When worshippers descend on the holy city of Mecca in years to come, they will be greeted by what promises to be one of the biggest property developments in the Gulf region, surrounding the Grand Mosque.
It will include five-star hotels, 4,500 shops, a central transport station, prayer facilities for more than 200,000 worshippers and parking for 12,000 vehicles, all to be built on some of the world's most expensive plots of land. The facilities are intended to cater for the four million Muslim pilgrims who make the Haj every year. In addition, housing for 87,000 will be provided as part of the project within the city.
But first developers will need to raise billions of dollars from regional credit markets struggling to overcome increasingly cautious investors. Originated as a plan in 2006 during an era when the Gulf was in the middle of a property boom fuelled by easy credit and soaring oil prices, the sizeable task of securing the estimated US$3.3 billion (Dh12.1bn) funding for the scheme has become increasingly tricky as the recession has struck.
The Jabal Omar Development Company (JODC), a property investment company, was established in October 2006 by the Makkah Construction and Development Company with capital of $1.33bn and with the sole task of developing the project, which was originally due for completion next year. JODC appointed Jadwa Investment a year ago to advise on raising funds for the project, but ended the relationship in April, replacing Jadwa with Al Rajhi Financial Services, an affiliate of Al Rajhi Bank, the world's largest Islamic lender.
Al Rajhi now faces the challenge of whetting investor appetite for the project at a time when the regional property market is suffering from reduced demand and falling prices. Gulf credit markets remain tight as banks come under pressure to boost deposits and reduce their exposure to property. The fallout from the struggling Saudi conglomerates, the Saad Group and Ahmad Hamad Al Gosaibi and Brothers, has been compounding the problem, making lenders more cautious about extending finance. Standard & Poor's has estimated that 30 Gulf Arab banks had a combined exposure of $9.6bn to the two Saudi firms.
Yet despite an uncertain economic backdrop, analysts say Jabal Omar remains a special case for investment because of its religious significance and the considerable investment the Saudi authorities are pumping into Mecca to improve its infrastructure. Deepak Tolani, a banking analyst at Al Mal Capital, said: "Fundamentally, many still do believe in the Saudi Arabia middle-income story and this is a special project. Jabal Omar is underdeveloped with real estate and it's not been as crazy as Abu Dhabi and Dubai with development.
"There is still money on the sidelines and they will still be able to raise the finance, but they will have to be prepared to pay more for it." JODC raised $537 million by selling a 30 per cent stake in an initial public offering in November 2007. The remaining 70 per cent of the company is held by the owners of a 23-hectare plot of land in Mecca across a main street from the Grand Mosque. Construction work, which involves the development of 15 towers, began in September last year. But securing the necessary finance for Jabal Omar has been hampered by turbulent market conditions.
Uncertainty hit the development in April when JODC sacked Jadwa. It had announced Jadwa's appointment amid much fanfare at a press conference in Jeddah in July last year, under an agreement in which the company was required to provide both long-term financing through issuing sukuk, the Islamic alternative to conventional bonds, and short-term financing. But Jadwa's brief became that much tougher when the global credit crisis hit the Gulf towards the end of last year. The crisis took its toll on the Islamic finance market, too, with investor caution spreading to sukuk sales.
Nine months later Jadwa's contract was cancelled by JODC. The Riyadh-based investment bank failed to secure financing "within the deadlines they promised", according to a statement issued by JODC to the Saudi stock exchange. Jadwa, whose founding partners include Saudi royalty, the Saudi billionaire Mohammed Ibrahim al Issa and leading Saudi firms, said shortly afterwards it may seek damages over the cancellation.
A month later, JODC appointed Al Rajhi Financial Services Company to provide financing through Islamic Sharia-compliant instruments. JODC was given the go-ahead by shareholders in June to issue sukuk after the Saudi stock market regulator launched a market for debt securities in response to growing demand by firms to diversify sources of funding as bank lending dried up. "Given the nature of a project like this for Mecca, it lends itself to Islamic financing," said Sheikh Yusuf Talal DeLorenzo, the chief Sharia officer of the US-based Shariah Capital.
"If, from a commercial proposition, it is a good business deal, then I think owing to the slowdown in sukuk over the past year, a sukuk of this nature would appeal to investors." Mr DeLorenzo said: "Al Rajhi is well respected and above reproach within the kingdom and will do a thorough job on the Sharia side but public perception about commercial risk, loan defaults and debate within the kingdom will have to be overcome first."
So far, Saudi banks have been reluctant to detail their exposure to the multi-billion debt restructuring at Saad and Al Gosaibi. But Standard & Poor's said of the 30 commercial banks it rates in the Gulf, it found banks in Saudi Arabia and the UAE accounted for almost two thirds of the total net exposure to the conglomerates. Al Rajhi, the kingdom's largest bank, disclosed last month that had it booked its highest level of provisions for loan losses this year, at $112.4m in the second quarter, but it did not give loans to the groups as a reason for the increase.
Standard Chartered has $250m in syndicated loan exposure to the groups, according to a document circulating among bankers in the UAE, while HSBC has $215m in exposure. However, Robert McKinnon, the managing director of equity research at Al Mal Capital, is doubtful that exposure to Saad and Al Gosaibi would deter Saudi banks from investing in Jabal Omar. "It will have some implications for non-Saudi banks who may be concerned about due diligence processes but local banks may have political and strategic reasons for involvement," he said.
"Compared to last year, there's a lot more scrutiny on deals and governance: how the contracts are awarded and the viability of such a project. Outside of Saudi Arabia I'm not sure they are ready for it but I think they could do it within Saudi." Mr McKinnon said he saw a syndicated loan arrangement through a group of five or six Saudi banks as the most likely scenario to raise short-term financing for the project.
Analysts say the alternative for short-term financing is a bilateral loan, involving a loan from one bank, or a club deal, meaning finance would come from a group of lenders directly involved in the transaction rather than through syndication to other banks. "A bank like Al Rajhi has vast resources," said Mr McKinnon. "There may be a tough sell in terms of syndication but I'm sure they can pull it off with banks in Saudi."