Growth backers: financing Asia’s rapid expansion

Based on estimates by Asian Development Bank, infrastructure projects in Asia will require approximately $US1.7 trillion per year in funding to maintain its growth momentum, as well as incorporating climate change mitigation and adaption costs.

" It is more important than ever for NBFIs to partner with banks to originate desired credit exposures and execute strategic transactions."

{CF_IMAGE}

In addition, China’s massive Belt and Road Initiative is expected to attract cumulative investments of up to $US 10 trillion from 2015 to 2025. The project includes a range of infrastructure-related investment opportunities across the region from constructing roads to building pipelines.

Syndication

The syndicated loan market plays a vital role in financing Asia’s growth. In the first half of 2017 the total syndicated loan market volume amounted to $US186 billion.

Out of the total syndicated loan volume, loans for refinancing purposes accounted for 39 per cent, whereas loans allocated to infrastructure and capital expenditures accounted for 21 per cent and 16 per cent respectively.

In 2016, 99.72 per cent of Asia Pacific (ex-Japan) loan financing came from banks and only 0.28 per cent from non-bank financial institutions (NBFIs). In comparison, contributions by NBFIs were far more substantial in the United States, making up 29.48 per cent of the total loan volume.

{CF_IMAGE}

Alternative

In light of a tightening regulatory environment, evidenced by the implementation of the Basel III reforms, many banks are facing challenges in terms of tighter capital requirements and escalating compliance costs.

Consequently, certain sectors impacted by these regulations may be avoided by the banks, which can result in a lack of liquidity. Alternative sources of funding from NBFIs could potentially be attractive to these borrowers.

To maintain the growth momentum in the region, a huge amount of funding is required and NBFIs could be well-placed to fill the funding gap.

The difference in funding sources poses a challenge for NBFIs to achieve required returns. This is exacerbated by current market conditions where a lack of deals has driven pricing to historical lows.

Unlike traditional bank investors, NBFIs are unable to boost returns via cross-selling by offering ancillary products to borrowers.

Nonetheless, we see potential for NBFIs to be involved in more structured transactions where yields are noticeably higher. NBFIs could also provide value by occupying a space where traditional bank lenders are unable to do so.

{CF_IMAGE}

Transformation

Currently, Asia’s loan structures are optimised for bank investors and unlike the US and European markets, structured lending is still relatively underdeveloped. To increase the attractiveness of the loan market for NBFIs, some key developments would need to take place.

Firstly, there is a maturity mismatch between term loan financing and tenor requirements of the borrowers. Some companies may only be able to raise short term bank loans, whilst actual financing needs are longer term.

Financial institutions could endeavour loan structures that match the companies’ requirements for longer-tenor financing and also match NBFIs’ needs for higher yields.

Secondly, the borrowers in Asia are typically unrated - in contrast to the US loan market where loans frequently are. Further, evolving regulation and legal framework in emerging countries deter potential NBFI investors in the region.

Substantial regulatory and legal framework reforms geared towards ensuring the integrity and resilience of financial systems are vital to build and instil investor confidence. Lastly, there is a relative lack of secondary loan market activity in the structured finance space.

NBFIs’ typically prefer to hold liquid assets (i.e. bonds over loans), which allow them to mark to market on their investments. Hence, a more liquid secondary loan market could attract NBFIs’ funding in the loan market.

Opportunities

With various loan financing structures from project finance to high yield loans in the Asia market, the opportunities for NBFIs to finance Asia’s growth are abundant.

With different risk appetites and investment profiles, there are two types of loan financing options which could be attractive for the NBFIs - the acquisition finance and project finance transactions.

NBFIs with higher price expectations and return requirements may prefer leveraged finance transactions such as limited-recourse financing structures.

{CF_IMAGE}

Due to the high proportion of debt in the capital structures, coupled with the limited amount of recourse to the borrowers’ specific assets and cash flows, these leveraged finance deals are usually riskier than ‘vanilla’ loans.

On the other hand project finance transactions have the potential to provide a great opportunity for investors to invest in longer tenor assets.

These transactions are often attractive for investors who prefer to match their assets to their long term liabilities such as insurers, sovereign wealth, pension and super funds.

To seize these opportunities NBFIs should work with major banks to evaluate a range of structured loan options which address the NBFI’s investment objectives and risk management needs.

Next up

Since 2015, over 30 different NBFIs have participated in the Australian loan market. NBFIs can also point to Australia as a leading light in terms of having a strong regulatory regime, sound legal framework and mature loan market.

However, the same cannot be said for emerging market risks. As NBFIs go searching for higher yields, they would be pushed towards considering investments in these emerging markets and therefore it is crucial to evaluate political risk.

It is more important than ever for NBFIs to partner with banks – which are now more constrained by regulation – to originate desired credit exposures and execute strategic transactions. Only then will Asia realise its full potential as a self-sustaining investment destination.

Carl Roberts is Head of ANZ Loan Syndications for South & Southeast Asia