“The buoyant market plays in favour of the borrower. In the last five years structures have become ever more flexible and more borrower-friendly,” says Reinhard Haas, head of DCM loans at Commerzbank in Frankfurt.
“It’s a borrowers’ market,” agrees Mathias Noack, managing director and head of syndications, EMEA at Mitsubishi UFG in London. “In today’s world you will almost always find somebody else willing to do the transaction.”
This is especially true in EMEA. Despite bank mergers removing some big names, competition remains intense as new entrants continue to arrive — most recently, Chinese banks.
“Amazingly, the number of people trying to bank with clients is the same as before 2007/08,” says Matthias Gaab, managing director, syndicated lending for German-speaking countries at Deutsche Bank.
Cheap central bank funding has also rekindled lending appetite. “Within five years we came from a period of retrenchment after the crisis to a renewed ability to do billion dollar underwrites,” recalls Nigel Houghton, managing director at the Loan Market Association in London.
Marginal pricing
Hyper-competition is also reflected in lean margins. “It is good news that pricing has only reduced marginally in the past two to three years, but the level was already so low,” Gaab observes.
After the leveraged finance sector’s recent tightening, the gap between triple-C pricing and the risk-free rate has fallen as low as 650bp.
“We are surely hitting lows in terms of where certain areas of the loan market can be priced. But I’ve been saying that for a year,” notes the LMA’s Houghton.
Further evidence of the market’s meagre returns comes from minimal participation of non-banks like credit funds away from cov-lite/cov-loose levfin loans.
In turn, this reflects a return to relationship-driven banking with smaller syndicates. This gives borrowers sub-market pricing, particularly on undrawn back-up facilities, in return for the prospect of more lucrative ancillary business.
“Cross-selling of ancillary business has clearly improved. But it is so difficult if you lose a relationship — so expensive and uncertain to get back into the client — that everyone does their utmost to look good. As a result, everything is at rock bottom price-wise,” says Noack.
However, there may not be enough to go around. “A blue chip treasurer told me recently he doesn’t have ancillary business for more than 12 core relationship banks,” reports one market participant.
Moreover, loans face increasing competition from capital markets products. “Particularly in Europe, the biggest change since Lehman Brothers has been the move to a more diverse investor market with increased bond issuance across the credit curve and, consequently, lower volumes of loan facilities,” says Michael Dicks, head of loan syndication, distribution and agency at SEB in London.
Europe’s division between bank and capital market corporate financing is now 35/65, he estimates, versus a 20/80 proportion in the US and Europe’s 80/20 before the crisis. However, the proportion of term loans taken out through capital markets has fallen, according to some bankers. Having been as high as 70%-80%, it has fallen back to 50%-60%.
“I don’t buy the argument that the bond market has ever eaten the loan market’s lunch,” says the LMA’s Houghton. “Multi-billion jumbo deals work because of them working in tandem and the capital markets welcoming huge issuance.” He believes loans bankers “want deals to be taken out at least partially”.
Nonetheless, “something that has definitely changed is the overall movement from the lending market to the capital market,” says Deutsche’s Gaab, who attributes some of the decline in syndicated loan volume to this trend. “That is unlikely to be reversed, though there will still be opportunities for lending in areas like structured finance and term loans in connection with acquisitions.”
Last year was the weakest for EMEA syndicated loan volume ($1.011tr) since 2012, according to Dealogic, while 2017 is on course to fall short of even this total.
Moreover, the next investment grade refinancing wave is not due until 2019-20.
Still, with liquidity abundant and banks hungry for opportunities to deploy it, the first $100bn loan may be imminent. “It could happen at any time. I don’t think there is an upper ceiling for our market at this time,” says Haas at Commerz.
Indeed, Kraft’s bid for Unilever this year might have required a facility of this size had it been accepted. That would have been far larger than the previous AB InBev ($75bn) and Bayer ($57bn) records.
Acquisition financing could be a boost. “We are looking at event-driven financing to keep volumes up and allow us to do funded deals,” says Noack, but high equity valuations could mitigate against this.
“We all hope for an explosion of M&A,” agrees SEB’s Dicks, though he says many corporates are cautious on the outlook.
Moreover, an important new category of strategic buyers has begun to pull back. Bankers hope the slowing in Chinese and Indian purchases that culminated in ChemChina’s $43bn acquisition of Switzerland’s Syngenta is primarily a pause to digest ordered by the Chinese government, rather than a fundamental change.
Enticing EM
Besides M&A, a potential source of growth is the eurozone periphery. While mid-caps in core Europe have been active in the product since the early 2000s (and earlier in the UK), southern European names have been much slower to adopt it. “The number of users is way behind what we see in the core,” says Haas at Commerz.
As Mediterranean economies rebound, corporate financing requirements should rise. Spain has already seen a pick-up.
EM corporates may offer greater long-term potential. Much of lenders’ limited EM activity in the current environment is to local financial institutions or to project financings. The corporate penetration rate is “minimal”, says one senior banker.
Realising this potential may require a political shift, however. Western banks are discouraged or prohibited from lending to important emerging economies under sanctions, such as Iran and Russia.
Legal and governance changes will also be needed in EM jurisdictions to reassure lenders. There are other new challenges, including IFRS 9 (“it should not be underestimated how it might affect the market, says the LMA’s Houghton); Brexit (though most loans players expect UK borrowers to retain full market access); and Europe’s €900bn of overhanging non-core assets.
The return of a dollar premium is also weighing on lenders. “US dollar drawings are more expensive than 12-18 months ago since some banks have funding difficulties,” says Noack.
The biggest question, though, may be technology: how much longer can this clubby, old-school product hold out against it? Bankers distinguish between loans processes and more value-added, bespoke areas, where successful deal structuring requires human contact and creativity hard to replicate with software.
Most see administrative tasks — perhaps including credit decisions — becoming fully digital. Distributed ledger/blockchain technology may feature. Marketing could be accelerated with technology too.
“In 10 years’ time vanilla syndicated lending will be digitised,” says Dicks at SEB, who reports a loan auction via digital template in the Nordic market already.
Haas is more sanguine. “The financial crisis signalled the resilience of the loans market. It is a relationship-driven market — banks stood by their clients, even if they had to adapt.” says Haas.
Gaad adds: “The loan is probably the most flexible financing product. That is a key strength that should help it survive.”
But banks’ capacity to retain the product is in some doubt. “The big change will be that banks won’t be able to afford to hold loans on their balance sheets,” counters Dicks. “There will be much more intermediation of lending. The banking community will be a broker, underwriting and distributing loans/PPs and bonds.”
