insto - Australian financial markets

Welcome to the club

Syndicated loans teams kept their deal pipelines open, even in the darkest hours of the credit crisis, laying claim to the title of “cornerstone of the markets”. Our roundtable of leading bankers reviewed the year, and made some predictions.

PANEL:

• Stephen Boyd, Director, Loan origination and syndication
  NAB
• Gavin Chappell, Director, Loan markets
  Westpac Institutional Bank
• Wayne Green, Head of Australian syndications
  BNP Paribas
• Michael Isaacs, Senior director,
  Syndicate, RBS
• Sean Joseph, Director
  Syndications, ANZ
• Kevin Salerno, Managing director & regional head,
  Asia Pacific loan syndications, WestLB AG
• Loretta Venten, Executive vice-president, Institutional loan markets
  CBA
• Bernard Kellerman, Editor
  Insto

INSTO: Other than the well-documented restrictions on liquidity, what’s changed in the last 12 months for you?

Chappell: Refinancing has definitely dominated the market over the past year. We’ve gone through a period where the market deteriorated over the 12 months up until January, February this year. Since that time things have started to improve slowly again. Despite these challenges, deals have been able to get done the entire time for the right names and on the right basis.

Boyd: We are seeing larger lead bank groups. There is little if any banks at the senior level being subordinated in terms of their roles and responsibilities, so in terms of refinancing we are seeing very top heavy lead arranger in groups because no one is willing to accept a participant role in refinancing.

Joseph: It’s also a bit of an interesting challenge for CFOs and treasurers, given the way the market is. I suppose 3 years is about what you can get at the moment in terms of tenor, you might be able to get 4 years for the right transaction. You’ve got to refinance 18 months before you mature anyway so you have really only got a deal on foot for 18 months in the loan market before you have to be seriously looking at your refinance. That’s a very short cycle compared to where corporate treasurers and CFOs had been 2 years ago.

Green: Liquidity is important but I think it’s the overall credit perspective and profiles as well. Credit departments are having a much stronger say in what’s being done in the banks and that then does equate to liquidity as well, and I think it sets overall perception – are there more dangers, are there more fallouts out there that we don’t know about.

INSTO: And what other trends are you seeing?

Venten: I think some of the interesting deals are where borrowers are almost simultaneously recapitalising via the equity market and refinancing their debt by extending their debt maturities - with the overall result being lower gearing and refinancing risk reduced. On these transactions both the debt and equity components are being delivered to clients as a total capital solution.

INSTO: Another hot topic is whether the global banks have left the Australian market.

Salerno: Look, I think there has been a misrepresentation that the foreign banks have actually exited in that sense. It’s good for headlines but I think there’s a lot more to it, and the reality is, in some of the cases, the foreign banks, including our bank, have actually increased their lending year on year. There is a misunderstanding between banks that choose to no longer do certain sectors that they may have entered into. I think it is also important to remember that whilst foreign banks may have reduced or exited their office space in Sydney or Melbourne, they are actually still lending in Australia through their other offices.

INSTO: Any of the big four want to buy into that?

Chappell: I most definitely agree with Kevin’s comments. I think it’s definitely been overstated by the media in terms of who is exiting and so forth. It is fair to say, though, that some banks have exited the market both in Australia and in region but it is a relatively small number. However, in addition to exiting banks, there are a number of banks that have reduced what they can do either by sector or in terms of the size of transactions.

Boyd: Our experience has been most banks have definitely been more selective in what transactions they will support and have greater expectations for ancillary business. Most will take the opportunity in refinancings to assess their commitment with several either reducing or not renewing their commitment.

INSTO: Another point of contention with your colleagues elsewhere is that you’re pricing too generously and killing off the bond market, for one.

Salerno: I think they’re two different investor markets. For as long as I can remember there’s always been a distinction. The loan market tends to be sold in the Asia Pacific to end holders

who do a credit assessment and buy an asset for long term hold. The institutional market and the other bond markets tend to be buying probably more on a opportunistic, perhaps speculative view and they’ll take a trading position on that and therefore they’ll move [assets] very quickly.

Green: It’s the deal with availability as well and when you’re comparing an Australian corporate going to US bond market or another market overseas, they’re obviously paying premiums because they’re not that big in the overall picture of the global environment. They are considerably better known in the local market but not so when they get overseas. There’s a lot of competition in the offshore bond markets and companies can get better value through the domestic loan market because they’re much better known. Investment grade rated loans with a three to four years tenor is the sweet spot at the moment right across the region, particularly where there is a strong name in a resilient sector, such as Woolworths, retail, commodities with Woodside. So you’ve got to have the right deal to entice everybody to come into it. The loan market is still the cornerstone to borrowing and the capital markets are the next alternative but never the first alternative.

