The diminishing profits that banks are making on Gulf energy project financings are putting the spotlight on deal format, and banks are questioning whether the current fashion to ‘club’ deals is an improvement on the classic underwriting that was popular a few years ago. Melanie Lovatt reports.
Gulf energy project finance is a buyers’ market and banks are snared in Catch-22. The deals pose little risk so they want to participate. But less risk and a strong and growing bank appetite translate into thin margins and fees (the profits banks make on deals). While some banks, particularly local and regional players with a higher cost of funding, have passed on some deals, banks are generally continuing to participate. But as margins contract further, complaints have become more vocal. In the LNG market, lenders are wary about the request for cargo diversion and the increase in spot market sales. And some are finding the trend for increasing tenors (period of repayment) problematic. Overall, there is a sense that they are being forced to accept more risks for less reward. It is, therefore not surprising that the structures of the deals themselves are coming under scrutiny.
Gulf project finance has undergone a fundamental shift and most of the oil and gas project financings seen over the past few years have been ‘clubbed’ as opposed to going through the classic ‘underwrite/syndicate’ process. In clubbed deals, the sponsors and their financial advisors bring in a large group of banks (Qatargas 2 attracted 36) at a relatively early stage in the financing and they are all given the mandated lead arranger (MLA) title. They commit up front to the portion of the financing they keep on their books (take and hold). Syndication is not a prerequisite, but may take place.
For classic underwriting, a smaller number of banks (1-5) are brought in, and then this group works closely with the financial advisors/sponsors to add value to the deal, after which it will ‘sell down’ or syndicate the deal to other banks. There can be more than one phase of syndication. The first phase can bring in larger banks and/or those which missed securing an underwriting role; and the second might be a ‘retail’ syndication which would mostly be of interest to smaller banks or large banks looking for a foothold in the region.
Cost-Effective
Banks with a financial advisory role on a project obviously want to keep sponsors happy and are expected to continue to recommend club deals, with a few notable exceptions, because they are proving the most cost-effective for sponsors. However, the banks which participate in these deals have criticized the clubbing trend, suggesting that it is cutting bank margins and, particularly, fees. In a classic underwriting role, a bank can skim off 20-25 bps in the form of fees for underwriting and selling down. The clubbing of deals has commoditized the role of MLAs. Where deals are well structured, they have less due diligence to perform and are generally taking on less risk than in a classic underwriting role and thus getting paid less for it. Criticism of the club approach has come from large internationals because they want higher fees, and also from regional and local banks which see clubbing as yet another reason for the fall in their profits. However, club proponents point out in the current market that locals and regionals would be unlikely to secure an underwriting role on a large deal. “Look at Sohar Aluminium. The three banks are internationals,” commented one banker.
The shift to clubbing in the region goes back to Q-Chem, the Qatari petrochemical project, which went to market in August 1999. This attracted – at the time – a record 24 MLAs. For Q-Chem, which was advised by Royal Bank of Scotland, it was a defensive approach. At the tail end of the emerging markets crisis few banks were prepared to underwrite because they had little confidence they could syndicate the deal. Bringing in 24 MLAs immediately cut the risk. “Q-Chem did go to syndication, but that was the icing on the cake,” commented one banker.
Qatar’s Project Finance
Clubbing quickly became a staple of Qatari project finance and was adopted by sponsors of projects in other Gulf countries. It was even used on Qatar’s Oryx, the first gas-to-liquids (GTL) project ever to seek financing. “From a borrower’s point of view the club approach is better. When banks bid on a final hold basis they tend to be more aggressive. If they are bidding on a syndicated deal, they are not just bidding for their own book, but keeping in mind what the syndication market can take,” said one proponent of clubbing. “Deals are not about earning money for banks. Why should borrowers pay for underwriting while they get better deals from the club approach?” In an underwriting deal, a bank’s credit committee will demand compensation for the extra risk taken.
Price flex and market flex are a component of classic underwriting deals which allow banks to request more money from the borrowers or even restructure the deal if the market changes adversely impacting the risk they are assuming. The club deal is based on final hold commitment and encompasses neither price flex nor market flex, so is a stronger commitment.
Clubbing has brought more banks into the Gulf energy project finance market, its supporters argue. “It’s a way to expand capacity – smaller banks are more likely to come in with more money if they are getting MLA status,” said one. Qatar, in particular, has successfully courted the southern European banks. Detractors argue that such banks are being brought in at the expense of regional and local players.
Bumpy Road
Given that it is buyers’ market, it is questionable whether a classic underwrite/syndicate deal can be successful today. Sohar Aluminium and its financial advisor, Citibank, are having a bumpy road to market. They recently bucked the trend and opted for the classical underwriting approach in the hope that financing would proceed more smoothly if they appointed a smaller number of MLAs – there would be fewer banks to consult at the early stages. They sent out a request for proposal to a group of about 10 banks and selected three underwriters – Citibank, ABN Amro and Sumitomo Mitsubishi which had agreed to commit to 50% of the total $1.5bn debt (MEES, 7 November). The other banks were unhappy, and when approached by the MLAs they shunned the offer of a secondary role. MEES understands that the three MLAs had to then offer them a bigger fee to get them on board. MEES further understands that up-front fees are 95 bps, which, explains one banker, “is 20 bps above where they should be.” It was unclear whether the banks would eventually accept sweeteners and the Sohar situation was unresolved as MEES went to press.
Recent developments suggest that even in a market awash with bank capacity, if banks feel snubbed, they will walk away. It further supports the case for clubbing and suggests that those which choose the syndication route for oil and gas deals have to tread carefully. The next tier of lenders is only likely to accept a higher tier of underwriters if they are perceived to have earned their extra fee by adding value to the deal. However, if a financial advisor has sufficiently fulfilled the role, then extensive extra work should be unnecessary. A major exception is the financing for independent water and power projects (IWPPs). Here, banks support a bidding consortium. Once a winner is announced, the banks backing the unsuccessful consortia often join the successful banks. It is thus tailor made for the classic underwrite/syndicate process.
In the oil/gas market, club deals have become the norm, with underwriting the exception, and this trend is expected to continue in the near future. But if the market were to change, with the ball moving into the sellers’ (banks’) court, it could be a different matter.
