2022 trends for banking and finance – Finance and Banking

With increased demand for integration of environmental,
social and governance considerations into financial strategies, the
expected upturn in spending on sectors that lay practically dormant
due to the pandemic (i.e. travel), a positive outlook for project
finance and the likelihood of rising interest rates, we look ahead
to the rest of 2022 and share some of our key predictions for
banking and finance.

Real estate development finance

We expect 2022 will be another busy year for development
financing, across all classes. Build-to-rent and residential
development, particularly land subdivision, are likely to drive
deal volumes and headlines for the short to medium term. Banks
continue to chase senior debt deals that are within bank tolerances
and major non-bank lenders report strong inflows and transaction
volumes across the capital spectrum.

However, there are some headwinds expected with the spectre of
rate rises and cost of funds increases throughout the year and
construction cost increases and material shortages to remain a
drag. The fall of ProBuild (following the demise of Grocon and
others last year) is a timely reminder of the vulnerability of the
construction sector. Against this, the reopening of borders and
return to offices may result in fresh demand.

At this stage, our prediction is that demand will remain strong,
and lenders will have plenty of capital to deploy, sustaining
growth for most of 2022.

Corporate finance

Towards the end of 2021, Australia’s corporate leaders were
expecting the economy to boom in 2022 – despite the threat of
skills shortages, cost pressures and supply chain problems.

While 2022 may not be off to the smoothest start, given
COVID-19, the situation in Ukraine, Australia’s current
relationship with China and increased general uncertainty,
Australian CFOs still seem optimistic about the year ahead.
According to the latest edition of Deloitte’s biannual
CFO Sentiment survey, 58% think now is a good time to be taking
on increased balance sheet risk.

Nevertheless, we expect that CFOs will generally maintain their
prudent approach to balance sheet management and headroom in their
funding lines, to ensure sufficient financial resilience to cope
with whatever the year may bring – including the expected
rise(s) in interest rates.

As always, high on the agenda for corporate treasurers will be
enterprise risk management. The corporate treasury is key to
driving diversification and flexibility across sources of debt
financing, shoring-up financial risk management in the face of
potential business disruption (including through financial risk
management products to lock in low interest rates and mitigate
cash-flow uncertainties) and funding increased corporate spending
needs in areas such as technology infrastructure and digital
transformation.

Corporate Australia clearly recognises that nearly all
stakeholders (including debt and equity providers) want action on
environmental, social and governance (ESG)
matters. As a minimum, many corporates are looking to embed ESG
actions as ‘business as usual’. In respect of corporate
finance, the rise in ESG-focussed debt products is gaining much
more momentum. Notably, Sustainability-Linked Loans
(SLLs), under which borrowers are incentivised to
achieve predetermined ESG-related targets to benefit from improved
pricing or potentially other advantages (such as in relation to
covenant packages), are becoming increasingly common.
Significantly, SLLs can be used in a range of financing types and
for various corporate purposes. The key to making SLLs work is
being able to achieve an agreed, objective ESG outcome.

We anticipate that the integration of ESG into corporate
financial strategies will continue apace, despite concerns in some
quarters about lack of capability and resources in relation to ESG
initiatives.

Project finance

The 2022 outlook for project finance in Australia is off to a
promising start, with a number of tailwinds underpinning this
segment of the Australian debt markets. In the short term, strong
commodity prices are driving interest across all project types,
including more traditional natural resources. In addition, the
continued emphasis on net zero and the rising important of ESG is a
focal point, as projects that will assist in achieving ESG outcomes
are particularly sought after. We consider this demand will only
grow over 2022 and each year thereafter until ambitions of net zero
are achieved.

In terms of project subsets, there will be a continued focus on
the Built Environment Sustainability Scorecard (BESS) and other
battery related projects, as well as continued support for solar
and wind projects due to their shorter timeframes for development
and relatively proven technology – although they still have
challenges in terms of getting operational. This year will also
give rise to a particular focus on responding to capacity and
network restraints in the National Electricity Market (NEM), as the
market responds to the continued announcement of early closure of
coal power stations. This will give rise to particular focus on
Renewable Energy Zone projects, which are being supported by
generous State government incentives and grants. Similarly, there
will be a continued focus on transmission projects, in particular
those identified as priority projects by Australian Energy Market
Operator (AEMO) in its
2022 ISP Plan. The CopperString 2.0 project to connect the
North West Minerals Province to the NEM in Northern Queensland is
likely to be a key focus, as its development, regulatory and
procurement activities are well advanced.

There is growing enthusiasm for waste projects on the East Coast
of Australia. Western Australia pioneered the Australian market
nearly five years ago through several large-scale projects, but
equivalent projects on the East Coast have been beset by policy and
planning barriers – which have delayed those projects gaining
any significant traction. This looks to be shifting for the
commercial scale projects as both the New South Wales and Victorian
governments have provided or are working towards providing greater
policy certainty for these projects. We also consider there to be a
promising year for more bespoke biogas and bioenergy projects.
However, those projects due to their bespoke nature will largely be
underpinned by concessional funding, sourced from Australian
Renewable Energy Agency (ARENA), the Clean Energy Finance
Corporation (CEFC) and state governments, until their can satisfy
commercial lenders of their project’s viability. These projects
will benefit from obtaining long-term offtake from credible
counterparties.

