Landmark issuances of green instruments suggest a growing trend in the Middle East and North Africa; Lebanon's beleaguered banks prepare for another challenging year; and Kenyan lenders are set to benefit from a risk-based loan pricing model.
Green financing set to grow
Green sukuk and bond issuance in the Middle East and North Africa region will likely increase in 2021 as governments and state-linked companies seek to diversify their financing sources and take advantage of falling pricing.
Investor appetite for regional green debt appears strong, with three landmark issuances in September. Egypt's $750 million, five-year bond was the first by a MENA sovereign and received $3.7 billion of orders, while state-controlled Saudi Electricity Co.'s $1.3 billion green sukuk was 4x oversubscribed. Investors from Europe and the U.S. bought 88% of Egypt's bond, which carries a coupon of 5.25%. Qatar National Bank (QPSC)'s $600 million of unsecured notes, which MENA's top lender by assets will use to finance green projects, attracted orders totaling $1.8 billion.
"There is a desire amongst borrowers to align what they're doing from a funding perspective with overall commitments to corporate social responsibility organizationally," said Stuart Ure, a partner at Clifford Chance law firm in Dubai. "Moreover, amongst borrowers, there's a desire to continue to diversify funding sources and seek liquidity."
National Bank of Abu Dhabi — now First Abu Dhabi Bank PJSC — issued MENA's first green bond in 2017. At that time, there were questions as to whether selling green debt required issuers to pay a premium above their established yield curve. Now, the depth of investors seeking exposure to investment-grade environmental, social and governance products has increased, while Gulf issuance of such instruments remains below other regions.
"Consequently, green bonds are pricing flat to existing credit curves, and in many instances lower," Ure said.
"In 2021, particularly in the Middle East, we will continue to see from clients — sovereigns, corporates and financial institutions — more and more queries on the required framework and processes for issuing green bonds/sukuk."
In the United Arab Emirates, ambitious plans are in place to expand the country's capacity to produce clean and renewable energy. The Gulf's continued development of large-scale solar power plants and investments in other environmentally beneficial infrastructure should lead to increased activity in green financial instruments, although bank financing is usually the main means to fund large-scale regional projects.
"The Gulf is still at a relatively early stage of capital market development so banks take a larger share of credit generation," said Timucin Engin, senior director & cross-practice coordinator for the GCC region at S&P Global Ratings.
"There is increased regional activity in green finance. The long-term outlook for green infrastructure projects is quite positive so green financing will continue to grow."
Lebanese lenders still in 'deep hole'
The future of Lebanon's beleaguered banks, which used customers' deposits to buy billions of dollars of government-linked instruments, will depend on the country restructuring its ever-increasing debts.
Lebanon defaulted on Eurobonds in March and had a record 127.9 trillion pounds, or $84.9 billion, of local currency debt and $35.2 billion of foreign currency debt in August. Bank customers could lose a large chunk of deposits as part of a proposed state debt restructuring that is slated to result in overall financial sector losses of 154 trillion pounds.
With such massive losses and an economy forecast to contract 25% in 2020, Lebanon's sole hope has been to agree on a rescue package with the International Monetary Fund.
The IMF's Middle East and Central Asia director Jihad Azour in October said Lebanon must "present a comprehensive and credible reform program" that will restore macroeconomic stability and address financial sector losses. The country's annual inflation rate hit a record high of 136.8% in October.
"There has been no progress at all in the debt restructuring," said Sami Nader, an economist and director of Beirut's Levant Institute for Strategic Affairs.
The stasis is due to Lebanon's fraught politics. Saudi Arabia-backed Saad al-Hariri was reappointed prime minister in October, but has struggled to form a government.
"Nothing is moving on the economic side, because we need a government to make policy decisions," Nader said.
Lebanon faces total economic collapse, Nader warns, noting central banks' reserves are dwindling and it will be unable to subsidize basic commodities within weeks.
Similarly, he describes banks as being in a "deep hole," with shareholders set to be wiped out, according to the restructuring plan.
"On the asset side of their balance sheet, they have government treasury bills that have lost 80% to 90% of their value, plus they have nonperforming loans increasing by the day and also have real estate assets that have lost much of their value," Nader said.
Prospects for Kenyan banks
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Kenya's retail borrowers are struggling to repay their debts despite banks restructuring over one-third of their loan books. Yet the outlook for lenders in 2021 appears positive — providing they obtain regulatory approval for a long-awaited risk-based loan pricing model that should boost margins.
The combined annual profits of Kenya's four major banks — Co-operative Bank of Kenya Ltd., Equity Group Holdings PLC, KCB Group PLC and Stanbic Holdings PLC — will likely fall 45% in 2020, Egyptian investment bank EFG Hermes estimates. The slump comes as Kenya's economy stumbles due to the coronavirus pandemic.
Banks had hoped for a better year after the central bank in November 2019 scrapped interest rate caps that limited loan pricing premiums to 400 basis points over Kenya's benchmark interest rate. But removing the cap did not allow lenders to set loan pricing, and net interest margins contracted 50 bps this year, EFG estimates, as the central bank slashed rates to their lowest level since 2011.
"The central bank wants to allow banks to reprice loans according to risk but won't allow loans to be priced arbitrarily — instead it wants banks to deploy risk pricing models that consider various factors like funding costs, probability of default and collateral," said Ronak Gadhia, director of research on sub-Saharan African banks at EFG Hermes.
Meanwhile, the banking sector's nonperforming loan ratio has increased steadily to around 13% as of August, according to the Kenya Bankers Association.
NPLs are up despite banks restructuring 38% of their loan book, according to the central bank. This restructuring did not require banks to take "haircuts" so will not necessarily lower their interest income.
"We should now be at the peak of [NPLs] and with the economy improving it should help asset quality," Gadhia said.
Yet Gadhia is nonetheless upbeat.
"Next year, earnings could more than double for most major banks — they've developed significant NPL buffers so their cost of risk should normalize. Banks should achieve higher interest margins should the central bank approve the loan risk-pricing model," Gadhia said.
As of Dec. 18, US$1 was equivalent to 1,519 Lebanese pounds.