The risk aversion of the Asian loan market is not a bad thing

Critics of the syndicated loan market in Asia have more to come. If the wider turmoil in the region’s debt market this year has proven anything, it’s that a conservative – and somewhat risk-averse – mindset about lending can pay off in the long run. .

The stress in the Asian US dollar bond market shows no signs of abating.

Leading real estate developer China Evergrande Group missed coupon payments last month on dollar bonds, along with other payments this week.

His situation is no longer an isolated case. Bad news has come from luxury developer Fantasia Holdings Group Co, which missed a dollar payout last week. Modern Land (China) Co announced a solicitation for consent on Monday morning, proposing changes to its $ 250 million 12.85% notes due October 25.

Developer Sinic Holdings Group Co also warned of an impending default, saying it did not plan to repay a $ 250 million bond due Oct. 18, a move that could trigger cross defaults on its other two notes. .

These developments raise critical questions about the health of the Chinese dollar bond market. Is a larger contagion effect looming? Will the developer debt crisis start to impact other parts of the Chinese bond market? Are problems looming elsewhere in Asia? And what can we learn from the rapid fraying of the financial health of these companies?

One risk that has been exposed in these situations is the weakening of the covenants carried by bonds in Asia.

Moody’s said in a report released in September that Asian investors had sacrificed covenant protection for better returns over the past decade.

The credit rating agency’s conclusion came from its analysis of 422 Asian high yield bonds from 2011 to 2020, where the proportion of Chinese real estate bonds rose to over 80% in 2020 from 59% in 2011. bonds weakened to 3.33 last year, which is considered moderate, down from 2.36 in 2011, which is considered good.

A lower score represents better quality on a scale of one to five.

Moody’s also added that the average fixed charge coverage ratio thresholds fell from three to 2.2 times over the period, meaning companies have more flexibility to issue new debt.

This approach among investors of sacrificing protection for juicier returns is now coming back to haunt them.

Stable, resistant

On the other hand, the Asian loan market has remained conservative over the years.

In addition to the fact that loans come with sustaining covenants – which are more stringent than the occurrence clauses typically seen on bonds – credit bankers have insisted on a high level of credit.

Even with a few recent leveraged buyout loans – like the $ 570 million deal for Baring Private Equity Asia’s acquisition of the healthcare unit of Hinduja Global Solutions – while the leverage ratio has grown to more than 5.5 times, the focus on debt to EBITDA remains critical among lenders. A senior banker from a major lender said GlobalCapital Asia this week that his company abandoned some transactions this year because the leverage ratios were too high.

Bond investors have long been viewed as more liberal. Credit bankers, however, take a close look at a company’s cash flow when making a lending decision. The fact that the borrower has a persistent cash flow and how he will use the cash are generally taken into consideration.

Certainly, this approach means that while Asia’s G3 bond has flourished over the years with volumes hitting new records every year, the opposite is true for loans. Volumes declined, with some issuers abandoning a traditional bank loan altogether.

For example, Barings Asia changed its original plan from raising a term loan to opting for a unitranche loan to support its takeover of the Philippine company Straive. Private equity firm Carlyle raised a loan to the bond bridge and added a mezzanine tranche for its leveraged buyout of India’s Hexaware Technologies.

More flexible covenants and an appetite for higher leverage ratios in the bond and unitranche markets, compared to the bank loan market, are appealing to sponsors.

But the escalation of the bond market crisis this year shows that credit bankers can be justified with their conservative lending strategy.

Stricter covenants on loans not only benefit banks, but also prove to be a boon to the rest of the market.

In Asia, bank liquidity has long been an important source of funding. The loan market is liquid, more stable, and offers businesses a less expensive way to meet their financing needs. It also often serves as a back-up source of funding for borrowers when the bond market is volatile and inaccessible.

The bank credit market may very well be cautious in its risk appetite. But in tough times, its stability and resilience is exactly what borrowers – and financial markets at large – need.

Priscilla C. Carnegie