Asia’s par loan market undergoes a “quiet revolution”
Theron Alldis, Sourcing – Asia Pacific at SC Lowy
Asia’s secondary par loan market – which broadly speaking comprises trading in loans valued at a price of 90 and above – continues to develop strongly, driven by a sharpening of balance sheet and portfolio risk management by banks as well as by a contraction in primary market lending volume in the region.
The par loan market in Asia has had a patchy history but its ongoing development can best be described as representing a “quiet revolution” in the way banks go about their commercial lending.
Conventional wisdom had it that banks would use the syndicated loan business to establish or further relationships with counterparties and that loans would be held on the books until maturity. Reassignments were relatively few and far between and in many cases frowned upon on the view that they had a detrimental effect on client relationships.
The traditional view that reassigning loans could be detrimental to the client relationship is eroding and the industry is far more realistic about the secondary loan proposition.
Managing exposure is increasingly regarded as standard operating procedure for banks and reassignment is not viewed as potentially damaging to the client relationship. There are some exceptions where borrowers include transfer restrictions in the loans docs, but this is more common in the US and European loan markets.
The growth of liquidity in the secondary par loan market in Asia has impacted bid/offer spreads, where typically, 10bp-20bp prevails for paper that is trading above 90. This compares to around 50bp-100bp on distressed paper priced below the 90 mark.
Typically, banks will be sellers where they are looking to manage their risk profile in relation to a name or an industrial sector or where they have participated in a syndicated loan for relationship or league table reasons and are selling down in secondary for risk management purposes.
Other emerging reasons are growing pressure from new capital rules and increasing funding costs.
For buyers, there are a variety of motivations. With the Asian primary loan market having contracted around 33% last year in volume terms, and the pace of borrowing also falling in 2016, there is a shortage of assets to book and banks have struggled to replace redemptions in their loan books.
Meanwhile, there is the chance to establish a lending relationship with a borrower by purchasing its paper in secondary. In addition as the secondary loan market in Asia becomes ever more liquid, there is also the motivation of profit via trading par loan paper, i.e. taking short term proprietary positions in loans. Only a few banks have taken this step to date.
At the same time, liquidity in the secondary loan space has been rising as a function of the moribund primary market, where volumes have been diminishing over the past few years due to the relative unwillingness of companies to borrow, even though absolute rates are at historic lows.
There is added pressure on commercial banks from industry disruptors trying to disintermediate the market, such as peer-to-peer lenders.
A potentially fertile source of secondary paper is the portfolio sale, where chunky agglomerations of loans in both the par and distressed silos are shown to the market. In Asia this year, the bulk of the loan portfolios up for sale have emerged from banks seeking to reduce risk in the resources, shipping, real estate, infrastructure, gambling and steel sectors.
At the same time, SC Lowy is working to assemble collateralised loan obligation vehicles, typically containing vanilla syndicated loans as collateral. This will increase liquidity dramatically.
This article was first published in The Asset.