IFR Asia/LPC Evolution of Asian Loans Roundtable 2016: Part 2

IFR ASIA/LPC: Richard, do you agree with Michel on the pricing that you see in secondary markets on loans? Do you buy them at those kind of levels and are they attractive?

Richard Monnington, PruCap: I might answer this in two ways because my book tends to focus on high-grade. So if we are seeing underlying names that are starting to show signs of distress they might be interesting, but they wouldn’t really suit our portfolio. That’s not to say that they wouldn’t be attractive to other pools of capital within our group. I would agree with what Albert and Michel have been expounding. If you are looking at more esoteric or second-tier credits or credits that are in difficulty, there is a more well-priced supply out there then you will find in the high-grade, syndications space. Large institutions are becoming more active in that space. We talked about leveraged loans, direct lending probably for those second-tier clients, even distressed credits. Large institutions that have been active in those markets in Europe and in the US are starting to look at the Asian markets more and more. Now, again as you would attest, it’s not an easy thing to crack. These are intensive assets to look at and manage. You need to have knowledge on the ground, understand sectors and the credits very well. Although we’re starting to see interest from those institutions, I don’t think it’s really come yet in the form that it will do over the next two to three years. We have been fortunate within the group to have strong fund managers across all of those sectors, but it will take us time to build up that capability in the region. That’s where I really do think that the institutional investment businesses can start to have a very positive impact on the investment market. Be it in that space or be it in areas that are closer to what I do, which will be providing liquidity that is a little different to what the banks will be able to supply.

International managers are beginning to provide longer tenor than the banks would. We have seen that in Australia, for example, where international managers have provided 10-year money into transactions over there. My overriding point is it’s going to take time and care for institutions to build up the types of resources that are necessary for us to bring the kind of firepower that we could have. Looking across the investment pools, the liability pools of a large insurers business like ourselves, we do have pools of capital that have a very, very broad investment risk appetite. We can be very, very compelling to the underbanked areas in the markets that we see today.

IFR ASIA/LPC: That raises questions on pricing because you focus on investment-grade credits and pricing in Asia is extremely low for those kind of borrowers. So isn’t that challenging in itself for you to operate in this market?

Richard Monnington, PruCap: Yes. For us, it’s acknowledging that there are transactions that we should just stay away from, where the relative returns that we will see elsewhere in the globe are more compelling and we will just deploy the balance sheet there. There are other areas where because we are capable of covering the sorts of transactions that do attract better pricing which the bank liquidity isn’t currently chasing. We tend to be one of a very few in a particular transaction. We tend to invest in fairly substantial size. That gives us some access to the borrowers and helps us understand their business plans, the challenges they face in delivering those plans and we can take a view on it. That gives us more capability to go where some of that bank liquidity isn’t happy to go and therefore still get reasonable relative returns as a result.

I see the future for larger institutions is being able to access those pools of capital that I talked about in those different areas of risk appetite. There is nothing to say that a large insurance business shouldn’t be able to provide short to medium-term debt and some mezz and even some minority equity. It does have pools of capital within the business that is attracted to those relative levels of return and bring that as a unitranche offering, a more compelling offering. Again something that hasn’t really taken off yet in Asia.

IFR ASIA/LPC: What’s stopping that from taking off?

Richard Monnington, PruCap: It’s a level of coordination and it is bringing the burgeoning appetite for private credit and other forms of alternative investment such as private equity, minority equity or mezz. There is appetite, but coordinating it and then putting the resources behind it to deliver it to the market, it’s not an overnight fix, although there are agencies that are very capable to help institutions like us through that path.

IFR ASIA/LPC: Justin, talking about pricing, in an environment where dealflow is shrinking and banks are struggling to make returns and meet their budgets, there will be a scramble to try and book assets, to do as much business as you can. But in the process, high grade borrowers get away with pricing that continues to head south. Do you see a point where it will reverse?

Justin Crane, StanChart: My heart says I hope so, but my head says no. Pricing compression is a function of the liquidity available. There’s nothing actually wrong with that. What is slightly concerning though is that for a lot of banks, except the US banks, our dollar cost of funds is actually increasing. We are still lending into a decreased pricing environment and we will continue to do so on the basis that lower margins is better than no margins. As many of us are actually short on assets, we can’t afford not to do deals. That’s obviously going to hurt overall revenues, but that’s the environment that we are in at the moment.

