Lowy warns on India ‘financing catastrophe’
It was a bold call to launch a specialist credit business in Asia in 2009, but SC Lowy celebrates its 10th birthday as an established figure in distressed debt and high yield not just at home but also increasingly in Europe. Events in India, however, where the firm holds a position in Essar Steel, are testing its patience and resolve.
It is 10 years since Michel Lowy decided to leave his job running the strategic investment and distressed products group for Deutsche Bank in Asia and go it alone. A ballsy move: October 2009 was a lively time to try to launch a whole new business based on Asian credit.
But the result, SC Lowy, is going strong a decade later and its plans are, if anything, more ambitious than ever.
Euromoney meets Lowy in the firm’s Hong Kong head office, in a meeting room where a glorious lake and mountain landscape from Jackson Hole, Wyoming, fills every inch of the wall. This photo shows the location of an off-site – Lowy and his colleagues crossed the frozen lake on snowshoes – and today it serves as a useful circuit breaker during difficult days, a reminder of a life beyond the screens and phones in the trading room.
When you pick a market like this, there are plenty of difficult days.
SC Lowy is today a three-pronged business embracing sales and trading, asset management and banking, but it started out focused purely on Asian distressed debt sales and trading.
“Typically, when you invest in distressed debt you tend to be a contrarian investor,” says Lowy, who looks like a younger and considerably less creased Willem Dafoe. “I moved to Asia in 1997, when everyone was fleeing. So it’s natural that we would start our own business when most others are in fear and wondering what’s going to happen in the world.
“Cycles are like that: when you are a fundamentally driven investor, that’s what you do, you try to keep a cool head when everyone else does not, whether it’s on the way up or on the way down.”
We very rapidly realized that to be successful in this business you need balance sheet and you need to put your money where your mouth is - Michel Lowy
Lowy and his team were correct in believing that the combination of volatility, risk, fear and uncertainty that pervaded the immediate post-global financial crisis era would bring plenty of opportunity for a business that was prepared to face it all down without blinking. But it wasn’t enough to just trade the debt.
“We very rapidly realized that to be successful in this business you need balance sheet and you need to put your money where your mouth is,” he says. “You need to be able to provide liquidity to market participants in times of stress. You’re not always going to have a buyer or seller lined up and that’s why we’ve evolved much more as a market maker using balance sheet.”
This conclusion led the firm into two new business lines. The first was a natural evolution into asset management. The second was more of a surprise.
Twice, in Korea in 2013 and in Italy in 2018, SC Lowy has gone out and bought an entire local bank, taking control, recapitalizing, revamping and relaunching it.
These ventures each started out as an opportunistic free-standing financial investment, but both are now considered separate and sustainable banking businesses.
This idea started when the firm was looking closely at Korea, a market it knew well: a co-founder of SC Lowy and now the chief investment officer is Soo Cheon Lee, a Korean who previously ran in-house research and trading in Deutsche’s distressed product group. Soo Cheon is the SC in SC Lowy.
“We realized there was an opportunity to buy a stressed deposit-taking institution and turn it around,” Lowy says.
The bank in question was Choeun Savings Bank, which serves retail and small and medium-sized enterprise customers.
Buying it brought a host of other benefits beyond the financial return: it helped with deal sourcing, broker-dealer and asset management. It also brought a local banking licence. Without the acquisition, SC Lowy probably couldn’t have handled Korea’s first debtor-in-possession financing, a $85 million facility for shipping firm Korea Line.
Is it a bold step? It is and it isn’t - Michel Lowy
Emboldened by its success in Korea, last year SC Lowy went one step further and bought Credito di Romagna, now renamed Solution Bank. This institution has 11 branches in Emilia Romagna and serves 25,000 customers, including 6,000 corporates, but the play, surely, is that Italy has more non-performing loans to intermediate than anywhere else.
