DUBAI, (Reuters) – Embattled European lenders are offloading parts of their Middle Eastern loan books to raise dollar liquidity, allowing regional banks to buy at a discount high-quality assets previously off limits to them.

Secondary loan markets have seen a significant increase in supply of Middle Eastern paper in the past few weeks, Gulf-based banking sources said, which has pushed out prices already hit by market volatility.

“Most of the selling in the last few weeks has been from French and Belgian banks who have large portfolios of high-quality regional debt,” said Ahmad Alanani, director of fixed income sales at Exotix in Dubai.

“They are selling back to the region with the aim of fetching better prices and to attain better recoveries on decent quality names from relatively cash-rich buyers.”

Much of the debt is described by bankers as being high-quality quasi-sovereign names from Abu Dhabi and Qatar, as well as project finance loans from those two states and Saudi Arabia.

Loans from financial institutions have also formed a large part of the recent trading activity.

One source said his bank had purchased six loans during August and then more last month, with a second banker saying his bank had brought “quite a bit” more than usual in the last two weeks of September.

Both said they were buying the debt at a discount to where it was originally priced.

A French banking source, speaking on condition of anonymity, said his institution was willing to offload loans at 97-98 cents on the dollar, but deeper discounting was not taking place.

“This is not a complete firesale, but we are getting attractive discounts,” the second regional banker said.

“These are good assets, and I would have paid even money for them,” the first source added.

Regional banks are taking advantage of the impact of the euro-zone debt crisis on European banks to replenish their loan books, which have been run down since 2009 because of the lack of primary issuance available to them.

Much of the Gulf loan business since the collapse of Lehman Brothers has come from government-related entities, such as Abu Dhabi’s Mubadala Development Co and investment arm International Petroleum Investment Company .

They could demand low-margin lending that was not viable for regional banks due to their higher cost of U.S. dollar funding.

Therefore, lending was predominantly provided by international banks, in particular French banks, which had actively targeted the Gulf to compensate for reduced market activity in the West.

Now, with European banks keen to offload assets and returns pushed out to more generous levels, regionals are in a position where they can afford to buy these names.

“The dollar liquidity is now with the locals, so it’s a real turnaround,” the second source said.

SIZE MATTERS

However, while local banks are doing more business in the secondary market than before, only a handful of institutions are involved, and they are buying small amounts of debt at a time.

“At the end of the day, we’ll nibble and buy $20 million or $30 million, but in the context of how much European banks have lent into the region in the last few years, regionals will only be able to pick up so much,” the second banker said.

In 2010, Middle Eastern companies raised $52.34 billion in the loan market, according to Thomson Reuters data.

This leaves significantly more supply than demand, with bankers noting that a lot of paper has remained unsold despite the discounting.

The last couple of weeks has also seen market volatility feeding through into the cost of funding for local banks, and as dollars become more expensive they are asking for deeper discounts or are walking away altogether from the market.

“While I can understand the logic of offloading now, the timing is terrible, as the cost of dollar funding for regionals is limiting their appetite,” Alanani said.

“If the European banks had been selling at the beginning of the year, then they would have gotten a better response.”

Ultimately, while the trend has been beneficial for local banks, European institutions cannot solve all their problems through deleveraging their Middle Eastern loan books.

“We are not the cavalry arriving to bail out the Europeans,” as the second banker put it.