The Asia Pacific loan market is growing again, after being set back by the Sars outbreak in 2003. But there is a tremendous oversupply of credit, and lenders? terms are being eroded as banks compete on price and structure. Lenders are hunting yield in bright spots like leveraged buy-outs and the recently liberalised Indian market, but, as Adam Harper discovers, Asia?s economic recovery will need to gain pace before lending becomes more profitable.
Bankers in the Asian loan market should be able to look ahead with confidence. Stronger economic performance, rising lending volume, the potential for growth in the leveraged finance market and outstanding prospects in India in particular have all contributed to this sense of optimism.
But there is an undercurrent of concern running through syndicated loan desks in Hong Kong. The banking sector is awash with excess liquidity, which has driven down pricing and weakened loan structures, just as it has in Europe and the US.
Several participants, including Chinese, Japanese and Taiwanese banks as well as international firms, are striving to increase their market share, putting further pressure on margins, fees and structures.
?Pricing has been coming in since 1998,? says CH Lee, regional head of debt capital markets for Asia at ABN Amro in Hong Kong. ?Lack of supply and excessive demand [from lenders] are compressing spreads to a level that is difficult to justify on a risk-adjusted model. Nobody is making any money out of 70%-80% of plain vanilla flow deals and they haven?t for a long time.
?There is decent money in maybe a dozen deals a year that are more structured or for more difficult credits.?
Lee says there are no more than eight wholesale banks in the Asian market with the necessary staff or expertise to underwrite and structure large deals. But he argues that competition from houses trying to step up a level will not even help borrowers in the long run.
?Companies need a stable loan market and will suffer if there is a hiccup,? he says. ?I don?t think we will hit a turn in the cycle soon, but it has gone too far in terms of price and structure.?
Bankers also point out that low interest rates have encouraged companies to turn from the loan market to the bond market, where they can lock in long term money at cheap rates.
Numbers of bond deals have risen from as little as three or four a year at the time of the Asian financial crisis in 1997 and 1998 to 70 or 80 a year.
However, this trend is beginning to reverse as interest rates start creeping up, led by the US.
But the main source of optimism for bankers is simply the health of Asian economic growth.
?The Asian economies are all looking in better shape through consumer-led growth. Sooner or later, this will lead to an increase in capital expenditure and investment, and that will mean increased syndicated lending,? says Philip Cracknell, global head of syndications at Standard Chartered in Hong Kong and chairman of the Asia Pacific Loan Market Association (APLMA).
?There?s normally a time lag but you can see the growth in loans already in Japan, where there have been tremendous volumes,? he adds.
In a loan market stacked in borrowers? favour, self-arranged and club style deals have been the most popular structures with Asia?s blue chip companies this year.
When Kerry Properties, the Hong Kong property company, came to the market for a HK$7bn five year revolver in June, it arranged the deal itself, with a 16-strong co-ordinating arranger group. Despite paying a tight margin of Hibor plus 35bp, the BBB- rated firm?s deal received underwriting commitments of HK$15.38bn and was increased from HK$6bn.
Sun Hung Kai Properties also arranged its own loan in March ? a HK$5.5bn five and seven year deal, paying Hibor plus 27bp. In 2002, the same borrower was paying a 43bp margin on a HK$7.5bn financing.
Henderson Properties and Hang Lung Properties have also self-arranged deals and managed to drive down margins.
?This is what you get in a borrowers? market, although blue chip property companies have been self-arranging deals for some time,? says Cracknell. ?But who?s going to underwrite a tightly priced HK$7bn deal on their own? Anyone that aggressive is going to get in trouble with other banks, who would not support a deal underwritten by one of their competitors. These deals are relationship driven.?
Self-arranging, the argument goes, works for borrowers because they can approach a broad group of banks for smaller and more tightly priced underwriting commitments.
Peter Chan, head of syndicated finance at DBS Bank in Hong Kong, is not too concerned about self-arranged deals for blue chips, but worries that the plentiful supply of credit could encourage other companies to try and arrange their own deals.
?In the more structured, high yielding area, it can be very dangerous for borrowers to try and self-arrange deals,? he says. ?They can miss market timing and end up without their deal getting done.?
As in other regions, the overwhelming surplus of cash looking for a home has weakened deal structures as well as cutting pricing.
?People have been more receptive to looser covenants because of competition among Hong Kong banks,? says Aaron Tan, a managing director in the debt finance group at HSBC in Hong Kong. ?But I think banks will still try to be prudent and exercise caution.?
Mohsin Nathani, co-head of Asia Pacific debt markets at Citigroup in Hong Kong, does not see a growing problem with structures in the Hong Kong blue chip market.
?The stronger names in Asia hardly agreed to any major covenants,? he says. ?Since you didn?t have much, there has not been much dilution. The problem comes with more structured deals, such as a lack of upstream guarantees in loans to holding companies.?
