$500 MILLION, AND COUNTING

Dubai-based investment bank, Alpen Capital expects the investment deal flow to diversify now that political uncertainty is waning

Few capital market participants would have heard of Dubai -based Alpen Capital. However, during the last three years, the investment bank advisory firm has arranged over $500 million to be invested in Sri Lankan banks and finance companies as debt.

Dilip Samanthilaka is its chief deal maker in Sri Lanka. So far, Alpen Capital has arranged syndication and bilateral loans for banks and finance companies here. During the next year, they are aiming to arrange the first equity and debt deals outside of the financial sector.

Investments in Alpen Capital-arranged deals for Sri Lankan clients are usually for banks. Typically, many of these investors would not be looking at investing in Sri Lanka.

Samanthilaka says pricing changes depend on the client, investor appetite for Sri Lanka and global market movements. However, when Sri Lanka’s constitution was suspended in late 2018, all outstanding deals went into limbo. After the crisis, when the credit rating had been downgraded, Sri Lankan borrowers faced much higher prices.

Excerpts from the interview are as follows….

Is Alpen Capital the largest arranger of facilities for banks and non-bank financial institutions in Sri Lanka?

At the moment, we are possibly a leading company. I am not fully aware of marketwide numbers, so I cannot claim that we are number one. But we will surely be in the top three.

So you have arranged around $500 million, in total?

Yes, by way of syndications or bilateral loans.

Have you raised debt for corporations here?

We have not yet arranged any corporate loans.
We are working on a couple of such transactions

Lenders like ADB and DEG also directly lend to financial institutions here. Why would a bank work with an investment bank such as Alpen Capital?

This is our bread and butter. We work with lenders and clients every day. If you are a bank wanting to raise $50 million, who will be given the responsibility? Either the CFO or the Head of Treasury. But since they have a separate job apart from raising $50 million, we have an opportunity.

To fundraise, you will need to be on a roadshow. After that, you will have to follow up and consider the terms and conditions. You might be unaware of other banks’ rates, and what ADB or DEG are pricing for a similar transaction.

The advantage with us is that we provide innovative solutions, a unique feature on almost every transaction we are part of. Second, we know the market and understand who has an appetite for Sri Lanka at this moment, for the long term and short term. This evolving understanding of the market will help structure a transaction in ways that work for the client.

Banks and non-bank financial institutions (NBFIs) like DFCC and LOLC sometimes have better relationships with lenders than we do. But the structures we can create aren’t something they would have thought of. As an example, when we arranged $69 million to LOLC, it was by way of a syndication with ADB. Most Middle Eastern banks will not lend to LOLC because they do not have the mandate to lend to Sri Lankan NBFIs. However, since we arranged a syndication involving the ADB, Middle Eastern banks were able to participate. Separately, for NSB, we arranged $100 million, and went through a request for proposals (RFP) process to win the mandate. Major international banks also pitched alongside us. We had an advantage since we aren’t confined to one lender.

The country rating is critical for pricing. There are other parameters: political stability, inflation, the interest rate in the world market, and liquidity

Is it fair to describe Alpen Capital as an investment bank?
It’s an investment banking advisory firm.

How do you price a deal, as you deal with many lenders? What are the pricing trends you’ve seen over the last few years?

I cannot disclose pricing, as it’s not public knowledge. When we started in 2016, we worked on pricing connected to the country rating. LOLC was the first transaction. We came to Sri Lanka in 2015, and it took six months to finalise the deal. The country rating is critical for pricing. There are other parameters too. Political stability, inflation, the interest rate in the world market, and liquidity of Sri Lanka and the world; all these matters. The Sri Lankan government has an international bond that has a publicly available price, which is also a benchmark.

Is it quoted as Sri Lanka sovereign plus or LIBOR plus?

LIBOR plus.

What is the pricing premium clients here pay in addition to the sovereign yield?

Up to 100 basis points. In some cases, it does go beyond 100 bps. The pricing is a function of the credit profile and standing of an institution in the market. However, in some cases, especially for NBFIs, there is a small premium charged.

How much did NSB pay? I’m asking since its a state institution.

The pricing is confidential. Nothing goes to the public unless it is a sovereign transaction.

We had a constitutional crisis last year and then bombings on Easter Sunday in 2019. In your discussions with potential investors to Sri Lanka, did the pricing change? Was there a slowdown in negotiation, and how did the lenders react?

Two things here. The constitutional change was a shock to all the investors and the downgrading of the country’s credit rating was really bad. The appetite of the three types of investors, banks, DFIs and investment funds, were severely affected, and three to four transactions around $200 million in value were put on hold. However, the independent judicial system had a positive impact on investors. Unfortunately, still, some banks increased pricing owing to the country’s credit downgrade.

What would be the price change?

Around 50 basis points.

A one-notch downgrade would cost 50 basis points?

Easily, yes. A country credit downgrade will overpower anything, regardless of how good you are. When it’s downgraded from B+ to B, the risk automatically goes up and so does theprice. It may be due to some political issue, which has no direct impact on government debt, but that’s secondary. First is the country credit rating.

A country with a similar credit rating to ours would, on average, have much lower relative government debt. Around the 40% of GDP equivalent mark. Sri Lanka’s debt is double this average. Does this figure in conversations with investors?
Since we deal with private banks, the country rating does come into the discussion. Government repayment of debt won’t figure into our discussion in-depth, because we deal with independent institutions. They have no idea how the government will repay debt.

