Talking to a cross-section of bankers in the Gulf will reveal that few describe their view of the region’s project finance market as anything worse than optimistic. Although no-one is entirely sure how many new projects are due to come to market in the next few years – value estimates dither between $50bn and $80bn up to 2010 – about $14bn of deals were closed in 2004 alone, just shy of double 2003’s performance.
As oil prices nudge $70 per barrel, countries with sizeable crude production capacity are expecting record-breaking budget surpluses, so bullish governments are pressing ahead with projects for new roads, power plants and refineries at an unprecedented rate. Foreign lenders who had never entertained Middle Eastern risk before are now to be found arranging non-recourse infrastructure debt packages, while Islamic financial institutions (IFIs) are quietly carving out their share of a market that many believe is ideally suited to sharia-compliant financing techniques.
Big deal breaks the mould
By a margin of more than $8bn, including equity and sponsor loans, the finance package raised for QatarGas II was the largest syndicated project deal in the Gulf Cooperation Council (GCC) states last year and broke the mould in terms of scale and lender diversity. Royal Bank of Scotland, acting as adviser to sponsors Qatar Petroleum and ExxonMobil, put out a call for banks wishing to arrange $3.6bn of 15-year risk to finance a two-train LNG plant, and more than 40 responded from across the globe.
Alongside this significant conventional package, a landmark $530m Islamic tranche was also developed. Seven banks joined a team of sharia-compliant mandated lead arrangers (MLAs), including both pure-play local IFIs, such as Dubai Islamic Bank and Kuwait Finance House, and the Islamic arms of conventional lenders BNP Paribas, Gulf International Bank and HSBC Amanah. Not only was this news because the sponsors were prepared to entertain an independent Islamic finance package in the first place, but also because the prices that the IFIs met were equal to those of their conventional peers. Here was a multi-source pari passu transaction on a huge scale, and one that seemed to herald the arrival of IFIs into the big league of infrastructure finance.
According to data compiled by Dealogic, Bahrain Petroleum Company’s $1.01bn debt package for its Sitra refinery expansion is the largest deal concluded so far in 2005 that included an Islamic tranche. The package was signed in February, wherein seven MLAs contributed $330m of Islamic finance alongside $370m of conventional debt. On July 9, however, Abu Dhabi-based Dolphin Energy confirmed that it had secured four-year commitments worth $3.45bn to finance construction of its trans-Gulf gas pipeline project.
Announcing that $1bn of the finance package will be sourced from IFIs within the “largest ever Islamically structured oil and gas financing”, Dolphin CEO Ahmed Al Sayegh said he was “particularly pleased that our lead banks made a special point to invite Islamic investors from across the Middle East and Asia to join the financing”.
On the issuers’ map
His comment highlights the increasing willingness of major issuers to include IFIs in their financing plans. Sometimes socio-political motives are the driving force. The UAE’s Etisalat, for example, turned to Islamic financiers for all $2.35bn of the non-equity finance it raised last September for a Saudi Arabian GSM licence, and this August opted for a share murabaha to fund its partial acquisition of the Pakistan Telecommunications Company. Like many other local corporations and government ministries, Etisalat wants to be seen to be supporting an industry that is home-grown and that complies with the state religion. In other cases, the prevailing argument is that it is simply a good idea to tap into a new pool of liquidity and to diversify sources of funding for risk management purposes.
Sometimes client needs present few problems for the Islamic banks. Ijara, a sale and leaseback contract for operational assets, lends itself easily to aircraft and ship finance, while the istisna’a forward lease for assets under development is well suited to construction finance. Accordingly, IFIs have successfully penetrated the Gulf’s acquisition and real estate finance markets.
For the smaller players, Muthuswami Chandrasekaran, head of project and structured finance at Bahrain-based Gulf International Bank (GIB), believes that such short to medium-term financing activities will suffice. “As long as these asset-backed and real estate finance transactions remain profitable for them, I can’t see them trying to increase their share of the tougher non-recourse infrastructure project finance market,” he says.
Big ticket hurdles
Larger IFIs that do want a piece of the big ticket action, however, face several hurdles before they can confidently take on larger volumes of business. The first, and probably the most intransigent, is the issue of scale. By the standards of international banks, the balance sheets of even the largest pure-play Islamic banks are small, so their ability to participate in syndications is perforce constrained.
