This time it’s different

IFR 2156 22 October to 28 October 2016 By Jonathan Rogers

THE SECONDARY LOAN market in Asia has been expected to boom for a long time. It was a hoped-for venue of rich liquidity and was seen as a handy, indeed necessary, means for banks to tweak their balance sheets.

I even wrote about it in this publication during a previous life as loans editor – coming up to 13 years ago if memory serves.

I remember announcing secondary loan trading in Asia was about to take off, that bid/offer spreads were on the verge of contracting and the sourcing of paper would become as easy as it was in the secondary bond market. That was the wrong call, and it never quite happened. But it seems like it’s about to happen now.

You can see why it’s on the radar and where the market ambition comes from. Secondary loan trading in the US averages around US$500bn annually, whereas in Asia it’s around US$2bn-$3bn. Set this against a backdrop where regional economic growth, although patchy in recent years, still outpaces that of the US by a comfortable margin, and you appear to have a rationale for market growth staring you in the face.

The thing I find quite fascinating is the main driving force behind the emergence of the Asian secondary loan market lies not in the distressed arena – although that’s part of it – but in the so-called par loan trading market, which involves loans trading between 90 cents on the dollar and par.

Spreads are tight at around the par level, but there’s flow there and one thing that’s driving it is the dearth of primary loan issuance. There’s a shortage of assets to book in primary and so the obvious place to turn to is secondary. It makes perfect sense.

Quite a few of the bulge-bracket banks in Asia are nursing wounds inflicted in the glory days of lending when the China demand juggernaut was barrelling on and the commodity super-cycle at its peak.

THE CAVEAT TO the growth of the secondary loan market in Asia, back in the day when I wrote my hopeful piece, was that relationships were tighter between borrower and bank: reassigning a loan in secondary was an easy way to offend your customer, and the practice was broadly frowned upon for that reason.

Everybody is apparently much more grown up nowadays, and borrowers who are perennially on the lookout for credit are willing to accept the harsh realities of the loan business and sign loan reassignment documentation without the pursed lips of chagrin. Indeed, the notion, which was an aspiration back in the day, that you could build a relationship with a new borrower by buying their paper in secondary is fast becoming a reality in Asia.

But it’s not plain sailing for all of the parties involved. Quite a few of the bulge-bracket banks in Asia are nursing wounds inflicted in the glory days of lending, prior to the global financial crisis, when the China demand juggernaut was barrelling on and the commodity super-cycle at its peak. Numerous bank loan books remain bogged down with toxic, legacy assets from those halcyon days, principally in the resources, infrastructure and shipping sectors.

That, of course, brings out the quintessential bifurcation of the secondary loan market in Asia: between trading in performing loans and those in the distressed sector. On the performing side, the price kicker is less of a motivation for trading than the desire to tweak overall risk exposure, whereas on the distressed side the price upside can be spectacular.

I’m told that entire distressed loan portfolios are doing the rounds, and that some institutions are working for customers who are actively looking to buy with a view to participating in the steering committees of debt workouts – a “loan to own” strategy with an eye on debt-for-equity swaps.

ONE INTERESTING AREA of activity is the emergence of collateralised loan obligations, which are utilising a mixture of distressed and par paper. Boutique player SC Lowy is apparently in the midst of putting together a CLO originated from Asian loans. The company is also ramping up on the par loan trading side in the region.

It remains to be seen whether the secondary loan trading business in Asia can legitimately aspire to the depth and sophistication of the business across the pond or whether the recent infusion of vigour is simply the function of a moribund primary sector. I’m told that even though loan margins are painfully skinny, banks are having a hard time giving money away, even though they are trying with all their might.

My loan banker contacts tell me they are hoping for a further round of Basel bank regulation to give the primary market a kick in the pants and return margins to palatable levels. That may or may not happen, but the folks newly engaged in trading Asian loans will be looking to make hay while the sun shines.

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