Salerno: As you saw in this crisis over the last 12, 18 months, we have seen the inability for issuers to issue in their own name, they’ve gone back to their banks to get loans again, and that’s because, again, the wholesale investor who buys the securities is just that, buying the security as opposed to a loan so it’s a different end holder.

Green: Well, it’s easy to discount the corporate bond market in Australia because it basically closed. I know that’s an exaggeration but it’s certainly difficult. Overseas markets give the benefit of longer tenors, but if you’re looking for something put together quickly at competitive pricing, yes, it’s going to be a loan market.

Salerno: Remember that the bond market dried up well before the crunch and loan markets kept on going. But loan markets were struggling with the weight of deals because the bond market wasn’t there.

Chappell: There’s another important factor – there’s a timing issue, from when those deals were actually launched to when they closed or at least all banks had committed (syndicated deals have a much longer gestation period and time to close than a bond deal). So using the Woolworths example, if they were to do a bond deal today for 3 years at those sort of pricing levels, I’m sure there would be quite a reasonable amount of appetite out

there to actually buy that paper – however that may not have been the case when the bank deal was launched. There’s also a timing consideration that people need to think about in terms of how fast the market is moving and what point you approach the market, at what price level.

Joseph: I think the tenor is something that’s quite often forgotten and people are going to the USPP market to get 7 and 10 year money. Like in Australia, obviously the bank debt mark is pretty much capped out at a 3 to 4 years environment plus we haven’t seen the domestic corporate or debt capital markets stretch anywhere beyond the 3 years.

Boyd: I think it’s an important point for any one of our banks going into a loan transaction. We don’t just look at lending, we look at the relationship opportunities – the financial markets, business or transactional banking or whatever else we would like to do with the client. In any case, loan pricing in Australia is not inconsistent with pricing in offshore markets. Most banks will benchmark pricing with comparable deals in globally so you will not get much traction with an underpriced deal in this market.

Green: The loans are also a flexible product that gives borrowers a lot more opportunity to do things down the track, whereas you don’t get that flexibility with bonds.

INSTO: The argument from the corporate bond market teams is that loans are clearing because you are offering such an appetising spread that you’re mispricing loans.

Green: Banks are not mispricing loans but are now seeking a balance to their risk/return ratios after including liquidity and capital costs. Borrowers are not necessarily pleased with this, just ask a borrower that’s having to pay margins that have increased fivefold in the last two years and see how happy they are with it.

Venten: The other thing on bonds is timing. If a borrower is going to issue bonds, they have to ensure where possible the “stars are aligned” on the day, given the volatility experienced during the GFC, particularly if there is adverse news in the market on the day you are issuing. This can impact on your pricing quite dramatically. Bank loan credit margins are not as vulnerable with respect to day to day volatility. Also, investors in bonds require liquidity to sell the bonds back and trade them which can impact on pricing, whereas on bank loans you’ve got the end holders being the banks that are prepared to continue to hold to maturity.

INSTO: Talking of liquidity, what about development of a secondary loan market here?

Salerno: There are some secondary loan sales that have happened. Would I call it a market?

Isaacs: In Europe it has always been a very big feature and you know every major European bank has a very large secondary trading desk and have been doing it for years. Here it’s never been a feature it’s always been more ad hoc. With hedge funds here and leveraged loans and the distribution of leveraged loans, certainly there has been a lot more interest from funds looking at secondary sales. I think you are seeing banks more focused on it as well and certainly using development of secondary desks in Asia and in Australia as well.

Joseph: I think we are the only bank with our own dedicated secondary market desk based in Australia. And because we are the holders of most of the assets in the market, so if we’re not trading then no one is trading. On the investor side, distressed buyers are really just looking for 50 cent type trades they’re not really looking for the 80 – 90 cent trade. I think you need a new type of investor who can go up there and say “I don’t need 30 per cent IRR to make my money, I can actually make it in 20 per cent.” There should be a lot more trading going on at the 80 – 90 cent band in corporates, rather than trying to find one that is distressed, where you typically just follow it all the way down the curve.

Isaacs: And also you look at the corporate market and corporate pricing there are banks with loans on their books with very thin margins. There are clearly banks out there with capacity looking to buy good quality corporate names and I think you are seeing some of that develop into a secondary market as well. I wouldn’t say it’s ramped with lots of trading but you can see the formations of what could become quite an interesting market for everyone.