You talked about the pricing impact due to the constitutional crisis. Was there a similar impact after the Easter Sunday attacks?

The pricing did not change, but a lot of questions arose about bank’s exposure to the tourism sector. Overall, it will have an impact if bank non-performing loans rise, for reasons attributable to the fallout from the Easter Sunday attacks. This was a concern for most investors. Pricing wise, there wasn’t an impact.

If banks and finance companies want to improve pricing, having dealt with many of them, what do you think they can do better, besides the obvious, which is to improve their own credit rating?

First, the country has to work at large before coming to the banks. For that to happen, everybody has to work on one agenda on how to improve the economy. We are no longer considered a poor country, as GDP per capita is now $4,000.

The banking system is vital for economic development. How well regulated and run the system is matters. The Central Bank regulations, at the moment, are very stringent, and their supervision is word class. Some investors visit the Central Bank before the money is disbursed. Everyone likes the way the Central Bank operates. Minimum capital has been increased for banks and finance companies.

It is also critical for banks to manage their NPL levels. In addition to this, cost-to-income ratios are expected to be kept low, and their capital adequacy & overall profitability are expected to be healthy. Besides equity, investors are also watching return on equity (ROE).

Since last year, ROE has taken a hit. It was around 20% a year or more ago, but has declined to about 13% industry-wide now. Does that significantly impact investors’ view?

There are two types of investors. Debt investors are watching the NPL ratio, capital adequacy and other leading indicators to see if their money is safe. So, they are not very concerned whether ROE is 30% or 10%. Equity investors, on the other hand, are interested in ROE and a decent dividend.

Have you done anything on equity?

Yes. We did an equity deal for LOLC’s Pakistan unit. Apart from that, we are working on a couple of deals here. For equity, three things are essential. First is the return on investment. At the moment, ROE here is low due to falling profitability. Most of the listed companies are trading below book value. It’s a good time to buy, depending on an investor’s appetite.

Second is exchange rate stability. If the investment is in dollars, banks must be doing exceptionally well. In five years, if the CAGR is 15% and if the exchange rate is hit badly, then the return may end up at almost nothing. The third is the exit mechanism. There should be liquidity in the market for investors to sell after five years or so.

For equity investors, the exchange rate is a matter of concern. Then they are obviously looking at the government’s ability to service its debt, which is a significant factor in the exchange rate in Sri Lanka. Does that figure in your conversation with investors exploring equity investments in banks?

Yes, it will have an impact. They dislike sudden policy changes or shock movements in the rate; this impacts their confidence. Besides, a safe environment in the country, and political and economic stability, matter.

Are potential investors suggesting there are good deals to be had now? An excellent bank can be brought at less than its net asset value. So this must be appealing to some?

Yes, they see opportunity. The most significant restriction is that you can only buy only up to 9.99% of any bank in Sri Lanka. Under special approval, this can go up to 15%. Four exceptions have been made by the Central Bank to this rule: when TPG invested in Union Bank, LOLC in Seylan, John Keells Holdings in NTB, and Dhammika Perera-controlled Pan Asia Bank. At the moment, there are unlikely to be any more exceptions since the system is running well.

That restriction has put a lot of barriers to entry. If I have a 9.99% stake in a bank as a strategic investor and the bank does not pay a decent dividend, why should I stay there? If I am investing in a bank, I need to get a majority and take the valuation to a higher level by turning the bank around, and exiting. If I don’t have control, I’ll only have a board seat as a passive investor. What’s the point in that.

Do you think foreign investors have an appetite to buy at least a 30-40% equity stake in a bank?

If you give me an opportunity with 51% available, we can bring an investor for sure.

Investors dislike sudden policy changes or shock movements in the rate. A safe environment and political and economic stability matter

Is that type of investment happening in other frontier markets?

This type of investments happen in banks mostly.

Have you been involved in deals where there was majority control or high control, passed?

We have not been involved in the banks for majority control because we haven’t got any deals like that in Sri Lanka. Development Financial Institutions (DFIs) like to invest in minority stakes. They can only buy at the primary level, not in the secondary market. There are potential investors since Sri Lanka has a good story, especially after the war, Sri Lanka is sought after. The upcoming Colombo Financial Centre makes it attractive too. An investor entering early can grab the market.

Is there any investor appetite for large finance companies?

A couple of NBFIs are up for sale, but these are in trouble; that is difficult to solve. So the Central Bank has to resolve and come up with a mechanism. But there is a greater appetite for banks than for NBFIs.

Anything to add?

It’s been a wonderful story for us so far in Sri Lanka, as we continue to grow. We believe in the Sri Lanka story. Despite the war, Easter attacks and political instability, the banking system and Central Bank are run by highly qualified professionals who know precisely what they are doing. The country has not defaulted or delayed on any single dollar repayment, which demonstrates how respectable and responsible we are. We have seen delays and defaults in other countries who are better rated than us.

Now that you have done $500 million, are you still optimistic that you can continue this and maybe do another $500 million over the next three years?

I do think so. This liquidity situation can completely change after the elections. At this moment, we are working with four institutions to raise money. So that shows the appetite in the long term. The Central Bank has provided guidelines and restrictions on how much they can borrow. We know where and at what time to place these deals. Based on this, our raising $500 million in Sri Lanka won’t be difficult, but to manage client expectations is the key challenge.