The Middle East has arguably been the most active region in CEEMEA over the last 12 months in terms of primary bond and loan issuance. But the primary market is not the only area with activity in the region, as both distressed and private credit opportunities are becoming more prevalent.
In an exclusive podcast with REDD Intelligence, Berkay Oncel, Head of Investments for the Middle East at SC Lowy, spoke about the current distressed and private credit opportunities in the Middle East and Turkey, how the situation there compares to the state of play in developed markets, as well as recent regulatory and cultural shifts that have facilitated the maturing of the regional market.
SC Lowy has been investing in the Middle Eastern market since 2011, participating in large debt restructuring situations like Dubai World and Drydocks, alongside first generation of restructuring names, Oncel said.
The opportunity was always there, but it is now growing significantly on both the distressed and private credit sides, Oncel added.
On the distressed side, the regional banks, especially in the GCC, are becoming more proactive in managing their balance sheets, Oncel said. It is much more commonplace to see a bank from the United Arab Emirates (UAE) or Saudi Arabia engaging with the secondary market, to look at liquidity options for their distressed assets, he noted.
“The best proof of that was obviously the large ADCB portfolio that was sold at the end of last year, which was USD 1.1bn notional, quite a sizable ticket even for the Western market, but for the Middle East, it’s a benchmark transaction, is the first of its kind of that size,” Oncel said.
The transaction represented the first sale of a significant portfolio of non-performing loans by ADCB and is thought to be the largest such transaction in the UAE, as reported.
On the private credit side, there are opportunities both in the UAE and Saudi alongside the peripheral markets like Turkey and Egypt, all with different dynamics, said Oncel.
The UAE is mostly driven by the real estate sector, where the banks have caps on how much they can lend into the market. With asset prices increasing so rapidly, these caps are met quite quickly, Oncel noted. If you are a second or third tier developer, you are looking for alternative sources of financing, which represent a considerable part of the deal flow seen today in the UAE, Oncel added.
In Saudi Arabia, the banks are heavily lending towards the government-driven giga projects, but there is a private credit opportunity for small and mid-cap companies which are in need of working capital or growth financing and cannot access those large banking facilities as easily, said Oncel.
On the other hand, Turkey and Egypt have very different macro environments compared to the GCC countries. There the opportunity lies in blue chip companies with some hard currency-denominated revenues that are in need of financing, but are not willing to pay the high interest rates in local currency, while the banks are not lending in hard currency as frequently these days, said Oncel.
Lessons learned from Europe
Commenting on the issues witnessed in Europe following the increase of private credit in recent years, Oncel shared his views on how the UAE can avoid falling into the same cycle. In Europe, corporates are now seeking restructuring on the back of the earlier trend to lend at a higher leverage level than traditional high yield investors.
“It just comes down to the lender discipline,” said Oncel.
The beginning of private credit market in Europe was extremely competitive from the direct lenders’ perspective, where everybody was competing for a handful of deals because the liquidity was so robust and the interest rates were so low, he added. Therefore, lenders were willing to give up covenants, security, and prudent deal structuring while the quality of issuers decreased.
“The advantage you have in the Middle East is that it is a relatively new market in this sector, and you don’t have the history of mistakes that we’ve seen in Europe,” Oncel noted.
There is a certain amount of caution, not everybody can access the private credit market, said Oncel.
“You need to have a sustainable business that has some kind of visibility around what your downside protection is going to be. Ultimately, what it comes down to is underwriting discipline from the lender side and what we try to do is we try to find situations where even in the worst-case scenario we feel comfortable that the business will be able to repay the debt, or we do have some kind of security in place that gives us comfort that our capital is protected," he said.
“As long as that discipline is maintained by different market participants, I think we can set good precedents in this region, and we can avoid the mistakes that some of the direct lenders made in Europe over competing for some of these deals and basically bidding against themselves in the quality of security and covenants,” Oncel noted.
Secondary market loan trading
The GCC countries have rewritten their bankruptcy laws over the last years, and now there are good precedents in most of these geographies, Oncel said.
A landmark case was Ahmad Hamad Algosaibi and Brothers (AHAB) in Saudi Arabia, Oncel said.
In the UAE, the NMC case before the Abu Dhabi Global Market (ADGM) was a massive success, and there are other cases that are coming through before the federal courts. For example, Gulf Aluminium Rolling Mill BSC (GARMCO) case in Bahrain has been a successful debt-to-equity transaction, he added.
“It is quite interesting from a distressed investor’s perspective to look at these opportunities because you can come up with more creative structures than you did in the past. You can do a DIP financing in a court restructuring in the UAE, you can do debt-to-equity swaps, you can do managed liquidation, you can come up with different variety of solutions, which makes it easier to get comfortable around the investment thesis rather than being stuck in a process which ends up in the sale of assets,” Oncel said.
