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Sat 20 Nov 2010 12:00 AM

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The cost of recession

Construction Week finds out how firms are coping with restricted access to project finance. Elizabeth Broomhall reports

The cost of recession
RISK AVERSE: As the construction market recovers, banks have been reluctant to return to previous levels of lending.

As one of the most pertinent topics in the construction industry today, the issue of project finance is one that continues to spark debate among the region’s key professionals. Across the board, they agree that access to finance is getting easier, but diverge on the subject of how to move forward. At the centre of the controversy, is the argument over whether banks should be doing more.

It all started for the sector’s financial departments with a sudden shift in bankers’ attitudes. Almost overnight, there was a switch from a strong confidence across financial institutions and an easy period of asset-based lending, to a strict clamp-down on borrowers and a sudden realisation that the market was plummeting.

“When cashflow was positive, predictable and consistent, and the market was excited about the sector, the banks were falling over themselves to fund construction projects, and there was no shortage of project finance available either in local markets, or for expansion,” says Arabtec CFO Ziad Makhzoumi. However, in the wake of the crisis, he explains, companies that were undercapitalised and left with outstanding receivables were hit hard by restrictions on bank loans, as it meant they didn’t have the necessary funding to expand into new markets.

Unfortunately, the main problem with the lack of available funding today remains much the same. According to experts, limited financial support both for developers and contractors is what’s keeping the market in a period of stagnation.

“The truth is that the economy is starting to improve, but unfortunately, because of the real estate overhang, the growth is being eclipsed,” says Jones Lang LaSalle’s director of capital markets for the MENA region, Gaurav Shivpuri. “In the real estate sector, better access to finance would allow firms to finish projects and hand them over to end-users. It would allow developers to pay contractors and ensure money is supplied back into the economy. The money needs to move around to ensure the economy continues to remain vibrant.”

For many companies, one of the big questions at the moment is why, if the economy is improving, are banks are still veering away from lending.

“The encouraging news is that we are slowly seeing financial institutions extend new loans to developments that deliver a convincing and clearly communicated value proposition,” explains BCG Middle East partner and managing director Sven-Olaf Vathje. “But financial institutions are still cautious and expect proven business cases and risk sharing models before they consider financing. The days of ‘easy money’ and balance-sheet lending are over.”

Shivpuri agrees. “The market is particularly tight for lending to speculative projects,” he says, “so projects that have limited or no commitment of sale during construction, or lease following completion.”

Under such circumstances, industry professionals have come up with a range of possible solutions for overcoming the problems. The first, perhaps most obvious, is to look beyond real estate developments, towards a more stable sector such as infrastructure. Shivpuri explains. “Assets in non-core sectors such as healthcare and education have more appetite as the supply in these sectors is not significantly higher than demand. Moreover, most of the development in these sectors is customised for an end-user or operator. Moreover, the covenant of the operator or lessee allows for the mitigation of the risk in loan payback.”

Vathje agrees. He argues that when evaluating business plans, financial institutions look for predictable and stable revenue streams, which characterise infrastructure projects, contrary to office and residential projects which are in oversupply, and thus facing difficulties.

Another option which is gaining weight in the Middle East is for companies to form public-private partnerships (PPPs). According to PPP advocates, these create additional revenue streams, offer long-term security, as well as demonstrating a commitment to the region. But certainly, not everyone agrees that they are the best way to move forward. Many firms see them as risky, whilst others don’t believe they are a complete solution to today’s problems.

“Public private partnerships are, for various reasons, on the rise all around the world. The Middle East has seen a number of benchmark projects as well, especially with respect to infrastructure,” says Vathje. “But PPPs are not a magic bullet to resolve the financing bottlenecks, as lenders will still require a solid business case. That said,” he adds, “they often provide access to export credit programmes and offer to alleviate the overall financing requirements.”

As an alternative, Vathje does float the possibility of investing in capital markets. In many other parts of the world, he suggests, deep and broad debt capital markets provide access to alternative means of financing (eg: bonds).

“In the Middle East, the debt capital markets are still nascent. In the current situation, investments into further building the capital markets would have a good capital return.”

Of course, the other main option currently on the cards, and the one that everyone is talking about, is the possibility that the banks themselves adopt a different approach to lending. For many firms, this is the only way of re-stimulating the construction industry, and also the economy, into the upturn that it needs. Combined with government intervention and regulation relating to finance in this sector, this new lender attitude could, according to some analysts and industry players, create a significant and sudden shift in the market.

“In any capital markets, the equity investors and financial institutions play a significant role in providing investment funding and working capital for supporting businesses and stimulating the economy,” says Makhzoumi. “For this reason, banks should take a longer term view in providing the necessary funding without increasing the risk on their balance sheets.”

Shivpuri is mostly in agreement. “We can’t blame them entirely as the valuations have not completely stabilised. However, they need to realise that unless they provide funding in the market, unfinished projects will not be completed and the negative sentiment to real estate will not be lifted, keeping  prices subdued. Unfortunately, it’s a negative sentiment spiral.”

Others have a different idea, suggesting banks are well within their rights to hold back in a period of risk and uncertainty.

“Banks in the past have lent excessively to construction companies and it is natural that they retrench from undue risk which they have piled out carelessly,” says Dubai International Financial Centre Authority economist Fabio Scacciavillani. “This implies that many construction companies and developers run by incompetents will have to go bankrupt and leave room for those that are better managed by professionals. After this process is completed, some degree of normality will be restored, and banks will be able to make a fresh start.”

In response, the question raised by many contractors is: does this mean the industry should just sit back and wait for the problems to die down? Or is there an argument for trying to resolve the situation?

For Vathje, it seems the sooner the issues are sorted out, the sooner we can move towards a prosperous future.

“Resolving a credit shortage is equivalent to supporting the acceleration of economic development. GDP growth is driven by the availability of credit and any limitation in access to credit is preventing the economy from following its natural growth path,” he said.

Whether this is enough to stimulate banks into action, remains up in the air.

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