The western world’s banks are fretting.
The longer the sovereign debt crisis in Europe continues – and as Asiamoney went to press in mid-December there were few signs of it abating – the more the contagion will impact the ability of European and US banks to raise competitively priced funding.
The signs are worrying. Credit default swaps are at 2008-era highs and talk is of prudence and deleveraging as risk departments brace for moribund economic recovery in the US, a wave of sovereign defaults in Europe, and rising capital commitments.
Barclays Capital expects that European banks will need to deleverage by between €500 billion (US$651.3 billion) and €3 trillion. It estimates the total Asia exposure of these banks at around €560 billion, or 5% of their total assets, according to a November 23 research report.
These lenders are under pressure from rising regulatory requirements and a need to cover painful write-downs of exposure to sovereign bonds in weak southern European states, particularly Greece.
To compound their woes, US dollar interbank lending is drying up as US banks and money market funds grow more hesitant to dole out greenbacks. That is causing a liquidity crunch as the cost of US dollar funding soars.
“Money market funds are the most liquid providers of US dollars in the world and they’ve pulled back US dollar funding to European banks and created a Lehman-like situation [where interbank liquidity almost disappeared in late 2008],” says a senior loans banker at a large European lender. “So if someone wants US dollars it’s not business as usual but if someone wants euros then it is.”
In such grim times it’s little surprise that the mood among leading European banks is to avoid risk where possible. And when the risk appetite among such banks decreases, emerging markets have historically borne the brunt.
The shift has already begun. As of early December, European lenders’ overall Asia loan volumes were not drastically different from those recorded over the same period in 2010. But look at these volumes of late and a different tale emerges.
In the first and second quarters of the year Crédit Agricole conducted 0.6% of overall Asian lending, according to data provider Dealogic, rising to 1.6% in the third quarter. But so far in the fourth quarter the French bank’s position has plummeted; it is ranked 42nd for lending, with just 0.2% of volumes.
Commerzbank's lending activity has also declined. While the German bank didn’t lend into Asia at all in the first quarter, it conducted 0.6% of overall volumes during the second quarter and 0.8% in the third. But in the fourth quarter to date it had conducted just 0.1% of activity, participating in one deal.
The European debt crisis and onerous Basel III requirements mean this erosion of European bank lending into Asia is set to continue. Every banker away from a continental European bank that Asiamoney spoke to said the Europeans were reducing participation in regional loans.
The full impact is likely to be felt in 2012. It could herald change in the lending landscape of a region that has traditionally enjoyed substantial European-sourced lending.
While that could bring lending challenges, it offers enticing possibilities for regional banks.
A gradual withdrawal
Some observers argue that the recent pullback of European lending in the region requires perspective.
“This is a sovereign debt crisis and it’s a fact of life but … different institutions are affected differently,” says one banker. “If you look at credit ratings, European banks, in spite of the crisis and rigour of agencies looking at them, still remain some of the best rated in the world.“
Not everyone is as sanguine. Another senior loans banker states that the withdrawal of European lenders from the Asian syndication space began years ago.
“Their loan volumes have been diminishing … since the [Lehman] financial crisis,” he says. “They’ve been more focused on which relationships to go for and a bit less scattergun.”
Statistics support this. In 2001, BNP Paribas had a 5.9% share of Asia ex-Japan loan syndication volume and was ranked fourth with US$5.8 billion worth of deals. By 2009, this had slid to 0.5%, a rank of 33 and only US$846 million in deal volume, according to Dealogic. This year so far it commands 1.3% of loans and sits 17th, having conducted US$3.72 billion worth of deals.
Crédit Agricole had 3.5% of the market in 2005 and was ranked sixth with US$4.1 billion in deal volume. This year to date it had only 0.9% and sits 27th with US$2.47 billion in volume.
These two banks have been the biggest participants in Asia from continental Europe over the past decade. While other banks have increased exposure, theirs has declined.
Many rival bankers predict that current pressure will force European banks, including these two French lenders, to further downscale regional exposure, causing volumes and league table positions to drop even more.
But what’s unfortunate for European lenders could benefit regional rivals.
“A lot of European banks are lenders to companies within Asia and by pulling those facilities they would create some opportunities for Asian banks to take on those lines,” says Daniel Tabbush, head of Asia banks research for CLSA. “I think StanChart is well positioned for that, not only because it’s global and Asian but because it has a lot of capital.”
