29/05/2017

Bank finance in the Gulf: Liquidity up, pricing remains low

Bank finance in the Gulf: Liquidity up, pricing remains low

Airlines across the Middle East have around 165 aircraft orders scheduled for delivery between May and December 2017, with the ME3 carriers (Etihad, Qatar and Emirates) accounting for 74 of those deliveries. Competition between banks, both established and regional, to finance these orders, has been fierce.  Local banks across the Gulf Cooperation Council (GCC) region have mostly experienced increased liquidity as a rise in oil price bolsters deposits.  This has helped to keep pricing relatively low. However, the quantity of deliveries needing financing is pushing the banks up against their concentration risk limits.

Stable oil prices increase regional bank liquidity

Stabilising world oil prices has boosted the liquidity of gulf lenders.  The oil price fell precipitously from June 2014, losing around two thirds of its value.  At its nadir in February 2016, it fell close to $30 a barrel, but has since stabilised at around $50 dollars a barrel.  

 An IMF study has shown the linkages between credit growth and financial stability in GCC region, highlighting how an expanding deposit base and high liquidity (owing to high oil prices and short-term capital inflows) resulted in credit and asset-price booms before the global financial crisis.

Regional bank lending has been constrained over the past two years.  However, in a March 2017 report, Moody’s anticipates that increased government and corporate deposits will continue to improve liquidity over the course of the year, with Omani and Qatari banks set to benefit the most.

 

Source: US Energy Information Administration

 

European commercial banks, previously the main source of funding for airlines, withdrew heavily from the gulf region around 2013, while GCC lenders stepped in.  Since then, traditional banks have played the role of arrangers, providing capital alongside local partners.  See the deal box below for Etihad’s December 2016 re-financing of two Airbus A380 aircraft. 

The deal was the first aircraft transaction to make use of a special-purpose-vehicle registered in the Abu Dhabi Global Market (ADGM), the city’s fifth and newest free trade zone.  As a result of this transaction, Natixis and ADGM are in advanced discussions for setting up an aircraft investment platform in ADGM that will provide a focus for future investors and banks looking for high USD yield.

 

Source: Ishka research

 

Bank pricing has been fiercely competitive 

 

2016 experienced very competitive pricing from local and international lenders.  According to sources, current bank financing hovers at around 150-200 basis points for most credits and up to 250 basis points for lesser credits.   However, the market has cooled slightly following a recent spate of poor results from the main ME3 carriers.  Emirates reported an 80 percent drop in net profit during the 2016-17 financial year. See Ishka Insight: Could Emirates slide into the red?  Overall, pricing is approximately 30-50 basis points higher than a few years ago. 

Some traditional European lenders, such as DVB bank, are struggling to compete with these low margins. However, continued interest rate rises from the US Federal Reserve will exert an upwards pull on pricing over time.

Buoyant liquidity and intense competition has resulted in competition on loan terms.  As one banking source explained: “In order to squeeze out a few more basis points, lenders are prepared to make compromises on their demands.”  In some cases, lenders are going beyond their traditional 75-85% loan to value ratios.

Potentially, this could lead to over exposure to some asset classes as technology changes exert downward pressure on residual values.  For example, Boeing 777-300ER aircraft are popular with the large gulf carriers. A significant number are due to come off lease with Emirates in the near term, which can affect prices on the secondary market and increase the refinancing take-out credit risk for investors.  And while its successor aircraft, the 777-8 and 777-9 will not be in service until 2020, more than three quarters of orders to date have been placed by Qatar, Emirates and Etihad.

 

Source: CAPA Fleet Database

 

Banks are reaching internal concentration risk limits

 

Middle Eastern airlines have around 165 orders scheduled for delivery between May and December 2017, (see table above), with around 45% of deliveries going to the ME3 carriers: Etihad, Qatar and Emirates.

According to market sources, the number of financings and deliveries is putting strain on banks’ concentration risk levels, with local lenders and international lenders such as DVB Bank, at the upper end of their exposure limits.

 

Source: DVB Bank

 

One consequence has been that Asian banks and investors have been stepping in to the region.  Korean investors in particular have predominantly focussed on funding widebody assets to the ME3 carriers, see Ishka Insight: Korean institutional investors continue aviation assets spree.  As of today, there is no real shortage of liquidity in the region.

 

Ishka View

 

Airlines in the Middle East continue to be a popular destination for aircraft finance, with a steady stream of scheduled deliveries.  A recent spate of poor results, including from Emirates has done little to change this fundamental dynamic. Local banks are liquid owing to a stabilisation in the oil price, and are working in tandem with traditional European lenders.  Pricing remains highly competitive at around 150-200 basis points for most credits but is rising. However, bank lenders in the region and in Europe are approaching their concentration risk limits, resulting in a great deal of Asian capital entering the Middle East market to provide alternative sources of aircraft finance.  In addition, the new free trade zones, like the Abu Dhabi Global Market initiative, offer attractive platforms for investors to lend in the region.

 

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