Gulf lenders now more selective in financing projects

Banks still have appetite for project finance but are being more selective in lending as the project pipeline in the Arabian Gulf region stabilises.

Project awards in the Gulf region this year are forecast to rise slightly to US$172.7 billion from $171.7bn last year, according to the data provider Meed Projects. In the first quarter of this year $46.6bn worth of projects were awarded versus $53.7bn in the first quarter of last year — a figure skewed by the $15bn worth of contracts for Kuwait’s clean fuels refinery project.

“We have appetite for the sector provided the projects are well structured and well priced,” says Mark Yassin, a senior managing director and the head of global banking at National Bank of Abu Dhabi.

“We are not led by the product itself though, but by the requirements of our clients.”

One reason banks are eager to finance good projects is the vast liquidity they amassed during the years of strong oil prices. Although prices are down by some 40 per cent since last June, banks are still flush with cash. Gulf governments have also pledged to continue spending on infrastructure, a sign that encourages banks to continue to lend.

“We haven’t witnessed yet in the project finance market any material pressure on the banks’ liquidity and pricing due to the decline in oil price,” says Mario Salameh, the head of project finance in the Middle East and North Africa for HSBC Middle East. “There is usually a time lag between the decline in oil price and potential slowdown in the project finance market.”

Nonetheless, lending to the oil, gas and petrochemicals sector, the biggest market for project finance, will decline this year because of the lower oil price and shelving of some projects.

For example, Qatar has cancelled two petrochemical projects, the $6.4bn Al Karaana and the $6bn Al Sejeel projects.

“A combination of factors has led to a slowdown in the oil and gas and petrochemical sector,” says Mr Salameh.

“The first factor is the major decline in oil price. The second one is that the major large developers have already built multibillions [in] assets and are now focusing on developing and optimising their portfolio. The last factor, which is specific to the petrochemicals, industry is the limited availability of gas feedstock in the region.”

To be more specific, Saudi Arabia, which produces about 70 per cent of the region’s petrochemicals output, is suffering from a shortage of gas. That is why the petrochemicals giant Saudi Basic Industries Corp, or Sabic, is looking at shale-based projects in North America.

A number of other factors are encouraging banks to lend.

“Many international banks that had gone out of project finance during the financial crisis are coming back to project finance, and that’s an important source [of liquidity],” says Ravi Suri, a regional head of corporate finance at Standard Chartered.

“Export credit agencies are playing a role in project finance, especially the likes of JBIC [Japan Bank for International Cooperation] and Kexim [Korea Eximbank]. Local liquidity is playing a huge role. In countries like Saudi Arabia and the UAE, local banks play a major role and many projects get financed by them.”

The European benchmark Brent, which fell to a low of $45.19 per barrel in January, has since jumped to more than $65 per barrel owing to tension in parts of the Middle East, particularly in Yemen

However, more and more banks are reluctant to lend for long tenors, especially with the phased implementation of Basel III banking standards, which are expected to make it more expensive for banks to lend long term.

“If sponsors are prepared to pay more pricing and/or agree to adopt more creative financing structures, the bank’s appetite is likely to remain reasonably unchanged,” says Mr Yassin. “But if they continue to create more competition among the banks and insist on 20-year financing tenors, then this may not be the case.

“You will need to offload some of the project finance debt in the future on the bond market and other takers of this asset class such as hedge funds, infrastructure funds and sovereign wealth funds.”

Project bonds have been few and far between. In the Gulf, the Abu Dhabi-based energy firm Taqa, the Abu Dhabi sovereign wealth fund Mubadala and Qatar’s Rasgas, a producer of liquefied natural gas, are among firms that have issued project bonds over the past six years.

In 2011, state-run Saudi Aramco issued a 3.75bn riyal (Dh3.67bn) project sukuk to finance a refining and petrochemicals joint venture with France’s Total, the first time Islamic bonds were used for project financing.

“We expect to see activity in project bonds in the next two to three years in a big way in the region,” says Mr Suri. “There are many sponsors looking at project bonds as they are a fantastic way to diversify funding sources while also freeing up bank lines for additional projects.”

The advantages of project bonds is their long tenors and improved internal rate of return, he adds. Appetite for project bonds is also increasing because western investors are buoyed by the region’s strong economies and projects. Mr Suri expects pricing of project bonds, which are typically higher than bank lending, to be attractive because of “ the solid credit story of Middle East projects”.

According to the Standard & Poor’s credit analyst Karim Nassif: “Banks have to start to reflect increased risk perception in higher pricing, which is good for the capital markets, because traditionally the issuers would differentiate between going down the bank route and capital market route primarily on the basis of price.

“But to the extent that bank pricing might go up as the banks start to see some effect on their deposit base in this current environment, then the capital markets become more competitive de facto.”

For example, in Saudi Arabia bank deposits in the first quarter of this year grew 9.8 per cent over the first quarter of last year. Bank deposits grew 14 per cent in last year’s first quarter compared with the first quarter of 2013.

“In this region in particular they [banks] are experiencing some pressures in terms of the deposit base because a lot of the deposits come from the big government entities, and sovereign wealth funds, so you only have to have a few concentrated entities not generating as much money because of the oil and gas price dip and then the banks start to feel the pinch in terms of liquidity,” says Mr Nassif.

“It is too early to take a definitive view because loan to deposits are at still very healthy at 100 per cent roughly, but what we are noticing is some decline in [growth] deposits in Saudi and Qatar which ultimately is going to make it tougher for these banks to fund at the same price.”

Banks, ultimately, will remain the main financiers of projects, given that sponsors look for cheap loans.

“I think there is some evidence of some entities being a little big cautious in this region specifically where they are not very sure of market environment for issuing long-term and so they are preferring to deal in short fixes through banks and syndicated loans to deal with their refinancing risk and their infrastructure expansion risk,” says Mr Nassif.

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