Ratings of corporate credit are stabilising in Gulf, says Moody's

The outlook for corporate credit quality in the Gulf is one of "at least stabilisation" or even recovery albeit a slow one, as "the worst is over", Moody's Investor Services said yesterday in a new report on Gulf corporates.

Philipp Lotter, Senior Vice-President at Moody's in Dubai and the author of "Arabian Gulf Corporates: Review 2009 & Key Themes for 2010", said although the macroeconomic repercussions of the global financial and economic crisis have been milder in the region, corporate credit ratings in the region have faced significant deterioration.

However, Lotter pointed out in the report that "recovering oil prices and large amounts of liquidity in numerous sovereign wealth funds allowed governments to take interventionist counter-cyclical measures to stimulate their domestic economies and support flagship government-owned banks and companies", which softened the fallout of the global downturn.

"Liquidity was also restored via a renaissance in debt issuance, driven by sovereign and quasi-sovereign issuance in the UAE and Qatar," he added.

Six key themes that would drive credit quality among Gulf corporates this year were identified in the report.

The first of these themes is talks of the outlook for corporate credit quality in the Gulf, which is one of stabilisation and slow recovery, although some sectors will remain depressed over a longer period.

"Moody's expects corporate credit quality in the region to stabilise and eventually recover slowly as macroeconomic conditions improve in 2010. While our review of implicit government support assumptions in Abu Dhabi is likely to remain a source of uncertainty initially, we believe that fundamental corporate credit will stabilise in line with a gradual recovery of the global economy, but also on the back of some more rapidly recovering domestic economies," it says.

However, Moody's highlights that credit conditions in some sectors, particularly real estate, will continue to be challenging for 2010. The same also applies to Dubai where restructuring of certain entities is likely to be a prolonged exercise, it added.

Real estate companies in Dubai, Abu Dhabi and Qatar are expected to be under pressure although to varying degrees, Moody's said.

The agency sees key challenges remaining for the largest developers. "The need to develop a business model consistent with long-term market conditions, which remain challenging, as well as general liquidity issues that will require these companies to find alternative sources of financing given the limited ability to access the capital markets and the likely long-term disappearance of off-plan selling."

Historical benefit

Until the global economic downturn hit the region, ratings in the Gulf had historically benefited from the region's reputation as a creditor-friendly environment, Moody's said.

It highlighted that the precedent of a default – at least at a government-related level – has been non-existent, and the degree of government intervention has always been high. Furthermore, governments have played an important role in the region as both strategic central planners and investors.

In 2009, however, credit stability in the region suffered extensively, said the report, citing the case of Saudi Arabia's Saad Al Gosaibi groups, which showed that event risk and legal opaqueness can have severe and sudden implications on credit quality.

As defaults in the region have come to light, their outcome for creditors can be particularly difficult to predict due to the untested legal environment and significant event risk, said Moody's.

"This uncertainty has had numerous negative repercussions for many corporates in the GCC, particularly severe credit limitation and high financing costs, as demonstrated in the volatility in 2009 bond spreads."

The credit ratings agency underlined its belief that the worst is over. It cited a number of reasons to support this view.

"[First], general macroeconomic conditions are expected to improve. According to estimates from the International Monetary Fund (IMF), GCC countries will record a growth in real gross domestic product of 5.2 per cent in 2010 compared to 0.7 per cent in 2009. Sovereign wealth funds continue to have large pools of liquidity that can be used to support economic growth and replace private investments where needed.

"[Secondly], oil prices have recovered significantly in 2009. This should have a positive impact on investments in the strategic hydrocarbon sector with a possible increase in foreign private participation, which reduced significantly in 2009 as a result of the combined decline in oil prices and credit availability," the report said.

"[Thirdly], credit spreads have improved considerably. At the beginning of 2009, credit spreads on GCC corporate sukuk were above 1,300 basis points (bps) but have since then reached more comfortable levels of around 450-500 bps in January 2010.

"This more favourable pricing environment will positively impact any refinancing, particularly for healthy and cash-generative corporate issuers.

"[And fourthly], Moody's highlights that a sluggish recovery is the most likely global macro-economic scenario. We also believe that not all economies in the world will rebound at the same sluggish pace and that some emerging market economies will show stronger economic recoveries."

Coming to theme two of the report, Moody's focuses on Dubai. According to the authors of the report on Gulf corporates, Dubai will address its debt maturities over the next two-three years, which poses a major medium-term challenge.