In 2022, KBBO Group raised an AED 150m (USD 40.8m at today’s exchange rate) DIP facility from UK-based hedge fund Fidera Limited for its hospital business EHG, the first ever DIP facility raised by an entity in a bankruptcy process in the onshore UAE courts, as reported.
“Buying interest has definitely improved from the investors’ perspective, and from the bank side, we have seen them getting more and more educated on the secondary markets,” he added.
When SC Lowy started getting involved in this market, Western banks were selling their exposures in some of these Middle Eastern companies, such as Dubai World, which had a massive syndicated facility that involved lenders from all around the world, Oncel said. After the global financial crisis, the Middle East became increasingly less relevant for these banks, and they were keen to exit their positions via restructurings, he added.
The UAE banks were not selling and engaging with the secondary market as actively, said Oncel.
"As these debt restructurings happened, and more secondary players got involved in these deals, there was almost an osmosis of this idea across institutions. What is happening in the UAE now is the first tier banks are taking almost a Western approach in managing their balance sheet, but even the second tier banks, some of the smaller banks or, for example, the banks from the northern Emirates that a lot of Western investors might not have heard of in their careers, they are actually taking a very proactive approach as well, which is quite encouraging,” he said.
The same trend is also happening in Saudi Arabia. It has been very difficult to engage with the Saudi banks in the past, but now they are starting to become more proactive, chasing market players like SC Lowy on a number of situations to seek alternative liquidity options, said Oncel.
Commenting on Turkish banks' activity, Oncel said that he would like to see more from them in the secondary loan market space, as they have been "a bit of a laggard" in that area, said Oncel. They are still managing their portfolios super conservatively, which is causing them trouble in some instances, he noted.
Legislative and regulatory developments
The region's legislators were aware that their bankruptcy legislation needed an improvement, and they really did go out and try to get the best practices around the world when they were writing these laws, said Oncel. For example, Saudi Arabia’s Financial Restructuring Procedure (FRP), is a very tried and tested process, with hundreds of cases having already gone through it, he said.
Similarly, in the UAE, providing a DIP facility, for example, has been a novel concept in the region, and that’s a game changer, said Oncel.
“If you go through bankruptcy and all the liquidity is cut for the company, you are effectively killing it, and you are destroying value for all stakeholders, including the shareholders, lenders, government, the economy, everybody,” Oncel said.
But if you are able to provide a rescue line for these companies, even when they are in a bankruptcy process, you are actually generating more value to all the stakeholders that ultimately saves the business, or gets increased recoveries to the creditors, and potentially even for the shareholders, he said.
There are constant improvements that are being put in place, such as the UAE working on a revised version of its bankruptcy law after the experience of the first couple of cases, Oncel added, noting that although it is still early days, what has been happening in the last five years has been very promising.
“We can definitely feel that this is an area of focus, and they are looking to improve that because they realize [that] part of having a successful well-functioning economy is to have business solutions when the company gets into trouble. Otherwise, it is very value destructive, if the only recourse is just to go to court and execute and enforce on the hard assets or whatever you can find from the underlying company,” he said.
In Turkey, there is still room for improvement in the regulatory space, Oncel commented. There is a financial restructuring framework agreement, which has been tested, but it's not the easiest way to get deals done. It is also not always aligned with the best international practices, Oncel added.
“But we hope that that's going to be a part of the new economic regime in Turkey, […] one of the areas that they will pay attention to, and they will improve that field as well,” Oncel noted.
Distressed and private credit opportunities in Turkey
Speaking of available opportunities in Turkey, the high yield market there is only accessible if you are a company of certain size and statute, for example, a blue chip company such as Arcelik or Turk Telekom, Oncel said.
But the reality is, Turkey has a pretty sizable mid-cap company ecosystem that doesn't have access to the European capital markets. These companies are also finding it increasingly difficult to get financing from the local banks, mainly because of the very well-known hard currency issues that Turkey is facing right now, Oncel said.
“I would hope that we see more growth in that sector in Turkey, both for the improvement of the broader economy as well as improvement on some of these underlying companies, but it's still at early stages,” Oncel said.
Often the challenge is that those Turkish borrowers, which performed well in the 15 years prior to the latest currency crisis, are still not comfortable paying the returns that a private credit investor would require to consider investing in a Turkish company now. The returns now would have to be in double digits, said Oncel.
That is an education process that needs a bit of time, but once it gets over that hurdle, there are definitely benefits for both borrowers and investors, said Oncel. There are very good businesses in Turkey that can grow materially further, they just need alternative source of financing, he concluded.
by Asli Orbay-Graves