The global financial crisis and the current political events across the Arab region are a testimony of the urgent need for an alternative but complementary source of finance to the traditional capital markets and commercial banks. In particular, as regional corporates begin to re-invest and develop their businesses to tap into the broader regional long-term economic growth story, the lack of funding is emerging as a key challenging issue, mainly for many quality organisations.
Structurally, the regional financial markets have been severely underpenetrated relative to global standards. According to the Global Financial Stability Report released in April 2012 by the International Monetary Fund, the total size of MENA equities, bonds and bank assets amounted to around 113% of GDP, compared to emerging market and World averages of more than 200% and 400% respectively. Such statistics evidence the traditional sources of finance still have a large funding gap to bridge. (Refer to Figure 1)
During the recent years, several means of funding have even further dried-up. Capital raised on regional exchanges has become scarce and bank loans to the corporate sector did not restore to suitable levels. On the public equity front, liquidity on the regional stock markets has not yet fully recovered to its historic levels as the IPO market still lacks new issuances and the trading volumes on the secondary markets remain volatile. Out of the total primary equity issuances of US$ 50 billion since 2005, around only 11% were raised during the past 3 years. (Refer to Figure 2)
On the bank lending side, corporate loans which are critical for the survival of SMEs have failed to sufficiently pick-up and meet the mounting demand for funding by the broader economy. Based on data compiled from different regional Central Banks, new bank credits to the local businesses across the Arab world totaled circa US$ 740 billion since 2005. Of these new loans, a mere 25% was extended during the last 3 years. (Refer to Figure 3). In particular, access to bank credit by SMEs and large organisations in the Arab region is relatively limited when compared to emerging markets, reaffirmed by a recent survey of World Bank on accessibility to bank lending by the corporate sector and SMEs. (Refer to figure 4). As seen from the graph (figure 4) the insufficient financing is further exacerbated in the GCC region where SMEs are the most unprivileged, although operating in the most prosperous geography in the Middle East.
Role of Private Equity and Credit Components to fill the financing gap
Within this environment, the structured finance industry, in its private equity (PE) and credit components, can fill an important part of the large funding gap and, thus, capture an increasing share of the regional corporate house's financing needs.
The PE firms have accumulated, during the past decade, large amount of funds in order to tap the MENA opportunity. With more than US$ 23 billion raised since 2003, as per data gathered from the MENA Private Equity Association, and representing 0.9% of 2011 GDP, PE fund raising activities of the region surpassed that of other major emerging markets such as China, Brazil and Russia. (Refer to Figure 5)
However, a big part of these funds are yet to be deployed, with market estimates placing the dry powder at least at US$ 5 billion. When compared to global regions, MENA PE investment activity is growing from an exceptionally low base and has a long way to catch-up, as the whole industry is still at its nascent stages of development. Based on figures from the Emerging Markets Private Equity Association (EMPEA), PE investments as a percentage of GDP reached only 0.03% and 0.01% during 2010 and 2011 respectively in the MENA region, compared to World averages of around 0.33%. (Refer to Figure 6).
When weighed against the available investment opportunities in different geographies and industries across the Arab World, successful Private Equity firms are now able to scout for highly interesting growth stories at a more compelling risk/reward profile than in the past. An increasing number of quality firms are now available at more reasonable valuations in the aftermath of the global financial crisis and Arab spring, thus offering significant opportunities for PE firms. Private Equity firms can now generate higher returns as compared to non-PE backed companies, as they now contribute more than ever in creating value at their portfolio company level. Strategies such as buy-and-build have become a major aspect of building a sustainable track record for the regional PE firms. This is particularly right in an industry ripe for substantial but healthy consolidation during the coming years, with fewer but stronger and bigger players set to emerge (Refer to Figure 7)
In addition to private equity financing, another mean of funding emerging in the marketplace is the credit financing. In many cases where regional corporate houses are not willing to open-up their equity base to external investors, the debt alternative is frequently sought.
Corporate debt issuances in the Arab region have grown at a fast pace over the past decade, largely outperforming the equity issuances on public markets during the recent years. With around US$ 345 billion issued since 2005 and averaging 3% of GDP per annum, the corporate debt market has firmly grown to become a major source of financing. Looking forward, more room for growth is available if compared to similar performance in mature markets such as Western Europe which actually averages a ratio of debt issuance to GDP of around 19% per year (Refer to Figure 8).
As companies increasingly acknowledge that a major opportunity exists within debt, structured finance companies are increasingly adopting instruments combining a mixture of equity and debt. The emergence of mezzanine financing as an attractive financing instrument thanks to its hybrid nature is a prime example of it. This structuring of Mezzanine finance is highly flexible and is not typically found in senior debt or asset-based bank loans.
Structured Finance industry is being increasingly seen as a viable alternative source of financing to the traditional bank loans and capital market funding, with the current trends in the Finance industry also strongly favoring the emergence of structured financing. These businesses are financing the entire capital structure of large organisations from debt to equity, encompassing a wide array of hybrid instruments.
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