Tightening spreads, lower fees and fewer covenants are among the more savage uppercuts bankers are taking on the chin, reports Steven Irvine.
At the recent signing of a syndicated loan in Hong Kong, one of the bankers was heard to quip: “Ah, a Dunhill pen. Well, at least this should improve our profitability on the deal.”
In case you haven’t heard, this is not a good time to be a commercial banker in Hong Kong. Spreads on local syndicated loans have been narrowing dramatically. Meanwhile, an excess of liquidity in the system promises little respite.
If, however, you are a top-rated Hong Kong corporate, then in the words of Harold Macmillan, you’ve never had it so good.
Consider the recent HK$12 billion loan for Hutchison Whampoa. Hutch was able to get not just five-year money, but also push the loan out to seven years – and receive pricing (for the biggest Hong Kong dollar loan ever) at a very tight blended cost of only 49 basis points over Hibor.
Indeed, bankers say top names have seen their pricing tighten in from 120bp over (after the financial crisis) to pricing in the 40s and 50s.
But it is not just top-ranked players that are doing tightly priced deals. Local bankers say that the greatest spread compression has been among the middle-tier corporations. For example, Wharf was paying 300bp over Hibor after the financial crisis and is now getting five-year money for around 60bp over.
Similarly, the unrated Kerry Properties priced a deal at 65bp over.
The excess liquidity that local banks face is a driving factor. Consider that when Sun Hung Kai announced its revolving credit facility, the originally floated $5 billion was soon upscaled to $7.8 billion due to the welter of demand, as desperate local banks eagerly sought to put assets onto their balance sheet.
“We have seen a trend of excess liquidity,” says Peter Chan, who ran syndications for Bank of America, but has just joined DBS. “This trend will continue. It will be like this for most of the rest of the year.”
Says Clarence Tao, who runs syndications for BNP Paribas: “Has pricing bottomed? I wouldn’t say that. Today you really have to sharpen your pencil to win a mandate. Pricing is still going down.”
And says his counterpart at Barclays Capital, Grace Tam: “We’ve had 12 straight months of price declines. There has been a lot of refinancing going on of earlier, more expensive deals. Pricing is now half what it was during the crisis.”
And just in case you’re still in any doubt, Standard Chartered’s head of syndications, Philip Cracknell, further catalogues the banker’s tale of woe, and corporations' sense of bliss: “Keen competition for mandates combined with liquidity in the banking sector has resulted in margins falling. Thus borrowers have been able to enjoy the ‘double whammy’ of falling absolute rates and reduced margins. Many borrowers are taking advantage of low rates to secure funding and lock in rates through the swaps market.”
So what is causing this liquidity mismatch that is proving such a boon to borrowers?
The return of the Japanese banks (which at their peak were 30% of the market, but are now around 10%) is one thing. But more importantly, the demand for new loans is actually dropping. In the first quarter, Hong Kong loan volumes were 38% down on the comparable period in 2000.
JPMorgan’s co-head of debt capital markets, Paul Bartlett thus points out: “Banks are sitting here in Asia with budgets that are up from last year, yet with 30% less demand.”
Moreover, banks that never got so involved in the syndicated loan market – the smaller Hong Kong banks like the Wing Lungs and Dah Sings – have jumped into the fray. That’s because their old staple lending business – mortgages – is no longer the golden goose it once was.
These banks used to make prime plus 1.75% on low risk mortgages, making it a very profitable business – indeed, one that a head of syndications described as ‘daylight robbery’.
This is no longer the case. Banks are now receiving prime less 2.5% for mortgages, and in an increasingly competitive market. They are also realizing that mortgages are very costly to originate.
The problem is that Hong Kong property prices are down 50% since the crisis and show no signs of imminent recovery. There is thus very little growth in new mortgages.
Instead, banks are persuading homeowners to refinance their mortgages, to benefit from lower rates. The banks are hence cannibalizing each others’ mortgage books and gradually shrinking their loan books – since in a falling property market, the sums being borrowed at each refinancing are less.
Maybe you are you wondering why you are hearing so much about M&A in the Hong Kong bank sector? Look no further than the slow death of the mortgage business.
Thus with the mortgage business proving tougher, the banks have shifted their liquidity into the local syndicated loan market.
If that is one half of the bigger, structural problem, the other half is the fact that the number of borrowers is falling. According to one banker, the mainland Chinese borrowers – which used to be active users of the market – are now taking advantage of lower rates in China. They are taking a sensible view: why borrow in Hong Kong dollars and risk a devaluation of the renminbi?
Accordingly, one banker estimates, the universe of names using the Hong Kong market is only between 20 and 25, and these are the main beneficiary of falling spreads.
“Most lending in Hong Kong,” says one banker anonymously, “is to 10 families that own the big property companies. So the lending is already too concentrated and even with this, the banks are too liquid and don’t want to lend to other clients further down the credit curve, because they see them as a bigger risk exposure. In the Asian turmoil, most banks learned not to take too much risk.”
