With the price of oil having tumbled from US$103 per barrel to $50 per barrel over the past 12 months, we are now finally starting to see the effect of lower oil prices on regional liquidity.
Several UAE banks have reported meaningful outflows in government deposits during the first half of this year, and concerns about a potential liquidity squeeze are figuring more prominently in many borrowers’ thinking. Banks in particular are focused on rebuilding liquidity and securing quick access to funding, as illustrated by recent large syndicated loans by FGB, Union National Bank and Qatar National Bank. UNB made its first foray into the loan market since 2006, while FGB and QNB made their first since 2012. All transactions were supported predominantly by international lenders.
Tighter regional liquidity will push borrowing costs upwards, although we just haven’t seen it yet.
It is noticeable that lower oil prices and their corresponding liquidity impact have yet to result in higher GCC bond and loan pricing. There are two explanations for this:
1) The regional liquidity squeeze really 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. Consequently 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’ current secondary bond spreads anywhere from 15 basis points to 60 basis points wider than the period preceding summer.
2) In the syndicated loan market, because transactions typically take many weeks to execute, versus intra-day execution for a bond or sukuk, deals that are being completed now were negotiated before summer and consequently reflect an outdated view on market pricing. In this way, recent tightly priced deals such as Taqa’s jumbo syndicated loan should be considered evidence of abundant pre-summer liquidity, not a barometer of current market reality.
Second-half pricing will be higher than in the first half
Regional capital markets will reopen this month and can be expected to crystalise the new (wider) pricing paradigm as deals start to print. Not only are secondary levels now wider than before summer, but also investors are demanding greater incentive to put money to work. Whereas in May and June the new issue premium for an investment grade GCC name was five 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 as there is less market transparency, fewer secondary indicators and relationship considerations weigh 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 sukuks.
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.
Borrower categories will react differently to the new wider pricing paradigm
It is expected that regional bank issuers will realise the new pricing reality most quickly and react accordingly.Government-related entities (GREs) are likely to move next.
Given pressure on government liquidity, direct government funding of many GREs may be curtailed and GREs encouraged to borrow in the public markets.
Regional sovereigns are likely to take a more proactive stance on debt issuance. So far this year, Ras Al Khaimah is the only GCC sovereign to have issued debt internationally,
but more can be expected to follow over the coming months. Many regional sovereigns are presently weighing the perceived negative perceptions of issuing in this era of low oil prices versus 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. For instance, Saudi Arabia recently conducted 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 the bond, sukuk and syndicated loan 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. Over the past three years, syndicated loans have dominated GCC fundraising activity, representing about 65 per cent of deal volumes versus 35 per cent for bonds and sukuk. Given the rising pressure on regional liquidity that we are already witnessing, the proportion of borrowing conducted via capital markets can be expected to increase as more names look to prudently 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