The EM lending gap
Bank lending to emerging markets is falling sharply – but David Creighton writes that the growth in bond issuance isn’t filling the lending gap
The prolonged euro-zone crisis has led to a sharp fall in new loans written by Western banks in emerging markets. This comes at a time when appetite for long-term funding from companies remains robust, fuelled by years of solid economic growth. This paradoxical set of circumstances creates a timely opportunity for investors who are able to bridge the emerging market funding gap.
Recent data from the Bank for International Settlements (BIS) demonstrates how steep the fall-off of new loans has been. While 2011 showed signs of recovery from the lows reached during the ‘credit crunch’, with almost $80bn (€61bn) of new loans in the second quarter alone, in 2012 lending rates fell 31% in the 12 months to September 2012. Only $245.3bn in new loans were written, compared with $353bn during the same period in 2010-11. The fall in bank lending was most obvious in Eastern Europe, where it was down 37%, but even Asia – the region that has traditionally attracted the lion’s share of developing market bank lending – recorded a dramatic fall of 27%.
Banks, already under strain because of the financial crisis, are facing additional pressure from their own domestic governments. Lending to emerging markets is less politically palatable during times of domestic economic struggle, and a number of major banks across several European countries are focused more on lending within home markets than they were prior to the euro-zone crisis. Emerging market lending has become a notable casualty of their efforts to bolster economic growth at home.
Further exacerbating the situation are the Basel III standards. Although the standards have not turned out to be the threat feared prior to January’s relaxation of the liquidity rules, banks have nonetheless spent the last three years shedding assets in preparation to meet the capitalisation requirements of the regulations. Emerging market lending has been hit significantly as a result.
The casual observer might point to the huge investor appetite for emerging market bonds as an important offset to this reduction of bank lending. The market growth in emerging market bond issuance over the past three years reached a peak of $300bn in 2012.
Demand for these bonds has made headlines around the world, a case in point being Zambia’s $750m government bond issuance that resulted in $12bn in orders and attracted 450 investors from across the globe.
This growth in bond issuance is excellent news for large corporates, and provides them with access to bond funding at spreads markedly lower than those prior to the credit crunch, but it does not necessarily help to medium-sized companies – or even all larger ones. For one thing, the costs associated with a bond issuance are prohibitive for all but the very largest companies. For another, investors are unlikely to be tempted by anything but the largest companies with high profiles. As a result, the majority of emerging market bonds are issued by multinational companies operating in limited sectors and geographies. Particularly common are bonds issued by conglomerates in Brazil, China and Russia in the telecom and resource sectors.
A significant funding gap has emerged that affects businesses that require long-term funding – the likes of which banks are presently unwilling to provide – but are not big enough to issue bonds. Many emerging market companies require funding for longer durations for investment in everything from manufacturing capacity to large-scale infrastructure. Years of growth in emerging market economies means that many enterprises have simply outgrown the short-term loans typically available through domestic banks within developing economies, and further sources of long-term funding are required.
This unfolding of events has created a wealth of opportunities for investors capable of offering this alternative form of financing.
Spreads on senior secured emerging market loans have moved from a pre-crisis level of 300-400 basis points to 400-600 basis points over the past few years. Investors providing emerging market private debt for the longer periods required are being rewarded with attractive risk-adjusted returns and an increased level of diversification. Emerging market private debt investment reaches into sectors and companies within emerging markets that are rarely touched by bond issuance.
Ultimately, investors willing to bridge the funding gap are finding high demand, an interesting pool of potential investments, and desired returns that are much more accessible than in the bond market.
David Creighton is president & CEO of Cordiant Capital