBS: I would agree with that. But Im not sure the bond markets are very suitable during the early phase of a project when investors have to take build-out risk. It should start playing a role when the project is fully built and the revenue streams have been established.
EuroWeek: So more suitable to infrastructure finance than project finance?Jundi, BTMU: During the construction phase there are often so many amendments and waivers that it would be almost impossible to get hold of all the bond investors to get approval for the changes. Whereas in a loan it is easier to contact the lenders and seek the waivers.
Borrowers like to refinance sometimes and that would be almost impossible to achieve on a bond financing you just wouldnt be able to round up all the investors in order to change the terms of the financing.Molloy, HSBC: There is the cost of carry of course as well.
But there was a much more developed bond market in the European infrastructure space before the crisis with stiff competition between the loan and the bond product for PFI structures at least until the monolines lost their ratings.
EuroWeek: Dale, do you think one of the legacies of the crisis is that it has changed the way banks view maturities on project finance?Summerville, Calyon: In the short term certainly, but I would go further with Raoufs point about the inability to refinance the terms of a bond, whereas it is easier amending them on a loan. As an example of how banks look at maturities, we were involved in a telecom project financing in Egypt where by the time they were financing they already had 2m subscribers and were a year ahead of schedule and they organized a bridge to a refinancing. We had some banks saying to us we needed to do a full payout seven year deal. Their credit committees were more comfortable with a full payout, fully funded business pan, as opposed to a two year bridge on a corporate basis.
Now thats a very particular example. But while I hesitate to predict, I think that maturity, although it is a problem now for much of the market, wont necessarily be the concern in the future as long as projects are viable on a cashflow basis. The security and ability to refinance in time will be the most important issue for credit committees, I suspect.
What has changed though is pricing and that is perhaps the real legacy of the crisis when we are talking about project finance in the region. I dont think well be seeing too much of 45bp over 15 years in the near future.
EuroWeek: What are banks worried about now in project finance maturities or pricing? Summerville, Calyon: I dont think maturity is really the problem, at least not for us certainly, since our reorganization where structured finance (including project finance) is one of the three pillars of expertise identified and prioritized by Calyon. Unlike corporates where, yes indeed, you struggle to go beyond three years, projects are treated differently. There is a bit more resistance to ultra-long tenors nowadays, but it is not the same thing as the corporate cycle and it is deemed to be a safer and more manageable form of finance. Perry, Standard Chartered: One of the benefits of project finance in this region is that you are dealing with the governments directly either through a sponsor or sponsor and offtaker. This gives you a real sense of security which means tenor really shouldnt be a big problem. I would say pricing is a bigger issue, as well as the fact that many banks have retrenched or withdrawn from the region potentially impacting liquidity that way.Jundi, BTMU: One thing banks would like to see is an end to sponsors taking out their equity very quickly through the cashflow. Banks now want to see that money coming back to them. Hence I think structures like cash sweeps will be popular because they allow banks to get some of their money back before the sponsors have taken out all of their investments.Molloy, HSBC: One of the reasons why banks have had a knee-jerk reaction to maturities is that, as a result of the crisis, banks now have a number of layers to go through to get approval not just the credit committee.
At the height of the crisis, banks were questioning whether they should lend to a project over 15 years that was paying similar margins to a corporate over two or three years. Many banks took the view that they shouldnt participate in order to preserve their capital.
While that concern is easing somewhat, jumbo transactions will be harder to finance since banks are not lending in such large amounts post-crisis and the bank market will need to be augmented by other sources of finance such as increased equity and more ECA finance before those jumbos return.Jundi, BTMU: I dont think capital constraints have eased that much yet. Well see more bad debts and more provisions and many banks are downgrading their clients internally which requires more capital. So the pressure is still very much there. Perry, Standard Chartered: Id go one step further than Grainne looking at what happened last year. I agree it was a knee-jerk reaction but everyone looks at project finance as a rather tricky product to price up because it is so long and drawn out. In fact that was what aided the sector. New solutions had to be found in order for banks to support their customers. Banks literally said Our underwriting has expired, markets have changed, so lets get round the table and have a chat to find solutions. It didnt go down too well with sponsors at first but ultimately both sponsors and governments have accepted the situation and pricing has been re-benchmarked to a higher and more appropriate level, structures are more stable and much less aggressive. Keijzer, RBS: Another interesting question is: on what basis does a longer term financing actually make sense for a lender? Does a 10 year project financing at 300bp work because you are comfortable saying Ill fund myself for two years and roll it over five times and Ill get there? If you compare that to your cost of funds for 10 years. the enitre facility might not make any sense at all. Thats a discussion a lot of firms need to have at some stage has your asset-liability management been tightened up to the extent that you need to have 15 year funding to match that 15 year project financing? If banks want to raise 15 year money on a non-guaranteed basis that is going to cost a fair amount that it cant necessarily pass on. It will be interesting to see how banks deal with this issue.
EuroWeek: What about the non-bank investor getting more involved in primary loan syndications for regional project financings?Keijzer, RBS: Im not sure whether it is feasible. For example, a lot of pension funds are not allowed to buy loans which is somewhat problematic.Perry, Standard Chartered: I would feel very nervous about structuring a deal in a certain way just to get a slice of pension fund money. I just cant envisage ever doing it. You might get a pension fund buying something up six years down the line but I cant see them taking part in a primary syndication. Molloy, HSBC: It would be very challenging from a structural perspective. You would need to devise a tranched structure that will attract both traditional lenders and funds. With no real visibility on what their appetite would be, this approach would be very challenging indeed.Perry, Standard Chartered: Even when there is visibility it can be extremely difficult in an over-leveraged market. Summerville, Calyon: Another issue is that you cannot prepay an investor like you can a lending bank. Keijzer, RBS: But where the bond market really can work in project finance is once construction is completed and revenues are starting to come in. A lot of investors should be very interested in that kind of deal. Perry, Standard Chartered: People were trying to do project bonds 10 or so years ago from day one. But it just doesnt bolt together well enough in terms of what a bond is all about. A bond is all about money up front day one for 10, 15 or 20 years at a fixed price.