May 8, 2020 / 9:56 AM / a month ago

Taiwan loan floors under pressure

* Loans: Lenders grapple with declining returns as benchmark drops to historic low

By Evelynn Lin

HONG KONG, May 8 (LPC) - Pricing floors on domestic currency syndicated loans in Taiwan are under pressure following a repricing request from five-star hotel owner Mandarina Crown Hotel for a NT$23.8bn (US$794m) loan agreed last year.

Designed to protect lenders from declining returns, interest rate floors are in the spotlight following a rate cut from Taiwan’s central bank that has taken a benchmark lending rate to historic lows.

The one-year post office savings rate is a fixed rate and is typically used as a benchmark in domestic currency syndicated loans in Taiwan that carry tenors longer than five years.

However, it has dropped to a record low of 0.81% after the Central Bank of the Republic of China cut its policy rate by 25bp on March 19.

That has taken the rate to below 1% for the first time in its history, prompting questions over whether the interest rate floors on domestic currency loans need to be reset lower.

Taiwan’s central bank has not issued any directive or guidance with regard to the floors on syndicated loans and lenders are reluctant to change.

“It’s understandable that the borrowers would think they are paying too much. However, the interest rate floor mechanism protects us from downsides as our returns are already very thin, therefore no lender would be the first to break the unwritten rule,” said a Taiwan-based senior loan manager. LOWER FLOORS? Typically, the majority of Taiwanese domestic currency syndicated loans carry a 1.7% pre-tax interest rate floor, which is embedded in the loan agreements. This level already seems high in the current environment.

Mandarina Crown Hotel, which owns and operates the Mandarin Oriental in Taipei, has requested a repricing of its loan signed in January last year to cope with the difficult business environment and steep losses in the hospitality industry due to the coronavirus pandemic.

The borrower is attempting to slash the interest margin by half to 50bp over the one-year post office savings rate for one year from the amendment date. That comes to 1.31% at the current base rate of 0.81%. However, to benefit from a repricing, Mandarina Crown Hotel also needs to renegotiate the interest rate floor in the original loan agreement, set at 2%.

Some loan bankers worry that Mandarina Crown Hotel’s repricing will give top-tier Taiwanese borrowers more bargaining power, leading to a series of copycat moves. Others think lenders should accommodate a short-term pricing reduction to help relieve the burden caused by Covid-19.

“If a borrower can make a case that it needs relief measures under the current situation, banks could be willing to lower the interest rate floor, but only in the short term,” said another loan banker.

Such moves are expected on takeout financings for bridge loans totalling NT$40bn that Bank of Taiwan provided in late April to state-controlled China Airlines and private sector operator EVA Airways Corp.

“There is no doubt that the pricing on the takeout financings, which will come to the market in the next few weeks, will breach the 1.7% interest rate floor,” said the first loan banker. “The loans are part of the government’s NT$50bn bailout for the aviation industry announced last month, and we will follow the guidance.”

The bridge loans carry an interest margin of 29bp over the one-year post office savings rate. The takeout financings are expected to have five-year maturities. PROFITABILITY HIT Whether the interest rate floors are reset lower or not, Taiwan’s banking industry has long been plagued by low returns given the dominance of plain-vanilla loans with wafer-thin pricing.

The uncertainty about the impact of Covid-19 and the market volatility is likely to further impact the sector’s profitability.

Rating agency Fitch revised its sector outlook for Taiwanese banks to negative from stable on April 19 due to the global demand shock and rising pandemic-related risk to the island’s export-oriented economy.

The Taiwanese government has announced measures to mitigate the shock, including a rate cut of 25bp, and a relief and stimulus program of NT$1.05trn, equivalent to 5.4% of GDP, Fitch said.

Notwithstanding the announced government relief measures, the return on assets for banks could fall to 0.4% this year from 0.6% last year, due to slower loan growth, narrower interest margins, and weaker fees and investment income, but higher credit losses, Fitch added.

Reporting By Evelynn Lin; additional reporting by Aileen Chuang; editing by Prakash Chakravarti and Adam Harper

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