You don’t tend to see it so much these days, but I remember going into shops and seeing a notice reading, “Please do not ask for credit, as refusal often offends.” I wonder if that is what banks are currently saying to one another?
It is almost impossible to pick up a newspaper or switch on the TV or radio news without being confronted with doom and gloom about the world’s financial markets. Despite efforts from governments and central banks to calm the markets through interest rate reductions and injections of large amounts of cash, the credit squeeze continues and inter-bank borrowing remains extremely fragile.
The crisis began when US mortgage companies made hundreds of billions of dollars of inappropriate loans to individuals with poor credit histories. These debts were then packaged up and sold to financial institutions around the world, which then sold them on to pension funds and hedge funds. When the buck finally stopped, savers with the UK mortgage lender Northern Rock were surprised to find themselves caught up in the debacle and participated in the first run on a bank in the UK for over a generation.
Northern Rock’s acute problem may turn out to be an isolated case, but it is symptomatic of the lack of liquidity in the international banking community and the altogether tougher environment for those looking to borrow large amounts of money. This comes at a time when there is a huge call on banks to lend to the vast number of infrastructure projects being planned around the world, not least in the Middle East. The current boom in projects in the region means project funding requirements are higher than ever and increasing on the back of capital cost inflation. Figures published in July put the total value of projects planned in the GCC at $1491.6 billion. The value of GCC power generation and T&D projects either under way or in the tender stage stands at around $257 billion (see Tenders, Projects & Contracts p.6)
So should project owners be concerned about their ability to finance planned large energy projects in the Middle East? The feeling in the banking community is that, while there is no immediate problem, this may not be the case if the crisis continues. One senior officer from one of the largest UK lenders told me, “I’m not seeing any direct influence as yet, but it is about to happen. The crisis coupled with the lack of dollar liquidity among local banks is meaning that some projects are becoming more difficult to place.”
There are a number of factors that are working in favour of projects in the GCC and providing some insulation from the worst of the crisis. An important one is the overall strength of the projects and deal structures in question, which are based on actual economic need i.e. a shortage of power, drinking water, oil production, pipeline or refining capacity. In many cases these projects also benefit from a quasi sovereign-backed off-take agreement. Given the current economic strength of the oil-rich countries in the region and their good non-default records, this adds weight to the deals.
Market conditions mean that lenders are looking to prioritize project finance deals and some of the weaker deals may be harder to place. Where credit is available, developers are bracing themselves for tougher terms. “Although I see no issue with availability, there is likely to be a trend towards more conservative pricing,” said David Barlow, Business Development Manager at International Power in Abu Dhabi.
This view was supported by the UK lender who went further still, admitting that terms and conditions had been allowed to get “fast and loose” but predicting that both pricing and covenants were going to get tougher. “Lenders are going to be more circumspect in the future and make decisions on a project-by-project basis.”
Even in the water industry, where projects tend to be fully contracted or natural monopolies, some tightening in terms is expected. John Dewer, partner in the global project finance group at law firm Milbank, who has worked on some of the largest IWPPs in the Middle East, was recently quoted as saying, “We are seeing some upward pressure on pricing, but not enough to seriously impact the economics of projects. In the Middle Eastern water project market we may be looking at a 20bp to 25bp increase in margins for new deals.”
Right now it seems that most project owners need not worry. As banks look to prioritize lending on projects, it seems likely that speculative real estate projects will be the first to feel the effects of shrinking liquidity. But the longer the credit crunch continues, the more likely it is that the general economy will start to feel the impact and the greater the chance of encountering that unpleasant, if not offensive, refusal.