The sun still shines on participant banks

Far from disappearing, the role of participant banks in the trade-related syndicated loan market remains as vital as ever. Guy Brooks, head of trade-related syndications at Deutsche Bank in London, explains.

The year has started well for emerging markets. All asset classes – including bonds, equities and loans – have been buoyant against a backdrop of high market liquidity, strong economic fundamentals and a stable political environment in the key countries.

Of course, this has also had a positive impact on the trade-related syndicated loans market, especially in the former Soviet Union – a key area of concern for Deutsche Bank’s trade finance team in London.

Indeed, money supply into the trade-related syndications market has been boosted from the trickle down of liquidity from new sources, previously restricted to more liquid emerging-market assets such as bonds and equities. Institutionally invested emerging-markets funds are looking at new ways to invest capital – including joining trade or unsecured loan facilities.

This is as an asset that may have previously been unavailable to them because of the asset class’s relative illiquidity, as well as the tight pricing. Certainly, these funds are still restricting themselves to a minority percentage of investments in less-liquid assets such as loans. However, that percentage take is creeping up as many now see the trade-related asset class as a strong diversification – especially in the more established trade-finance markets such as Russia and Turkey.

And while the funds have been slow to pick up on the potential of trade-finance paper as an asset class – partly because trade finance has traditionally been something of a discreet product within banks – some specialist players have been entering the market.

These include the recently established New York-based Rosemount Capital Management – led by a team of former trade-finance bankers. GML and Ecoban are also understood to be leveraging their emerging market trade finance heritage to launch funds specialising in trade-related lending. Other names too have mooted plans to create trade-specific funds to enable institutional investors to take advantage of trade finance’s low default rates and in some cases relatively high yields.

One aspect that fuels the thinning returns is the diverging market perspective of the mandated lead arrangers from the participants. Increasingly, the leading MLAs are taking a flexible and holistic view of the relationship, which means that thin returns on syndicated lending can be supported by other activities being sold by the bank. Yet while this can make sense for the big arranging banks – offering cash management at one end and IPOs and bond issues at the other – it makes less sense for the market’s many participating banks.

Participant banks are simply looking for a strong asset for their balance sheet. Deals are judged on their merits, which means that in some markets an increasing number lack the required returns and are being brushed aside.

This dilemma partly explains one seemingly contradictory trend starting to emerge in the syndicated loans market to the FSU – the fact that, as the number of jumbo Russian deals grows, the number of participant-level investors in Russian deals shrinks. Several of the jumbo Russian deals have been notable for the fact that there has been little or no participation in the deal below the mandated lead arranger level – with the participant-level banks finding no value against such stretched terms.

Behaviour of banks

Yet all is not what it seems. The MLAs are not simply taking a battering for the sake of the relationship. When the deals with the tightest margins come on to their books, the leading trade-finance banks have a choice. Most will hold on to the loan – as stated, aggregating any losses against the range of products sold to the leading emerging markets names. However, two other possibilities have been growing in importance – the increased appetite in the capital markets and the insurance market. Both are being used more aggressively than ever, and both are still providing the leading MLAs with returns on some of the tightest credits in the market.

The capital markets route is the most interesting. Credit default swaps are now providing a liquid exit route for once illiquid loans. They are also bringing benchmarking efficiencies to a once largely opaque market. Of course, the capital markets are not competitive in all circumstances, but its ability to offer a skim for the MLAs in certain situations is making it an increasingly viable alternative.

This trend has been fuelled by the growing interest of the capital markets team to their bank’s lending operations, which makes this an ever-more likely exit route for the leading trade-finance MLAs – as long as the capital markets continue to offer a skim. Certainly, the capital markets are helping to make trade-related lending a more liquid and transparent market, which is having a positive impact on pricing efficiency.

Far from taking a bath, it seems, the leading MLAs are finally leveraging the full resources of their investment banking operations to remain competitive – as well as helping Russian borrowers achieve pricing that is now comparable to equivalent OECD credits.

Of further help to the leading MLAs is the political-risk insurance market (PRI), which offers an alternative route for guaranteed returns against tight loan margins. Current premiums for credit insurance on Russian loans remain consistently lower than the margins on many loans, allowing the MLA to wrap the loan and, again, skim some margin. However, given some of the current pricing, this is coming under pressure.

Yet the insurance route is more restricted than the capital markets route. First, political risk insurance covers 90% of a transaction’s value – leaving a 10% residual risk with the banks. Also, insurance policies require a claims process, while bankers may prefer the on-demand and irrevocable nature of a credit-default swap. Finally, the capacity of the capital markets is far greater than that currently offered by PRI.

Participants still have a healthy role

So where does this leave the old participant bank lenders? Surprisingly, not out of the game – and, in fact, strong and vital players in the trade-related syndicated loans market. What is obvious is that Russia, although still given the tag of an emerging market, is now an investment grade credit, with its premier borrowers being treated as such by the market. And it is for these names that the old participant market may be closing due to the wave of price-tightening interest from the capital markets.

And as long as systemic shocks are avoided, this is likely to remain the case. However, recent closings for transactions in Kazakhstan have seen record numbers of participant banks. The Deutsche Bank-led record $1.3bn transaction to Kazkommertsbank, for instance – which signed in late December 2005 – attracted 54 banks into the syndication at various levels, against 25 lenders for its first post-crisis transaction in 2001. This figure, however, was beaten by the August 2004 BankTuranAlem transaction, which listed 66 lenders.

Participant banks, it seems, find Kazakhstan returns still relatively fruitful. At the same time the number of non-MLA banks involved in transactions in Ukraine is steadily increasing – with the barrier here the need for credit committees (often in small banks without a major credit function) to become comfortable with what still seems to many a volatile and unstable political environment, although one with a lot of strong potential credits and a price premium in excess of 150 basis points.

As things stand, therefore, while the sun maybe setting for Russia as a strong market for the participant banks, the sun shines brightly for Kazakhstan. Meanwhile, for Ukraine, the hottest part of the day may be some way off.