Trade financiers have welcomed a correction in pricing and asset quality in recent months as the credit crunch brings markets back down to earth. Syndicated lending is feeling positive too, writes Helen Castell.
For many corporate financiers the current liquidity crisis would be a crisis indeed. Trade financiers however thrive on such events. Yes, it’s getting hard to attract second-tier banks, yes some deals are being dropped and yes, anxieties about what is coming next are keeping adrenaline levels high. But more than a minority of syndicated lenders are simply enjoying themselves.
“Is there still a strong market for pre-export finance transactions
- Yes there is,” says Simon Jackson, co-head of loan syndication at Sumitomo Mitsui Banking Corporation (SMBC). “Look at Kazakhmys in the market at the moment, which has done very well.”
“But it’s becoming more of a minefield,” he continues. “We are seeing a large amount of caution amongst lenders – some don’t like the price, some don’t like the structure.” And there is a “reluctance to underwrite on an unflexed primary basis and almost total reluctance to sub-underwrite anything.
“There is still scope for new structures, but one has to be careful in assuming that whatever one dreams up will sell – which had been the case for several years until last summer.”
Banks take the advantage“The market is slightly slower – but it’s still definitely open,” says Robert Scott, director, DCM – loan markets, at Standard Bank.
“If anything, banks are actually looking more towards the trade finance-type transactions than the plain-vanilla transactions that the market was moving towards until the end of the fourth quarter last year.”
“Banks have the upper hand now,” he notes. “They can pick and choose the deals that they like.”
This crunch has led to significantly higher volatility “and a repricing of risk all across the board,” says Valentino Gallo, managing director, global manager, structured trade, at Citi. But by how much and who has been hit hardest
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Rosneft’s current five-year deal is priced at 95 basis points, compared with 50bp for its May 2007 loan with the same terms and structure, notes Guy Brooks, managing director, global head of trade finance distribution, at Deutsche Bank.
The margins for all transactions have increased, although by varying degrees depending on the borrower, says Scott. For borrowers who used to pay 50bp, spreads have widened by 5-10bp, while those who were paying 2-3% are now paying 25-50bp more, he estimates.
Margins for transactions where the natural investor market is in the Middle East have been particularly affected, says Jackson. That market has suffered from severe funding problems, particularly in dollars, and these have fed through quickly to primary pricing, he notes.
Pricing for loans to some Korean banks has jumped 500% – to around 60bp from as low as 12bp pre-crunch, adds John Ahearn, managing director, global product head, trade services and financial institutions, at Citi.
The repricing was overdue, he adds. “Twelve basis points was probably way underdone. They should never have got to that point based on the risk parameters. But there was so much liquidity chasing so few assets that that’s where you saw the spreads going.
“In non-investment grade countries, places like Brazil where liquidity was enormous, you were seeing companies raising money cheaper than triple-A credits in the US, which theoretically didn’t have that country risk.
“I think we’re actually seeing a return to normalcy of what those markets should be. The last three years were the aberration – not what we’re seeing today.
“The problem that the markets have right now is that everyone likes corrections that happen over a longer period of time, and with a lot more certainty,” Ahearn adds. “This one has been significantly condensed over the last six months.”
Varying hikesLoans to solid corporate borrowers have seen prices hiked by 5-10% since last summer, but the increases vary from region to region, says Hiren Singharay, head of syndications for Europe, Africa and South Asia at Standard Chartered.
Pricing for African deals was already high and so has changed very little, while deals in Turkey for example have seen margins increase by 5-10%. Financial institution borrowers have been affected more than anyone, he adds.
Secondary market spreads have jumped even more, says Brooks. “In this market, clearly banks will be offloading debt at levels significantly higher than at the primary level.”
For many clients however, the cost of borrowing is effectively unchanged, or even net cheaper, because of the interest rate cuts effected by the US Federal Reserve and European Central Bank, Gallo notes.
The banks that Standard Bank arranges trade finance facilities for are also slightly better off, says Scott. Their Libor borrowing costs have reduced but the majority of their lending is fixed rate, benchmarked to the local currency, he explains.
“The margins they’re making on transactions have obviously increased.”
“The challenge at the moment then is not that much the cost of financing, but overall the access to capital – because certainly investors have become more selective in what they do,” notes Gallo.
“There’s clearly a flight to quality,” says Brooks. “And that’s not just in terms of what kinds of names people are going to look at within a country, but it’s also the countries themselves. So clearly the more risky end of the Eastern European market is going to be less easy than it was 12 months ago.”
Look eastIt’s not all bad news for borrowers though. The last couple of years have seen increased demand from Asian and Middle Eastern banks, says Caroline Kuijt, director of syndications at ING Wholesale Banking. “Those markets are opening up.”
And with most banks prepared to take smaller and smaller shares of deals, the market certainly needs them, she says. “Because of the huge need for liquidity, you need to find new banks – because with just the European banks you’re not going to get there.”
