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The ability of banks to lend continues to be affected by the financial crisis, and the Middle East is no exception to that trend. Indeed, many businesses are struggling to meet repayments, and are running the risk of defaulting on their loan obligations. Others are worse off still, teetering on the brink of bankruptcy. Consequently, restructuring has become a priority for many Middle Eastern companies, although the process is more complicated than in other jurisdictions. Firstly, restructuring is a relatively new phenomenon to the region, and secondly, the presence of Islamic financing instruments means that restructurings tend to play out a little differently. As such, companies and creditors will need to be particularly vigilant when conducting restructuring efforts in the region.
Restructuring activity on the rise
Until a few months ago, restructurings in the Middle East were more or less a rarity. This was due to a number of factors, including the region’s tendency to avoid public failure of businesses, the mistaken belief that the Middle East would not be impacted by the financial crisis, and the fact that insolvency laws have failed to keep pace with the economic development, notes Simon Schmidt, a partner at Patton Boggs LLP.
“But out of necessity, activity has picked up over the last few months, as government-related entities, off which much economic activity feeds, have begun to publicly consolidate subsidiaries and group companies. No major corporate failure has yet been publicised, although the Saad Group/Al Ghosaibi issues may result in being resolved more publicly than is customary. The general rule is that creative and piece-meal ways are being sought to keep businesses alive since the regulatory frameworks are either insufficient or untested,” he observes.
Of course, certain sectors are seeing more activity than others. “Obviously, real estate and financial services have been hit particularly hard regionally,” asserts Oliver Holder, managing director at Deloitte Corporate Finance Limited. “A marked difference is that, up to now, international banks rather than local banks have tended to initiate restructuring processes. But the difference is likely to become less pronounced as we go through the next 24 months,” he adds. The global turmoil has also reanimated the longstanding debate as to how family-owned businesses ought to be restructured. Indeed, given the large number of such companies, this form of restructuring may mark a new trend in the coming few years, and is likely to contribute to an uptick in the number of restructurings. M&A-led restructurings are also on the rise. “Significant consolidation activity is starting to occur in the struggling banking and real estate related sectors,” notes Andrew Lewis, a partner at Norton Rose LLP. “However, consolidations are challenging, often requiring substantial injections of new capital to create a viable merged entity, and are progressing slowly. The long-awaited merger, featuring former leading Dubai mortgage lenders Tamweel and Amlak, is a good example,” he says. The two companies have been in merger talks since November, but the collapse of the credit markets scuppered their business models, and the process has been on ice ever since. A banking licence is yet to be granted by the government, and the companies themselves are still not lending.
Indeed, consolidations and restructurings generally come complete with an abundance of challenges that both borrowers and creditors have to face. One of them is to be able to obtain reliable information regarding the extent of the financial difficulties. With a high level of cross-ownership in the region, it can prove difficult to rapidly identify and address the different issues. Also, creditors’ rights and options in the region are often more limited than in other countries, while borrowers are struggling under heavy debt, thereby making the restructuring process longer and more complex, delaying a potential recovery. “As a result of the slowing global economy, an increasing number of borrowers are failing to meet their loan obligations,” says Ziad G. El-Khoury, of counsel at Squire, Sanders & Dempsey LLP. “Bankers lending to such troubled borrowers are often faced with a dilemma: enforcing liquidation – which can provide certainty of a short-term return but can also involve a significant loss of principal – or giving the borrower more time, which adds yet more uncertainty to a risky recovery process. In tough liquidity conditions, such as today's global credit crunch, credit professionals are required to quickly identify what is causing borrowers problems, and provide the most appropriate and cost effective financing solution,” he advises, adding that those solutions can be specific to the sector concerned, therefore requiring specialist knowledge. Some experts predict that, going forward, banks will likely adopt more formalised credit-scoring processes and will have a stronger focus on ongoing monitoring creditworthiness. Borrowers will therefore be required to provide more regular information about their financial situation to lenders.
Fluctuating asset values is another main issue. “If lenders believe the market is going down, they will demand more collateral and lend less against existing collateral. This should create opportunities for asset managers, as most banks do not wish to manage large portfolios of real estate and other assets,” explains Mr Schmidt. “Large majority government-owned but public listed developers, whose market capitalisation is based to a large extent on land values, have been unwilling to write down the value of these assets. Public scepticism about valuations has led to volatility in share prices, which has fed into the rest of the stock markets, largely sentiment-driven.” Such volatile markets are considered to be a disincentive to long-term investments, particularly in the infrastructure sector. Overall, several sectors, including retail, financial services, tourism, and real estate, have been particularly affected by the crisis. “The issue with real estate is that, as a bank, when you look at possible balance sheet exposures, you need to consider whether there is real estate exposure further down the chain – that is, to really understand where funds have been deployed by borrowers,” says Mr Holder. “In many cases, the road ultimately leads to real estate investment. Going forward, banks will be likely to adopt more formalised pre-lending decision making processes and have a stronger focus on the ongoing monitoring of credit risk.”
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