China’s loan market faces a harsh reality
China-focused lending bankers eagerly awaiting a recovery in transaction prices over the next few months may have more to come.
Chinese borrowers, like businesses in the region, are expected to face a possible interest rate hike by the US Federal Reserve, which will cause their cost of funding to soar. Bankers are pricing loans cautiously through mid-March, when the Fed is expected to announce its first interest rate hike of the year.
The decision to raise interest rates will naturally have serious implications for borrowers – many of whom have gotten away with wafer-thin margins on their fundraising over the past two years.
Many bankers cite examples from Midea Group and JD.com, saying companies shouldn’t expect similar prices for the rest of the year.
Chinese e-commerce company JD.com’s five-year, $1 billion loan, signed with bookrunners in December 2021 and now in syndication, pays an 85 basis point Libor margin, with all -ins in the 90 basis point low zone. A banker close to electrical appliance maker Midea’s three-year, 3 billion euro loan, also signed in December and now on the market, said the margin was well below the group’s last two borrowings, including a contract of $634m over five years in 2019 that paid an all-in high of 110bp.
An increase in transaction prices will certainly be good news for loan bankers – but for lenders to benefit from higher prices, they will actually have to set up transactions. This is where the challenge lies.
For starters, the Fed’s interest rate hike is long overdue, 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 that the company deliberately launched the refinancing plan early. The maturity of the deal to be refinanced falls in December 2022. Midea also started its discussions earlier, given that its old deal will not expire until August.
JD.com and Midea are just two examples of a much larger group of companies refinancing their debt well before maturity.
That has left many bankers in limbo this year, given their reliance on refinancing activity – which typically accounts for the majority of loan flow – to meet their annual business lending targets.
Worse still, the already low share of new money lending activity is also expected to decline.
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 following three quarters to 4% in the fourth quarter, according to data from the National Bureau of Statistics.
This figure is expected to be even lower in 2022. ING has revised its Chinese GDP growth forecast for 2022 to 4.8% from 5.4% in February, due to weak monetary and fiscal policy. The GDP growth rate for the whole of 2021 was 8.1%.
The macroeconomic slowdown, together with the impact of the Covid-19 pandemic, will lead to limited capital expansion. Bankers say production lines at many overseas Chinese companies have come to a complete halt, while others have no updated plans.
Companies’ onshore activities will still need to be financed, but companies are unlikely to come overseas to meet their domestic financing needs, especially since the cost of onshore financing is cheaper than abroad. international.
Slowdown in the mergers and acquisitions sector
Event situations are also not likely to provide much deal flow. Global private equity firms, many of which have raised new funds for their Asian portfolios over the past year, are more interested in South and Southeast Asia than China.
Their shift in focus is largely driven by limited acquisition targets on the continent. Like banks, global sponsors have also stayed away from the property sector, which has been struggling since financial problems at China Evergrande Group came to light in September last year. Since then, many real estate developers have missed bond payments, defaulted, conducted distressed exchange offers, sold assets to fill liquidity holes and been downgraded by global rating agencies.
Before the problems in the real estate sector unraveled, many private equity firms were already turning away from the tech and education sectors amid the Chinese government’s crackdown.
Business-to-business acquisitions will also remain slow. With scrutiny from the United States and Europe, as well as China’s own policies, Chinese overseas M&A deals have seen a steady slowdown since the peak in 2017. This trend is not expected to change so soon.
Outbound M&A deals completed in 2021 totaled $24 billion, down from $29 billion the year before and $138.9 billion in 2017, according to a report by Baker McKenzie.
Of course, some Chinese companies will continue to expand overseas, and the market will continue to see action from smaller private companies seeking modest-sized loans. Bond market turmoil may also push some borrowers into syndicated deals. But the heyday of the Chinese loan market is probably over.