Margin financing has been a lucrative fee earner for investment banks – albeit a risky one.
Many company owners and high-net-worth individuals in China have put up blocks of shares in internationally listed companies as collateral against loans from investment banks, much of which they recycle into equity investments.
A head of investment banking at a prominent ECM bookrunner told FinanceAsia that revenues from margin financing were equivalent to a meaningful proportion of deal-making fees.
Several banks ended up weighed down with large share positions in July and August after China’s stock market plummeted and some borrowers could not pay back the money. Multiple investment bankers told FinanceAsia that all major houses are believed to have traded out of their positions successfully but at least one is understood to have had its request for further margin financing denied by its US head office.
Still, the abrupt market collapse has fire-tested their risk management capabilities, some bankers said. So the likelihood is the banks will keep offering such loans, despite the risks. The fees are too good not to.
“If margin financing was a fad it would have disappeared after the turbulence in the year. But it hasn’t, it’s here to stay and will likely work hand in hand with new pools of capital,” said Dieter Turowski, co-head of Asia investment banking at Morgan Stanley.
Delivering debt
Asia’s bond market has endured some tough times in 2015, with $182.5 billion of dollar-, euro-, or yen-denominated debt raised by November 27 versus $219.8 billion in 2014, according to Dealogic.
With a long-delayed but much anticipated first US interest rate hike finally arriving in December, the coming year promises its own trials.
China remains the most prolific source of deal flow. Mainland borrowers account for 60% of G3 bond issuance in Asia ex-Japan in 2015.
However, China’s property companies almost stopped issuing after the first quarter and instead turned to the renminbi bond market for cheaper funding. That is likely to limit G3 high- yield issuance in 2016 too.
China’s provincial borrowers could become more active after the government of Tianjin raised $800 million through the sale of a two-part bond in July.
“Increasingly, provincial, and municipal level SOEs are successfully issuing debt in the offshore markets in addition to the central SOEs, and it’s likely they will continue to do so,” said Alexi Chan, co-head of global debt capital markets in Asia ex-Japan for HSBC.
The liberalisation of China’s currency could also offer opportunities for international borrowers to issue Panda bonds, or local renminbi debt.
HSBC and Bank of China (Hong Kong) were the first foreign commercial banks to issue bonds in China in September, reopening the country’s renminbi bond market for overseas issuers. The government of Korea began selling renminbi-denominated debt in China in December.
Banks from across Asia, but especially China, will also issue bank capital-applicable debt and hybrid offerings due to rising regulatory requirements and bad debts.
In November, the Basel-based Financial Stability Board said China’s big four banks required the same amount of total loss-absorption capital (TLAC) as other institutions on its list of 30 systemically important banks. TLACs are largely comprised of bonds that sit on top of regular bank capital requirements.
That means Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China will require TLACs equivalent to at least 16% of their risk-weighted assets, or about $400 billion. They have until 2025 to raise the instruments.
China’s banks are still lending more too, with outstanding loan growth expanding by nearly 14% from January to October, according to the People’s Bank of China. Yet bad loans increased by 30% in the first half, according to the China Banking Regulatory Commission. To combat this, Chinese banks need more capital.
“China’s joint-stock and regional banks in particular are likely to need to issue [onshore] and offshore transactions for capital purposes,” said Paul Au, co-head of Asia debt capital markets and head of Asia debt syndicate at UBS.
Chinese insurance companies are growing fast too and also face rising capital requirements. Meeting these needs could require some innovation.
In addition, regular regional borrowers could consider liability management exercises to reduce their debt costs, especially if a gradual rise in US rates leads to greater volatility in currencies and bond yields.
The Republic of the Philippines was a successful proponent of this strategy in January 2015, issuing a $2 billion 3.95% 25-year bond in conjunction with a switch tender offer for bonds expiring in 2016, 2017, 2021, 2026, and 2031.
“Buying back bonds either through tenders or exchange offers is an active way of managing balance sheets during market volatility,” said HSBC's Chan.
The year could also see more securitisations. BOC Aviation’s $808 million aircraft leasing receivable transaction in 2015 opened the door for a new form of asset-backed security. Other banks could conduct similar deals.
In debt, as in equity and M&A, China will define banking in Asia in 2016.
For earlier entries in FinanceAsia's series on the outlook for 2016, click here, here and here.