IFR ASIA/LPC: Do you see more clubs being done as a result instead of syndicated deals, because there will be five to 10 other banks like yourselves, which are hungry for assets and want to maintain that relationship?

Justin Crane, StanChart: Actually looking at the data, the proportion of club deals versus syndicated deals hasn’t really changed this year. It’s about 30%, which has been the same pretty much for the last five years. The actual question that we should be asking is what is the volume of bilateral loans that has happened this year and last year? That’s information that we are simply just not going to be able to get. I expect that it has gone up significantly as banks will say: “Right, I’ll go in with a large bilateral cheque and it might be at off-market pricing, but I need to secure a level of assets by a certain time.” I think that’s one of the reasons why you might see syndicated loans and club volumes coming down. I wonder if total loan volumes have come down and that’s just been replaced by bilaterals. That’s something we’ll never know.

IFR ASIA/LPC: Syndicated volumes have obviously come down because, perhaps, there have been more bilateral deals. Augustine, what is your focus in those kind of situations where your bank has won the sole mandate? Do you look at holding as much as you can on that deal because it earns you better returns?

Augustine Lim, BOC: We are just a branch in Singapore, so a lot of the transactions are pushed forth from head office. To some extent obviously if there’s a deal and because there’s a lack of deals in Singapore or in the region around here in Asean, we will try and grab whatever head office distributes to all the other branches. We share the risk in a sense. Being in Singapore obviously because of the tax regime and funding liquidity, we are in a good position to take on that loan because it’s more efficient, funding it from here where the liquidity is. From a Singapore branch we will try and get as much of the deal that we can get. That’s one part of the answer. The other point is that it is zero-sum game in some sense. If they are going out and getting financing offshore just for the sake of doing a refinancing as opposed to going out offshore for an M&A deal, not all banks will have all the capital in the world to do all the mega deals. Sometimes you need to manage capital as well and also have partners because the borrowers may dictate some relationships with some investment banks, which can help them tap the IPO market. I think it’s a merit of various considerations there, it’s not just dictated by Bank of China. Obviously we are doing only the loan sometimes. The other parts of it could be some advisory roles. We also try and help them or lead the customers to where the investment banks are, which can re-partner to deliver what the borrower wants in the future. So a lot of consideration goes into that.

IFR ASIA/LPC: Oshima-san, there’s always a lot of talk of the loan product being used to subsidise and win ancillary business. We’ve seen it is not always the case that the bank providing the loan wins the bond or M&A advisory or the refinancing mandate, for example. We have seen MUFG in a couple of situations in India for state-owned oil and gas companies where you provided bilaterals for an event-driven financing. Obviously everyone would like to get that business on the take-out, but there is no certainty. How do you go and just do a bilateral pricing that is completely off-market?

Koichiro Oshima, MUFG: Obviously in general a lot of the international banks are playing in that way. I think for the US centric banks, syndicated loans or revolvers are always loss-leaders and other cross-sell products including bonds in some fashion have always been where the fruit is. As an international bank, we have a global view and that’s one way I think the Asian market is going. The current market has hindered that a little bit because there’s so much supply compared to demand. It’s a more of a borrower’s market today. Lenders that provide certain bridges or rollovers today would not necessarily get the follow-on business. However, we take a long-term view at the business and are very much relationship-oriented. We do believe that whether that might guarantee the repeat business or not, we might have a better chance of getting the various cross-sell products by providing that facility. Although the pricing in Asia is very competitive, and the cross-sell is not always guaranteed, we try to find ways to justify providing those loans today. We will have to see how that works out.

IFR ASIA/LPC: Justin, has your bank’s approach changed in the past few years because there was always this focus on trying to do a deal, not just for the deal’s sake, but to get ancillary business from the borrower, be it a bond or something else?

