Asia levfin: banks should rise to the challenge
Rising leverage ratios in Asia’s normally conservative loan market will require banks to perform a careful balancing act
Asia’s bank loan market appears to be showing signs of growth — at least when it comes to the leverage ratios banks are able to accept on deals.
A few recent buyout loans have come with leverage ratios of about 5.5 times, higher than the 4.5 times levels from a year ago.
For example, Baring Private Equity Asia is looking for two loans: one for the acquisition of Philippine company Straive, a data services provider, and another for the purchase of Indian firm Hinduja Global Solutions’ healthcare unit.
Both fundraisings will have 5.5 times leverage, as GlobalCapital Asia reported last week. In comparison a year ago, when the private equity firm took India’s Hexaware Technologies private through a $600m loan, the leverage ratio was below 4.5 times, considered a standard level for the region.
The bigger risk appetite bodes well for the long-term development of Asia’s loan market — but only if it is done right. Banks will need to tread a fine line between winning business through aggressive means and maintaining stability in the market.
One advantage for lenders looking to accept higher leverage ratios is that it will help maintain the competitiveness of the region’s bank loan market. Loans are used by sponsors to support their acquisitions because they need committed facilities to tap into. Loans are also less impacted by gyrations in global markets and are relatively easier to execute.
However, Asia’s bank loan marker risks losing its appeal if it fails to meet sponsors’ demands. In such situations, PE firms may only tap bank liquidity for a bridge loan, and later refinance the deal through bonds — a market where investors can easily accept higher debt levels.
Outside of Asia, there is also competition from the US term loan B market, which offers borrowers higher leverage ratios, as well as loose covenants.
There have been a few cases where Asian companies have tapped the US TLB market. Although not to back acquisitions, their successful fundraisings show that TLBs could be an option for companies with overseas businesses or those that are well-known in the international market.
For instance, Singapore’s ride-hailing firm Grab raised a $2bn five year term loan B early this year, boosting it from the initial size of $750m thanks to strong response. In June, India’s Oyo Rooms, a hotel booking site, closed a $660m term loan B, also oversubscribed.
Risk vs reward
The TLB market can pose a valid challenge to Asia’s syndication market.
This can be even more so when sponsors move their focus to firms in the new economy sectors, like online pharmaceutical companies or fintech firms. PE firms’ current focus on technology has made banks comfortable lending to asset light firms — but lenders need to quickly equip themselves with the skillset for evaluating new business models with weak revenues but stable cash flow. Otherwise, they risk losing business to other, more mature, fundraising markets.
The timing could certainly not be better.
The Covid-19 pandemic has put banks’ budget targets under pressure as deal flow from corporate loans slows down. Combined with the ample liquidity, conditions are ripe to test the market with higher leverage ratios.
The deals are likely to be well supported — not only by international banks that are competing for the underwriting fees, but also by Mainland Chinese and Taiwanese banks that are actively looking for better returns. Retail banks have changed their tune from being opposed to PE-driven deals, to now being keen to participate in loans from trusted sponsors.
This calls for the right balance between risk and return. Banks should embrace the tick-up in debt levels, but hold their ground when covenants get too loose, or leverage ratios hit unsustainable levels.
Some bankers that spoke with GlobalCapital Asia expressed concern that sometimes the market only realises that terms have been pushed too far when a serious default happens. That may be the case, but banks should learn their lessons from past situations.
Thorough due diligence of borrowers, detailed modeling of risks and rewards, and constant follow-ups with the borrowers and the sponsors during the life of the loan will be critical. Banks in Asia should rise to the challenge.