In ING’s Glencore deal last year there were 50 or 60 banks involved, and in its lending to commodity trader Trafigura around 30, she notes. “So that’s completely different to the corporate loan market, while these days you just do the deals with the relationship banks – maybe add one or two and you’re done.”
“We are seeing a rise of alternative investors, who are interested in emerging market assets, of course at the right return,” says Gallo. One phenomenon is the new role of sovereign wealth funds, he notes.
Hedge funds and other non-traditional investors are coming to market,” and they’re chasing both quality and yield at this point,” agrees Ahearn.
And as commodity prices continue their bull run, banks need to sell off a greater portion of their risk exposure, he notes. “Because banks are not comfortable taking that much concentration, that’s forced the secondary market to become much more agile, and much more diverse, because the price of commodities has become so large.”
Too many chiefsAs banks’s appetite diminishes, deals are becoming more top-heavy, with a larger MLA group and proportionately higher amounts raised at the senior end versus the retail, says Brooks.
For loans currently in the market, MLAs are stumping up some 80-95% of the total, compared with 60-70% pre-crisis, he estimates.
Deutsche’s current five-year pre-export deal for Kazakhmys will mainly be taken up at the senior level with relatively little being offered into retail, he notes. “That kind of deal, a year ago, probably would have had about three MLAs at most.”
More prudence in terms of security and structuring arrangements is already becoming apparent, following a period when excess liquidity and over-optimistic perceptions of risk led to some worryingly loose structures, says Gallo.
As covenants have become gradually weaker, the term ‘trade-related’s no longer means what it used to, notes Scott. “It’s a bit like cars,” he says. “Look at the Honda Civic. It’s been made for 30 or so years and it doesn’t look anything like how it used to look. Its design has changed but they still call it the same car.”
In 1994 Singharay was involved in two of the very first trade-related syndicated loans – to South Africa’s Rand Merchant Bank and Turkey’s VakifBank – but he says that the concept has slipped since.
In those deals, he and former employer Citibank requested detailed information about importers and exporters being financed. Since then interpretations of the term ‘trade- related’s have become much looser.
Today’s tight liquidity however means that a reversal could be around the corner, he says. “I would prefer it to happen sooner rather than later.”
“I think you’ll start to see a tightening up of structure,” agrees Brooks. “Some of the loans that we’re bidding on now, six or nine months ago would have had wording with a loose link to trade. We’re now saying we want a full schedule of transactions as part of the loan agreement – similar to what we saw three to four years ago.”
Unsecured trade-related loans are already suffering. Immediately following last summer’s first spike in volatility, emerging markets held up fairly well, Brooks notes. As soon as cracks appeared in Kazakhstan though, some big pricing disparities started to emerge, and especially for trade-related facilities.
“The prices that borrowers and banks were expecting remained at pre-crisis levels, but the levels that the market wanted went up,” he says. “And this led to a situation where deals weren’t being supported as well, deals were being pulled.”
In the second half of 2007, the volume of unsecured trade-related loans issued plummeted by as much as 40% compared with the first half and the financial institutions sector was particularly hard hit, he notes.
Commodity successesOne bright spot is commodity deals, which haven’t suffered the same downturn in appetite, says Kuijt. “We need oil, we need metals and grain, and these deals have done extremely well.”
One example is the US$300mn Ivolga deal that ING closed this January in Kazakhstan, which has recently been downgraded. Despite this, the transaction was oversubscribed, and its success can be credited to the deal’s structure and the fact that it was financing grain, a commodity buoyed by huge global demand, she says.
ING was mandated for the Ivolga deal before last summer’s credit crunch, leaving it with a quandary after the problems kicked in – to raise pricing or leave it as it stood. In the end the original pricing held tight.
“We’re in the market with a Trafigura transaction now, and I’m a firm believer that it will be oversubscribed as well,” she says.
Part of the success of commodity deals comes from the strong relationship between commodity traders and their banks, says Kuijt. Because of the volatility of commodity prices, “commodity traders seriously rely on their banks for their liquidity,” and despite a commodities boom, they have not squeezed lenders on price, she says. “They know that if you go down with the pricing they will have less liquidity and it hurts them immediately.”
However, “I don’t think [commodity deals] will be immune from the general pricing changes,” says Scott. “They’re still managing to get better terms than others in their peer group. But I think they’ll still have to pay a higher price for their debt.”
“The effects of liquidity crises take longer to filter through to some sectors than others,” says Jackson. “The shipping and property sectors, along with some areas of project finance, often imagine themselves to be immune, and trade financiers occasionally seek to buck the trend.”
However, “in a bad credit environment, secured trade is attractive. But that doesn’t get you over increased funding costs,” he adds. “Because if you are paying Libor plus 40 for funding, then any loan at Libor plus 30, whatever the credit, loses money.”