Standard Chartered is one of a number of banks consistently named as a potential winner from this regional lending shake-up. The Singaporean banks (DBS in particular), the Australian banks (led by ANZ), the Chinese banks, and the Japanese banks all recur intermittently in conversation about where regional balance sheet will emerge.
“ANZ has aspirations to be more regional so this’ll be a good opportunity for them to do a bit more as others are leaving the market,” says Tabbush.
“It’s going to become an Asia-Pacific market,” says John Corrin, global head of loan syndication for the Aussie lender. “The banks that will play in this field will be Asia-Pacific banks.”
While all agree that regional heavyweights should benefit, US banks could also pick up some slack. After retracting amid the global financial crisis, US banks appear increasingly keen to build a greater presence in Asian loans.
“The US banks are lending very little to European banks in the interbank market so they have plenty of surplus US dollars,” says ANZ’s Corrin. “So their access to dollars is much cheaper for them than for Asia-Pacific banks.”
Betting big
While new entrants and resurgent lenders are understandably gung-ho about grabbing market share, the persistent uncertainty over Europe’s debt crisis casts a pall over all predictions.
Fears of risk contagion abound. While in good times banks are most worried about the value of their loans deteriorating, in tougher times their larger fear is outright risk of default.
“If the market moves against us and shifts two to three cents then we’ll take our medicine, we can absorb that, but if we lose 50% on a credit default, that’s a different story,” says Corrin. “We take market risk seriously but it’s not the biggest of my worries, credit risk is the real concern.”
The key to which banks emerge the strongest in Asia’s lending space will depend not only on origination and syndication skills but also on the ability to demonstrate finely honed risk management. And that takes experience.
“If banks enter the market, I would expect them to be more selective and more focused on specific sectors and countries rather than trying to cover as many as possible as it may be challenging…from a low starting base or a limited [regional] customer franchise,” says Phil Lipton, regional head of syndicated finance for HSBC.
“Next year there are risks and opportunities,” says Stephen Ching, co-head of structured finance and syndication at Citic Bank International. “…All the banks will want to make sure…that they monitor…where the money is being applied rather than accepting general corporate purposes.”
“StanChart has been very good at picking and choosing when things go bad like they did in 2008…but it is a risk,” adds CLSA’s Tabbush, referring to the emerging markets lender’s strategy to aggressively build market share.
Tabbush is not concerned about established regional players such as StanChart and HSBC, which boast size, liquidity, top-notch risk management and established corporate relationships. Instead he worries about new entrants from places such as India and China, which have a grip on their domestic markets and can see the opportunity but have little experience across Asia.
“Even ICICI in India said they want to buy some loan books from European banks,” says Tabbush. “That would worry me because I don’t really know what experience they have.”
“We’ve also heard that some of the banks in China are participating in loan syndications for aircraft leasing. I don’t know what expertise they have in doing that so I would add that to the higher risk category.”
There is little hard evidence to support what Tabbush is hearing, but if it is true it is likely to raise questions over the risk capabilities of these institutions.
This isn’t to say that all aggressive lenders are reckless. ANZ is repeatedly mentioned for its interest in Asian expansion, and some question its risk management. Unsurprisingly, Corrin disagrees.
“We’ve underwritten US$17 billion worth of deals this year and have about US$50 million to sell out of that,” he says, referring to ANZ’s remaining exposure of loans it has underwritten. “You can be aggressive and successful or you can be aggressive and unsuccessful; I would claim we’ve been very successful.”
Secondary market impact
While it is not uncommon for banks to manage balance-sheet risk via a variety of means – limits on how much debt can be held on balance sheet from particular issuers, sectors and markets; aforementioned secondary market trading; or simply canny syndication – managing credit risk is a different story.
But in a volatile global environment that could see the eurozone collapse, can banks be too careful? Some bankers say that recent secondary-market loan sales have picked up, indicating banks’ skittishness about possible defaults.
According to axe sheets seen by Asiamoney, Crédit Agricole has more than US$1 billion worth of trading mandates in the secondary loans market and Standard Chartered has around the same amount in Indian loans to sell alone. Commerzbank and Société Générale are also offloading loans, but not in the same volumes.
“There are a lot of banks selling in the secondary market at the moment,” says a senior loans banker. “And [it all] involves making a big loss between primary and secondary pricing.”
