LBO Loans Jump as Fees Double Average Worth Risk: China Credit

Chinese banks extended at least $8.3 billion in loans for acquisitions and leveraged buyouts this year, seeking to generate new business as a bond-market boom cut syndicated lending to a four-year low.

Finance companies entering the riskiest part of the loan market are being rewarded by fees that are more than double regular corporate loans, according to data compiled by Bloomberg. The $1.525 billion loan to acquire display advertising company Focus Media Holding Ltd., the subject of China’s biggest leveraged buyout, pays a top level all-in rate of 619 basis points versus a 249 basis-point average for U.S. dollar-denominated loans signed in the region since Dec. 31.

Chinese companies were involved in 25 percent of the mergers and acquisitions in the Asia-Pacific outside of Japan this year, with deals valued at $110.7 billion, Bloomberg-compiled data show. Banks in the world’s second-biggest economy are keen to expand their lending relationships with companies to increase their chances of being selected to help manage initial share sales and other potentially lucrative investment banking transactions.

“Leveraged loans offer decent returns to compensate for their higher risks and more complex structure,” said Stephen Ching, the general manager of structured finance and syndication at China Citic Bank International Ltd., a unit of the nation’s largest state-owned investment firm. “They’re attractive for lenders especially given the slowdown in corporate loan deal flow.”

Volume Slump

Average interest margins for U.S. dollar-denominated loans signed in the region since Dec. 31 have dropped 58 basis points from 12 months ago to a two-year low of 251 basis points more than the London interbank offered rate, Bloomberg data show. About 65 percent of loans signed in the past year have been to either refinance debt, replenish capital or for general corporate purposes, the data show.

Loan volumes have slumped as companies turned to the region’s bond markets for their financing needs. Dollar corporate yields in Asia touched a record low 3.77 percent on May 9, Bank of America Merrill Lynch data going back to 1997 show.

Bond sales in Asia outside Japan surged to a record $362 billion this year, 10 percent higher than the same period of 2012, according to data compiled by Bloomberg. China National Petroleum Corp., the country’s largest oil producer, led issuance, selling $14.9 billion of notes, followed by China State Grid Corp., Bank of Beijing Co. and six other borrowers from China.

Resilient Pricing

Syndicated lending totals $131.9 billion since Dec. 31, down from $145.9 billion the same period of 2012 and the worst start to a year since 2009 when $80.6 billion of transactions were inked, Bloomberg-compiled data show. Only one of the top 10 companies taking bank loans this year was Chinese.

“Corporate loan volumes have suffered from the strong downward pricing pressure over the last 18 months,” said Aaron Chow, the head of event driven syndicate for Asia-Pacific at HSBC Holdings Plc., the region’s fourth-largest arranger of transactions this year. “LBO deals have been relatively resilient toward pricing movements with interest margins generally remaining at 4 percent to 4.5 percent.”

Leveraged loans in the region pay an average interest margin of 463 basis points so far this year, up from 438 basis points in the same period of 2012, Bloomberg data show.

China has become a more popular market for LBOs in the past year as falling asset values attract financial sponsors, Chow said, adding that Chinese banks are more willing to support leveraged buyout deals which come with the “right context, such as Chinese shareholder sponsorship.”

Focus, 7 Days

Focus Media’s buyout loan backing the bid of a Carlyle Group LP-led consortium including Chinese private equity firms FountainVest Partners Co. and China Everbright Structured Investment Holdings Ltd., attracted 18 lenders ahead of its signing last month, Bloomberg-compiled data show.

Among the banks, four Chinese -- China Development Bank Corp., China Minsheng Banking Corp., Industrial & Commercial Bank of China Ltd. and China Citic Bank Corp. -- lent more than one third of the total.

Other Chinese LBO deals in the market include a $330 million facility to fund the $890 million buyout of Chinese software services provider AsiaInfo-Linkage Inc. by a consortium led by Citic Capital Partners, and a $120 million leveraged loan backing the Carlyle Group-led buyout of budget-hotel operator 7 Days Group Holdings Ltd.

‘Fine Tuning’

Not only are banks in China participating in a wider variety of financing, they’re increasingly lending to borrowers outside of their home territory. Bank of China Ltd. and Wing Lung Bank Ltd. joined Australia’s flagship carrier Qantas Airways Ltd.’s A$780 million ($747 million) financing in April and were the two biggest lenders to the deal, the data show.

“Chinese banks have been fine tuning their loan mix,” said Grace Wu, the head of greater China financial institutions research at Daiwa Capital Markets Hong Kong Ltd. They’re focusing on “higher-margin lending because interest-rate liberalization in China is putting pressure on them.”

The People’s Bank of China reiterated the country will push forward with interest-rate liberalization and yuan exchange rate reform in a “stable” fashion, according to a financial stability report posted to its website June 7.

That will help promote market pricing of capital, according to Moody’s Investors Service, and comes at a time China’s new leadership has signaled an unprecedented tolerance for slower growth.

Growth Downshift

Industrial production rose a less-than-forecast 9.2 percent last month, while export gains were at a 10-month low and imports dropped, National Bureau of Statistics data released June 9 showed, adding to pressure on President Xi Jinping and Premier Li Keqiang to shore up economic expansion less than three months into their tenure.

Growth in China will “downshift, averaging 6 percent to 7.5 percent annually for the next five years versus more than 9 percent on average for the past five,” according to Pacific Investment Management Co., which manages the world’s biggest bond fund.

“The previous engines of Chinese growth -– net exports and investment -– are reaching their limits,” Ramin Toloui, Pimco’s global co-head of emerging-markets portfolio management, said in a June 11 report. “Before the global financial crisis, each $1 of new credit generated an average of about 60 cents of GDP. Now that number is falling toward 20 cents.”

Credit Risk

As growth optimism flags, benchmark bond yields are dropping. The yield on China’s 10-year yuan-denominated government bond has fallen eight basis points this quarter to 3.46 percent.

The dollar bond market is also showing signs of concern among global investors, with the yield on debt sold by Chinese companies surging to a near one-year high of 6.03 percent on June 13, according to JPMorgan Chase & Co. indexes.

The cost of insuring sovereign notes against non-payment has jumped 24 basis points since the end of March to 97.5 basis points on June 13, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

The risk of extending leveraged loans, which typically refer to debt carrying ratings of less than Baa3 from Moody’s and below BBB-from Standard & Poor’s, are “well justified” and will continue to attract Chinese banks, HSBC’s Chow said. HSBC has completed four LBO loans in the Asia-Pacific region this year.

“Financial covenants and other conditions for LBOs are usually much tighter than plain vanilla corporate loans and that gives lenders a lot of control over how a company may be run in the future,” he said. “LBO loan volume is expected to grow steadily this year and China will be a very important market.”

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