Eric Mason

Has leverage become a dirty word post-US subprime meltdown?
The overall impact from the global credit market turmoil has been somewhat muted in Asia although concerns about underwriting exposures at international banks to large LBOs, largely outside the region, could have ripple effects. The region, however, has never been that dependent upon the non-bank institutional investors or the traditional US high-yield market to finance deals. But because the non-bank investors – CLOs and CDOs – have stopped funding new LBOs for the time being, this will and has impacted debt underwriters that were relying on this as their distribution channel. For mega-deals that usually require some level of participation by US and European banks, you can expect some constraints or struggle until the backlog of underwritten deals in the US and Europe are cleared. However, it is important to note there are a lot of banks and financial sponsors that want to keep their business running in Asia, so we definitely won't see the last of leveraged finance.

How would you describe what was perceived to be an aggressive lending market prior to the credit crunch?
Competition between underwriters had definitely been on the rise in the past year or so, and naturally underwriting banks are going to be more cautious today about large-scale sole mandates. More aggressive lending was the result of the escalation of asset prices for LBOs, increased competition among financial sponsors as well as investment banks for mandates.

“For deals with more variable cashflow, debt may only be offered up to 60-65 percent of the capital structure.”

As a result, from the perspective of an underwriting bank, spreads and fees had tightened to all-time low levels globally. Today, debt pricing in terms of spreads on secondary trades as well as new issues have naturally widened and other terms and conditions will likely follow suit to better reflect the risk-return profile of these transactions, compared to a few months ago.

In the past, the vast majority of the debt structure was senior secured loans but as competition increased there was a need to introduce subordinated or mezzanine debt to help boost the sponsors' return, or enable them to offer higher valuations to sellers. Two or three years ago, less than 50 percent of debt structures would have included a non-senior debt tranche but in recent times, I would estimate that over 75 percent of these structures include some type of subordinated debt.

With regard to balance sheet leverage, a debt/equity ratio of 75/25 or 70/30 was relatively common in most markets in Asia. Today new deals may require slightly more equity but this is very dependent on the nature of the cashflows, the industry of the underlying credit and the size of the deal. For deals with more variable cashflow, debt may only be offered up to 60-65 percent of the capital structure.

Why are you confident that the Carlyle leveraged product can be successful in Asia?
Having spent more than ten years in Asia as a lead underwriter, I was acutely aware of the lack of non-bank debt providers in the market. It seems logical that non-bank debt investor like Carlyle will become a more active part of the Asian leveraged finance market. Over the last several years, the market here has developed in many ways, but there is a noticeable lack of diversity in the investor base when compared to the US and Europe were well over 50 percent of the debt is provided by non-banks. Only in the recent past have some dedicated mezzanine funds and some hedge funds begun to participate in traditional leveraged finance. Financial sponsors-related deals have, in effect, been overly dependent on the commercial banks for liquidity.

Our target investments will include senior secured and mezzanine loans that finance private equity deals. We will also invest in debt related to growth capital in both public and private high yield debt.

What markets will you focus on and why?
Singapore, Japan, Australia, Korea and Taiwan would be the first group of markets on our list, followed by China, India and Indonesia in the second. Given the market depth of Japan and Australia, we would likely have people on the ground. We are seriously considering Singapore as the base for Carlyle's leveraged finance business, from where we could look at assets across the region, but we have not made a final decision.