Justin Crane, StanChart: For most banks there is no longer the option of just doing a deal for the deal’s sake. It is beholden on us to deliver the product suite and service levels of that ancillary business to make it attractive to the client. It’s wrong to classify all loans as being loss leaders. If you are doing a bridge to a high-grade corporate and let’s say you are only getting paid Libor plus 80bp, that’s 80bp more than you get paid for sticking it in a central bank on a short-term basis. So if you are long dollars it’s actually not a bad option. You can see, particularly globally, the US banks being far more active in the short-term dollar bridges now at much lower costs than they have been because they are long dollars and pricing of 40bp is better than nothing.

IFR ASIA/LPC: So do you think lenders are gravitating more towards lending on a short term basis?

Justin Crane, StanChart: No, I don’t think so. It’s whatever the client needs at that particular time. I think if you ask Mike or Augustine who have to run a book, they obviously like short-term assets but they would love decent yielding five-year assets as well because that’s not a headache they have to deal with every year to replace that asset. It’s a combination of both.

IFR ASIA/LPC: Kaili, do you see terms being stretched out on loans where tenors are getting longer, pricing is shrinking and there’s a crowd at the table?

Kaili Jen, CTBC: I don’t see really tenors stretching, but yes there is pressure on pricing. For certain credits, even second-tier names from India, five-year loan pricing is near 100bp. Everybody is hungry in this market, you have to grab whatever you need and you compromise on certain things.

Augustine Lim, BOC: As Justin mentioned, pricing is thinning and tenors are stretching. There are still opportunities for getting higher margins. It’s just whether or not you want to take the higher risk on the customer because they may have groups that are outside of Singapore, for example. There are all these TLCs which are very thinly priced in Singapore, but when they go offshore they may actually still pay a little bit more, with limited or no recourse. So there are opportunities like that, but it’s rare and you have to dig really hard and that’s where relationship then comes into play a lot. That’s where we are always looking for value in terms of different markets. It is just playing the differences in tax, in funding costs, in geographies. The risk profile maybe slightly changed, but still at the back of it you have a very strong sponsor and hopefully that doesn’t run away.

Richard Monnington, PruCap: I have a question,. I’m just interested in this point, it’s something that Justin raised earlier about the fact that club deals aren’t increasing. One would expect a strong borrower to want to control its banking group. I know we are acutely aware of our responsibilities as a treasury to make sure that there are open business lines for peripheral businesses for liquidity providers in the group. Therefore you look for banks that have and are interested in the business lines, Oshima-san mentioned, the FX lines, derivatives etc. What strikes me as interesting in Asia at the moment is that one of the large peripheral business lines – the take-out to debt capital markets just doesn’t seem to be functioning for lenders. That’s in my view, because loan terms have got to the point where the covenants have been relaxed to some degree, tenors have gone longer for high-grade loans and pricing is at a point where actually the premium that you should expect for the illiquidity of a loan over a bond isn’t really there. So it doesn’t seem to incentivise the borrower to want to ever award a debt capital markets mandate to the banks that are providing that liquidity. Is that just a symptom of what we’re talking about there, that actually that whole peripheral business topping up the pricing of a loan has just become less relevant now?

Justin Crane, StanChart: Bond markets can be fickle at times and Singapore is a great example. In 2014 the Singapore dollar bond market was able to raise funds for credits at terms that we simply couldn’t match in the bank market. A lot of that was being driven by retail or private banking liquidity going into the bond markets. However, today the Singapore dollar bond market is very tough because of the recent defaults. If you can get a loan in size at the price and tenor you want, outside of just doing the right thing and making sure that you’ve got access to the various capital markets, what is the incentive to do something else?

Koichiro Oshima, MUFG: I agree, I think from a borrower’s point of view if you compare what you can get in the loan market versus the bond market, whether that’s overseas or domestic, it looks like sometimes even the loan market is cheaper. If that’s the case, there’s less incentive for the borrower to take out the loans with bonds. It’s just a matter of pricing or it’s just maths I guess.

IFR ASIA/LPC: But you’ve had situations earlier in the year when there were a couple of issuers which just came out of the blue and raised money in the bond markets. A US$300m–$400m bond issue was oversubscribed to US$4bn. When that happens obviously it’s very hard for loan bankers to try and justify to the borrower to go for a loan and go through the whole three to four-month syndication process educating the loan market and establishing those relationships, right?

