Lenders get selective on leverage

Asiamoney, February 2008

Last month [JANUARY] the sub-underwriting closed for an US$800 million leveraged buy-out. A year ago a sentence like that would have been so commonplace, and the sum so unremarkable, it would scarcely have raised comment among the region’s growing crew of leveraged finance personnel. These days, though, it’s a cause for some celebration.

The deal in question was a five-year LBO facility for Huawei-3Com Holdings, part of $1.2 billion in debt financing backing the US$2.5 billion takeover by Huawei Technologies and Bain Capital of the US network equipment supplier 3Com. Quite apart from being significant as a rare successful Chinese LBO, the deal tells us two significant things: one, that unlike most of the rest of the world, there is still some life in leveraged finance in Asia; but two, that deals today look markedly different than they did before the credit crunch a year ago.

Fees are an obvious point of difference: the deal was split into a US$750 million term loan, paying 306.25 basis points over Libor, and a US$50 million revolver paying 300 basis points over. That’s clearly wider than it would have been a year ago, albeit probably only by 25 to 50 basis points.

But to see what’s really changed, look at the syndicate: five mandated leads and bookrunners, plus another two arrangers at launch, then joined by another five banks, for a US$800 million deal. Citi, UBS, HSBC, ABN Amro and Bank of China (Hong Kong) all shared top-line honours, with China Development Bank (a cornerstone investor committing $200 million) and West LB then joining as equal-status arrangers before launch. Sumitomo Mitsui, Aozora Bank, Rabobank, Bank of Nova Scotia and Chinatrust Commercial Bank all then came into the mix and the arrangers might still sell the deal down further in general syndication.

A year ago, “the syndicate strategies would have been quite different: you would not have seen five banks mandated at the top. Two or three, maximum,” says Aaron Chow, executive director and head of syndicate at UBS. But this is how it’s likely to stay for the foreseeable future. “You used to see firms keen to get a sole mandate for transactions. Now banks would prefer a top heavy approach: five, six or even more, to try to build up momentum and de-risk themselves quickly.”

Partly, this is about wanting to spread risk; but it also reflects a feeling that if a bank is going to commit to a deal in this uncertain climate, it wants a decent role on it. “Capital is becoming a much more scarce commodity, and to the extent that banks play in a deal, they want to get title,” says Tim Donahue, head of high yield and mezzanine capital markets for Asia Pacific at JP Morgan. “You find a much broader list of MLA banks [mandated lead arrangers], whereas previously there were one or two leads but lots in the second tier. If banks are going to ask their credit committees to commit to a deal they want to say that they are an MLA.” Farhan Faruqui, managing director and head of leveraged finance and loans at Citi, agrees. “There’s definitely a desire to de-risk early on. What we’re seeing now is a lot of banks coming up at the top, MLA level, in sub-underwriting, but not going for the retail syndication piece.”

Still, whatever the format, deals are going through, and more are coming. At the time of writing, a senior secured loan for Supernova, a unit of Citigroup Venture Capital International, was expected to be signed any day. This $200 million facility will help finance the acquisition of Seksun, a manufacturer of specialised metal components, and features Chinatrust, DBS and UOB Asia as mandated lead arrangers and bookrunners. OCBC and First Commercial Bank have since put in commitments.  Macquarie has an LBO underway of Miclyn Express Offshore, formed by the merger of Express Offshore Transport and Miclyn Offshore. Twelve banks are known to be participating in a US$261 million LBO with a seven-year tenor supporting the deal: Bank of Scotland, ICBC, Chinatrust, OCBC, Standard Bank, Mizuho, AMP Capital Investors, BayernLB, First Commercial, DZ, Aozora and Nordcap. In Indonesia, a chemical tanker company called Berlian Laju Tanker is seeking financing for a US$850 million acquisition of US company Chembulk Tankers, the largest overseas acquisition by an Indonesian company since 2000. The company is aiming for $500 million through a dual-tranche loan, which alongside a previous 12-month bridge is understood to represent total leverage of five times debt to EBITDA, a deal that at first sounds preposterously ambitious,  in the current environment but which has attracted a mandated lead arranger group of DnB NOR Bank, Fortis, ING and NIBC. And CVC Asia Pacific has mandated five leads (ING, ICBC, Rabobank, Royal Bank of Scotland and WestLB) for an LBO of a Singaporean paper maker, Plantation Timber Products Group (the funding will also refinance a previous $86 million LBO). The deal is understood to be worth between $100 and $200 million.

