Borrowers, buyers, bonds: A banker's view

Mark Leahy, regional head of global risk syndicate at Deutsche Bank, discusses the new challenges faced by borrowers, investors and advisers in Asia's bond markets.
How would you describe the market in the last few months and what is your outlook?
The market has been open to appropriately-priced, investment-grade transactions all year and remains so. Some issuers may say itÆs closed because the price is too hard for them to contemplate. Nonetheless, deals can get done at sensible levels. Every Asian investment-grade deal has priced cheap to fair value, but not excessively so. I think that the market is open for double-B and some single-B repeat borrowers. Solid new double-B high-yield names can also work.

A single-B debut issuer would need something heavenly to succeed, such as an equity injection from a strong sponsor, something particularly attractive about its underlying business, or be in a certain sector that investors are still hungry for. Otherwise, it would need to have economics that are simply too attractive to ignore, or market conditions that allow investors to close their eyes - again.

How do bankers draw issuers out and manage their expectations?
ItÆs a challenge. In the US and Europe, most borrowers are seasoned and lucid about the state of the markets. This is not always the case in Asia where being the harbinger of bad news can lose you a deal. Some bankers are defensive when it comes to laying out the facts if these arenÆt what the client wants to hear. I think the key to winning mandates today is being factual and forthright.

What sort of deals do we need to see in the public market?
As we move from investment-grade into high-yield, we need to see credits that are able to pay coupon and principal for life, that have a liquidity profile that is unlikely to trip them up and that are engaged in sensible mid- to late-cycle capex and M&A behaviour. If an issuer doesnÆt exhibit all of those characteristics, then they should stay out of the public markets and instead consider other bespoke forms of private financing.

Which credits can damage the markets?
Credits where governance has been compromised, or those that have a chequered history or individuals with questionable ethics on their board. If the market weakens, these credits are the first thing investors will sell. A poor market shows us whoÆs naked, to paraphrase Warren Buffet. Realising that you own something you donÆt really understand knocks your confidence and further lessens your ability to make rational decisions.

But, given that so few deals have come to market this year, isn't a deal pricing, regardless of the quality of the credit and the cost of financing, a good thing?
No, I donÆt agree with that. Yes, itÆs good for the bank because it boosts morale for an under-utilised team. It can be good for the issuer, although in some cases a dealÆs covenants can prove too challenging, or force them to pay sums they canÆt really afford. But itÆs not necessarily good for the market as a whole.

Many investors rely on short-term external drivers: the marketing pitch, ratings, or market sentiment at the time. Or perhaps they donÆt have much inventory on their books on a particular day and theyÆll choose to buy for that reason. Maybe, at a senior level, a bank has decided to increase its exposure to a specific geography or sector, which would lead it to invest without paying enough attention to the specific risks. I think too many investors are still relying on third parties to do the real credit work. This may work in primary markets, but in the secondary market those investors are on their own, and in the dark. Hence, investors can be at greater risk of being taken by surprise by a poor or weak transaction. This undermines their confidence to the point that when a strong deal does come along, they arenÆt willing to participate.

But as the market grows, so will the number of ôconviction buyersö, or dedicated fund managers with the appropriate level of credit expertise making considered and independent investment decisions. Such investors can more readily handle bad news or illiquidity, and manage and hedge specific credit or macro risks.

Conditions have improved. Why aren't more issuers coming to market?
Many borrowers in Asia are government-linked: totally or partially government-owned, recently privatised, politically influenced and/or operating in a state-regulated sector. The decision-making process for those issuers is very bureaucratic and avoiding mistakes can be as important as seizing opportunities. In contrast, private companies are more pragmatic.

This means that for the majority of Asian borrowers, the opportunity to print small, cheap arbitrage deals in local currencies, small loan transactions or private placements will seem much more appealing than the probably much more suitable but bolder step of doing a large international transaction.

Also, I guess Asian borrowers are less nimble...
Yes. Unlike borrowers in more developed markets, Asian issuers typically canÆt take advantage of narrow windows for issuance. The timeline of bringing a deal to market (request for proposal, pitching, mandating, documentation, and road show) can take up to two months, which constrains borrowersÆ ability to price when the market says they can. By the time a deal is ready to launch, that window of opportunity may have closed. Look at how few issuers have MTN programmes or SEC shelf registrations.

Also, issuers tend to mandate when markets are good. Really, they should mandate before so that they can take advantage of the market when it improves. But at such times, they might be faced with very unappealing borrowing costs, and the approval process for a deal can be stalled. This is often the nature of the Asian issuing client, which is very different to clients in more developed markets.

How has your relationship with clients altered in recent months?
The balance of power has shifted materially towards investors. Frequent borrowers have been able to play their bankers and the market very effectively since 2004. That phenomenon was a function of the marketÆs now obvious flaws and is no more.

As bankers, we need to explain to issuers how that balance of power has shifted and how borrowers can nonetheless achieve their objectives. Coverage teams who can adapt to this new environment will be the most successful.

The real opportunity to add value comes from how a bank answers the call from the client. In the past ôHow do I raise a billion dollars?ö was good enough. The question may not have changed much but the answer has. Unless a bank can think from different perspectives the opportunity will be lost. ôAre there several ways of doing this? How do we meet the objectives of both the issuer and the market within current constraints?ö

Bankers need a new prism through which to see the business. We still assign each transaction to a product expert in the team but now the entire team has input on the process. This broader perspective has led to us doing more private deals for frequent borrowers than ever before, which is better business for issuers, the market and Deutsche.

Job cuts are looming in fixed-income divisions of international investment banks, but Asia is still growing. How will this affect the industry?
The stronger players can use this as an opportunity to increase market share, but others are under considerable global pressure to reduce costs and restructure. There is no doubt that the regional business will continue to grow, providing some houses with a large opportunity. I think we will see a shift in the balance of power amongst the major and mid-tier players in the next one to two years.

Are you less willing to do sole book deals in these markets?
It makes sense to have a multiple bookrunners structure in these markets. We have typically been recommending joint books - two strong houses û because we think thatÆs the surest way of controlling a transaction in both primary and secondary markets. From a fees point of view, this is obviously bad, but it ensures the best possible outcome for deals and therefore generates more business.

How much can you influence issuers on their choice of bookrunners?
ItÆs issuer-specific. When you have a good relationship with a borrower sophisticated enough to have been through both good and bad transactions, you can have a lot of influence. But the borrower would probably draw the conclusions youÆd want them to anyway. For debut borrowers whose banking relationships have probably been more commercial bank-driven, more personal relationships come into play. This helps weaker houses get mandates they wouldnÆt otherwise deserve. That can be difficult because they may be a good commercial bank, but are not necessarily qualified to be a good bookrunner.

What do you do when an issuer insists on mandating a house you donÆt want to work with?
I typically tell the issuer itÆs going to cost them X basis points if they want to structure the syndicate that way. Then itÆs their prerogative. On occasion, we have refused a transaction and have lost business because we have thought the deal would be seriously compromised.

Finally, what are you telling investors? How are you reassuring them?
WeÆve had a crisis of global capital markets infrastructure, possibly the worst ever. Central banks are repairing that infrastructure, but the fundamentals continue to deteriorate. Inflation has hit recent highs across the region and in Europe and the US, oil is at $135 a barrel and default rates are increasing. While the first phase of the bear market has ended, the next phase is just beginning. But if you have a sensible capital markets infrastructure, then you can provide solutions and do business during those times. There's a very rough road ahead. It's too early to say whether or not the wheels stay on the bus this time.
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