How to make money in Asian debt as competition bites

Amid growing competition, Morgan Stanley’s Julien Begasse de Dhaem gives his strategy for a profitable debt business, from financing ChemChina to selling Formosa bonds.

It’s tough in debt, says Julien Begasse de Dhaem, head of Asia Pacific global capital markets for Morgan Stanley. You have to box clever. 

Begasse’s recipe for success is to mix a focus on high-yield bonds with the ability to match issuers from outside of Asia with the region’s growing cohorts of investors. The cherry on the top is to selectively take risk by creating solutions for borrowers such as state-owned China National Chemical Corp., or ChemChina, which is seeking to become the world’s biggest chemicals company via its takeover of Swiss agrichemicals firm Syngenta.

“We’re having our best year ever by quite a margin when it comes to debt capital markets,”  Begasse said in an interview with FinanceAsia.

Morgan Stanley is also looking to take a certain amount of risk itself, so it can earn extra fees by helping clients to solve knotty financing problems.

“If a client has an issue, you spend a lot of time creating the solution, and then you make the solution available to them by putting your balance sheet at risk. When you do that, you get paid more than your usual fee, but you’ve helped unlock a very difficult situation for everyone involved,” Begasse said.

In the sphere of M&A financing, some US and European banks have been quick to react to a pullback by Chinese banks. 

Chinese offshore lending in the first nine months of the year was down 8% on the previous year at $35.2 billion, data from Dealogic shows, illustrating how China’s deleveraging campaign has begun to bite.

People selling businesses to Chinese companies have become more cautious as the risk of deals falling through due to funding problems has grown. Chinese regulators asked Chinese lenders earlier this year to scrutinise their loans to acquisitive companies, market sources have said.

“Boards of companies selling are now very keen to see international banks involved in the financing,” Begasse said. “For the first time in a while, the acquisition financing business is becoming interesting again in Asia.”

Taking (calibrated) risk 
 
The US bank stepped in when Shimao Property was looking to raise $600 million in June.
 
The Chinese real estate developer struggled to place the full amount with investors at the price it wanted in the wake of huge bond issues by two peers, Kaisa and Evergrande. So Shimao downsized its sale to $450 million and sold bonds due 2022 priced at 100 with a 4.75% yield, which traded higher in the aftermarket.

Morgan Stanley then offered to buy the rest of the developer’s planned debt issuance before its approval for fundraising from China’s National Development and Reform Commission expired at the end of June. It reopened the deal for $150 million at 100.25 and a yield of 4.62%, a slightly more favourable rate for the issuer in a so-called tap which settled at the same time as the original deal, according to a market source.

In another complex situation under time pressure, Morgan Stanley helped finance ChemChina’s $44 billion acquisition of Swiss agribusiness Syngenta.

After keeping in touch with the company about financing since the acquisition launched in February 2016, Morgan Stanley was able to step in when it became clear there was an equity-funding gap.

Beijing-headquartered ChemChina had arranged a fund structure that would invest into convertible preference shares, according to a May 18 SEC filing.

Morgan Stanley, the only non-Chinese institution involved in this part of the funding, was able to bridge a hole by buying $2 billion-worth of the convertible preferred shares, alongside one large sovereign wealth fund co-investor. The US bank then sold the balance onto international investors via private placements, according to people familiar with the fundraising.

“So, a very highly complex product, very little time, and so that’s why, in the end, we bought it,” Begasse said.

Morgan Stanley also had to bridge the gap between the investors, who demanded a hefty premium to invest in such a complex structure at such short notice, and the company, which did not want the terms to go public.

“It’s one of the biggest trades we’ve done in a fully underwritten format, globally, in terms of an investment grade bond,” Begasse said.

Competition

On the surface a profitable year in debt capital markets is hardly surprising given G3 volumes in Asia-Pacific excluding Japan hit a record $334.2 billion in the first nine months of the year, up 36% year-on-year from the $246.6 billion recorded last year, according to data provided by Dealogic. Fees garnered by banks for handling sales also shot up to $1.056 billion from $642 million in the year-ago period.

“Based on Dealogic data, the fee pool in [the] Asia ex Japan International G3 market is at a record high and has already surpassed [the] full-year revenue for 2016 ($809 million)," Louis Ng, Asia-Pacific head of fixed income at Dealogic, said.

Ng added that the growth of the fee pool was being driven by a significant jump in Asian high-yield business.

But dig a little deeper and there is a banking war on fees going on in the public bond markets, driven by increased competition from Chinese banks.

Historically Chinese commercial banks have lent to Chinese issuers, particularly state-owned enterprises, and bought the bonds issued in the domestic market, particularly from financial borrowers.

So it has been a convincing pitch for them to ask for a place in the syndicate selling their bonds. Their position in the league tables has been amplified by the fact Chinese issuers were responsible for 46% of bond issuance across Asia Pacific excluding Japan in the first nine months of the year, up from 36% in 2016, according to Dealogic.

““A lot of these deals are becoming increasingly invested by Chinese investors for Chinese issuers with Chinese banks book running them, so it’s very interconnected,” Begasse said. 

Begasse picking DCM battles carefully

One consequence of this shift is that practices that are commonplace in the Chinese onshore market are now becoming the norm offshore as well. For example, some Chinese borrowers now reward bookrunners on the basis of the buy orders for bonds that they bring in. This instils competition into the syndicates to reach investors first. 

It  is similar to what has been happening in equity markets: one syndicate member brings in a cornerstone investor and then lays claim to a bigger share of the fees.

International investors may also struggle to secure the allocations they want, as increasingly Chinese banks either buy and hold the debt themselves or, in many cases, allocate to Chinese investors who are long-standing customers.

For high-yield bonds, the Chinese commercial banks are so far less visible, partly because they don’t often buy and hold higher-risk instruments.

“High-yield bonds still need a lot of international investors’ participation,” Begasse said. Also “most issuers understand that this is not a commodity product, and you need execution capabilities.”

In public markets across Asia, excluding Japan, Morgan Stanley raked in fees of $48.1 million from G3 investment grade bond issuance in the first nine months of 2017, up from $20.49 million over the same time period last year. In high yield, Morgan Stanley collected $18.88 million up from $6.35 million, according to Dealogic’s analysis. 

Dealogic data does not always capture private market deals.

Import business

Morgan Stanley is also focused on what it dubs the import business: bringing issuers from outside of Asia to the region’s Asian investors.

In this respect, the US bank has been particularly active in the Formosa bond market: foreign-currency-denominated bonds sold in Taiwan.

Morgan Stanley has also arranged large private debt placements from US utilities to a handful of investors in Asia.

“This is under the radar screen but again, for us, if we can get US issuers paying US fees and add value to them by bringing them Asian investors buying very specific products, this is a win-win for everyone,” Begasse said.

Additional reporting by Ernest Chan

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