The Saudi government has ambitious plans to continue its huge round of infrastructure spending, but does the region’s banking sector have the capacity to fund its project finance needs if international investment dwindles? Laura Benitez reports.


According to a March 2012 Moody’s report, the Saudi banking sector is about to experience a short-term liquidity squeeze as European banks curtail their activity in the region. As a result, local banks will have to step up in order to meet the government’s infrastructure spending plans for 2012.

However, questions remain about the Saudi banking sector’s current capacity for long-term project financing.

Although the region’s economy is strong, both fiscally and in terms of its vast oil reserves, local banks traditionally tend to fund short-term cycles only.

“Where there will be an impact is on the longer tenor lending. Saudi has a vast amount of infrastructure development going ahead; power stations and roads and railways. This is funded by 10, 15-year project finance funding. That’s something that Saudi banks are not very well-equipped for because they raise most of their funding in short-term, overnight or 30-day deposits,” says Khalid Howladar, senior credit officer in Moody’s financial institutions group.

He adds that, aside from their insufficient funding structures, Saudi banks lack the sophistication and expertise of the international banks to fund long-term
project financing.

“Project finance requires a different set of human capital – it’s very sophisticated and somewhat more complicated than the usual corporate lending that is prevalent. European banks have been doing that for decades, and so the skill set probably needs developing in Saudi banks.”

Arup Roy, head of transaction banking at Saudi British Bank (SABB) agrees that European investment is likely to fall. However he disagrees with the lack of faith in Saudi banks’ capacity to fill the gap: “Whilst these banks [European banks] were involved in syndications for industrial/infrastructure projects, the Saudi market is currently flush with liquidity so the gap left by the reduced involvement of the European players has been more than filled up.”

He adds: “In recent cases where financing was raised by large industrial/commercial entities in Saudi Arabia, the offers were four to five times oversubscribed. We therefore don’t see any material adverse impact from the reduced presence of the European banks on the Saudi trade and infrastructure development space.”
He goes on to say that local banks − including National Commercial Bank (NCB), Riyad Bank, Samba and SABB − are well-equipped in terms of products and services to support the sophisticated requirements of both local and international companies operating in Saudi Arabia.

“The payment environment in Saudi Arabia is well developed. The Central Bank has been proactively encouraging the banks to adopt the latest systems and technologies to ensure process efficiency, risk mitigation and enhanced client experience,” he adds.

Moody’s Howladar explains, however, that the Saudi government is in a very solvent position and has the capacity to issue further debt and fund projects directly if local banks do not rise to the challenge. Saudi Arabia’s strong reserves and lack of debt stand in its favour and, as it develops its banking structures to meet upcoming project finance demands, it will continue to be well supported by high oil export earnings.

“The continuing upward pressure on oil prices is sustaining Saudi’s fiscal surpluses, despite its significant year-over-year expenditure increases. The country can therefore continue its pace of essential investment without diminishing core reserves. Saudi Arabia is in an extraordinarily strong position, with US$0.5tn in reserves and almost no debt,” says Tristan Attenborough, head of JP Morgan’s treasury and securities services in Saudi Arabia.


Heavy demand

One thing is certain, the Saudi government’s infrastructure development spending is continuing at a fast pace.

The country’s public spending for last year raised the bar for the value of this year’s construction contracts. According to NCB‘s construction contracts index for Q4 2011, the value of awarded contracts reached SR93bn (US$24.7bn) – the highest to date.

The index also reports that the highest valued contracts during the last quarter of 2011 were awarded to the transportation, power and industrial sectors; a trend that is set to continue throughout 2012.

“If you look at the spending patterns over the decades it’s moved on from a narrow focus on oil production capabilities, core utilities and defence to one that includes the oil sector but also extends to infrastructure spending related to the development of a more diversified economy,” says JP Morgan’s Attenborough.
This year’s infrastructure projects span the rail, road, power and construction industries.

The Saudi Rail Organisation (SRO) has two high-profile rail projects lined up for 2012/13. First is the Al Haramain high-speed railway line, linking Mecca and Madinah via Jeddah, which will be financed by the state-owned Public Investment Fund (PIF). PIF will arrange the contracts on the basis of interest-free loans. According to the SRO website, PIF will be compensated for this service with budget allocations in the coming years.

SRO is also in the process of constructing the North-South Line to transport minerals from the north-western region of the Kingdom, through Al-Jouf, Hail and Al-Qassim, terminating in Riyadh. The project, which is expected to transport 4 million tonnes of commodities and 2 million passengers every year, is estimated to cost US$3.5bn and will also be financed by PIF.

The network will have extensions to haul phosphate and bauxite to Hazm Al-Jalamid and Al-Zubayrah respectively, and to Ras Al-Zour on the Gulf where a major port will be constructed to export these and other mineral ores.

Another high-profile rail project in motion is Saudi Railway Company’s (SAR) US$7bn Landbridge project. This 1,300 km railway project will connect the Jeddah Islamic port in the west to the Dammam port in the east, as well as creating a link to the land bridge from Yanbu. It will also bridge the gap between the Red Sea and the Arabian Gulf and is expected to transport approximately 300 million passengers a year.

PIF is set to finance this state-owned project as well.

The Saudi government was initially planning to develop the Landbridge project using private finance as part of a public-private partnership. However, it has been reported that private banks have pulled out due to the problematic commitments of a long-term project.

The majority of the large budget rail contracts are being awarded to project developer Saudi Oger, although Saudi Bin is also receiving a large portion of the contracts, says a source close to the deals.


Driving the energy sector

The Saudi government’s 2012 spending plans also include energy sector projects. It has announced plans to use solar energy to generate 10% of the country’s electricity by 2020 in an attempt to become the world’s largest electricity exporter. Increased use of solar-generated energy will inevitably reduce Saudi Arabia’s reliance on home-produced oil for domestic use, consequently increasing its oil export volumes.

Support for deals in the energy sector will come in part from export credit agency (ECA) involvement, which could be an important component in financing Saudi’s heavily import-driven economy.

“The make-up of many imports to the country, like plant and machinery, includes big components such as turbines for power generation, which are eligible for ECA support. We are also seeing an increasing range of ECAs from across the globe participating in export flows to Saudi Arabia,” notes Attenborough.

An example of this is the Sadara Chemical Company − a joint venture between Saudi Aramco and the Dow Chemical Company to build and run a US$20bn petrochemical plant in Jubail in Saudi’s eastern province. It has been reported that nine ECAs, including Saudi’s Public Investment Fund, will supply direct loans or loan insurance for the project.

The project will deliver 26 new chemical manufacturing units, making it one of the largest of its kind in the world. The plant will produce chemicals used for energy and transportation as well as the manufacturing of consumer goods such as packaging, electronics and furniture.

Sadara is set to tap the debt markets in the second quarter of 2012 to raise finance for the project. GTR’s anonymous source confirms that RBS is acting as the financial advisor on the project. He predicts that as many as 25 banks will lead co-arranging of an uncovered tranche on a limited recourse basis.

Whether there will be a scale back in European lending in Saudi Arabia remains to be seen. If this does happen however, then Saudi banks will need to reconsider their funding strategies and improve their capabilities in order to meet the government’s ambitious infrastructure plans for 2012.

Moody’s Howladar remarks: “I’m sure the government will try to encourage Saudi banks to step up to the plate, because that hole needs to be filled, and there is a strong and critical social dimension to the infrastructure development.”