IMF World Bank 2006: Privates
As ever more investors seek double-digit returns, the Asian private placements loan market is growing rapidly. But as more seek to move into this lucrative market, spreads are moving lower and structures are loosening. Consequently, some investors are eschewing syndicated private deals and sourcing and structuring their own. Luc Mongeon reports.
The emergence of the private placement market in Asia stems largely from the fact that many commercial banks are refusing to lend to a number of the region's companies even though most economies are now very healthy and despite the fact that many corporates have now very low debt levels. The banks lending were forced to take huge haircuts on the claims in the years following the 1998 Asian crisis because debtors – which were often protected by the judiciary or by powerful politicians – were able to impose cram down restructurings on their creditors.
With the syndicated loan market emerging markets credits shut down, investment banks such as Credit Suisse had to look to other lenders to revive the market.
Many bankers agree that the US$385m 2.5-year amortising loan for the Indonesian miner Kaltim Prima Coal (KPC) arranged in 2004 by Credit Suisse (then known as CSFB) was a watershed event. The deal offered a high level of protection through its project finance-style structure, but because KPC is ultimately owned by the controversial Bakrie family bankers doubted it would fly when it first emerged in August 2004.
As it turned out, the transaction was a huge success, generating US$686m in orders. Credit Suisse’s success came only partly from the structure of the deal. The bank’s strategy of targeting hedge funds and offering them leverage financing showed that a nominally single-digit yielding loan could be turned into a double-digit earning asset. For its efforts, CS is thought to have made fees of close to 10% while a number believe the bank also made money by obtaining some form of equity kicker in the coal mining companies.
It is no wonder then that investment banks began to imitate Credit Suisse and moved into offering hedge funds similar deals, and earn fantastic fees. When Merrill Lynch completed a US$135m bond with warrants (exercisable at IPO) in late 2005, the investment bank earned US$10m in fees.
Barclays Capital, JPMorgan, Morgan Stanley, Goldman Sachs, and Singapore’s DBS Bank have also entered the private placements market over the last year, though some have had less success than others.
In addition to these players, a number of boutiques are seeking to make money from the market, especially those that are bringing their experience from the US private placements markets.
For instance, US high-yield specialist Jefferies was in the market in July with a US$75m senior secured FRN for Indonesian polyester chip manufacturer Polyfin. The five-year non-call two deal has warrants attached, reinforcing the need of issuers in the private placement market to provide equity kickers to investors. Jefferies in August was also said to be arranging a US$65m loan for a real-estate company in China. Elara Capital Management, a London boutique has come up with a number of small and medium-sized deals, especially for Indian credits.
As competition in this area has grown, the quality of structures deteriorated markedly, while the double-digit returns investor obtained on previous financing were increasingly hard to find, while fees for investment banks were also on the decline.
Thus, to take just one example, Encore International, a special-purpose vehicle for the Panigoro family (who are the majority shareholders of Medco Energi Internasional), were late last year, through Credit Suisse, able to refinance a US$200m facility it had raised earlier in the year at 1,000bp-1,050bp over one-month Libor with a US$200m facility that paid 600bp over six-month Libor.
“It’s the cruel logic of funds under management: you have to find some place to invest your money and you have to talk yourself into these deals even though they might not meet your investment requirements,” said one hedge fund manager.
One way for those investors sophisticated enough to respond to such pressures is to put transactions together themselves. “Why get involved in these deals that barely give you a double-digit yield and don't give you the credit and legal protection you need when you can do a deal by yourself that pays 15%–17% and gives you all the control you want?” asked another emerging markets investor. "And there is no disappointment over allocations."
In addition to poor structuring, some deals suffer from inadequate due diligence on the part of arrangers. Investors discovered that security that was meant to be in place either did not exist or was impaired. Meanwhile, some guarantors have shown they cannot fulfil their commitments. And, to their horror, some investors are also discovering that facility agents they had once put so much faith in have been asleep on the job.
As a result, a number of loans that were drawn in the last year have fallen into technical default or worse and investors are finding that they are not as powerful as they though they would be in such circumstances.
