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Middle EastJuly 31 2005

Projects flow

Bahrain’s economy has benefited from diversification, and Manama’s status as the Gulf’s premier financial hub is not under imminent threat, write James Gavin and Kevin Godier.Bahrain’s relative lack of hydrocarbon resources has helped it to become one of the region’s most diversified economies, stimulating a steady flow of project finance and other corporate activities in a range of sectors.
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Critical to this mix, the central bank, Bahrain Monetary Agency (BMA), has won plaudits for its efforts to ensure that financial services remain the island state’s strongest suit.

This seems likely to remain the case: despite competition from newer regional financial hubs, such as Dubai and Qatar, Manama’s prime position in the Gulf is not under imminent threat. Under the leadership of a new BMA governor, Rasheed Mohammed Al Maraj, Bahrain is trying to extend its reach as the Gulf’s banking hub, adding new ballast to its armoury of financial services. In this, the BMA is starting from close to home, launching an ambitious review of its own structure and regulatory framework. A new law is expected to buttress its regulatory prowess by pulling together, for the first time, laws on banking, insurance, capital markets and other financial services into a streamlined enactment.

The main thrust of activity is on developing the Islamic banking and insurance sectors, where Bahrain’s leading edge can be most effectively deployed: shariah-compliant issuance that is regulated and led by the BMA has gained traction since 2002, with monthly issues of sukuks (Islamic bonds), comprising the three-month maturity sukuk al-salam instruments and the long-tenor sukuk al-ijara. Corporate and sovereign sukuk issuance amounted to about $6.7bn in 2004, a three-fold rise on the previous year.

The BMA has strengthened its status as a financial innovator by setting up a specialist bank to develop new Islamic financing techniques, the Liquidity Management Centre (LMC), created in 2002. The LMC has been putting the finishing touches to a new technique that will allow investors to raise short-term funding against their sukuk holdings. The so-called sell/buy-back tool will allow investors to use sukuk paper held as security, and is seen as another means by which Bahrain will tighten its grip on the booming Islamic financing sector.

Islamic insurance

Aside from these repo techniques, the LMC has contributed to major deals through novel combinations of investments, project financings and leasing, such as in the $1.3bn Durrat al-Bahrain housing project.

Bahrain is also planning to develop the Islamic insurance (or takaful) sector, in which members contribute money to a common pool in which losses are divided and liabilities are repaid according to the pooling system rules. Funds are invested in a shariah-compliant manner.

The rise of sukuk and takaful in Bahrain is not coincidental. In the past, the development of takaful was obstructed by Islamic portfolios lacking tradable fixed income components, but the growth of the sukuk provides for an asset class that will foster the creation of annuity types of products. The BMA anticipates a steady increase in takaful licences, from the 16 registered in 2004, as consumer awareness grows.

Local bankers expect the concentration on Islamic finance to reap dividends for Bahrain’s expanding roster of financial institutions. “Bahrain will continue to perform very well as its banking sector carries on developing, particularly as a hub for Islamic banking,” BMB Investment Bank chief executive Albert Kittaneh told The Banker. “The increasing sophistication of Islamic banks in real estate development and fund management will continue to improve the investment choices for Bahraini and Gulf Co-operation Council [region] customers.”

Oil price bounces

Bahrain-based banks, like others in the region, have enjoyed the benefit of oil prices feeding in to increase private and public investment levels. Consolidated assets of the banking system registered a rise of $18bn year-on-year in 2004, to $118.9bn, the BMA’s figures show.

The three largest Bahraini banks – Ahli United Bank (AUB), National Bank of Bahrain (NBB) and Bank of Bahrain and Kuwait (BBK) – all reported robust profits last year. Income sources have been diversified and retail lending is showing strong growth across the board. These trends continue in 2005.

This marks a welcome change from a challenging period, when the investment banking sector in particular faced a tough few years in the wake of the 9/11 attacks on the US and the downturn in global markets. Key players’ results have been affected by illiquid markets, preventing exits from private equity investments. Bahrain-based Investcorp, United Gulf Bank, Taib Bank, Bahrain International Bank and BMB have at various stages been hard hit by the collapse of stock markets since 2000. But there are signs that the corner has been turned.

BMB, for example, has undergone a restructuring, concluding in a July 2005 rights offering that has so far raised $35.5m – the first stage of its capital-raising programme. With a Q1 2005 net profit of $6m, income from investments played a major role in the profitability.

“The development of the capital markets in the region in recent years provides a tremendous opportunity for regional investment banks, particularly those that are able to bridge the gap between the Western world and the Middle East,” says Mr Kittaneh. “Middle Eastern customers find it difficult at the moment to invest in Western markets because the local returns are substantially higher.”

Bankers are confident that the situation will be transformed, leaving Bahraini banks better placed to capitalise. “These local markets will eventually retrench and become more normalised, at which time investors will begin to look again at opportunities outside the region,” says Mr Kittaneh. “With the recent improvement in US economic performance and the re-emergence of mergers and acquisitions, we expect our private equity investment to do very well over the coming years.”

Growth areas

Local banks are looking forward to building up their balance sheets and securing new lending opportunities in the growth areas of retail and project finance. But Bahrain, an island of just 600,000 inhabitants, is inevitably restricted in the small size of the market. This may trigger moves outside the kingdom for some of the leading Bahraini banks, eyeing the larger markets in neighbouring economies that are in the process of dismantling barriers to investment.

AUB, which aims to win significant market share in all GCC countries, has set the tone with the acquisition of a 15% stake in the Bank of Kuwait and Middle East as well as an acquisition in Qatar, making it a truly regional player. NBB plans to open its first branch in Saudi Arabia in the next few months.