This year will also see strong support for Australia’s
dominant participator in the project finance debt markets, the
mining sector. The pipeline of projects entering the development
pipeline is growing, as well as those projects which may be bought
back online to take advantage of higher commodity prices. With
commodity prices high across the board, there will be activity
across the market. We expect that the critical minerals sector will
receive greater policy and regulatory support, as well as benefit
from access to various government funding sources such as Export
Finance Australia’s newly established A$2 billion 10 year
facility. Stemming from discrepancies in (liquefied natural gas)
LNG production and production across Australia, resulting in
significant pricing differences between the states and territories,
there is also a particular interest in building LNG import
terminals on the East Coast. These projects are being supported by
well-funded industry players, such as AGL and Viva Energy, however
they still remain very much prospective projects as it is unclear
at this stage whether they will obtain the necessary community
support and environmental approvals.

In addition to the A$2 billion allocated to Export Finance
Australia for critical mineral projects, we expect an even busier
year for the Northern Australia Infrastructure Facility this year.
In its now seventh year of existence, it has committed A$3.2
billion of its A$5 billion to domestic projects and moving forward
will benefit from an increase of its funding to A$7 billion. This
increase was announced in February 2022 and complements an
extension of NAIF’s statutory life by five years, which
occurred last year. The CEFC should also have another busy year as
it continues to support clean energy projects, critical minerals
and agriculture. We also expect the CEFC to have a particular
focus, working alongside ARENA, on supporting pilot and
pre-commercial stage hydrogen projects.

Notwithstanding, the strong tailwinds for project finance in
2022, a significant barrier will be overcoming supply chain
disruptions as well as significant pipeline of large-scale projects
in Australia creating unprecedented demand for contractors. It is
unclear when these pressures will ease, but with the recent
collapse of national builder Probuild (who had a particular focus
on high rises as opposed to infrastructure and mining projects) and
recent ownership changes in Australia’s limited number of tier
1 and 2 contractors this remains a key risk for new projects.

Debt capital markets and securitisation

While the ongoing impact of COVID-19, the situation in Ukraine
and the upcoming federal election will continue to drive a level of
uncertainly, strong GDP and employment numbers should ensure
another positive growth year for the Australian debt capital
markets.

We expect ESG and energy transition to continue to be at the
forefront of that growth. 2021 saw a record year for sustainable
debt issuance, exceeding 10% of global market bond issuance. While
the focus on ESG has been building over recent years, the United
Nations COP26 climate talks are seen as having raised global
awareness of climate risk and climate finance and played a key part
in driving increased inflows into ESG-focused funds.

Sustainability Linked Bonds from leading Australian issuers in
2021, including Wesfarmers, Worley Parsons and Woolworths, have
shown that in addition to ESG appetite in the loan markets,
significant appetite exists in the debt capital markets. As a
further positive sign for the Australian domestic medium-term note
market, it is notable that large benchmark issuance have been
undertaken in both Euro under euro medium term note programs and
also in Australian dollars and placed in the Australian domestic
market.

The outlook for the Australian securitisation market in 2022 is
also positive, driven by a continual growth in lending volumes.
Despite COVID-19, 2021 saw the continued proliferation of fintech
and other non-bank lenders funding new originations through
warehouse securitisations. While the AOFM’s Structured Finance
Support Fund supported the market by buying mezzanine tranches in
2020, real money investor demand returned strongly in 2021 with the
AOFM not writing new transactions and actively selling down
mezzanine positions taken on in 2020.

We expect this trend to continue in 2022, with the return of
offshore senior bank lenders and a growing number of mezzanine
investors providing the demand required to support the continued
growth of the warehouse market and term out transactions. We also
expect sustainability to be a significant theme in the
securitisation market in 2022, coming off the back of the Clean
Energy Finance Corporation’s support of the first green home
loan securitisation by Firstmac last year.

Syndicated lending

While the outlook for syndicated loans in 2022 continues to be
favourable, the likelihood of rising interest rates, inflation and
sustainable lending will impact financings. 2021 showed that there
was a strong appetite in the syndicated loan markets to support
corporate Australia, with funding coming from both domestic and
foreign lenders. However, ‘trickier’ credits or borrowers
in industries out of favour (such as fossil fuels) found raising
facilities harder. These issues will continue to be at play in
2022, but with a sharper focus in what will arguably be a less
benign environment.

ESG considerations will continue to be a key consideration for
lenders. This will mean that some borrowers who do not meet
lenders’ ESG requirements will find it harder to raise money in
the syndicated markets and may even have to seek funding elsewhere.
To date, the most visibly impacted borrowers have been those where
lenders have had environmental concerns. However, we expect to also
see an increased focus on social and governance compliance.

