By Steve Garton
Asian borrowers are struggling to come to terms with higher funding costs as the impact of the global credit crisis hits home
Whoever said Asian capital markets were immune from the impact of the credit crisis? The volume of international bonds sold by Asian borrowers has plummeted since the summer of 2007, and only a handful of deals has been launched since last August. If anything, the region remains as reliant on global liquidity as ever.
Those that have launched new bonds since the credit crisis took hold – including the Republic of Indonesia and the Philippines – have had to pay bigger spreads as demand for emerging market debt has fallen, while others have found it difficult to access the market at all.
Country Garden, China’s largest property developer by market capitalization, was one of the biggest casualties. The company was forced to cancel plans to sell $1 billion of five- and 10-year bonds at the end of October last year despite offering yields of over 10% – much higher than other borrowers with an investment-grade rating. Investors didn’t like the prospects for the Chinese property sector amidst the government’s crackdown on real estate speculation, and a confusing band of seven lead managers didn’t help either. The market for leveraged loans also took a hit. The debt backing the $1.5 billion private equity buyout of United Testing and Assembly Center, a Singaporean services provider to the semiconductor industry, could not be shifted and remains on the books of JP Morgan, ABN Amro and Merrill Lynch a full nine months after the acquisition was announced. The flow of new leveraged buyouts dipped as a result.
Hopes for a resurgence in early 2008 were quickly dashed, as fears for the US economy and further write-downs by the world’s biggest banks took their toll on the global credit markets. Compared to the same period in 2007, the volume of new dollar bonds sold by Asian issuers shrank 48% in the first quarter to just $5.8 billion.
With trading of cash bonds almost nil, attention turned to the credit default swap market, where the iTraxx index of 20 high-yield names in Asia ex-Japan widened from 328bp at the start of 2008 to 650bp in mid-March, showing how appetite for risk dwindled in that period.
As investors often hedge their exposure through the credit default swap (CDS) market, the big numbers make it more expensive for Asian companies to borrow money, and concern is growing that the credit slowdown will have a knock-on effect on corporate growth.
“Asia has a lot of sub-investment grade borrowers, and those have been hit more drastically by widening credit spreads,” says Aaron Low, principal at Lumen Advisors, a fund specializing in Asian debt and equity.
As of April 9, no Asian company had sold a public high-yield bond since October last year, and investors remain wary of the sector. “We’re only looking at the investment-grade names we are already very comfortable with, and not touching high yield yet,” said Joel Kim, head of Asian debt at ING Investment Management in Hong Kong, speaking in early April.
First-time borrowers will find it harder to raise international funding, says Mark Leahy, head of Asia debt syndicate at Deutsche Bank in Singapore. “The credit markets remain open for companies with a good track record. A high-yield deal could get done at the right price, but the markets will be harder for a debut borrower.”
There are signs that appetite for riskier deals is returning, with falling credit spreads tempting some borrowers to look at bond issuance again.
Bank funding costs rise
Asia’s banks have also found themselves caught up in the crisis, even though most have avoided the big credit losses seen on Wall Street. Minimal exposures to the US subprime mortgage sector and the credit derivatives market are now tempting investors back to the sector.
“Banks here do not have the same problems, but they have been caught up in the contagion,” says Dilip Shahani, head of global credit research for Asia at HSBC in Hong Kong. “After the Federal Reserve made it clear it would provide a backstop for troubled banks, the contamination from the US has slowly receded.”
Most banks in Asia have a loan-to-deposit ratio of well under 100%, according to HSBC, meaning that they do not need to rely on the capital markets for wholesale funding. Only the Australian banks, with ratios towards 140%, and some Korean lenders, with ratios around 110%, are regular capital market issuers. Helped by some very attractive cross-currency swaps, the Australian lenders have found a big alternative source of cost-effective funding in the Japanese samurai bond market, with the big four banks raising a total of Y449.9 billion ($4.3 billion) in the year to April 9 – already more than four times the amount they raised in the whole of 2007.
Korea’s commercial banks have yet to accept the increased cost of international credit, but have been able instead to fund themselves through small, local market deals or private placements.
One bank that has been forced to scale back its offshore borrowing drastically is India’s ICICI Bank. The country’s biggest private-sector bank was Asia’s biggest borrower in 2007, raising a total of almost $7 billion through international bonds and loans. It sold $2 billion of five-year bonds in October, but had still not returned to the international capital markets six months later.
