Ever since the petrodollar the boom of the 1960's and 70's, structured finance in its many forms has been the glamorous end of corporate banking in the Gulf. Now with a new wave of development projects being undertaken in the region, structured finance once again begins to take off
Projects such as power plants in Saudi Arabia and Oman, gas projects in Qatar and aircraft purchases in Dubai and Bahrain all require syndicated financing. This financing requirement brings together, the top banks in the region and the world, and at the same time pits them against each other.
"Yes, the boom of the 70's was when infrastructural growth was at its peak," says Suresh Kumar, chief manager of treasury and capital markets at Emirates Bank International (EBIL). "In the 80's, most of the Gulf's financing needs were met out of Bahrain's offshore banking centres. But since the BIS risk and capital adequacy requirements, banks are now regionalising their appetite."
It also means that international banks are sensing an opportunity to capture an area of the market that regional banks have in the past kept to themselves. As part of this awareness, the HSBC group became the first international bank to open up a full fledged investment banking arm in Dubai, HSBC Financial Services (Middle East). "We began to realise that the market here is developing and deepening," explains Mukhtar Hussain, chief executive of the firm. "The appetite for syndicated lending is increasing and borrowers are aware of the potential of getting financing from world markets at competitive rates. Also, this market is attracting international financing."
An old adage has it that 'The best time to borrow is when you don't need to borrow.' Banking runs on a similar philosophy, that the more money you have and the less you need, the more banks are willing to lend. When it comes to structured finance, the numbers are in the major leagues, with kick-off loans in the region US$ 50 to 100 million, and sovereign loans, lending to a government, begin from US$ 100 million and run to billions. With such numbers, the rules of the game, the risks and the repayments become ever more complex.
To the observer, the most intriguing part of syndicated financing is its most fundamental rule, that of full disclosure of financial information. In a region known for its secrecy and privacy, the fact that such lending is playing an increasing part in corporate life means that more major local and regional firms are beginning to play for the first time by international rules, and are having to disclose information.
"Information and the quality of that information is what matters," explains P. Balasubramaniam, head of corporate banking for the Gulf at Standard Chartered Bank. "To take a calculated risk, you need that information." According to Kumar at EBIL, "Syndicated financing requires good disclosure but there are firms here who have such transparency." He cites the cases of Dubal in Dubai and ALBA in Bahrain, which recently raised a successful US$ 100 million bond issue. "These are firms that regularly go to capital markets for such financing and therefore 'know what's needed," he says. "As long as they are in a viable business, have good cash flow prospects and have good regulation, then the markets are usually willing to take them on." However, the fact remains that for companies in the region to seek such major financing, the application process would require them to open their books much more fully. most companies are reluctant to accept this. It will only be when the benefits of more disclosure become apparent that attitudes will change.
The way the loan is structured depends upon the amount involved, who the borrowers are, the level of risk and many other parameters. Because of the many factors involved, structured finance itself has begun to take on various forms. Among the methods used are 'warehousing,' where a bank provides the finance, then syndicates the loan at favourable rates in two to three months. When the numbers and risk are relatively small, banks may go in for 'clubbing,' where two or more banks provide different percentages of the financing without having a lead arranger.
Syndicated Loans still remain the most popular form of financing for large capital amounts. The one aspect highlighted by every banker is the inherently individual nature of syndications, making them a flexible financial instrument. One of the biggest debates over the past five years has been whether syndicated loans should have a fixed or floating rate of interest. "With fixed rates, the borrower takes out the uncertainty of rate fluctuations, while floating rates provide the flexibility to take advantage of rate lowering," explains Mukhtar Hussain. According to Balasubramaniam, "It depends on the long term view of interest rates. But for a borrower dependent on future sales earnings to make his repayments, a floating rate would be better because his sales prices would be based on current interest rates, and therefore, so would his income."
