Grace Tam, managing director of Barclay's Asian loan operations and her colleague David Matthews discuss developments in the regional syndicated lending market.
What are your thoughts on the issue of liquidity in the secondary loan market in Asia? Does it tend to suffer due to the fact that deals in the primary market are priced so aggressively?
Matthews: The reality is that the loan market has underpriced the secondary market since time immemorial. It's a factor in Europe just as much as it is here [in Asia] because you have a concept of "relationship-defining deals". Banks want to be in the primary syndication because they want to be seen to be giving that support to clients and be visibly supporting them when they come to market. And if the deal is a tough sell then the client will make those calls to banks to encourage them to support that particular deal. What they get out of a relationship is often the flow of ancillary business.
Is that the prime reason behind relationship defining deals?
Matthews: I think it is. Somebody made a comment to me the other day that the loan product is the universal door opener in Asia. And there's not a client in Asia who doesn't have a loan transaction somewhere in their debt portfolio and capital structure. This is slightly different from Europe and the United States where the CP market or the fixed income market is much more dominant. But in Asia, particularly with the volatile times we've had in the last five years, the loan market has been a constant source of debt capital for nearly everyone. The significant increase in bond market issuance, often at the expense of the loan market, reflects the dramatic change in investor sentiment towards Asia over the past few months.
So it is a question of pricing going lower and lower until there are a few players left in the market?
Tam: I think a lot of corporates in the region are using the syndicated loan as a relationship defining facility. The facility allows the corporates to maintain contact with the banks, whom they expect to be like an all-weather friend. There are however limits to the down spiral in pricing, even for relationship deals, and I believe we are fast approaching that point for most of the developed markets in Asia. The client would like to have a group of banks to continue to support them. The client is certainly pushing the envelope in terms of what pricing they can get, but at this stage even the client is aware of the limitations. For instance, if they only want a dozen banks in the deal but there are 24 banks keen to do business with them, then why not drive the pricing lower. They don't need 24 banks. But if there are only 12 or eight banks which can accept the pricing, the client will know where to stop because if they go beyond that they may not even get the eight banks.
If the client continues to push the pricing lower will they get support for the next deal?
Is that true for domestic currency deals?
Tam: The pricing is more aggressive in domestic deals.
Matthews: The tight pricing at the shorter end of the domestic curve tends to be reflective of the excess liquidity in the marketplace. The other driver there might be dollar interest rates vs local currency interest rates. In the last couple of years, we've seen local currency interest rates in most parts of the region come tumbling down. The incentive to go offshore is not so great.
Can I just return to this other issue of secondary loan pricing? Europe is a relatively sophisticated market for secondary loan trading. Most paper trades in the 90s, very few trade above a 100 cents to the dollar i.e. secondary loan assets are rarely priced at a premium to the primary syndication in the short term. Most of them come into the secondary market at a price of somewhere in the 90s, suggesting that the primary market is priced tighter than the view of an indifferent investor, which is what most secondary investors are. They don't have the relationship and ancillary business to factor in. They're always looking for yield assets against a certain credit profile. The problems of secondary market appetite versus primary market expectations are just as acute in Asia at the moment.
What is Barclays attitude to the merging of loans and bonds departments? Is this something you're doing?
Tam: We have got a very integrated operation in Asia. We operate as one investment banking outfit. The total headcount in Asia is less than 800 and in Hong Kong it's less than 200. We work really closely together. In practice, we already work as one integrated group. So it is less of a concern on how we integrate the people or the business. We don't really feel the pressure as we are already doing it in practice. Because of the very close relationship, we have found synergy in doing things together. If it's a loan-style FRN, for instance, we place most of it with the loan market investors. Or if this is a bond-styled FRN or a fixed income issue, we can some still find interest in the loan market.
Matthews: We have been co-located and integrated with our bond colleagues for the past few years, so Barclays does not regard the co-operation that ought to exist across the debt products as a dramatic departure from our current experience.
For it to really work properly do you have to have a single P&L for bonds and loans?
Matthews: Ultimately You probably do. For a fully integrated business, the sales people need to be motivated to sell loans today, FRNs tomorrow, asset swaps on the following day Currently, the credit products line is integrated at the highest level, so we do not have any particular issues at the operating level.
You were mentioning earlier about how this is so relationship-driven and pricing is only one of the issues? What about extending maturities?
Matthews: Typical tenors for the loan market are three to five years, but for the better credits during the right time in the credit cycle, the same can be seven years or longer. I think a lot of participants have got the new return on equity (ROE) adjusted risk-return type of models today and quite often get penalized for going beyond certain tenors. That again introduces another issue that might not have existed five years ago. Now you have cost of economic capital, risk adjusted over time and that has a direct financial consequence on a lenders risk appetite.
What about covenants? Hong Kong blue chips get away with relatively lax covenants. Is that good or bad?
Tam: Actually the direction is going two ways. One is with the prime credits where people have the confidence in the way the company operates, the management, etc. They're prepared to be more relaxed in terms of the covenant requirements. Those covenants have been set so loosely, that if you have the confidence in the management, why bother to have those covenants, which are no more than something cosmetic. The trust really rests with how this group of people manage the business, which they have proven doing a good job in the past 10-20 years.
The other extreme is that banks are becoming more stringent in terms of covenant requirements for companies that have a shorter history. Instead of asking for less, banks are beginning to ask for more. In terms of the typical balance sheet covenants like minimum net worth or gearing, it may not be possible to ask companies with a shorter history to meet these covenants. But in the event of a downturn of the economy or a business cycle, cash flow driven covenants such as EBITDA (earnings before interest, tax, depreciation and amortization) and interest coverage, can be matched against the performance of the company more quickly. We are beginning to see bankers more commonly asking for cash flow-driven covenants from corporates with a shorter history or business in a volatile sector.
Do you think there is going to much acquisition finance this year?
Tam: I believe so. There will be more in some countries than the others. If you consider privatization as part of that we will continue to see deal flows from this area in Asia.
