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Asia CommentGC Asia View

China’s loan market faces tough reality

GlobalCapital China loan market cartoon 1744 March 3 2022.jpg

Deal flow rather than pricing could encumber the market’s further growth

China-focused loans bankers looking forward to a pick-up in pricing of deals over the next few months may have another thing coming.

Chinese borrowers, like firms across the region, are set to face up to a potential interest rate rise by the US Federal Reserve, which will lead to a spike in their funding cost. Bankers are carefully pricing loans between now and mid-March, when the Fed is expected to announce its first interest rate hike of the year.

The move to raise interest rates will naturally have serious implications for borrowers — many of which have got away with razor-thin margins on their fundraising over the past couple of years.

Many bankers are citing examples of Midea Group and JD.com, saying that companies should not expect similar pricing for the rest of the year.

Chinese e-commerce company JD.com’s $1bn five year loan, signed with the bookrunners in December 2021 and now in syndication, pays a margin of 85bp over Libor, with all-ins in the low 90bp area. A banker close to electrical appliance maker Midea's €3bn three year loan, also signed in December and now in the market, said the margin is much lower than the group’s past two borrowings, including a $634m five year deal in 2019 that paid a top level all-in of 110bp.

A rise in deal pricing will certainly be good news to loans bankers — but for lenders to enjoy higher pricing, they will actually need to roll out deals. That’s where the challenge lies.

Agile borrowers

For starters, the Fed’s interest rate rise has long been widely expected, so many savvy companies have already taken action by raising loans early to lock in lower funding costs.

A banker close to JD.com cited the deal as an example, given the company deliberately started the refinancing plan early. The maturity of the deal to be refinanced falls in December 2022. Midea also started its talks early, given its old deal will not mature until August.

JD.com and Midea are just two examples of a much larger group of companies that are refinancing their debt well ahead of maturity.

This has left many bankers in limbo this year, given their reliance on refinancing business — which usually accounts for the majority of the loan flow — to meet their annual loan business targets.

Even worse, the already small portion of new money loan business is likely to shrink as well.

China’s slowing economic growth is the main concern. After a strong performance in the first quarter of 2021, the GDP growth rate slowed in the next three quarters to 4% in the fourth quarter, according to data from the National Bureau of Statistics.

The number is expected to be even lower in 2022. ING revised its forecast for China’s 2022 GDP growth to 4.8% from 5.4% in February, due to insufficient monetary and fiscal policy. The GDP growth rate for the full year 2021 was 8.1%.

The macroeconomic slowdown, together with the impact of the Covid-19 pandemic, will lead to limited capital expansion. Bankers say that many Chinese companies’ overseas production lines have stopped completely, while others have no updated plans.

Firms’ onshore activities will still need to be financed, but there is little likelihood that companies will come offshore to meet their domestic funding requirements — especially given the funding cost onshore is cheaper than internationally.

Slow M&A biz

Event-driven situations are not likely to provide much deal flow either. Global private equity firms, many of which raised new funds for their Asia portfolios in the past year, are putting more interest in south and southeast Asia rather than China.

Their shift in focus is in large part driven by limited acquisition targets in the Mainland. Like banks, global sponsors have also stayed away from the property sector, which has been in distress since financial troubles at China Evergrande Group came to light in September last year. Since then, numerous real estate developers have missed bond payments, defaulted, conducted distressed exchange offers, hived off assets to plug liquidity holes, and been downgraded by global rating agencies.

Before troubles at the real estate sector unraveled, many private equity firms were already shying away from the technology and education sectors amid the Chinese government’s crackdown.

Corporate to corporate acquisitions will remain slow too. With strict scrutiny from the US and Europe, as well as China’s own policies, Chinese overseas M&A transactions have seen a steady slowdown since the peak in 2017. That trend is not expected to change anytime soon.

Outbound M&A deals completed in 2021 totalled $24bn, compared to $29bn the year before and a whopping $138.9bn in 2017, according to a report from Baker McKenzie.

Of course, there will still be some Chinese companies coming offshore, and the market will continue to see action from small privately-owned firms seeking modestly-sized loans. The turmoil in the bond market may also push some borrowers to syndicated deals. But the heydays for China’s loan market are likely over.

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