So the pipeline is not empty, although these deals will look altogether calmer than they used to. “Banks are not shut down for business, that’s for sure, but there is clearly a more conservative view being taken,” says Faruqui. “The leverage multiples we saw in the first half of 2007, and some of the terms and documentation, are certainly not happening anymore. Deals are going to be done on more conventional-style loan documentation. They will be fully covenanted; leverage multiples are going to stay in the sanity zone; and pricing will be adjusted upwards.” Tim Donahue at JP Morgan notes “a slight uptick in pricing in the bank market, of at least 25 basis points, but not a dramatic shift like we’ve seen in the public bond markets.”

The biggest change is going to be the people doing the lending. The mandated leads on the BLT deal in Indonesia are not, ING apart, mainstays of Asian leveraged finance (although they are big names in ship financing). And look at the Supernova deal: all Asian names. “European players are certainly pulling back of bit of the aggression they had before; that’s been compensated thus far by a lot of local and regional banks in Asia becoming more actively engaged in the leveraged buyout basis, albeit on a more conservative basis,” Faruqui says.

Chow agrees. “In Asia market conditions have been benign,” he says. “While banks in this region have been affected by the global environment, they have continued to be active.” Ticket size and underwriting appetite have changed, “but for certain countries like Taiwan and Korea, sizable financings can still be executed for well-known local assets.”

Asian banks are still lending because they can: by and large, they weren’t badly hit by sub-prime, they’re still flush with liquidity and are still happy to lend. “There is clearly going to be a greater role that local and regional banks are going to play in these transactions. That’s where the liquidity is going to be,” says Faruqui.

The story varies from market to market. Taiwan and Korea are the names that keep cropping up: strong local banks with a lot of liquidity in local currency funding; low interest rates; and in Taiwan at least, lots of potential deals. China is interesting in sectors where Chinese banks can lend, and India has no shortage of liquidity but perhaps a shortage of buyout candidates who are willing to sell. Plenty is happening in Japan and Australia: JP Morgan recently closed a deal with $140 billion in senior credit facilities and Y45 billion in mezzanine for the purchase of Arysta Life Sciences in Japan, while the A$2.26 billion senior and sub debt facilities for Carlyle and National Hire Group’s acquisition of Coates Hire were finalised in December in Australia, to the great relief of the seven lead arrangers on the deal.

An example of the sort of deal we’re likely to see more of is Nien Made Enterprise, a Taiwanese curtain and blinds manufacturer being bought by CVC Capital Partners Asia Pacific, for whom a NT$14.22 billion seven year, four-tranche LBO was signed in December. The package, supporting a NT$18 billion buyout, was led by Citi and JP Morgan, but the list of other banks who joined as equal-status arrangers is almost entirely made up of regional names: ANZ, Bank of Tokyo Mitsubishi UFJ, Chinatrust, DBS, E.Sun Commercial Bank, Hua Nan Commercial Bank, Industrial Bank of Taiwan, Shanghai Commercial & Savings Bank, Taishin International Bank, and Taipei Fubon Commercial Bank, with Ta Chong Bank and Mizuho also making commitments. (With pro forma leverage of 4.7 times according to JP Morgan, it was reasonably conservative on the gearing; deals are unlikely to try to push the boat out on leverage for quite some time.)

These regional banks are keeping the market alive. But they obviously don’t have the deep pockets of Wall Street institutions. So size is clearly an issue, even in the markets that appear unscathed. “If you reach a deal size of over $2 billion in Korea, or $1 billion in Taiwan, you may have to tap into international banks rather than just local banks,” says Chow. “So there is a capacity limit.”

