Why international banks shun Asia high yield

Author: | Published: 25 Jul 2011
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Immaturity in Asia’s high yield market is prompting some international banks to walk away from deals.

Bankers in the region told IFLR naivety among south-east Asian banks over structuring high yield deals was particularly apparent.

Local banks often start deals before seeking legal advice or establishing inter-creditor agreements with other lenders in the transaction, one acquisition finance banker at an international bank explained.

"In one transaction we only became aware that inter-creditor arrangements had not been put forward some way into proceedings," he said. "We had to walk away or risk signing up for un-market friendly agreements which could pose a major problem in the near future."

HSBC’s managing director and Asia-Pacific leveraged and acquisition finance head, Lyndon Hsu said there was still a long way to go before the Asia region became homogenized on structured lending and senior debt. "The market lacks sufficient uniformity on terms and therefore insufficient investor liquidity," he said.

It would be some time before the market accepted the more advanced structures seen in the US and European markets, he said.

Standalone market

Allen & Overy’s international capital markets partner, James Grandolfo agreed the Asian market was still very much in its infancy. But he was optimistic about its future.

The market is currently around 10 years behind that of Europe and further behind the US, he said.
But there
had also been a very large amount of corporate high yield deals in the region since the end of the financial crisis. And signs that a financial sponsor-driven high yield market are emerging.

"Involvement of hedge funds and large financial institutions depends on how acquisitive companies become," he said. 'It could be some years off but the signs are positive."

Low interest rates globally had prompted a flurry of recent deals. This has enabled corporates, who wouldn’t normally have had the opportunity, to enter into debt capital markets at affordable coupons.

Financial sponsor-driven transactions, in which large institutions buy a large percentage of the deal and dictate inter-creditor arrangements and covenant packages are rare, according to Grandolfo.

Large private equity funds would help drive the process, he said. He added that it was more likely in more developed markets with a greater degree of certainty in cases of default, such as Japan, Australia, Hong Kong and Sinagpore.

Challenges

In the meantime, it was important to be aware of the risks and challenges that participation in a comparatively unsophisticated high yield market involved.

"Bankers in Asia face helping companies to understand what they are signing up to when entering into a high yield deal," he said.

Many issuers still don’t understand what is expected from high yield covenant packages. "It can be very difficult for those who don’t work with this product regularly, to understand the full extent of the restrictions involved over the life of a bond," said Grandolfo.

Educating less sophisticated companies on the covenant package on offer was therefore critical to the deal’s success.

A proper understanding of a corporate’s business plans was imperative. This would help to ensure the covenant package drafted worked not only for investors but also for the issuer.

"When acting for issuers, making sure the structure works requires a lot of discussion with the issuer as well as the banks underwriting the deal to ensure the covenant package is right for all parties involved," he said.

"Given the volume of deals in the market, bankers face the challenge of educating a wide-spectrum of companies varying in sophistication and familiarity with the product," said Grandolfo.

In a sponsor-driven market, the sponsors lead development of covenant packages. But in the Asian market, these are led by the banks underwriting the deal. They put together what they think the broader investor base want to see in terms of covenants.

But according to Grandolfo understanding the issuers’ medium-term goals over the life of a deal was important. The covenant package could then be structured to take these into account.

Investors’ unfamiliarity with the region had help to promote concerns regarding the efficiency of local insolvency regimes. Often such concerns were exaggerated or unfounded, he said.

"People assume there is more certainty around US and European deals because you can rely more on the bankruptcy law and governance regimes," he said. But Asia has actually seen fewer defaults than the US or Europe in recent years.

"The problem is in a lot of jurisdictions, insolvency regimes are unclear, under-developed and frequently unenforceable so the likelihood of getting any significant returns if there is a default is limited," he said.

But he was optimistic corporate governance would increase as the market matured, and participants became more sophisticated and familiar with the products. "Asian high-yield is here to stay," he said.