Another area where we expect to see ESG related developments is
in the ESG provisions in credit agreements. In 2021 these were
increasingly common and the coming year should see a more uniform
approach to the drafting of ESG provisions, as the market becomes
more sophisticated and as the impact of greater regulation in
Europe filters into the drafting of Australian credit agreements.
We also expect to see more key indicators focussed on addressing
social and governance issues, in addition to environmental
concerns.

2022 will also likely see a greater focus on the impact of
rising interest rates. Many deals over the past couple of years
have not had a requirement for interest rate hedging. In addition,
some strong credits have been able to negotiate financial covenant
packages without an interest cover ratio. We expect hedging and
coverage ratios to be under a renewed focus in the event that
interest rates start to rise during the course of this year.

We still believe that there will be a strong appetite for
lending in 2022. However, in light of the above, it will be
important for borrowers to allow sufficient time to negotiate with
lenders, particularly so for borrowers who are weaker credits or
who potentially have ESG considerations that need to be
addressed.

Leveraged finance

The outlook for leveraged finance in 2022 is positive. While
2021 continued to be impacted by the pandemic, government programs
like JobKeeper and JobSeeker combined with a coordinated response
from the Federal Government and the Reserve Bank of Australia
(RBA) on fiscal and monetary policy underpinned
the economy and avoided what might have otherwise been a sharp
economic downturn.

Against this backdrop, private equity acquisition activity
continued at pace. Investment activity shifted focus from industry
sectors that were impacted, such as leisure and hospitality, to
industry sectors that were either not impacted or which stood to
gain from changes in public policy and consumer behaviour, such as
social infrastructure, healthcare, online retail and information
technology.

With the pandemic hopefully receding, sectors that lay
practically dormant should come back into focus. For example, we
expect the travel and leisure industries to be beneficiaries of the
A$260 billion Australians have saved during the pandemic. Other
underlying factors that suggest 2022 will be another good year for
private equity investment include:

• overall superannuation assets totalled A$3.4 trillion as at 30
  September 2021, representing a 17.5% increase on the previous year.
  Australia’s compulsory superannuation, whereby employers must
  contribute 10% of each employee’s salary to a complying
  superannuation fund, underpins year-on-year increases in the size
  of the investment pool. About 5% of superannuation funds are
  directed to investment in alterative asset classes such as PE;




• each of the ‘Big 4’ Australian banks are active in
  leveraged finance, along with other domestic banks like Macquarie
  Bank and a large number of offshore banks that have a local
  presence in Australia;




• private credit managers, sometimes referred to as debt funds,
  have expanded both in number and in terms of funds under
  management. For example, Metrics Credit Partners has grown from
  managing A$2.7 billion in 2018 to A$10 billion today. Several
  smaller funds have launched (such as Epsilon Direct Lending) and
  some of the global players have opened up credit offices in
  Australia (such as Blackstone Credit);




• superannuation funds are lending directly into the market,
  either through their own office (like Aware Super) or via industry
  fund pooling (like IFM);




• Australia’s Term Loan B (TLB) market
  continues to expand. In 2021 AUD TLBs eclipsed TLB borrowings in
  all other currencies for the first time, with an overall share of
  58% (up from 20.2% in 2017 and 37.5% in 2019). TLBs and unitranche
  facilities represent an increase in overall funding available for
  private equity transactions; and




• funds raised by private equity sponsors have seen year-on-year
  growth. While numbers for 2021 will not be available until later in
  the year, in 2020 A$4.3 billion in capital was raised which was
  almost 2.8 times the funds raised in 2019 (A$1.55 billion). Private
  equity dry powder in 2020 was A$11 billion (with numbers for 2021
  to be determined). It is also interesting to note that A$3.6
  billion has already been raised by BGH for Fund II, so 2022 numbers
  are looking strong (Corrs acted as Australian counsel for
  BGH).

On inflation, an emerging theory is that much of the recent
inflation is ‘transitionary’ and attributable to increases
in product prices as a result of supply lines being disrupted
during the pandemic. According to this theory, supply lines will
recover and consumer sentiment will shift to services, including
healthcare (elective surgery), leisure (particularly travel) and
education (international students), which were forcefully shut down
as a result of the pandemic. The net effect of this will be a
cooling of inflationary pressure. Perhaps the only likelihood here
is that if interest rates do rise lenders may once again require as
a term of their financing that borrowers hedge a percentage of
their floating rate exposure.

Similar to corporate finance, we also expect the appetite for
loans that satisfy ESG criteria (ESG loans) and SLLs to be present
in the leveraged finance market. To this end, loan agreements will
likely contain provisions that will permit the borrower and the
lender to seek certification against the relevant criteria such
that the loan can be categorised as either ESG or SLL.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

Chambers Asia Pacific Awards 2016 Winner – Australia Client Service Award	Employer of Choice for Gender Equality (WGEA)