Bonds & Loans speaks with Karim Zine, Director of Corporate and Investment Banking at Bank of America Merrill Lynch about the outlook for the GCC credit markets in 2017, and how the region’s CFOs are adjusting their borrowing and treasury management strategies to the new economic reality.
How do you see the GCC debt markets performing in 2017? What are the most influential factors in play?
The GCC region has gone through rough waters in 2016. This was mainly due to lower oil prices and their impact on budget deficits, bank liquidity and credit deterioration in certain sectors such as oil & gas, retail and SMEs. This resulted in a number of credit rating downgrades at the sovereign level which in turn affected the ratings of GREs and some of the major financial institutions. Despite a certain degree of “headline shock” the ratings downgrades didn’t ultimately have a material impact on pricing and investor appetite for most credits, due to the strong technical backdrop in credit markets. This is mainly due to the continuation of the policy of low rates in the US and Europe accompanied by aggressive quantitative easing by the European Central Bank. In this context, fixed income investors have continued to search for yield in places like MENA where they can achieve a pricing pick up compared to developed markets. This is compounded by the fact that the GCC region has been technically undersupplied for years if compared to other EM regions such as Asia or Latin America, so many investors are structurally underweight and keen to increase their exposure within the region. This positive backdrop enabled several sovereigns such as Saudi, Qatar, Kuwait, Abu Dhabi, Bahrain and Oman to successfully tap the market for very large amounts, and to capitalise on the bid for duration by issuing out to 30-year maturities. Many of these technical factors continue to prevail in 2017 with continued inflows into EM funds and investors still searching for enhanced yields, so we expect the market to remain supportive of further issuance from the GCC.
You mentioned the large volumes of issuance from GCC sovereigns, something most analysts believe will likely continue this year. But we didn’t really see a similar trend in corporate or financial institutions issuance. Do you think that this trend will continue into 2017?
The GCC debt capital markets have historically been dominated by financial institutions and sovereigns. Whilst we have seen an increasing number of corporates tap the market in recent years, there has been rather a lack of regular corporate issuers. The main reasons in my opinion are a lack of M&A activity of a size which warrants international bond financing, the supportive bank lending environment, especially for the largest and most credit worthy issuers, a lack of credit ratings, particularly for private sector corporates, and the focus of boards on cost of financing (typically available from relationship banks) as opposed to diversification, building a credit curve or accessing longer maturities that the bond market offers. We do not expect this trend to change dramatically in 2017, especially when GREs are focused on cost rationalization and integration as opposed to expansion; however, this could change if we see any further pressure on regional bank liquidity, which may drive corporates to the international markets.
In the financial institutions space, the story is somewhat different and we have seen many of the major banks remain active in the international market. However, what was noticeable was the absence of some of the largest and previously most regular issuers from the dollar public markets. This was due to a combination of less supportive market conditions, particularly in the early part of last year, reduced regional liquidity (previously we have seen around 50% of GCC bank issuances placed into the regional investor base), as well as a more cautious view of asset growth and funding requirements on the part of the issuers themselves. This decline in public benchmark issuance was partly offset by higher levels of liquidity in private placements; notably, private placements from GCC banks exceeded public issuances in 2016 for the first time. We expect the situation to change this year since these banks have a desire to issue public dollar benchmark trades in order to refresh their curves and support future issuances, although the private placement market is likely to remain very active as well, with good levels of liquidity and investor appetite particularly from the Far East.
What are you hearing from your clients in terms of their many concerns and challenges? What is top of mind for the region’s CFOs?
In a difficult market context, the recurring theme in our conversations with corporate clients is rationalization. Most of our corporate clients are indeed focused on finding efficiencies in order to improve their return on capital. This includes cost cutting, reorganizing business units and in some cases selling underperforming lines of business. Many of these corporates went through an acquisition spree in the past few years and are finding this period opportune to consolidate their business and properly integrate these subsidiaries.
Our conversations with our bank clients are similar in terms of the prudent approach. With the ongoing implementation of Basel III in the region and its effects on risk capital, as well as NPL pressure stemming from SME exposure and in some countries also the cancellation or postponement of government projects, the focus has moved from asset growth to a more efficient deployment of risk weighted assets, taking provisions when needed, boosting liquidity and building a stable retail and wholesale funding profile which is appropriately matched to the tenor of assets.
Bank of America Merrill Lynch is quite active in asset-backed financing. What does this asset class offer borrowers in the region compared to the loan or bond markets?
We are indeed active globally in asset-backed financing, be it through operating leases where we take the residual value risk of the asset or finance leases which are akin to secured debt.
Outside of aircraft financing, where we are very active, we have been involved in financing several other asset types in this region such as vessels, containers, flight simulators, engines and spare parts. There are many other assets where we see a good fit for this type of financing such as rigs, cranes, and the like.
We do like this product because it enables an efficient use of capital while offering our clients diversification away from traditional bank funding, access to longer maturities at a reasonable cost of financing as well as a way of managing the residual value risk for certain types of assets.
In the GCC region most of the asset-backed financing business is done with airlines given the scale of the three super connectors Emirates, Qatar Airways and Etihad, but also the growing presence of low cost airlines. Shipping is another traditional user of asset-backed financing. Further growth of this business outside these two traditional sectors has historically been hampered by the borrowers’ relatively easy access to unsecured bank lending. The current environment could lead more corporates to look at this financing source as a means of diversifying their sources of funding and lengthening their maturity profile.
How is Bank of America Merrill Lynch differentiating itself from its peers in the region?
The GCC region is very competitive; while we have seen a few banks retreat or pull out of certain lines of business, other banks are expanding their presence. In this competitive context, it is important to stay focused on your areas of strength and offer clients consistency of coverage.
Our approach to the GCC region over the past 6 to 7 years has been consistent: focusing on a select number of clients in key markets where we can be relevant and differentiate ourselves. In practice, this means focusing on GREs, large corporates and large financial institutions where our competitive edge is our universal bank approach i.e. being able to offer these clients global solutions to their financial needs be it on the strategic level, in debt capital markets, cash management or risk management – to give just a few examples.
Clients like the level of attention and focus they get as well as the quality of dialogue we have with them, and they reward us for that. This kind of client selection discipline means that we have to turn down opportunities from time to time, but that is the price to pay for long-term success in this region.