Indian banks were able to demand tight pricing last year on their offshore bonds, but the securities have been hit hard in the credit turmoil. Investors who lost money on ICICI’s earlier deals are demanding big premiums for any new issue, driving the bank’s borrowing costs up. ICICI’s subordinated notes due in 2022 were trading in early April at just 86 cents on the dollar.
“ICICI is targeting on-lending to Indian corporate customers offshore, but its cost of borrowing is so high that this piece of its equity story will not work,” says Shahani at HSBC. “Is that a problem for corporate India? No, as companies can still get funding elsewhere, but it is a problem for ICICI.”
As banks’ costs of funds rise, loan volumes are beginning to fall, and Asian companies are finding their cost of borrowing is also on the increase.
Flex language within loan documentation – which allows the bookrunning banks to change pricing on a deal either upwards or downwards – has returned. During the bull market’s heyday, when the market flex clause was employed, it was used almost exclusively to lower pricing as a result of the phenomenal demand that chased nearly every transaction. Now some lenders are asking for an unlimited ability to flex margins up as their own cost of funds spiral. Asian borrowers, who have been in the driving seat for the last five years, are not impressed.
Equities hit
Asia’s equity markets held up for longer than their credit counterparts. Even after Hong Kong’s Hang Seng Index peaked in late October, big deals were still launched successfully months later. Chinese internet portal Alibaba.com and construction giant China Railway Engineering each attracted massive demand for initial public offerings (IPOs) in November.
But the party was never going to last for ever. Slumping Asian equity markets left investors with little appetite for new IPOs, leading to countless deals being cancelled or scaled back, including the Hong Kong listing of Chinese developer Evergrande Real Estate, which wanted to raise $1.3 billion to $2.1 billion in March.
China’s Shanghai composite index finished the first quarter 43% below its October peak. Vietnam’s stock market slid 46% in the first three months of 2008, while Hong Kong lost 17% in the same period.
“Everything is interrelated,” says Andrew Cooper, head of equity-linked capital markets at Merrill Lynch in Hong Kong. “Hedge funds borrow to buy equities, so when the market dips and banks cut their limits, investors have to sell off the underperforming parts of their portfolios. That depresses prices even more – it’s a vicious circle.”
Capital raising is still possible, despite the volatility. Country Garden, after the failure of its bond deal in late 2007, resorted to unorthodox funding: the company issued convertible bonds in mid-February and effectively bought back stock at the same time, in Asia’s first deal of its kind. Advised by Merrill Lynch, Country Garden raised $350 million and signalled its confidence in its own stock to the market, leading its shares to jump 15% in two days.
“The convertible market offers more flexibility in structuring and pricing than the equity and bond markets,” says Cooper at Merrill. “The second quarter will be busy, even if the debt and equity markets don’t come back quickly.”
Local strengths
Asia’s international debt and equity markets remain as vulnerable as ever to vacillations in global appetite. But the region is in a far better position to withstand global pressures than it was 10 years ago.
Asian banks have not suffered to the same extent as their US peers from the turmoil in the subprime mortgage sector, and the domestic debt markets are in good shape. In fact, international borrowers are looking to the local currency markets for funding advantages. The Export-Import Bank of Korea and the Industrial Bank of Korea – both state-owned lenders – each sold bonds in Malaysia’s ringgit bond market for the first time this year, raising M$1 billion ($313 million) apiece. State Bank of India, which backed away from plans for a dollar bond when credit spreads widened at the start of 2008, also picked up M$500 million of five-year money in March.
“The Asian economy will be impacted by the credit slowdown, but not to the same extent as the US,” says Low at Lumen. “Local banks are shifting funds away from stocks and towards loan growth, increasing their capacity for housing loans and so on, and it is not that difficult for companies to find money in the local markets.”
International investors are beginning to find value in the depressed markets, giving some hope for a recovery in credit prices. “After 10 years on an upward spiral, emerging markets had become overpriced. Asia offers better value now than where we were last year,” says Ooi Lay Leng, a senior portfolio manager within the global emerging markets group at Government of Singapore Investment Corp.
Leahy at Deutsche Bank describes this re-pricing as a normalization. “It will be painful and frustrating for some, but it’s about getting back to a fair price,” he says.
So far the credit crisis has not dampened profit forecasts among Asian companies, but concerns are creeping in that a prolonged lull in capital raising will hurt corporate earnings. “The worrying thing for Asia is, if it cannot find the money to fulfil its investment plans, then it will have to pull back. Those plans have not yet changed at all,” says Cooper at Merrill. “A three-month drought makes little difference, but if that continues then growth will suffer.”