Caution and due diligence have been buzzwords in the Hong Kong market since the Far East Pharmaceutical Technology scandal emerged in June.
The company, incorporated in Hong Kong but with its operations in the People?s Republic of China (PRC), signed an $80m three year loan in May. The oversubscribed deal was arranged by RZB and Standard Chartered.
But on June 17, Far East Pharmaceutical?s share price suddenly dropped by 92%. At the same time, the company was reported to have missed the first repayment on its loan, having drawn down a reputed $62m. The chairman, Cai Chongzhen, was nowhere to be found.
Chongzhen was later discovered in hospital suffering from a heart condition, while the company is still operational and not, bankers say, in default on its loan.
But the incident sent tremors through the loan market, raising renewed credit concerns over lending to ?red chip? companies ? those which are listed in Hong Kong but have their business operations in mainland China.
?There?s a bit of a sour taste in the market after the Far East Pharmaceutical incident,? says Tan at HSBC. ?It has caused lenders to be more cautious with China-flavoured credits. We had a deal of that kind and, although it had generous pricing, it became more difficult to syndicate after the incident. We have yet to see whether there will be any spillover effect to blue chips from the PRC.?
CH Lee at ABN Amro says such events are an inherent danger of lending to the mid-market. ?With mid-market companies it can be very difficult to do due diligence and you can be reliant on a single personality,? he says. ?Risk can be amplified and harder to monitor. You are also carrying a huge reputational risk.?
But other bankers play down the effect of the Far East Pharmaceutical incident and say banks already perform a high level of due diligence before lending to red chips.
?For sure, banks will be more diligent when looking at these kinds of companies, but the market has not been negatively impacted,? says Clarence T?ao, regional head of loan syndication at BNP Paribas in Hong Kong. ?We normally do plant visits for this kind of credit, spending half a day with management and seeing the operation in mainland China.?
China puts the brakes on
The PRC is probably the only major loan market in the world where pricing is rising at the moment.
Early this year the Chinese government imposed curbs on lending to the steel, carmaking and property sectors, in an effort to stop the economy from growing out of control.
Growth has fallen from 9.1% at the end of 2003 to 7% this year, but bankers say the move has set back the growth of syndicated lending by international banks.
Nonetheless, in the first six months of 2004, Dealogic recorded 21 loans in the PRC, totalling $4.95bn. This is well on course to match the 29 deals worth $9.25bn in 2003.
?With credit restrictions, the authorities have done the right thing at the right time to avoid overheating,? says BNP Paribas? T?ao. ?It?s a temporary situation because China needs strong growth to drive reform, but it needs growth at a more normalised rate of around 6%. I expect these restrictions to be relaxed in time, so that companies can get the funding they need.?
Jose Cortes, head of loan syndicate and distribution at Barclays Capital in Hong Kong, has been disappointed with loan volumes in China this year. ?This year there have been a couple of deals, such as the $500m China Unicom loan and $191m refinancing for UPM and a couple of club-style project refinancings, but nothing like what you would expect given China?s increasing importance in the region and impressive growth rates.?
Finnish paper company UPM-Kymmene needed the money to finance its paper mill venture in China.
Indian companies freed to borrow
Frustrated by restrictions in China and the pricing squeeze in the Hong Kong market, bankers have looked elsewhere for opportunities to pick up yield.
India has been the region?s new frontier this year, as companies are beginning to come into the market alongside the established financial institution borrowers.
The growth in volumes has been dramatic. ?We have done more business in India this year than in the last three years cumulatively,? says Nathani at Citigroup.
India?s rise to prominence has been helped by the Reserve Bank of India?s (RBI) decision early this year to increase the amount of foreign currency a company can borrow for a term of over five years, without seeking its approval, from $50m to $500m.
Tata Sons, the main investment holding company of the heavy-industrial Tata conglomerate, completed its first international syndicated loan for six years with a $100m deal in September 2003.
It has been followed by other Indian blue chips, including several units of the Reliance Group. Reliance Industries tapped the market for a $250m five year deal in April; Reliance Energy came in June for a $250m five and 10 year loan and Reliance Infocom is expected to hit the market soon.
Quasi-sovereigns such as the Gas Authority, Power Finance and Indian Railways have all been in the market too. But Jose Cortes believes that competition between banks seeking better yielding assets in India is beginning pricing under some pressure.
?I think the 80bp margin people are talking about for quasi-sovereigns in a BB+ rated country is a bit tight,? he says. ?Slowly banks are moving down the credit curve, looking for more yield.?
Indian blue chips offer a typical margin premium of 20bp-30bp over their counterparts in Hong Kong.
Cortes says the gold rush atmosphere immediately after the RBI changed its rules has evaporated.
?There was some euphoria in the first couple of months ? both from issuers and investors ? but this has slowed down,? he says. ?The RBI is still relatively strict and insists in most sectors except the financial institutions sector, that External Commercial Borrowings (ECBs) have to be linked to new capital expenditure and cannot just be used for refinancing. This is responsible behaviour from the RBI and in the long run should benefit corporate India.?
