Plugging the finance gap
Speaking to Banker Middle East, George Traub, Managing Partner at Lumina Capital Advisers provides an insight into the realities of mid-market capital dearth.
What is your view of the financing landscape in the UAE and wider Middle East?
The financing landscape is currently seeing some challenges and opportunities across the region. Bank lending is facing low levels of liquidity, inflexible lending practises and concern over asset security, which make it challenging for asset-light companies seeking financing for growth, particularly owner-managed entities whose business models are more suited to cash flow lending.
This need, is to a certain extent, being serviced by the emergence of private debt funds (mostly funds managed by the traditional private equity players) which provide the advantage of greater flexibility, with more appropriate terms for growing companies. These funds can also provide the added benefit of playing a more active role in a strategic capacity, to assist management in delivering the growth. While they are more proactive and flexible than banks, private debt in isolation is sometimes viewed as more ‘expensive’ if seen in a pure cash flow sense.
For longer-term infrastructure and project financing requirements, non-recourse project finance is rare. This type of financing is however much needed in the region, particularly to fund the development of the ambitious infrastructure financing requirements that the region presents over the next few years. The financing gap is primarily driven by a lack of long-term capital providers such as pension funds, insurance companies and other financial institutions that, in more developed markets, are active investors in longer term infrastructure financing projects.
What gaps do you see in this area?
Many companies that seek financing face frustrations including a lack of professional advice, which is increasingly necessary as a number of ‘alternative’ financing sources become more widespread in the market. Companies need to broaden their financing options beyond pure debt or pure equity and gain an appreciation of the more diverse options available to them depending upon their growth strategies.
Additionally, there is clearly a huge gap in the market for financing of owner managed businesses, although this is nothing new in the region. On the one hand, banks and other institutions are under pressure to manage the levels of delinquencies on their lending portfolio, which leads to overly conservative lending, and on the other hand a lack of appropriately structured lending to the owner managed entities leads to these delinquencies in the first place—so in short, a viscous cycle that continues to permeate the region. Unless there is a shift in thinking and a deeper understanding and assessment of the risks and rewards of a particular transaction by lenders and better preparedness from companies, I do not see any huge change in this dynamic in the near future.
How would you describe the appetite for structured capital amongst mid-market companies in this region?
The structured capital appetite for mid-market companies is significant, especially for infrastructure, real estate and other project financing requirements. A more pertinent question is just how prepared lenders are to structure these products, and how prepared banks and other finance providers are in matching their own funding profile in order to be able to cater to these project financing requirements. Therefore the key question still remains of how prepared are the banks and other finance providers in matching their own funding profile, to be able to offer these products amid increasingly burdensome capital ratios and other regulatory requirements for balance sheet presentation.
span style="font-size: small;">The private debt funds, mezzanine lenders and other pools of finance that are capable of servicing the needs of the structured capital market for mid-market entities are miniscule compared to the overall demand. To fill this gap, the development of the insurance, pension funds and other government-related investment entities’ allocation to structured capital products requires significant development.
How does the nature of structured capital in this region compare to those in developed markets? And how do they fare amongst their emerging market peers?
There are strong parallels to be drawn between the nascent stages of structured capital development in the region, with those that Asian markets experienced during their early days as the tiger economies—something that I have witnessed develop during my investment banking career in the Far East. There are a number of reasons for this, some of which I have alluded to above, including the lack of long-term capital providers such as pension funds, insurance companies and government allocations to the sector.
In addition, while the sophistication of banks in flexible corporate lending and transaction understanding is developing away from the pure ‘vanilla’ lending, this aspect still has a long way to go. The other key aspect where the region lags behind is the corporate and legal framework that facilitates these structured transactions, for example ownership of real assets, the sometimes-grey areas of Sukuk financing which have led to a number of high profile disputes and the lack of bankable public private partnership legislation.
All these aspects, whilst not new, face their own individual challenges for effective implementation, both from a legislative and corporate framework, and these areas will continue to develop over the next 10 to 15 years.
As banks become more stringent in lending, many non-bank financial institutions (NBFI’s) have stepped up to fill in this gap. How do you see the competition evolving going forward?
Banks in the region have a distinct advantage over NBFI’s—a huge client and customer base to tap into. The challenge that they face is how to do this effectively, profitably and to also structure products and services in line with the changing market demands. NBFI’s are much more agile in this respect, and have less stringent regulatory requirements, which enable them to provide more bespoke lending to borrowers.
Having said this, the current state of play is that the amount of capital available from NBFI’s, private debt funds and the like are particularly low compared to the market requirements, so there is huge room for growth in those areas. The real challenge for NBFI’s and other participants is how they can effectively manage their own funding costs to provide competitive financing terms. After all, no matter how well the finance is structured, if the cost comes at equity rates, most companies will revert to seeking equity capital.
What is your outlook on the financial sector in the UAE and wider Middle East in 2018?
The dynamics of the financial sector in 2018 are unlikely to be materially different from 2017. Change is occurring gradually, despite the market demands evolving rapidly, which is a key feature of rapidly developing and growing markets. Regional instability continues to impact confidence in many sectors, although the ambitious pace of development in the region will continue to generate significant interest from investors and a heathy pipeline of financing transactions.