Chappell: I think one of the important things is to get a strong secondary market here, and I think we touched on it before is you actually do need a relatively stable market. Once you get a stable market people will have confidence about the levels they can buy and sell assets at and that will clearly help with development of the market. Banks in particular will also have a greater propensity to sell assets when pricing is stabilised such that they do not incur a loss through selling performing assets at a dramatic discount.

Venten: The other thing is the revolving nature of some loans where they can be redrawn and repaid. These loans are usually slightly more difficult to widely transfer in the secondary market as borrowers are conscious of counterparty risk as they want to know who is going to be funding them.

Green: We all believe in it, we all want it to work and we want it to see it work efficiently and we are all happy to contribute to it. It is just very slow; it has been very slow for years. Borrowers need confidence as to who their lenders are going to be and that’s one of the problems for the market.

INSTO: What would need to happen to move it forward to that extra step?

Joseph: Borrowers allowing transferability.

Salerno: I think you need more traders. At the end of the day I still argue that they are two different markets. The trading implies buying and selling for a profit as oppose to take and hold or simply buying because you want to reposition a portfolio. When you talk US or UK markets there are people who are still paid to actually pass the parcel around on movements in the market like the bond market.

INSTO: Moving down the curve, as you put it, Sean, is your bank seeing a big trade in distressed debt at the moment?

Joseph: What we are seeing is a lot of funds being set up to trade deeply discounted senior loans, not just domestically but from the Asian region. The reason behind that is that Australia is quite an easy place to invest with AAA rated transparent legal system. The domestic majors certainly feel that they’re in a better position to work through these sorts of distressed situations than they are of giving away to someone else, but I haven’t seen a lot of volume flow out of it.

Isaacs: We are getting a lot more calls about distressed corporate loans. A lot of the calls on the stressed corporates are potentially perceived to be overgeared and have a potential balance sheet issue, it is more from companies who are looking to get into a position where there is likely to be restructuring, where they can influence an outcome.

Green: What we have tried to promote – and we still see parts of it today – is institutions coming into the market. A lot of those in the market are hedge funds or high yield funds, but they are looking for a yield which is just not available in the Australian market unless they can pick up loans at a discount. We don’t call it distressed debt but they need a deep discount because they’re looking at yields in the high teens to low 20s.

INSTO: Another trend that seems to be emerging is increased activity between Asian banks and Australian corporate borrowers.

Joseph: Frankly that’s distribution and frankly I don’t think that’s anything new. You look back however many years there have been plenty of deals that have gone to Asia and we’ve looked at targeting Asian banks, but I think what’s actually happened now that the market has shifted in terms of pricing expectations of banks up in Asia versus 2 or 3 years ago. Two or 3 years ago the spreads for an Australia deal were way too low to attract some of the Asian banks that are now doing a deal that wouldn’t have done a deal 2 or 3 years back. I think there is a kind of a bit of dynamic change on that perspective.

INSTO: Why do you think that is?

Joseph: Well, it’s pricing and the structuring of terms and conditions that match the appetite for Asian Investors. Previously there was a perception in Asia that Australian transactions were only distributed to Asia if they were difficult. Now we specifically structure transactions to meet the Asian investors’ appetite.

Green: Two years ago triple B investment grades for 3 year loans was coming in at an all-in of about 50 to 60 basis points. Nowadays you’re looking at 300.

Venten: Clearly the Asian market is taking well rated credits and well known names and the size of those transactions are big enough to take up to those markets, like Woodside. I think the target was originally about $300 million and the response was quite overwhelming on both Woodside and Woolworths. Fosters is being distributed in Asia at the moment and the response has also been very good. It’s well known names, well rated corporates that are getting interest from the Asian market.

INSTO: And what will it take to move away from club deals to a more definite situation where the big banks underwrite loans on their own?

Isaacs: It will come down to right deal right time - that will be the one that gets underwritten. And you look at the deals that are successful in the market at the moment, certainly those are high quality corporate borrowers. Certainly you look at Woolworths and Woodside and I think they are two very good examples of transactions that tapped capacity in the market and certainly very well received and were very successful as a result of that.

Boyd: The syndication of loans need to be oversubscribed on the terms and pricing launched into syndication before you would consider underwriting a transaction. Another way to look at it is that we’re working with borrowers to put these loans together and achieve the desired volume so borrowers continue to have confidence in the loan market.