With the price of oil having tumbled from US$103 per barrel to below $50 over the past 12 months, we are finally starting to see the effect of lower oil prices on regional liquidity.
Several UAE banks have reported meaningful first-half outflows in government deposits and concerns about a potential liquidity squeeze are figuring more prominently in many lenders’ thinking.
Banks in particular are focused on rebuilding liquidity and securing quick access to funding, as is illustrated by UNB and FGB both raising syndicated loans – UNB has secured $750 million and FGB is finalising a $1.4 billion loan. This represents UNB’s first foray into the loan market since 2006, while it was in 2012 that FGB last sought a syndicated loan.
Tighter liquidity will push borrowing costs upwards
Lower oil prices and their corresponding liquidity impact have not yet resulted in higher GCC bond and loan pricing, but it is on the way. There are two explanations for this:
• The regional liquidity squeeze only began to take effect in July and since then, largely because of Ramadan and the summer slowdown, there has been no GCC bond issuance. There are no primary data-points to evidence that new-issue pricing is wider. Secondary levels, however, support the thesis of upward pressure on borrowing costs, with GCC banks’ secondary bond spreads widening anywhere from 15 to 60 basis points.
• In the syndicated loan market, because transactions typically take many weeks to execute compared to intraday execution for a bond or sukuk, deals that are being completed now were negotiated pre-summer and reflect an outdated view on market pricing. In this way, recent tightly priced deals such as Taqa’s $3.1bn syndicated loan should be viewed as a throwback to an era of abundant liquidity, not a barometer of current market reality.
Second-half pricing will be higher
Regional capital markets will reopen this month and can be expected to crystallise the new wider pricing paradigm as deals start to print. Not only are secondary levels now wider than they were before summer, but investors are also demanding greater incentive to put money to work. Whereas in May and June the new-issue premium for an investment-grade GCC name was 5 basis points, this has increased to 25 basis points today.
Syndicated loans will be slower to recalibrate to wider pricing than capital markets. Loan pricing typically lags bond pricing by six months through the cycle because there of less market transparency, fewer secondary indicators and relationship considerations weighing more heavily on lending decisions. However, it is likely that this timeline will be accelerated during the coming months, with syndicated loan pricing widening quickly to catch up with moves in bonds and sukuk.
Borrower psychology a key consideration
In any market recalibration there will be those who acknowledge the new reality more quickly and others who are stubborn unbelievers. Over the next several months there will be borrowers who postpone their funding plans in the hope that market conditions improve. Such delays are not a prudent strategy, as pricing can be expected to trend wider for as long as we remain in an environment of low oil prices.
Borrowers will react differently to wider pricing
It is expected that regional bank issuers will realise the new pricing reality most quickly and react accordingly.
Government-related entities (GREs) will likely move next. Given pressure on government liquidity, direct government funding of many GREs may be curtailed, and GREs encouraged to borrow for themselves in the public markets.
Regional sovereigns will likely take a more proactive stance on debt issuance. Ras Al Khaimah is the only GCC sovereign this year to have issued debt internationally, but more can be expected to follow over the coming months. Many regional sovereigns are weighing the perceived disadvantages of issuing in this era of low oil prices compared to the advantages of locking in long-dated international funding at levels that remain historically very attractive. In addition to tapping international markets, GCC sovereigns are investigating local-currency alternatives, as evidenced by Saudi Arabia’s recent 15bn riyal bond offering – its first government bond issue since 2007.
Given their lesser overall funding needs, any changes in corporate borrowing behaviour are likely to be least pronounced.
How will the new financing landscape affect markets?
Notwithstanding lower oil prices, there is ample liquidity to fuel regional economic growth. However, it is likely that the composition of regional funding will change. Syndicated loans have dominated GCC fund-raising activity over the past three years, representing about 65 per cent of volumes compared to 35 per cent from bonds and sukuk. Given the rising pressure on regional liquidity, we can expect the proportion of borrowing conducted through capital markets to increase as more names look to diversify their sources of funding.
Andy Cairns is the managing director and global head of debt origination and distribution at National Bank of Abu Dhabi