“We are buying an institution in Italy when everyone else is trying to pull out of Italy, but that’s the nature of what we do,” says Lowy. “There are a lot of attractive investment opportunities in Italy, but they are very complex, and unless you have a large network of contacts within the legal community, the ability to reach out to promoters and negotiate with them, and a network to originate the deals, you’re not really going to be competitive.”
One example is an Italian shipping debt transaction with a total gross book value of $160 million.
The acquisition was so big that two thirds of the group’s staff are now in Italy.
“Is it a bold step? It is and it isn’t,” Lowy says.
Many of the senior management, Belgium-born Lowy included, are European, and there has been a business in Europe since 2012.
“And with the experience we were able to acquire in Korea, it wasn’t as bold as it may seem at face value,” says Lowy.
With the acquisition bedded in and 10 years on from launch, SC Lowy is now unique. It is a $2 billion private and independent financial services group with hubs in Hong Kong, London and Milan, with a staff of 250, a trading book across high-yield bonds and secondary loans that topped $25 billion in 2018 and balance-sheet strength between the two acquired banks of over $1 billion.
It’s just as well it has such strength and experience, because right now, India is testing it.
When India passed its Insolvency and Bankruptcy Code in 2016, investors like SC Lowy sat up and took notice. Lowy and others had engaged opportunistically with Indian distressed assets going back 15 years to his time at Deutsche, but the opportunities were limited and the time frame required for an outcome excruciating.
“For investors that are looking at returns, if an outcome takes 10 years rather than two, you can imagine the returns achieved are not going to be that exciting,” Lowy says. “The discount rate one puts on these bonds when one gets paid in 10 years is pretty high.”
The Insolvency and Bankruptcy Code was meant to fix all that.
It was linked with a broader initiative to clean up the domestic state-owned banking sector, which was crippled with non-performing assets that it couldn’t digest, resulting in those big lenders not lending and the economy suffering as a consequence.
The logic went like this: create an infrastructure in which bad loans can be resolved quickly (180 days for corporates, in theory, with an option to extend for a further 90) and you free up the state banks to write off bad debts, resolve what’s resolvable and start lending again.
One natural knock-on effect of this was the creation of a distressed debt market, which is when SC Lowy, their old shop Deutsche and locals such as Kotak Mahindra, Edelweiss and JM began circling.
“It’s a huge market,” says Lowy. “The default rate is going up, there is about half a trillion dollars of distressed debt in the banking system and there is a lack of liquidity in India. That all sounds exciting. So when you add that the bankruptcy regime has been approved, you’ve ticked one more box.”
It was not a crowded field, which suited Lowy better still.
“You’re playing against history,” he says. “Many decision makers at a lot of investment firms have, at a more junior time in their career, had difficult experiences in India in credit. When they sit at the top of the pyramid now and someone comes to them and says: ‘Let’s look at this in India’, they say: ‘It’s been too painful for me, I don’t want to go back there.’”
Lowy deems the court ruling on Essar's creditors 'bizarre'
Everything pointed towards the sort of opportunity contrarians like Lowy thrive on, so it engaged heavily in the first and biggest insolvency restructuring of them all: Essar Steel. In March, SC Lowy and Deutsche bid for distressed Essar Steel loans. The hope was that, with swift resolution through the insolvency courts, there would be a quick and lucrative return.
“And then,” says Lowy, “last summer you had this bizarre court decision.”
Lowy is referring to a ruling by the National Company Law Appellate Tribunal that secured and unsecured creditors to Essar Steel would be treated exactly the same, with the holding of collateral making no difference to the way that investors are reimbursed.
This was a pleasant surprise for unsecured creditors like Standard Chartered, but dramatically less appealing for secured creditors such as State Bank of India and SC Lowy. The firm has not disclosed its exposure to Essar Steel and it’s likely that even if the decision is upheld it won’t face losses, but it’s still not what it was expecting.
The decision was swiftly appealed to the Supreme Court and the market eagerly awaits a ruling. But Lowy has no doubt about the impact if the original ruling is not overturned.
“This would have catastrophic repercussions for the Indian banking system,” he says. “It means, whether you are on a secured or an unsecured basis, you have to ask the same returns, because you don’t know if you are secured or unsecured.