Nonetheless, many bankers believe India will remain an exciting market for some time to come.
?India can be seen, to an extent, as an alternative to China,? says Robert Scholten, head of loan syndications for Asia at ING in Hong Kong. ?The appetite for Indian risk is increasing here in Asia. Besides the European and some US houses, we see that Taiwanese, Chinese, Singaporean and some Middle Eastern banks are going in. The top names such as Reliance and Tata are being financed now. When these are closed and banks move toward credits that are not financial institutions or blue chips, it will be interesting to see the level of demand.?
LBOs set to proliferate
The search for yield has also led to renewed interest in leveraged buy-outs in Asia. Private equity firms like the Carlyle Group, JP Morgan Partners and UBS?s subsidiary Affinity Capital have been raising funds for investment in the region and some bankers are upbeat about growth and development in the Asian LBO market.
?The leveraged business continues to show good promise in this part of the world,? says Nathani. ?I expect five to six large deals this year in non-Japan Asia, and at least two large deals in Japan. LBOs will be a growth area over the next two or three years and I think we are seeing results now.?
Nathani expects this growth to be brought about by a combination of new buy-outs and recapitalisations, such as the $500m refinancing of Carlyle?s Taiwan Broadband buy-out, launched in late June.
In the same month, DBS and Standard Chartered launched $109m of debt facilities backing JP Morgan Partners? acquisition of Sanda Kan Industrial. Sanda Kan is a model train manufacturer incorporated in Hong Kong, with a factory in Guangdong. It supplies toy manufacturer Hornby in the UK.
In July, DBS launched Singapore?s largest ever LBO loan ? a $130m deal partly financing JP Morgan Partners? acquisition of a 51% holding in Metalform, which makes parts for disk drives.
But loans bankers in Hong Kong doubt there will be much of an upsurge in deal numbers in the immediate future, even if deal sizes increase.
?It?s a horse and cart question,? says Aaron Tan at HSBC. ?Will LBOs drive lending, or will the availability of funding drive LBOs??
However, if typical deal sizes increase, it could lead to some structural development in Asian LBOs.
At the moment, most LBOs, including Sanda Kan, consist of a large term loan and a smaller working facility. They usually have five or six year tenors, shorter than the seven, eight and nine year tranches of a European or US LBO. Mezzanine debt has yet to make an impression in the region.
Structures are simple, bankers say, because deals are small, the market is developing and banks are aggressive: ?If you are holding half of a $100m deal, you don?t need the perfect structure,? says one banker in Hong Kong.
LBOs can also run into cultural opposition in Asia. ?You have to look at the mentality of a lot of Asian companies, many of which are still family owned,? says T?ao at BNP Paribas, who does not expect see the LBO sector taking off in a big way in the near future. ?A lot of owners are concerned about selling to institutional players because of the misconception that sponsors will alter substantially a business they built 30 or 40 years ago. Vendors prefer trade sales.?
Australia, Korea lead M&A
With a more buoyant economy in the region, bankers are increasingly confident that mergers and acquisitions will bulk up the demand for loans.
In late June, Barclays, BNP Paribas and Citigroup syndicated a A$1.336bn loan to finance Australian gas distributor Alinta Energy?s purchase of three pipelines and four power stations from the troubled Duke Energy of the US.
Bankers say there has been steady M&A loan activity in Australia, where pricing in general has not been as badly hit as other countries, but not so much elsewhere in the region.
One exception was the HK$11.1bn acquisition financing Barclays and Standard Chartered signed in June for Guoline Overseas, a subsidiary of Hong Leong Group, the Malaysian and Singaporean property-to-finance conglomerate, which was buying a stake in the Hong Kong listed Guoco finance and property group.
Some bankers are hoping for some big divestment-driven deals from South Korea in the second half of 2004.
Jinro, the distiller, is being restructured, after going into receivership in May 2003. It holds more than half the Korean market for soju, a drink distilled from rice, tapioca or sweet potatoes.
But it would take a big upsurge in M&A to soak up the excess liquidity of the Asian banking system.
?In Hong Kong, it?s a question of how fast the real estate sector can grow,? says T?ao. ?During the first six months of 2004, banks have been writing more mortgages, which took a tiny amount of pressure off liquidity. If they want to take more pressure off, banks also need to be more open to personal loans and credit cards as the economy recovers.?
A recovering economy will also tempt companies to invest more in their businesses, leading, in theory, to a demand for capital.
With economic growth as their main encouragement, bankers dismayed by the lending overcapacity and tightness of pricing are confident enough to predict a modestly successful year in 2004, with loan volume to the region beating last year?s $200bn by up to $50bn.
Asian Syndicated lending by Country (January 1, 2002 - July 16, 2004)
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