Australia’s big four banks are facing a challenging time at present. Investor skittishness about banks means that top-rated Australian companies can borrow in financial markets at cheaper rates than the banks themselves. At the same time, Australia’s two-speed economy means we’re seeing problems in a number of sectors – such as tourism, media, retail and property – and many analysts are tipping that the banks’ provisions for bad debts are about to start rising.
In an interview with Business Spectator, Jim McKnight, head of restructuring at UBS, talks about what’s happening in Australia’s banking market at present, and the outlook for the banks’ problem loans.
First of all Jim, what’s happening to debt markets now that you have a situation where investment-grade corporates can borrow at cheaper rates than the banks?
That’s absolutely right. But you have to remember that it’s not always about price. Sophisticated corporates look at a number of factors – such as the diversity of their funding, knowing the identity of the parties they’re borrowing from, and also, of course, the tenor (or length) of the loan.
At the moment, hybrids and corporate bonds and retail bonds are very much on the radar, with strong institutional and retail demand.
But, on the supply-side, you have to remember that these instruments are only available to a very small sub-section of Australian corporates – really the upper end of investment grade.
So far, it’s been the quality names have tended to tap this market first – the big banks, Tabcorp, Woolworths and Origin. Of course, there will likely be a shift down the quality curve as time goes on, but you have to remember we’re talking about relatively shallow markets. The banking market remains the predominant source of debt funding in Australia.
That said, we are seeing the beginnings of a high-yield market, and non-investment grade corporates are keenly looking at high-yield as a funding option.
So how’s the Australian banking market looking at present?
Well there are a few issues. In the first place, the foreign banks have had their issues offshore and they’re not getting the abundant funding they once had. They’re now under pressure to reduce their balance sheets, and they’re doing that.
There’s also a political element for the state-owned or state-influenced banks such as Lloyds and Royal Bank of Scotland. A bank like RBS is under pressure to lend to small and medium sized entities in the United Kingdom, and it’s certainly not going to win praise for lending in Australia, ahead of UK opportunities.
So what we’re seeing is that foreign banks are under pressure to withdraw from certain market segments, such as investment banking, and also from certain geographies. It’s most striking with the UK banks, but we’re also beginning to see it with the French and German banks – there are clear signals of Australia being strategically less relevant to many foreign lenders.
This is showing up in two ways. In the first place, the banks are trying to reduce their assets, and we saw the Bank of Scotland selling its Gold Coast and New Zealand portfolios recently. But also some of the European banks are having conversations with the senior management teams of large companies and letting them know that they won’t be renewing bilateral loans when they mature, or that they won’t be participating in the next syndicate refinancing.
Obviously not all the banks are doing this. You do see European banks in the market, but their enthusiasm has diminished and they’ve become much more selective.
And you’re seeing evidence of this. Many foreign banks are reducing their head count, and some of the smaller European banks are rumoured to be marketing their loan books. In the first instance, they tend to sell their project finance books, because that’s where the quality is, and there’s good demand from the big four Aussie banks for project finance loans.
One consequence of a smaller cohort of lenders, collectively with a more selective approach to lending, is that the days when private equity firms could raise the funding for mega-PE deals, such as Coles and Qantas, are over. We now see the debt capability of this market at less than $1 billion, and probably closer to $750 million.
Some people expect that Asian banks will fill the gap caused by the exit of the European banks. And we have seen the Japanese banks step up and take very large position in very large infrastructure and resource deals. But I think their focus will be more focused on infrastructure and resource transactions, particularly when there are Japanese interests involved. They will selectively target corporates and private equity, but not in such large volume
Actually, I don’t think that we’re seeing the gap caused by the exit of the British, French and German banks being filled. I still believe there’ll be a net shortfall in the banking market that will have to be filled by issuing more debt in the capital markets, and accessing more creative sources of funding.
What’s happening in the problem loan space?
Last year, the three largest completed corporate restructuring deals were Centro, Griffin and Hastie [McKnight worked as an advisor in all three].
So far this year, we’ve seen Reliance Rail, but there was always an obvious solution for that, because clearly the NSW Government had to have the rolling stock.
The other major deals are Nine Entertainment and BrisConnections. Brisbane’s RiverCity Motorway (Clem 7) is smaller, but may be focused on during 2012.
In terms of sectors, retail continues to struggle. Traditional media is clearly difficult. The smaller end of contractors, developers and construction are suffering. More speculative property development continues to be in the doldrums.
In real estate more broadly, there are two notable assets that may go to market – Raine Square – a large office and retail development in the Perth CBD, and the Top Ryde Shopping Centre in Sydney’s north-west. Finally, anecdotally, smaller and medium sized companies continue to face funding challenges, with working capital continually under pressure.
Are we likely to see more situations like Nine where hedge funds buy up bank debt so that they can ultimately have a role in a corporate restructuring?
Where opportunities arise, yes. If hedge funds can identify good corporates, with turnaround stories but problematic capital structures, they will chase hard. But the reality is that we’ve seen the largest deals completed last year, so there’s less around for the hedge funds to do, at least in terms of larger transactions.
I think we’ll see the hedge funds focus on other markets, or on primary deals where they refinance corporates directly.
In the secondary markets, the prices feel too high because there are too many bidders. Hedge funds arrived in our market for a number of reasons – Australia’s creditor-friendly system; the fact that Australian banks started to sell debt positions, and a ramp-up of bigger restructurings. Arguably, and perhaps flippantly, they also had the view that Australia is not Europe. The hedge funds thought having money tucked away from Europe was a good thing.
So they’ll continue to play in this market, and banks will sell more of their assets.
But I don’t see hedge funds being as active in the restructuring space in 2012 as they were in 2011 and 2010.