Critics of Asia’s syndicated loan market have another thing coming. If the broader turmoil in the region’s debt market this year has proved anything, it’s that a conservative — and somewhat risk-averse — mindset on lending can be beneficial in the long run.
The stress in Asia’s high year dollar bond market shows no signs of abating.
High profile property developer China Evergrande Group missed coupon payments last month on dollar bonds, as well as further payments this week.
Its situation is also no longer an isolated case. Bad news has emerged from luxury developer Fantasia Holdings Group Co, which missed a dollar payment last week. Modern Land (China) Co announced a consent solicitation on Monday morning, proposing amendments to its $250m 12.85% notes due on October 25.
Developer Sinic Holdings Group Co too has warned of an imminent default, saying it doesn’t expect to repay a $250m bond due on October 18, a move that could trigger cross-defaults on its two other notes.
These developments raise critical questions about the health of China’s dollar bond market. Is a bigger contagion effect looming? Will the debt crisis at developers begin to impact other parts of the China bond market? Is trouble looming elsewhere in Asia? And what can be learnt from the rapid unraveling of the financial health of these companies?
One risk that has been exposed from these situations is the weakened covenants carried by bonds in Asia.
Moody’s said in a report in September that Asian investors have sacrificed covenant protection for better yields over the past decade.
The credit rating agency’s conclusion came from its analysis of 422 Asian high yield bonds from 2011 to 2020, where the proportion of Chinese property bonds increased to over 80% in 2020 from 59% in 2011. It said that the covenant quality score of high yields bonds has weakened to 3.33 last year, which is considered moderate, from 2.36 in 2011, which is considered good.
A lower score represents stronger quality on a one to five scale.
Moody’s also added that the average fixed charge coverage ratio thresholds have declined from three times to 2.2 times during the period, meaning companies have more flexibility to issue new debt.
That approach among investors, to sacrifice protection for juicier yields, is now coming back to haunt them.
Stable, resilient
On the other hand, the Asian loan market has remained conservative over the years.
In addition to the fact that loans carry maintenance covenants — which are stricter than incurrence covenants typically seen on bonds — loans bankers have insisted on a high standard of credit.
Even with a few recent leverage buyout loans — like the $570m deal for Baring Private Equity Asia’s acquisition of Hinduja Global Solutions’ healthcare unit — while the leverage ratio has risen to over 5.5 times, focus on debt to Ebitda remains critical among lenders. A senior banker at a large lender told GlobalCapital Asia this week that his firm has ditched some deals this year because the leverage ratios were too lofty.
Bond investors are long seen as more liberal. Loans bankers, however, closely look at a company’s cash flow when making a lending decision. Whether the borrower has a sticky cash flow and how it will use the cash are typically taken into consideration.
Admittedly, that approach does mean that while Asia’s G3 bond has flourished over the years with volumes hitting new records annually, the opposite is the case for loans. Volumes have shrunk, with some issuers scrapping a traditional bank loan altogether.
For example, Barings Asia switched its initial plan of raising a term loan to opting for a unitrancheloan to support its buyout of Philippine firm Straive. Private equity firm Carlyle raised a loan to bond bridge, and added a mezzanine tranche, for its leveraged buyout of India’s Hexaware Technologies.
Looser covenants and appetite for higher leverage ratios in the bond and unitranche markets, versus in the bank loan market, appeal to sponsors.
But the escalating crisis in the bond market this year shows that loans bankers can be vindicated with their conservative lending strategy.
The tighter covenants on loans not only benefit the banks, but also prove a boon for the rest of the market.
In Asia, bank liquidity has long been an important source of funding. The loan market is liquid, more stable, and offers a cheaper way for companies to fulfil their funding needs. It also often serves as a backup funding source for borrowers when the bond market is volatile and inaccessible.
The bank lending market may very well be conservative in its risk appetite. But in tough times, its stability and resilience are exactly what borrowers — and the broader capital markets — need.