"Following the announcement by the Dubai Government on November 25 that it would restructure the debt of Dubai World and request a standstill on the financing of some of its liabilities, Moody's implemented a number of rating actions in its Dubai corporate portfolio: as a result, all but two ratings were lowered to their fundamental levels, thus no longer giving any credit for implicit government support.

Moody's also states that it is unlikely that their ratings in the emirate will be sharply revised after the recent receipt of funding from the federal government, "as Dubai World's restructuring will ultimately proceed and creditors will – in our view – ultimately have to share some of the burden of its unravelling", said the report.

"Dubai, which until 2008 was the driving force behind new rating and debt capital market activity, will in our view be preoccupied with the restructuring of its government-related debt portfolio well beyond 2010, as up to $50 billion (Dh183.6bn) will need to be refinanced over the next three years. Much of this is related to sound corporations, which should be able to return to the markets at some point soon based on their fundamental merits. However, those that are unable to do so are likely to require ongoing support from the government or may see themselves enter similar restructuring proceedings as seen at Dubai World."

In the third theme, Moody's talked about improving liquidity and extending debt maturity profiles, which would remain a major challenge. "We highlight that a key factor driving credit quality in 2010 will be companies' ongoing measures to improve liquidity and extend debt maturity profiles, which have remained comparatively short and at times clustered."

The liquidity challenge

Achieving a better liquidity profile will be particularly challenging and costly for those companies in the lower range of the rating scale, it mentioned. "We estimate that around half of our rated portfolio's debt maturities will materialise before 2012. However, when we look at debt maturities by ratings, we note that the short-term refinancing burden is particularly heavy for lower-rated issuers. We highlight that more than 70 per cent of the debt of Aa-rated corporates (primarily those based in Abu Dhabi) will mature after 2013, compared with 20 per cent for B-rated entities."

Moody's also expects an increase in corporate issuance in 2010 as companies replace shorter tenors with longer maturities, and reduce their historically heavy reliance on rollover bank lending.

"Companies that remain over-exposed to shorter-term maturities will remain vulnerable to negative rating actions, particularly if their business profiles are subject to volatile markets such as real estate, investments or commodity prices.

"As most rated companies in the region have little additional debt capacity for their respective credit ratings, we are not expecting leverage to rise materially, other than for some of the sovereign investment vehicles, whose liabilities we consolidate at the sovereign level. Sovereign ratings could therefore start to experience negative pressure over the longer term if a build-up of excessive leverage at these entities was observed over time," said the report.

Coming to the fourth theme, the report said that implicit government support will remain under scrutiny.

"Going into 2010, we will continue to undertake an in-depth review of our current policy assumptions, as well as reconsider past articulations of support given recent events."

"Moody's will need to re-evaluate its government support assumptions and assess whether these ratings continue to be positioned appropriately.


Transparency and bond issuance

The fifth theme identified by the Moody's report talks about transparency levels at both corporate and government level, which must improve. In addition to this, insolvency regimes established for investor confidence in the wider region should be fully restored.

Opaqueness around the criteria of government support for flagship entities has resulted in implicit support assumptions being reviewed, it said.

"Moody's believes that GCC governments and corporates need to implement a more transparent and investor-friendly credit environment in order to restore confidence and support participation of international investors.

The local insolvency regimes that are already in place have yet to be widely applied and remain largely untested, it added.

Lastly, Moody's believes that corporate bond issuance in 2010 will be mainly driven by those entities that have the urgency to address infrastructure, power and energy requirements that are key to supporting medium- and long-term economic growth in the region, with the respective explicit or otherwise clear implicit backing from respective governments; and play an important government role in the countries' diversification efforts and are entrusted with the strategic task to invest oil and gas revenues in non-hydrocarbon-related sectors domestically or in foreign entities.

Moody's believes that these entities are in a better position to attract investors and therefore obtain financing at relatively reasonable pricing.

"We highlight that this trend was already a key feature of 2009, which saw strong bond issuance, both conventional and Islamic, from Abu Dhabi and Qatar. Moody's expects this trend to continue in 2010, particularly in those markets where the combination of abundant liquidity and stronger economic fundamentals require private investors to finance investments and address short-term maturities. The emergence of non-government-related issuance is still an evolutionary process.

"We do not rule out the possibility of selective lower investment grade, cross-over and potentially even Ba-rated issuance over time, as companies begin to recognise the value of public debt issuance even at lower rating levels [particularly as regards liquidity], and as disintermediation from the banking market starts to develop at a faster pace," said the report.

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