Though lacking the revenue boost enjoyed by more hydrocarbon-rich Gulf states, the overall economic climate in Bahrain looks favourable with GDP growth rates in the region of 7%. There have been some concerns over an increase in levels of external debt, which now exceeds $1bn, yet overall debt-to-GDP levels do not look out of the norm at about 23% of GDP.

Project finance outlook

In terms of track record and need, Bahrain appears to be in a different project finance league compared with its more active oil-rich and gas-rich neighbours Qatar, Oman, Abu Dhabi and Saudi Arabia. When ABN AMRO estimated in early 2005 that the GCC region would require more than $34bn for its energy sector financing needs over the 2005-06 period, Bahrain was accorded a projected requirement of only $1.6bn.

That was slightly more than Bahrain has tapped in two projects in the past 12 months. While there is unlikely to be any new financings in the rest of 2005, the small kingdom will be tapping the market for money once again in 2006 as it seeks to boost its power and water sector, and to establish a new petrochemicals venture.

“Bahrain will never be a huge project finance market,” says a Paris-based project financier involved in a recent Bahraini deal. “It possesses lower levels of natural resources than its neighbours [and] the really big projects are elsewhere, but it is quite active for its size, and there are increasing demands for power and potable water.”

Revenue rises

There have been significant rises in the kingdom’s revenues from the export of about 240,000 barrels a day (b/d) of oil. Total oil sector income in 2004 was Bd943m ($2.5bn), up from Bd836m in 2003, according to finance and economy minister Sheikh Ahmed bin Mohammed al-Khalifa. Given the current state of oil prices, this figure will grow again in 2005.

But Bahrain is increasingly looking beyond its state revenues to create the infrastructure required of a 21st-century Arab state. The first new deal off the blocks should be the $358m third phase of the Al-Hidd power and water project on Muharraq Island, whose second phase attracted a $255m loan, lead arranged by BNP Paribas (BNPP), HSBC Amanah, BBK and Bank of Tokyo Mitsubishi. This combined export credits from Switzerland with an Islamic facility arranged by the Saudi-based Islamic Development Bank and Kuwait Finance House (KFH). Bahrain’s government has decided to turn Al-Hidd over to the private sector and to add extra power and desalination capacity. It is expected to issue a request for proposals soon, the French banker said.

Another project that is expected to be financed in 2006 or later is a $1.3bn combined petrochemicals, power and water complex to be developed in Bahrain. KFH is in the driving seat as project developer. It has said that the scheme is expected to be completed in Q1 2008 and will be financed through “a combination of equity and debt of $400m and $900m respectively” after obtaining the required licences.

Looking even further ahead, Bahrain will inevitably require further funding for its eventual role as an off-taker from the Dolphin sub-sea pipeline project, whose initial role is to provide the UAE with about two billion cubic feet of Qatari gas per day.

Track record grows

Bahrain set out its project finance stall in 2004, when the project financing for its $493m, 950MW Al-Ezzel power plant was named as a Deal of the Year by The Banker.

Developed by a consortium comprising Gulf Investment Corporation (GIC) and the Belgian-based Suez Energy International (formerly known as Tractebel), and advised by BNPP, the deal set a benchmark as Bahrain’s first greenfield independent power project. Other milestones included a 20-year maturity – the longest lending tenor seen in Bahrain for any type of debt – and completion of the scheme’s bidding, structuring and financing phases in a record time of just under 11 months.

The project’s $380m limited recourse loan agreements were signed with a consortium of regional and international banks, led by HSBC and Société Générale and including ANZ, Bayerische Landesbank, Calyon, Gulf International Bank (GIB), ING, Mashreqbank, Mizuho, Royal Bank of Scotland and Standard Chartered.

“It was a great success,” says John Dewar, a partner at law firm Milbank, Tweed, Hadley & McCloy, which worked for the sponsors. “Bahrain said it was going to build an independent power project at the start of 2004, appointed good advisers, got the request for proposals out, and Tractebel won from the five bidders. It closed very quickly and is under construction now.”

A larger and more complex transaction was a $1011m, 11.5-year debt financing that was concluded in early 2005 for an upgrade to Bahrain’s sole oil refinery, the Bahrain Petroleum Company (Bapco) facility at Sitra. The debt package included a $370m commercial bank facility, a $330m Islamic ijara sale-leaseback facility and a $311m tranche guaranteed by The Japan Bank for International Co-operation and Nippon Export Credit Agency. It will allow the construction of a new hydrocracker unit by 2007, with a capacity of 40,000 b/d to produce low sulphur diesel. Some of the funds will be used to prepay a bridge pre-export facility made available to Bapco in March 2004 by BNPP and HSBC.

According to Mr Dewar, the deal’s Islamic tranche – which was arranged by KFH, Dubai Islamic Bank, BNPP, GIB, HSBC, Apicorp, NBB and ABC Islamic Bank – is likely to become more commonly used. “Islamic finance is now taken very seriously by everybody as a source of finance, and is seen to be starting to match the longer tenors provided by commercial lenders,” he says.

Legal issues

Another banker, based in London, told The Banker that the Al-Ezzel financing raised several issues for the participating lenders. “Bahrain is generally an easy market in which to do business, but there were a few legal issues that banks had to get their heads around.” One was the question of the attachment of assets – a standard requirement for lending security in most power projects.

“For a government edict to work in Bahrain, parliamentary agreement is required. But the banks were very politely told that it wouldn’t happen immediately. The market decided in the end that the Bahraini government would honour its obligations – and that there was no need to attach assets.”

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