Adjusting to change
In keeping with the wider European theme, the German syndicated loan market reported a difficult first quarter in 2009 with volumes significantly lower than at the same point last year. However, with signs that worst could be over for the financial sector bankers next quarter could see an upturn of activity. David Cox reports.
In the first quarter of 2009 German companies signed eight loans for €22.5bn according to Thomson Reuters data. It was a more than respectable showing for a European loan market where volumes have dropped by around a third, making the country the continent's second largest loan market. That said, the amount raised was still modest against the wider capital markets: German entities sold 132 bonds, raising close to €112bn.
The figures are indicative of a year where borrowers have focused their fundraising activity in the bond market – and to a lesser extent the equity market. The decision to concentrate efforts outside the loan market has been purely pragmatic: despite the huge injection of taxpayers' money into banks across Europe and the world, lenders remain cautious at best. In Europe, banks have continued to support their key relationship clients but this has been offset by balance sheet pressures.
Lenders are therefore extremely circumspect in allocating new capital. It has often led to an element of unpredictability, in terms of what the appetite of a given bank is at any one time: "There has been uncertainty this year as to which banks are willing to lend and at what price," said Matthias Gaab, head of loan capital markets, Frankfurt, at Deutsche Bank.
It has also undermined the relative appeal of the loan market for many clients. "Many banks are still funding at a higher rate than some better rated clients can achieve in the capital market. For those clients this means while the loan market can provide certain funds for acquisitions these funds are unlikely ever to be drawn as they are simply too expensive in comparison to alternative funding sources," Gaab explained.
Typical of this trend away from bank finance was the way that RWE funded its acquisition of Essent in January. The Essen based power giant opted to bypass a formal syndication in favour of a €9bn loan that bridged directly to the bond market. The decision reflected the type of problems that even the best rated corporates face in raising small amounts through retail syndication in the loan market.
Since the collapse of Lehman Brothers last year, lenders have shown little appetite to add assets to their balance sheets. This situation became apparent at the start of the year when lacklustre syndications from top tier borrowers such as EdF showed how unresponsive the market was becoming to well priced debt from premier European borrowers. It became clear that RWE would not be able to raise enough via full syndication to justify its efforts. Rather than expending effort in corralling remaining relationship lenders for limited benefit, the company focused its efforts on the more responsive bond market. Pricing was weighted to encourage a swift take out, with a 150bp base margin increasing by 50bp every six months along with up front fees of 150bp.
RWE's actions demonstrated a paradigm shift: the pre-credit crunch standard of one to four relationship banks underwriting a large facility, before taking it out to a senior round of other relationship banks, was over. Banks are willing to underwrite large deals but are not willing to take underwriting risk, a seemingly contradictory position that demands lenders be absolutely confident of achieving sell down before they participate. RWE gave them comfort as an impeccable credit that guaranteed a bond take out. In the absence of a pre-placed club, underwriters would have demanded significantly higher pricing and potentially unlimited flex – something most European borrowers are not yet willing to contemplate.
Two underwritings in the US medical sector for pro-forma Double A credits has seen initial pricing increase to as high as 300bp, providing a potentially interesting benchmark for European corporates to follow.
Pricing has yet to reach any thing close to these levels in Europe. So far there is considerable scepticism as to whether European corporates would countenance paying such yields. "Large transactions are still possible but they need to be short term with clear capital market takeout, said Damien Lamoril, co-head of EMEA loan syndicate at SG. "It will take some time before there is a return of the medium to long term new money facility to the loan market.
"In the meantime the bank market will act as a broker between the bond market, which given its depth and diversity is now the most appropriate place to finance acquisitions," he added.
This is not to say that syndication has vanished altogether. In one of the year's largest European loans underwritten and intended for syndication, K+S secured a fully underwritten US$1.4bn loan to support its acquisition of US-based Morton Salt. In part, the underwriters have the confidence to support the loan because of a small number of syndicated GCP refinancing lines that have been placed successfully this year. These deals have provided enough pricing points on a pan-European basis to give lenders renewed confidence to price new loans.
K+S was also a good candidate to approach the market. Just prior to announcing the acquisition, the Kassel based fertiliser to salt maker reported strong results. It had relatively low gearing and an existing bank group from previous syndicated lines. Commerzbank, SG and Unicredit are providing the loan.
"The first quarter of 2009 has seen some stabilisation in banks' liquidity situation after the freefall of last year and this is giving everybody a better idea of what can and cannot be done in terms of new lending," said Roland Boehm of Dresdner Kleinwort, who will take up the role of global head of syndicated loans at Commerzbank in early May.
It is hoped that K+S will provide the template for new money deals in the coming year. Bankers said that a cheap equity market means strong corporates may feel the time is right to make bolt on acquisitions. Equity placings and divestments supplement the bond market as viable routes for take out financing. And while the Single A sector is most attractive for lenders, they are still receptive to Triple B borrowers.
Acquisitions related activity will, however, not be the main volume driver. Refinancings are set to provide the lion's share of the year's business.
Germany has already provided 2009's most intriguing refinancing in the shape of a €10bn rollover for Porsche (for more on Porsche see derivatives feature). Although the company did secure its requirement, negotiations continued until the evening before the expiry of the original facility, with an eleventh hour flex of 50bp added to the margin following an earlier 50bp flex to the fee. Porsche also missed its original target of €12.5bn, with an accordion feature added to the loan to allow it to be increased at a later time.
Bankers said Porsche's approach to the market made the refinancing unnecessarily fraught. The mishandling of the situation probably made the deal more expensive than would normally have been expected.
Other borrowers appear to be approaching the market in a less emollient manner. So far, given where German borrowers are in the borrowing cycle, the number of formal refinancings has been limited. That is expected to change as the year progresses.
Activity may also have been stifled by German borrowers’ access to the schuldschein market, which has seen considerable activity this year. Schuldscheins are private debt instruments that are sold predominantly to savings banks. The market has provided a liquid alternative to the bond and loan markets throughout the year. Yet the sector does not offer a long term alternative to the loan market, and refinancing syndications and clubs are expected to be more of a feature now. German borrowers are experienced users of the loan market and the year is expected to see techniques such as forward starts introduced.
"The syndicated facility remains a core financing tool for German corporates" said Boehm. "While there are few signs of a return to the bilateral funding strategies of 10 to 15 years ago, borrowers are very focused on relationships and refinancings and are expected to use their house banks to coordinate their loan funding in the short term primarily through club - like transactions.”
As the year progresses and more borrowers come to market, it will also become clearer as to the attitude of foreign banks. Across Europe there is political pressure to support domestic borrowers but on the whole there is not the type mass exodus that some have predicted. So far the evidence suggests that the German market is too important for any bank with European ambitions not to form a core part of its strategy. But the relative value investor has certainly stepped back, and that withdrawal of liquidity will need to be filled by domestic lenders which will mean the year will not be without considerable challenges.