As ever, a debate about a structural problem in Hong Kong comes back to ‘property’. Unlike anywhere else in the world, the blue chips in Hong Kong are basically all property companies. Banks don’t have the option of lending to real industrial companies because Hong Kong’s industrial base moved across the border to China long ago.
So from a lender’s perspective, it is property companies or the rare stable utility, such as Hong Kong Electric. There is precious little else apart from telcos, which aren’t exactly flavour of the month right now. The rest of Hong Kong companies tend to be small and medium-sized enterprises making up Hong Kong’s giant service sector.
And this brings up another issue compounding bankers’ woes: the competition from the local bond market. Says Bartlett: “A lot of the activity in the bond market this year has put pressure on the loan market.”
As one banker put it, the top names can get three or five-year money of amounts of HK$500 million from the bond market and then swap it into Hong Kong dollar floating for plus 15-20bp, which is over 20bp tighter than the loan market.
The Airport Authority did a floating rate note at 15bp over Hibor, and not for a small sum of money either, raising HK$2.4 billion.
When corporations can use this line of argument with bankers, it is hardly surprising they are able to exert such leverage and get such great terms.
This is reflected in their ability to raise seven-year money at hardly any pick up to five-year money.
It is also evident from the explosion in so-called self-arranged deals, which dis-intermediates banks from the arranger role. Instead, the borrower calls its favoured banks to arrange a loan facility without a syndication or an underwriting, thus saving many basis points of arranger fees.
In a world of banks begging to lend and loose liquidity, the borrower is able to make a few phone calls and carry out its own quasi-syndication.
“Self-arranging is inevitable when a market gets to a certain level of maturity,” says Chan. “Normally it can only be done by a very stable company with a good credit quality.”
Thus far Sun Hung Kai Properties has been able to self-arrange a loan with 22 banks. Amoy Properties, Henderson Land, and Kerry Properties have all self-arranged deals too.
Bankers look to the self-arranging trend with obvious disdain, but draw solace from the fact that it is essentially a cyclical phenomenon.
Says HSBC’s co-head of investment banking and head of loan syndications, Avi Bindra: “There have been a few self-arranged deals, but this tends to be a phenomena which occurs when the markets are very liquid. Banks participate in these deals because the borrowers are very good credits, yields are still within acceptable levels and because they expect to get collateral business. When the excess liquidity disappears or if the expected additional business flow does not come through, then there will be a reluctance to do so the second time around.”
Perhaps the more worrying trend for banks – if we assume self-arranged deals are a temporary blip – is the way corporations have been able to make banks jump through hoops in the area of covenants.
All of the bankers FinanceAsia spoke to emphasize this is a grave concern.
One of the first to come under pressure was the minimum tangible net-worth covenant, which triggers a loan repayment if the company’s worth goes through a pre-covenanted level. “In the crisis some of them breached this covenant, so many Hong Kong companies are very sensitive about this,” says one banker.
Says another: “The first to go is the minimum net-worth covenant. Then debt-to-equity ratios and interest-cover ratios. I’d give up the net-worth covenant first. Obviously, I don’t want to give up any. But we are seeing this happen as we speak.”
The standard three-times-interest cover ratio is also said to be under pressure.
Others that have been raised in recent ‘discussions’ between CFOs and local bankers are transfer language and increase cost clauses. The former surrounds whether the bank needs to get the borrower’s approval before it sells their loan to another bank. It used to be that the bank could do this without the borrower’s permission, but the borrowers are now saying they must agree.
Increased cost clauses came into vogue with the Japan premium whereby banks could pass on their own increased funding costs to the borrower, or else call the loan. CFOs are now saying bye-bye to this one with a vengeance.
Are there any rainbows on the horizon? Unfortunately the horizon is not exactly one that Wordsworth could write a poem about.
Some mention the Bank of China situation as potentially positive. The BoC dominates the local loan market, along with HSBC. Both banks are able to take down a bigger percentage of a loan thanks to their ability to parcel exposures out to subsidiaries – in HSBC’s case, Hang Seng and in BoC’s case its 12 sister banks.
Some bankers argue that this practice allows BoC to bring some loan syndications to market at “very aggressive levels”.
However, they are hopeful that once the Bank of China is listed with an ADR in New York and the sister banks are injected into the new entity, that a new transparency and return-on-equity culture will arise and that this may prove beneficial in the long term for rival banks in Hong Kong.
The other positive is the more structured deals. As Citibank’s head of syndications, Mohsin Nathani comments: “One positive is you are seeing pricing holding up in the more structured transactions.” Citi was an arranger on the Hutchison Global Crossing deal, which is being syndicated at 180bp over Hibor.
The bigger picture, however, remains grim.
No wonder one long-standing loan professional ended an interview by looking out of the window at the harbour and musing: “One thing is certain. This is not a good time to be a banker.”
Bruised, battered and on the ropes is an apt description. Indeed, local syndicate professionals are being put through so much pain, one almost wonders whether a course of massage and therapy might not be necessary to return them to their old plucky selves.