Justin Crane, StanChart: Yes, I think we should all be encouraging a fully functional capital markets because there will be periods of time where capital for banks is tight. You’ve got to remember that 10 years ago we were doing seven and 10-year corporate loans. Banks have become more disciplined. In the long term, I don’t think the loan market will transact long tenors even for project finance because that should and hopefully will end up in the bond or institutional markets, where it naturally belongs. In infrastructure financings banks will have a part to play in the construction risk etc. in that period. But a 20-year project is perfectly set up for longer-dated paper that the loan market with the continuously changing regulations will simply not be able to do.

IFR ASIA/LPC: I would like to touch upon one last topic which is regulation and regulatory challenges. There are various facets to that. In jurisdictions like India and Indonesia borrowers have to take approval from the central bank and there are caps on how much they can borrow. In some countries the classic leveraged financing or buyout is extremely challenging because of those risks. Is it going to get easier or more difficult for the loans business?

Justin Crane, StanChart: Things will get increasingly difficult but these regulations have happened for a reason. So even if you go back to looking at your ECB [external commercial borrowing] regulations in India, that happened as a result of people borrowing in the short-term at potentially the wrong price when they simply shouldn’t have been. We went through a financial crisis and regulations have come out as a result of that. I think that will continue and are just the new normal. The goalposts will continue to change and it’s just a question of adapting to that. This is why you need a fully functional capital markets environment because there will be times where banks, because of regulatory issues, won’t be able to deliver what the clients want them to. The only issue for banks is that it’s all happening at different times. So if you are adopting a regulation early you can be uncompetitive as a result of that than someone who is adopting it late. Having said that, once you are done and you have got into the new normal, when the laggards are then adopting that regulation you are better placed.

IFR ASIA/LPC: Mike, do you see regulations as a hindrance to the development of the leveraged finance market in Asia?

Mike Samson, StanChart: It certainly degrades the speed at which it can improve, but I think you touched on it. You have markets where taking up collateral or the movement of dividends are monitored or require approval. Borrowing in certain currencies or the offshoring of that currency requires approvals. Pushing leverage from a bidco into an operating company in the absence of whitewash is very difficult. Having said that though, people have learnt to process that risk. Structures have emerged and those are now bankable. The real effect of the new regulation, or what Justin called the new normal, is how banks will be deploying their capital, and how certain markets become very protectionist. Even in the US, for example, when Thai Union Frozen tried to acquire Bumble Bee and become the largest tuna canning company in the world it entered into some anti-trust discussions. I think there was a very big discussion around WH Group’s acquisition of Smithfield and whether that constituted anti-trust.

So you will see regulation expressing itself, not just in the strictures around what types of deals can or can’t be done, but also in how bank capital can be deployed and therefore how they affect liquidity. There are certainly concerns for banks that underwrite. In certain markets like Indonesia where people can take collateral of shares in an acquisition it limits who you can look at to sell the deal to. It affects the closure of a transaction and how likely a process will come to fruition. You could put in all of the work over six months, get to the point and regulation will stop you at the end where it just doesn’t get allowed. Those are the new elements because the structural elements have been there for the past seven, eight years. We have learnt to live with them. I think the new elements are around how banks are looked at and especially the large trades, how those are looked at by anti-trust regulators.

IFR ASIA/LPC: Michel, you get into situations sometimes where you want to enforce security and collateral. Do you find regulations challenging or stopping you from doing that?

Michel Lowy, SC Lowy: First of all it’s rare that we get to that point and it’s the exception when you need to enforce, but it’s not really regulations that are an obstacle. It’s generally either the weakness of insolvency laws or the way in practice courts are going to look at the various positions. So in the last 20 years, if you look across Asia, the banks regimes and insolvency laws have changed dramatically. The court processes in some jurisdictions have not. Unfortunately you sit at the mercy of the courts. So when you are underwriting you need to take that into account and that’s why if you look at our balance sheet at SC Lowy, most of it is deployed in countries like Korea or Australia at the moment. Those are jurisdictions where you are a lot more comfortable than if unfortunately the situation does not go according to the game plan, you have the ability to a real conversation which is not necessarily the case in other jurisdictions, which I think is a mistake because if you had insolvency laws that would be more favourable to creditors, everybody around this table would be a lot more aggressive about lending, there would be a lot more liquidity and ultimately that would be good for the economy in general.