The sudden collapse of Ocean Grand is an example that many point to. The company’s bonds sank from close to 80 levels to 8 cents on the dollar in little over a week following news that the aluminium extruder had defaulted on its bank debt and that US$100m in funds had gone missing from its bank accounts.
Ocean Grand’s debt included a US$195m bond that was arranged by ABN AMRO, of which US$35m tranche was privately placed to one large US-based hedge fund.
“The whole thing with Ocean Grand shows that even with due diligence by the like of ABN AMRO and accounts being audited by one of the Big Four, you can have fraud going. When you look at that deal you realise it didn’t have what we had in some of our own club deals in terms of bells and whistles to protect creditor interest,” said one hedge fund manager.
Some hedge fund managers also said they have been growing wary of deals arranged by investment banks because they tend to concentrate risk towards certain conglomerates and/or industries.
The obvious example in Indonesia case is the nearly weekly offering of deals that finance the Bakrie family’s investment activities.
Since May last year the Bakrie family or their companies have borrowed a total of at least US$2.1bn. However, investment bankers said the total amount of borrowing is probably much more because many of the Bakrie financings are discrete private placements whose existence is known only to very few. Indeed, of the 12 deals widely known to the market and done by the Bakrie’s or their companies since May 2005, only four were public deals. And as of August this year, the family had at least another US$3bn of deals in the pipeline if financings related to their coalmines are considered.
Many of the private placements, for example, have been share-backed transactions for Bakrie family holding companies and special purpose vehicles. Even those who fund such loans admit that the use of proceeds is always not clear.
All-told, the Bakrie family have competed at least US$600m in share-backed deals since May last year.
Nevertheless, investors admit they are unable to source the amount of deals necessary to invest the funds they have earmarked for private placements. A quick survey of emerging markets funds active in the private placement markets shows such investors dedicate 10%–40% of their Asian fixed-income portfolio to private placements. But these same investors admit that they are only able to source by themselves between 10%-30% of the private placements they need, leaving the remaining 70%-90% coming from the banks.
“There are far too many investment bankers going around doing these deals, so it’s hard to source by ourselves,” said one hedge fund manager.
Investors that were once the most active in Asia’s distressed-debt market – such as Argo Capital Management, Argyle Street Management, Ashmore Investment Management, Asia Debt Management and Spinnaker Capital – do have a certain edge in obtaining transactions with some creditors and these players have been behind a number of private deals.
Ashmore and Argo, for example, are widely rumoured to have provided the funding for companies like London Sumatra, Polytama and Petro Oxo Nusantara to buy the claims of their respective creditors at deep discounts.
Argo was certainly involved in arranging a five-year US$90m financing for Trans-Pacific Petrochemical Indotama and earned huge fees on the transaction on top of the 10% fixed rate it is paid from the portion of the loan it took itself.
“To be successful in this market means having to understand the credit very well, and that requires a very close relationship with the borrower which in many cases the banks have lost and given to distressed-debt investors as a result of selling their loans in the secondary market,” said one Singapore-based lawyer.
DB Zwirn, Pangaea Capital and Tribeca Capita – relatively new entrants to the Asian markets – are also active in seeking so-called proprietary loans. But these players have largely done so by poaching staff from the experienced distressed debt funds.
Because of their involvement in restructurings, distressed-debt investors have come to know the businesses of very large conglomerates and the needs of the majority shareholders. That experience has also allowed distressed-debt funds to understand in great detail the many risks that are involved in dealing in countries such as Indonesia. This, in turn, enables the funds to structure and price deals appropriately, the lawyer said.
The result is that public bond and loan arrangers, particularly those which specialise in Indonesian, Indian markets and the China markets are finding it harder to bring deals to the market. And with the private market increasingly able to match the public market in terms of deal size it looks for now as if private placement specialists have the upper hand.
One Hong Kong-based private placement specialist expanded on the dynamics involved. “The private placement market in Asia became active around 18 months ago but recently it’s really started moving,” he said. "This is largely the result of reverse inquiry from hedge funds and sits well with issuers. Typically it’s a pre-IPO situation and there’s an equity kicker, but the hedgies are attractive counterparties because they’re less dilutive than private equity players and less demanding in terms of management control.”