Obviously credit is tighter than it used to be. Where is the recovery phase in project finance (PF) in the Gulf now? What evidence is there of the mood strengthening, and why?
We need to split this question into two. Credit from international banks, particularly from the US and European banks, is tighter. Some GCC banks also slowed down project financing due to their higher exposure in the realty sector. However, liquidity in the Saudi bank market is almost at an all-time high. The year 2010 is one of the busiest in terms of PF activity so far. Projects with Enterprise Value exceeding $25 billion (Dh91.8 billion) have been signed and sealed in the first six months of this year alone. A few more deals are expected to close within this year. PF is a source of financing, primarily, infrastructure projects. Increasing oil income and population in the GCC present an ideal demand-supply scenario to expand existing infrastructure. New roads, airports, railways, ports and power plants are planned to meet the growing demand. Additionally (and this is a global phenomenon), manufacturing/processing industries are progressively moving closer to the sources of their raw material. This makes a strong case for large investments in refineries and the upstream hydrocarbon sector in the region.
As to market conditions themselves, would you describe how the details in terms of pricing and volumes, fees and margins, and tenors have changed? How is the balance between borrowers and lenders these days?
It is difficult to generalise an answer to this question. Pricing, volume and tenors are functions of risk. They vary in each project. But at a macro level, the prices have been decent in recent months; volumes are higher and tenors have remained at more or less the pre-crisis level. Having said that, I must admit that the significant reduction in the appetite of international banks has given a slight advantage to local/regional banks to negotiate better terms. I guess this is likely to continue for the better part of next year, and perhaps beyond. At the same time, borrowers invariably have options to re-finance expensive debt should the situation change in their favour. We are responsible for earning decent returns for our shareholders. However, banking is a relationship-driven business, which does not allow us to be too greedy or unreasonable with our clients either.
What are the key features of the project pipeline in the Gulf at the moment in terms of deals pending and participants?
Two of the biggest economies in the GCC, Saudi Arabia and the UAE, have announced mega spending programmes on the back of firm oil prices. Between them, they intend to spend approximately $1 trillion over the next seven to ten years. This translates into $100 billion in investments per year. Projected higher oil prices and resultant budget surpluses make this target well within their reach. I think largely local capital will be used to build local economies. Assuming that 30 per cent to 35 per cent of this will be funded through equity, it still presents about a $600 billion debt opportunity. Even if 35 per cent of this is raised locally/regionally (although more is expected to come locally), then we have more than $200 billion in PF opportunities over the next few years. On top of this, some ingenious teams such as ours come up with Equity Bridge Loan (EBL) solutions to fund even the equity part. All this combined gives us a sense of optimism in the near-to-mid term.
How about the potential funding sources, now that banks are much more constrained than in the past? What are the prospects for different providers, such as institutional lenders, export credit agencies (ECAs), bonds and Islamic finance?
Commercial tranches in multi-billion dollar deals seen so far are limited to approximately 12 per cent to 15 per cent of the project size or about one-third of the total debt size. In other words, almost two-thirds of the total debt is coming and will continue to come from ECAs, government agencies such as the Public Investment Fund (PIF) and Saudi Industrial Development Fund (SIDF) in Saudi Arabia; capital market instruments. A number of Islamically structured project bonds (sukuk) are lined up — perhaps for shorter tenors compared to the bank tranches — for local/regional projects. This will allow developers/sponsors to tap retail investors. This is a new liquidity pool that can be used for financing long-tenor infrastructure projects. Project bonds are a major source of financing infrastructure projects in developed markets. However, the success of this experiment in the GCC will depend upon a number of factors including the state of equity markets, as higher/quicker returns and liquidity prevent retail investors from locking their capital into fixed-return products such as sukuk. In Western markets institutional investors such as pension funds and insurance companies are the biggest subscribers of project bonds. Such institutions are fewer and smaller in the GCC.
Are there any other issues affecting the structure and outlook of project lending arising out of the experience of the past few years, for instance in terms of contractual arrangements and regulation?
Fortunately, in the PF arena the region has not yet witnessed major defaults. The way limited-recourse and non-recourse deals have been structured present a decent story so far. The only major change that has occurred, post-crisis, in the Saudi market is that even blue-chip names are prepared to borrow for longer tenors in local currency. Until 2008 it was almost unthinkable. This is happening partly due to lower prices and higher liquidity in local currency borrowings. The average price difference between the US dollar and Saudi riyal is almost 100 basis points. This is a significant saving for borrowers and substantially enhances sponsors' equity internal rate of return (IRR). Since most GCC currencies are pegged to the US dollar, borrowers are prepared to take the forward currency swap risk, as hedging for the Saudi riyal is either not available or too expensive for deals with tenors longer than five years.
How about your own institution specifically? How have you been impacted by or reacted to events, and what characteristics of business do you expect in future?
The Banker's 2010 rankings put NCB at number one in the Middle East. Obviously it is the largest bank in Saudi Arabia. Historically, it has been a retail/commercial bank. It was a somewhat late entrant on the real corporate banking horizon, and project finance is even a more recent occurrence. Having the largest balance sheet and extensive corporate relationships, it was inevitable for NCB to play a lead role in the infrastructure financing of the country. A decision was made to leverage our balance sheet and within a very short span NCB has become a top player in the PF space. Over the past five years, we have participated as lead arrangers in almost all the PF deals worth their salt in the Saudi market. Among them are a number of award-winning deals. Our commitments vary from $100 million to as much as $1 billion to a single project. In the most recent Saudi power deal, in addition to senior Islamic debt, we funded almost the entire $500 million equivalent of equity through an EBL structure to GDF-Suez consortium. To my knowledge, this was the first ever Islamically-structured EBL. We are primarily focused on the Saudi market as this is the most ‘happening' place in the region. We will continue to play the leading role here. In future we may selectively look at GCC deals that are (i) having some Saudi connection, (ii) offering acceptable sovereign guarantees, and (iii) having a Saudi riyal tranche in their financing plan. But this is unlikely in the near term.