There’s also the problem that when groups try to arrange financing there are big bits of the market now missing. “Last year we spoke about bank and bond transactions, senior secured and senior unsecured,” says Faruqui. “It’s going to be more challenging now because they high yield markets have shut down. That’s the difference for any transaction now: the high yield component is going to be missing.”

Donahue says that the mezzanine markets are still open, though. “It’s extremely active: it’s the private markets that are less immune,” he says. “If you were doing a deal that had 18% IRR and now it’s 25%, that’s less of an emotional leap for an issuer to make than a high yield bond in the public markets which used to cost 8% but now costs 11.When a borrower does mezzanine they know it’s temporary capital necessary to bridge them to an IPO or acquisition or other event, which is going to be so accretive that they’re willing to pay up.”

The investor side seems to support this view. “From our perspective, we see a good amount of deal flow,” says Stephane Delatte, who advises MezzAsia Capital, a fund managed by CLSA Capital Partners; his team is managing $200 million in funds intended for mezzanine finance at the moment and has so far deployed about 80% of it. “So far as we can judge, markets are still quite active. We see deals that are better priced coming our way. Asia never got into the excesses of Europe and the US in terms of leverage: Asian banks, compared to some of their western counterparts, are in good health so they still have appetite to lend.”

Activity like this means that few people are expecting to have to lose leveraged finance staff – not in Asia, anyway. Donahue says that JP Morgan is “actually looking at taking some more people on,” particularly since high quality people are coming out of European and North American businesses and are looking to find a home. “There’s no shortage of opportunities and people are looking to move out to Asia. We’ve absolutely not downsizing in Asia.”

He says a previous approach of hiring people who can be effective in a range of disciplines has proven beneficial. “My group focuses on everything from leveraged loans to high yield bonds to mezzanine,” he says. “As the public markets get difficult on the bond side, we rejig resources towards those markets which are open, such as the leveraged loan market in Asia.”

Faruqui agrees that “I don’t think there’s a lot of fat to cut. There may be a slowdown in additional hiring but not a lot of chopping. Those teams that were larger to start out with are going to continue to be kept busy in the corporate acquisition space – the M&A dialogue in Asia hasn’t slowed down. We will continue to see a lot of acquisitions and the people who were hired at the leverage finance space will continue to contribute to that.”

But for new people trying to get in to the industry, it’s going to be a challenge. “Right now hiring will slow down a lot,” says one banker. “I don’t expect investment banks would substantially increase their staff in Asia. They will be lucky enough if teams can be kept at the same size this year.” But it’s better than in other markets. “Europe and the US are going to be more challenging places to manage: activity there is so low for the team size. In Asia, you still have activity: deals close every month and banks are still talking to each other about new deals.”

One group that is said to be hiring, though, is local players. “I think Asian banks are very keen to look at leveraged deals,” says a banker who works closely with them. “They’re all trying to set up dedicated teams or people to review these kinds of transactions.” They’ll need to be wary about hiring lost souls from European and American teams, though: “Local expertise is very important, particularly when you need to make the right syndicated call. You can’t parachute a guy from Europe and hope he can tell you what is right and what is not in this market. Asia is different, and relationships with investors or borrowers can make or kill a deal.”

While Asia is having a more positive experience than most parts of the world, it isn’t all plain sailing. The clearest example of this is the US$1.15 billion package that was put together to fund Affinity Equity Partners and TPG Capital in their purchase of United Test and Assembly Centre, a Singaporean business. A victim of bad timing, the deal featured a so-called “covenant-lite” status and was originally aimed at offshore institutional investors, who were badly hit by sub-prime. The leads, ABN Amro, JP Morgan and Merrill Lynch, are believed to be holding the deal on their books until a more agreeable time arises in the market; Donahue declined to comment.

But for most sponsors, provided they go in with the right expectations, deals can go through. “The best deals can be done this year,” says one banker. “But the marginal deals need to wait a while until the market comes back to normal. It’s not the right time to be too aggressive or innovative.”