To the banker, the floating rate is infinitely preferable since it matches well with banking structures. "Our sourcing and our cash streams are short term, and therefore so is our interest rate," says Kumar. "After all, no one deposits money in a bank for a straight ten years. The usual deposits are calculated in months, or at most, a few years." That preference is also no doubt strengthened by the fact that the syndicate will always charge a margin on the interest rate, so whichever way the interest rate heads, the lenders are unlikely to lose out.
Having a lead arranger bringing together a syndicate may be half the problem solved, but getting them there can be, as one banker put it, "as close to hell as you'd want to get". "It's a specialist skill," says Kumar, "and getting the right documentation together is the vital ingredient." The key to this is also the selection of the right banks familiar with the business sector and the geographic base of operations of the company in need of financing. "We don't throw a deal at every bank around," says Achal Ghai, manager for Standard Chartered at Jebel Ali. "We must do our own studies and see which ones fit the specifications."
All of which means that when a certain industry needs such financing, only banks that know the game will be asked to play. One very specialist field is aircraft financing. The finalised initial stages of the Emirates Airlines' approximately US$ 700 million deal for new aircraft is one of the major recent structured deals in the region. Bidding for the financing was split into several stages and syndicates were formed to compete for each stage. One of the strongest contenders, and a major eventual winner, was the syndicate which brought together HSBC Financial Services, The British Bank of the Middle East, and National Bank of Dubai and EBIL.
But as a specialist pointed out, aircraft financing is a minefield. "For one thing, you have to know a lot about insurance, what's in and what's not in the policy. If the aircraft is impounded, the insurance must take care of loss of business and aircraft recovery. And, you have to make sure that unlike car loans, the aircraft is not in the bank's name ," he says. This is to ensure that in the event of a crash or the aircraft being impounded, the bankers do not become liable. Subramaniam cites the case of the crash of a DC9 in the US, where the list of defendants includes the airline's financiers, who are being sued for not ensuring that the aircraft they financed were airworthy.
While aircraft financing may have cornered the headlines over the past couple of years with a spate of fleet expansions, there is still much low profile industrial and trade financing going on.
Indeed, the secrecy with which most structured financing deals are negotiated is one of the most critical components in their success. the rationale for such secrecy is quite logical if you consider the impact on a company's reputation if the negotiations are unsuccessful.
In fact, for publicly listed firms, the news of a successful syndicated financing arrangement can be a major boost for its share price. Private firms have over the past decade become key players in the structured finance markets. one of the earliest private successes was Chrysler when it pulled off a coup of sorts by convincing the us government to guarantee them on a US$ 2 billion loan.
Governments backing major private enterprise on such heavy financing is not however, unheard of. In many ways, it is a necessary part of a structured economy as the strength of large companies and employers are critical to the health of the total economy. For smaller economies such as those of the Gulf region, where private enterprise is on a smaller scale, the need to back such financing for private enterprise can also have other reasons.
One major reason would be the need to strengthen and develop the private sector in an economy.
As governments here in the Gulf look increasingly to shift the balance of their economies away from their dependency on oil. They are endeavouring to develop trading and manufacturing capacity and services industries such as tourism to be successful it will require a great deal of financing particularly by companies and individuals to keep pace with the proposed changes.
Therefore there is a need to create capital markets. One method for local governments to do this is to encourage public sector institutions to raise syndicated loans. Even though government-backed entities do not typically require such lending, the local institution gains credibility and the local capital market expands its activities
The competition to provide such financing is heating up between local and international banks. "There are certain inherent advantages in being local, such as credibility," comments Kumar. "With the internationals, they can do the assessment but their risk-taking ability is not the same as that of the locals." The internationals, for their part, have the backing of enormous resources and well-honed skills to back them. "By being regionally based, there are synergies," says Mukhtar Hussain. "The local banks are happy with the risk. The internationals, however, may see things differently."
And as the need for such large financing becomes more acute, so will the need to develop local capital markets. "Banks are no longer jumping onto the bandwagon, " says EBIL's Suresh Kumar. "They are responding more sensibly. Also there are new instruments such as floating rate loans and venture capital. If the capital markets here become organised, corporate finance will grow."