Export finance and corporate lending to commodity producers in countries like Kazakhstan, Ukraine and Russia has certainly benefited from the liquidity crunch, says Brooks.
“Many of these companies would normally have been able to access the bond markets, but because of the volatility and the rising spreads they weren’t able to do that. So they had to resort to their traditional mode of finance, which was in the loans market, using commodity flows as security.”
And this is illustrated in how quickly pre-export financing flows in Eastern Europe and the CIS have grown, he says. “If you look at the volumes of that business – the second half versus the first – it’s ballooned.”
“Couple that with a situation where commodity prices are buoyant, he adds, “That creates M&A activity, and that’s when the requirement for financing increases.”
Despite commodity prices’s seemingly unstoppable growth though, bankers should consider the possibility of a slowdown, cautions Ahearn. “Everyone has been lending into a rising commodity market. If we see a reversal of that, it’ll be interesting to see what happens.”
“The structured commodity trade finance business works best in times of uncertainty, in times of crisis – it’s very much a cyclical business,” notes Brooks. “And you could argue that what we’ve seen over the last two years was working against it because as these markets were stabilising, investors’s appetite for risk was increasing and they were no longer needing or wanting structure to lend.”
A year ago, it was popular parlance that commodity producer deals would all end up unsecured, he notes.
“Prolonged bull markets always result in the erosion of covenants, the loosening of structures, the jettisoning of security and the compression of pricing between strong and weak credits,” says Jackson.
“Yes, there is a period during which the bond market goes out of fashion and borrowers return to the loan market,” but the bond market is merely in retreat,” he adds. “There are some aspects of this particular crisis that are unique, but that’s not one of them.”
In for the long run
What makes this liquidity crunch so different is the length of the period of instability, Jackson continues. “We’ve had the odd chaotic quarter many times before. What is unique is the fact that we’ve now had at least six months and we’re in for at least another two or three.”
“What normally happens towards the end of a pricing cycle is that everyone’s return on equity falls to unacceptable levels, then you see a drying up of liquidity and there is usually a period of sullen stand-off between arrangers and investors during which volume collapses.”
“What was odd about this cycle was that there was no drying up beforehand. One day everything was roses, and the next day it wasn’t.”
“Every time there’s a crisis, the syndicated loans market remains open,” says Kuijt. The future however looks uncertain.
“I think it will be a tough year,” even for commodity deals, she predicts. “Not because of the risk of the commodity traders, but because of the risk of any company.”
Mainly though, “it’s because there are going to be fewer participants available. With banks like Citi and UBS coming out with huge losses, it will be more difficult for these banks to attract funding at a cheap price. In general, commodity deals will get done, but we will have to look a bit further for participants than just relationship banks.”
“Emerging markets remain the main areas of growth for syndicated loans, even more so amid an OECD-focused liquidity crunch,” says Singharay.
“Maybe we are going into a recession, but life goes on,” he says. “We don’t have to play in the 20bp French market, or the 30bp Finnish market. These markets are going through a real headspin.”
We don’t have stacks of LBO papers or anything like that. Our markets are very strong. The only thing you’ll see is a bit of a pricing change, which is fine.”
Better marginsSpreads are likely to widen further over the next three to six months, with little or no contraction until the third or fourth quarter at best, Brooks predicts.
Although many of their problems will not have occurred in emerging markets, “there are still a lot of players licking their wounds,” he adds. “That’s going to take a lot of time to work through.”
Higher prices for syndicated loans look set to stay, predicts Scott. “This adjustment is not going to be a temporary thing where we’ll suddenly go back to the prices we say in the middle of 2007,” he says. “Banks have been hoping for something to happen so they can raise their interest margins anyway. For a long time people have been saying that they’re not making the returns they should be able to in this business.”
The improved treatment of trade finance facilities under Basel II could also give banks an advantage, he says. Basel II arms banks with a more efficient way of comparing the profitability of deals, so could help keep prices higher, he says.
“This is a market where certainly there are fewer traditional resources available,” says Gallo. “As a result, rather than talking about problems, we have to talk about solutions for customers and be creative – looking for the liquidity wherever it is.”
“Whether it’s the local markets, the bank markets or the international capital markets, you are going to see this year – especially for large fund-raising in emerging markets – the financing coming from a combination of different sources,” he adds. “And players that take the lead on this will be those that have access to all these alternative markets.”
“My business has faced an incredible headwind for the last three or four years with the amount of liquidity in the market,” says Ahearn. “Now what we’re seeing is a return much more to normalcy, and we’re seeing much better assets coming to market.”
So the markets are tough in places and holding on to higher prices will be tomorrow’s new challenge, but for the large part, isn’t a crisis like this just what trade financiers and syndicated lenders have been asking for
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As Ahearn insists, this is all “very positive” stuff.
