Levels of project financing in the Gulf have substantially tailed off since the onset of the financial crisis. ALB asks industry experts when they think the market is likely to bounce back and how different it will look when it does.
The number of banks actively lending has declined. Domestic banks have run scared. Liquidity is scarce, as is foreign currency, and the once strong real estate market is in the throes of correcting itself. Not the type of indicators you are looking for if you are a project finance banker, sponsor or lawyer. And the message coming out of the Gulf is that things will get worse before they get better – but this doesn’t mean that people are sitting idly by. The way projects are proceeding is markedly different from the past. Increased attention is being paid to not only the structure of projects, but also their underlying economics.
From shorter tenors and maturity terms to tighter loan structures, major players say these changes are here to say and that’s not necessarily a bad thing as they could open the way for greater involvement of Islamic banks in the project finance sector. “There is a strong need for infrastructure funding in this region – be it transport, waste water or power – which has been pretty much developed with project finance,” says David Wadham, managing partner at Ashurst’s Abu Dhabi office. “But if the availability of liquidity remains low, alternative structures have to be used. We have seen people tweak the model and bring in banks; we have seen some drop their tenors – people are doing things differently to source as much liquidity to get projects done.” However, Wadham says that while there are those who are looking to commence new projects, very few are actually getting off the ground. He estimates that “nearly 80%” of the projects at market currently are legacy deals, which were commenced or committed to before the onset of the global financial crisis. Hence, as much as new deals depend on finding new funding sources, they also depend on just how these legacy deals progress. “It will be interesting to see how the legacy deals of 2008 get done in the next six months and on what terms the new deals are brought to market,” he says. “Dolphin’s refinancing is critical, as is the Zayed University. Then we have the Shuweihat S2, which is one of the deals from last year, which had a US$900m bridge facility and they are in the final stages of securing long-term financing for that.”
The way deals are done has well and truly changed. “People are beginning to look forward again – beginning to lend again – but I don’t think that we will return to the same terms we used to have. Definitely this time, pricing and tenor are going to be different in order to attract the bond market and Islamic products. Sponsors are witnessing tough days,” he says.
Don’t rely on banks
Greg Fewer, an advisor to one of Abu Dhabi’s largest investment companies, Mubadala, says that despite the need for project financing, the tough times are here to stay. But, he says, borrowers shouldn’t necessarily only be looking to banks. “Banks are shrinking and, for now, they cannot be relied on to provide balance-sheet capital,” he says. “The important next step is to enable regional currency issuance by encouraging and developing the appetite of insurance and pension funds to be involved in project finance.” But just how this is achieved is the Gulf project finance: where to now? million-dollar question, according to Thomas Waterhouse, joint general manager and head of energy and natural resources at Sumitomo Mitsui Banking Corporation (Europe). “Dolphin, Aldur and the S2 financings have sent a strong signal to the market in terms of recovery, but how will the market interpret this information?
Underwriting is unlikely to return to the market for the foreseeable future and the self-arrange model will continue to be the norm. Book-running strategies will need to adapt to attract commitments,” he says. The result, Waterhouse says, will be a flight to quality where only the top projects make it at market. “The Middle East will remain a key region for energy project finance given the high credit quality of transactions and low regulatory risk but banks will need to identify both shorter- and term solutions to keep themselves in the market,” he says.
Energy: not such a sure thing
Rajesh Ramanathan, vice-president of Apicorp’s GCC Business Group, says financing strategies will have to undergo a dramatic shift and the hype surrounding the short-term viability of energy projects may well be unfounded, with access to gas proving the biggest hurdle. “Is it the right time to develop energy projects? The short-term outlook does not support that proposition. From a medium- to long-term perspective, viability exists but it will depend on the availability of feedstock, level of capital costs and medium- to long-term supply and demand outlook,” he says, noting that gas shortages are already hampering Gulf multi-billion-dollar energy projects and developers have made it clear that they would rather hold off on projects until their so-called “fuel of choice” becomes available rather than use liquid feedstocks such as naphtha. But apart from fuel concerns, the more fundamental question is just where funding will come from. In this regard, Ramanathan is adamant that a strategic shift is needed – one which will require their funding net to be cast much wider. “It is clear that a strategic shift is needed. These projects will now need to access all potential sources of financing, including international, regional and local bank markets, export credit agencies, international capital markets and Islamic financial institutions,” he says.
Are Islamic banks the answer?
Indeed, it is the latter which is being held up as the panacea to the Gulf’s liquidity ills. Islamic bank assets have been experiencing annual growth of 15% and deposits and financial assets are expected to double in 2010. Saudi Arabia, for example, has seen the ranks of its Shari’a compliant banks expand – with the latest, Al-Inma, established last year – and a number of conventional banks in the Kingdom and wider Gulf have had Islamic makeovers. These banks could represent a growing source of liquidity for GCC sponsors that are currently facing delays in implementing projects due to difficulties in securing conventional financing. However, up until now Islamic tranches have been dominated by Islamic ‘windows’ of commercial banks because they have been the main source of liquidity. The result is that Islamic tranches have not really generated much extra liquidity – only 15% of total Shari’a compliance demand is supplied by Islamic financial institutions. But as HSBC’s head of project finance execution (MENA), Jonathan Robinson says, this is not necessarily the fault of Islamic financial institutions, but has more to do with project finance structures, which have tended to be reactive rather than proactive, and a focus on conventional banks as the “largest providers of liquidity”. The retreat of conventional lenders means that now is as good a time as any for Islamic institutions to play more of an active role in project financing. Robinson says this process must start with revisiting the basic principles that are supposed to underpin Islamic financing. This means revamping structures “so we end up with truer Islamic financing and the recognition that there is different risk and compensation for that”, he explains.
Whether the region’s Islamic financial institutions are ready and able to deal with long-term financing schemes is another question. For while many have begun to get involved in some large deals, they still lack the long-tenor mega-deal experience that traditional lenders have. The key, according to industry experts, will be whether the shorter-tenor structure experiments being pioneered in other jurisdictions across the Asia- Pacific kick off in the Gulf. If they do, Robinson says, this could be Islamic finances’ own window through which it can play a greater role in the region’s project financing sector.
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This is a HTML version of the News Analysis which appears in ALB 9.7 issue