Banks are proving willing to lose money to dispose of some positions.
A Commerzbank spokesman told Asiamoney that there was nothing unusual about its secondary-market positions, while Crédit Agricole’s regional head of loan syndication Atul Sodhi declined to comment. Société Générale could not be reached for comment before press.
Ironically, this selling has led to increased liquidity in a typically shallow market. And it’s not all one way. Several loan-market participants are also buying in the secondary market to pick up better pricing than in the primary market. Crédit Agricole and HSBC both have mandates to buy and sell, according to sources, and Citic Bank International is also looking for assets.
“We are buying in the secondary market because it’s good value as opposed to doing primary deals,” says Ching of Citic. “Of course we have to strike a balance, but for some of the names that we might do [fewer loans with] in the primary market we can pick up the same credit in the secondary market at a much better rate.”
Primary pricing
While there are deals to be had, the secondary and primary markets are inextricably linked, particularly on pricing.
If banks begin to dump assets in greater volumes and at fire-sale prices, primary pricing – already under pressure due to economic volatility and rising banks’ cost of funding – will have to rise to compensate banks for taking new risks.
“In line with the volatility, pricing will continue to go up. And I think in Asia it’s not uniform again, we see more of that price pressure in North Asia and India, and increasingly in South-east Asia,” says Boey Yin Chong, a managing director in syndicated finance for DBS.
Moreover, the higher pricing and liquidity pressure have already impacted on loan volumes, although slower deal activity at year-end has also played a role.
“From the bilaterals people are talking about something to the extent of 30%-50% [higher than current pricing] especially for US dollar-based funding but…that’s overlaid together with the year-end effect,” says Boey. “But the European crisis has ratcheted pricing up quite significantly.”
“Cost of funding for banks has gone up so it will take a while fo the market to accept the new pricing reality,” Crédit Agricole's Sodhi says. “Until then we will see fewer and smaller deals.”
“It’s not a liquidity issue, it’s a pricing issue,” adds a senior loans banker. “If corporates pay up then they will secure the funding but you can’t expect banks to lend below funding cost and say you’re giving auxiliary business, I don’t think that works anymore.”
Where to from here?
Assuming that corporates do learn to accept higher pricing, market participants remain fairly positive about Asia’s lending market.
But such sentiments could turn on negative European news. How bad could things get?
“If conditions deteriorate, banks will tend to focus their balance-sheet lending to those corporates with whom they maintain close relationships,” says HSBC’s Lipton. “Asian banks came through the 2008 crisis in relatively good shape as they tended to be more conservative in their lending.”
“There was less of a bubble economy in Asia and a much smaller leveraged market,” he says.
But CLSA’s Tabbush points out that it would not take much to set off a domino effect that results in a renewed credit crunch.
“Credit markets could completely freeze up again, risk aversion could again become heightened like it was in late 2008 and European banks pulling loan facilities could create a credit crunch if no one wants to take on those loan facilities,” he says.
“Companies are then pushed into default, and they might also have some local credit lines which makes the risk have a knock-on impact; maybe local lines which can then turn bad because the debtor is in trouble.” The possibilities are frightening.
These uncertainties come when Asian refinancing is expected in large volumes in 2012.
“There should be a lot of re-financing activity next year [2012], stemming mainly from the maturity of five-year bullet loans originated in 2007 and three-year loans in 2009 when the market recovered from the Lehman’s crisis,” says HSBC’s Lipton. “The question will be whether they re-finance early at current levels of pricing or hold on till nearer the maturity date in the hope of lower pricing.”
He believes that it’s better for companies to bite the bullet and pay up if necessary. “The sensible option would be to secure funds as early as possible as, if pricing does go down later, they can always prepay and then re-finance,” he notes.
Of course some corporates can turn to the bond market – provided it has not also succumbed to global credit concerns. Morgan Stanley predicts that Asian corporate bond volume will increase by 63% in 2012 over 2011, according to a December 5 research report.
This is largely due to an expected decrease in loan funding. The US investment bank expects loans to account for only 60% of total new debt funding, the lowest level in six years.
Loan markets are in for an uncertain future and Asian lenders have yet to prove whether they can bridge the gap left by European rivals. But with Basel III and global credit concerns set to drag on European balance sheets for some time, this region’s banks have never had a better opportunity.