A market vastly in favour of the financier

What's the current state of play in leveraged finance in Asia-Pacific?
Leverage in Asia-Pacific private equity was a fast-growing business up to the beginning of 2008. We saw some aggressive transactions priced significantly below 200 basis points over benchmark rate, against blue chip credits at sub 50 basis points. EBITDA covenants could be at five to six times and the LBO lenders could allow a considerable amount of senior debt.

The second half of 2008 witnessed a complete reversal of the situation. Credit pricing became very expensive even for the banks themselves and buyout activity became quiet with a depressed capital market. Some of the previous aggressive deals turned sour and banks turned their focus to managing existing portfolios, along with their own problems. Some major players are now scaling back or closing their leveraged finance divisions. The local banks are re-focusing on traditional corporate loans. Still, there are a limited number of deals done in the market now. These are those with a strong sponsor, solid company fundamentals, and, of course, completely different pricing, leverage ratio, and covenants.

With the “over-swing” of market conditions, it will be a period of time before the market can recover.The recovery will largely depend on the local economic development. The most promising market, in our opinion, will be China, given its size and growth momentum. This is on the back of growing domestic demand, continuous urbanisation, bold infrastructure plans, and upcoming value enhancement of the country's manufacturing sector.

What is the outlook for mezzanine providers?
Post-crisis, with senior lenders retreating to lower risk traditional businesses and stock markets virtually losing fundraising capacity, the options for corporates to raise debt at low cost or equity at 15 times plus P/E are gone, at least for now. Mezzanine capital becomes an effective solution for companies in need of funding.

Mezzanine in Asia is different from the US, where it is by nature a “buyout attachment”. In Asia, many people see mezzanine as instruments ranging from debt to quasi-equity and filling the space between senior bank debt to pure equity. It can take the form of a stand-alone investment that offers a combination of credit product type of downside protections and equity conversion rights. Downside protections in the current market situation are of particular importance to investors. The equity conversion rights are also going to generate good return when the equity market recovers. We are witnessing a large and increasing number of mezzanine providers – funds, investment banks, etc – capitalising on the opportunities created by the crisis.

In China, mezzanine capital is of particular importance to many privately owned enterprises in China, where banks are not incentivised to lend to them. In the post-crisis environment, companies are even more in need of growth and working capital funding. They also have much more realistic expectations in financing terms and valuation. Therefore, mezzanine capital should be in strong demand in the next few years.

What kind of opportunities is the leveraged finance team at CITIC Capital seeing at the moment, and how do they differ from previous years?
If one believes the market will eventually recover, now is probably the best time to take advantage of a market vastly in favour of the financier and with much less competition. In particular, we see some great opportunities in greater China in respect to funding high growth companies that are showing solid performance even during the global slowdown; providing mezzanine finance to listed companies, where there are convertible debt opportunities in businesses with satisfactory running yield and low conversion premia that were not available to investors a year ago; and secondary opportunities, where we can buy CBs and other debt instruments for listed companies trading at huge discounts.

We are also looking at financing and refinancing carefully selected existing deals. In the past two years, there were many deals financed by investment banks and hedge funds based on the expectation that the underlying companies would IPO in the next nine to 18 months. Apparently, many of the IPOs did not happen, and some of the companies, and even some investors, are now in distress. We see great restructuring prospects in distressed companies with good tangible assets, usually real estate companies, as they can offer good security and rich pricing. The ones with distressed investors but performing businesses are also our focus.