“You can only lend on an unsecured basis, that’s what it really means. And when you look at interest rates in India, which are already very high, it would be a financing catastrophe for India Inc.”
We thrive in situations where we can understand the business, assess its cash flows, but that’s not the set of skills you need in China - Michel Lowy
It will also drive potential new investors away.
“If you’re a foreign investor dipping your toe into a new market and regime, thinking it’s going to be different this time around, and you’re suddenly faced with this, you’re going to fly back to London and New York and say: ‘Never again.’
“The reality is, if the Supreme Court does not make what sounds like the most rational decision possible, this would be a massive step back. Not necessarily the end, but I think most investors would then say: ‘We’re not touching India anymore.’”
The knock-on effects would be higher lending rates in India, lower liquidity and the unavailability of foreign capital for credit.
“A perfect storm,” says Lowy.
And has he had any guidance on when the Supreme Court might rule?
“This century,” he replies.
Dead-pan humour aside, he has been expecting it “next month” for several months: “But I’m sure there is political awareness that in the meantime the market is at a halt.”
Still, if the Supreme Court does overturn the earlier ruling, Lowy expects a lot of very attractive opportunities: “You are talking about one of the largest markets for high-yield and distressed credit around the globe. That has the ability to remain a very attractive market for many years.”
SC Lowy is scrupulously selective and picking one market as a focus often means leaving aside another potential opportunity. The focus on India, for example, has meant that the firm has not looked closely at China, partly because it seems to Lowy that the skills required to evaluate an asset in China are very different from those elsewhere in the world.
“We thrive in situations where we can understand the business, assess its cash flows, but that’s not the set of skills you need in China,” he says. “In China you need to know if a company is well connected and if banks are going to support them. Your Rolodex is probably a lot more important than your analytical skills – and that makes it difficult.”
Nevertheless, given the number of redemptions coming in Chinese high yield and the number of calls and emails the firm is receiving asking it to look at transactions, he does see distress coming to the Chinese debt markets.
Globally, he says: “It is harder to make money in the last couple of years than it’s been historically, and that’s been driven by abundant liquidity in the mature markets that we look at.”
He points to record highs in high-yield bond funds and collateralized loan obligation (CLO) capital raising in recent years, “three times the size of their heyday in 2005/06.”
In secondary lending, trading volumes are their lowest for 10 years. This isn’t a great environment for a firm such as Lowy: when retail capital floods into high yield and leveraged finance because everywhere else is low or negative yield, they don’t tend to make money.
“But that’s changing,” he says. “We are starting to see redemptions of high-yield bond funds, more fear in the market, more downgrades than upgrades.”
CLOs are finding it harder to raise capital and he expects default rates to rise.
It’s interesting that SC Lowy still looks distinctive and that few are trying to emulate such a focused model in the region.
“To be able to build what we have built, I think you need to be a little bit crazy and think you can compete with all the large established institutions, which many didn’t think we could,” says Lowy.
He also thinks he was lucky with timing – “had we started five years later or earlier, it would have been a lot more difficult” – and barriers to entry have become higher during his time in the market, particularly around know-your-customer obligations.
Balance sheet has been another differentiator.
“The experience and trust for a bank to call you up and say: ‘I’ve got $100 million of exposure to this borrower, we’ve been partners to these people for 20 years and we’re thinking about exiting, can you quietly and confidentially analyze that and work out ways to transfer that loan, syndicate it, get the right price, on a confidential basis’ – it’s quite complex. There aren’t many with that expertise.”
Ten years in, Lowy is still focused on growth. The immediate priority is becoming more established and mature in Europe, to get it to the level of the Asian platform. It is looking at Latin America and at creating onshore operations to replicate what it has done in Korea and Italy.
“What we are trying to achieve in Italy is to be a one-stop shop for distress,” he says. “Then the challenge is to expand it into other markets. But to be able to give that full offering takes years – and a lot of luck.”