IFR ASIA/LPC: That also brings us to the point of term loan Bs, for example, because you talked about Australia and Japan as being the developed markets that resemble Europe and the US. Again is that the main reason why TLBs are not taking off from Asia?

Michel Lowy, SC Lowy: I think it’s a combination of elements. So you talked about Europe, I mean quite frankly insolvency laws in continental Europe are not necessarily much stronger than they have been in Asia. If you go to Spain or Italy or Greece you are not necessarily in a better position than if you are a lender in India or in Indonesia. There are number of issues here that prevent the emergence of the term loan B market. Number one is the currency, it has to be US dollars. If it’s not US dollars maybe there can be an exception for yen, for Australian dollars, but certainly not going to have a term loan B market in Indian rupees or Indonesian rupiah. So you got a currency issue. You got the size of the market issue that other corporates outside of the larger economies are smaller corporates and in the TLB you need enough size, enough liquidity and finally access to accounting financials that meet your international standards which often aren’t met here. Then the cherry on the cake is insolvency. So there are a lot of hurdles.

IFR ASIA/LPC: One topic that we have touched upon very loosely is about underwriting of loans. Has the approach towards underwriting loans changed in the past 12–18 months?

Justin Crane, StanChart: I don’t think so. What we found is we have put out as much or if not more offers to underwrite but are getting hit less. I don’t think underwriting standards or disciplines have changed at all. We can’t be spending an hour-and-a-half talking about how much liquidity there is in the market and then be overly concerned about underwriting. So people are willing to underwrite as much, I just don’t think that the offers are being taken up as much.

IFR ASIA/LPC: If the borrowers are not taking up the underwriting then there’s less opportunity for the banks to make money, right?

Justin Crane, StanChart: That’s right, but then the make-up of the market at the moment is very much skewed to refinancing etc. You don’t necessarily need to underwrite. If and when the new investments, acquisitions, and those types of loans come out then the underwriting market will be very, very suited to do that.

Koichiro Oshima, MUFG: From a borrower’s point of view what is the value of underwriting? If you can get similar terms, speed, amount with club deal, it’s much safer in a way. As Justin said, like M&A or acquisitions where you need speed and secrecy, there might be a need for underwriting.

IFR ASIA/LPC: So what do you think is the outlook for next year? Is there any visibility?

Koichiro Oshima, MUFG: It’s the VUCA world. In general Asia has a requirement for capital, whether that’s in the infrastructure build-out or other areas. Commodity prices are coming back so hopefully some projects that have been postponed will get off the ground. Whether that’s going to happen next year is not clear, but it might take some time.

IFR ASIA/LPC: Augustine, do you think Chinese corporates will continue to be as aggressive as they are right now?

Augustine Lim, BOC: They will come out more, be it in the bonds market or in the loans market because they are always looking at opportunities to restructure their balance sheet, to look at matching their liabilities and their revenues and assets. I think there’ll be more REITs coming out so therefore they will borrow onshore as well as offshore. We are definitely pushing more deals out to the market. At least three more REITs are in the pipeline. It’s not easy because a lot of them are unknown to banks outside of China. So to that extent there’ll be some underwriting and we have underwritten some of the deals and then syndicated or clubbed it up subsequently on a smaller scale. Outside of China more acquisitions are coming from the Chinese corporates. They are definitely still looking to go global. So hopefully that will also give opportunities offshore in Singapore and the rest of the financial markets.

Justin Crane, StanChart: I think absent of one of the very many hotspots that we currently see globally igniting I’m somewhat optimistic in terms of next year in that hopefully the stars are aligned and by that I mean the less well-known Chinese corporates becoming more acquisitive. We have a number of governments that are at the point in the election cycle where they do have to start investment in a big way if they are looking to get elected again. I’m talking about India and Indonesia in particular. There is the dry powder at the financial sponsors that needs to be used and a combination of all of those and hopefully with stability and global growth picking up then you would hope for a more interesting year.