“Lack of consolidation is an issue,” affirms Dimitry Blasi, head of structured finance for the Bahrain-based Liquidity Management Centre (LMC). “For every big conventional bank, you need perhaps five Islamic banks to be able to match the level of capital they’re able to commit.”
Omair Mooraj, head of project finance, syndications and structure finance at Dubai Islamic Bank (DIB), points out that while many conventional banks sell down their portion of project finance packages, IFIs tend to retain their share. “At DIB, we commit as much capital as possible to project finance within our preferred sectors, such as power and water, and can deal with tenors of 10 or 12 years without refinancing, but we have to remain within our comfort level.”
Another hurdle is the issue of financing tenor, which at 15 years plus for an LNG train or oil refinery can pose a problem for IFIs that are reliant on short-term funding because it presents an asset/liability mismatch. To some extent, this issue has been mitigated successfully by developments in financing techniques, particularly the fusion of istisna’a and ijara contracts to produce a structure that deploys the former while the asset is being developed, and rolls into the latter once the asset is operational.
Nadim Khan, a partner specialising in Islamic finance at Norton Rose in Dubai, says this technique means that an Islamic finance package can be made to run as long as necessary to match the financing lifespan of major infrastructure projects. “We’re also seeing institutions trying to build into their documentation the ability to issue a sukuk after several years of ijara leasing,” he says. “Mid-term refinancing will help to extend tenors and thus make them even less of an issue.”
Although sukuk and murabaha placements are not yet in common use for refinancing purposes, they have been pioneered by the real estate sector to help boost pre-construction liquidity. Founded in 2002 under the auspices of the Bahrain Monetary Agency, the LMC focuses mainly on short and medium-term liquidity solutions for IFI clients but last year arranged a $150m sukuk for the Bahrain Financial Harbour project and another worth $120m for the Durrat Al Bahrain resort, both now in the construction phase.
Tight pricing
Although liquidity issues are less of a concern for the Islamic arms of large conventional banks than for pure-play IFIs, Islamic financiers of all sizes are expected to accept tight pricing in today’s big ticket projects: 35 basis points (bp) rising to 45bp in the case of Dolphin Energy’s latest offer. Practitioners say that a shortage of skilled Islamic bankers is not helping cost control efforts, and neither is the variance in scholars’ interpretations of which structures are acceptable and which are not, but that an increasing library of precedent is at least helping to limit documentation costs.
“There are now a number of structure templates available that clients often want replicated with modifications and enhancements,” says Asad Zafar, managing director at HSBC Amanah’s asset finance advisory group. “Cost is not the issue it once was because many of the upfront costs have been borne in the past by previous issuers.”
Mr Chandrasekaran of GIB agrees, observing that the incremental costs of sharia-compliance on a big ticket deal over $500m “would be insignificant to the sponsor anyway, perhaps a basis point or two, and easily outweighed by the benefits of Islamic participation”.
With Gulf project sponsors taking an increasingly favourable view of Islamic finance therefore, it looks correspondingly likely that future conventional MLAs will find themselves sitting at the table with pari passu IFI partners. Such partnerships are not always easy, and inter-creditor agreements must clearly set out fair title to assets so that all parties are treated equally in the event of default. For the sponsors, though, such partnerships are a means to spread risk and appeal to the widest possible range of lenders.
Competitive edge
In the Islamic finance industry it remains to be seen how far pure-play IFIs will be able to sustain growth of their balance sheets lest they lose ground to the sharia-compliant subsidiaries of larger conventional banks. The former have also yet to win a significant number of advisory mandates – a weakness that Mr Mooraj of DIB says his bank plans to address in a few months’ time by launching a dedicated advisory business.
In a straw poll of project financiers, The Banker found that most of them believe IFIs can win between 10% and 20% of the Gulf’s project finance mandates in the next five years if they are able to sustain the momentum built up in recent months. Market rumours that Dubai Municipality is planning to finance its metro light rail project entirely from sharia-compliant sources has several Islamic bankers salivating and if proven true, will further boost the industry’s credibility in the eyes of other potential issuers. Given the volume of debt expected to hit Gulf markets in the coming years, Islamic finance’s apprenticeship in the project finance market could be drawing rapidly to a close.
