Adjusting to the new reality
Bankers feared the worst in the German loan market as credit conditions deteriorated throughout 2007 amid the reverberations of the collapsing US housing sector, but the worst has not happened. Prices have been hit but the markets remain open, especially for corporates that have built up strong relationships with a syndicate of banks, as David Cox reports.
In keeping with a wider European theme, the German syndicated loan market has got off to a slow start in 2008. The market is open but borrowing costs are on the way up and opportunistic refinancings are off the agenda, leaving M&A as the expected sole volume driver in 2008. With banks loath to underwrite large tickets, the scene is being set for a challenging year.
The absence of new loans means the health of the German market is hard to judge. In all, across the first two months of the year, German entities raised just US$3.3bn in five deals, against US$10.7bn in 14 loans in the similar period in 2007. However, despite this apparent torpor, bankers remain sanguine about the general health of the market.
"The German market is open for corporates despite the difficult circumstances," said Roland Boehm, head of European syndicate at Dresdner Kleinwort. "Loans are closing successfully but volumes are down and there will be a marked reduction in opportunistic borrowing in 2008."
When the credit crisis bit last year, the German market was instrumental in proving that the wider European loan market was functioning. As the global credit market dislocated at a speed that left most participants reeling, Continental fulfilled a €13.5bn funding requirement from its acquisition of VDO Siemens. Prior to the summer's credit rout, this size of syndication was commonplace and a borrower of Continetal's pedigree could have safely expected few problems in clearing the market. However, by the time Continental came to launch, it was far from certain that the market was able to absorb a deal of this quantum.
As a measure of the tougher environment through MLAs Citi and Goldman Sachs, the deal was flexed up by 10bp prior to launch and given lenders reluctance to underwrite, a senior sub-underwriting phase was bypassed and the facility launched directly to a general phase. Continental is a well respected borrower that has been able to command A style pricing despite being in the BBB credit range. The borrower has good ancillary business to offer and a reputation in delivering on its promises, so took full part in syndication. The strategy paid off and the deal closed with a decent oversubscription, providing the market with a benchmark.
The market’s relief that Continental had cleared with relative ease, was palpable and a series of relationship led refinancings suggested that the syndicated loan market was navigating the wider credit storm well. Firstly, Merck KGaA closed a €2bn seven-year revolver at an out of the box margin of just 20bp rising to 22.5bp. The facility refinanced the remainder of a €11.5bn facility signed the previous year that was to be repaid following the sale of its generics unit for US$6.6bn. The new loan was designed to be its core facility going forward and significantly reduced Merck KGaA's cost of capital.
Despite coming as the credit crunch began to bite, with banks’ funding costs soaring, the deal closed with an oversubscription. This deal was quickly followed by Lanxess, which reduced its cost of capital with a €1.25bn loan priced at 25bp. Lanxess signed at the same time as Douglas Holding, a retailer, which closed €500m revolver also priced at 25bp.
Given that these deals came at a time when the bond and leveraged markets were pretty much cut off, the syndicated loan market looked like a haven in a stormy financial sea. A closer look showed that conditions were not so clement. Firstly, Merck's facility was designed specifically to reduce its banking group as it no longer had need for such a sizable syndicate. Merck is a world class company and the facility defined its bank group going forward therefore so pricing reflected this. Moreover, it soon became clear that the pricing that was achieved in the autumn months would soon no longer be available.
By the end of 2007, it was fast becoming apparent that the credit crisis was a long term structural shift that would be measured in years, not months. Life in the syndicated loan market would have to adapt. As Lanxess came to sign in November, bankers admitted the group would now not be able to achieve that cost of funds. The talk now shifted to where pricing would stabilize, and how open the corporate market remained.
Given the lack of new deals in the first three months of 2008, where pricing has stabilised is still somewhat moot. Although there are differences in national pricing, the European market is largely integrated; bankers and borrowers can look around the continent for pricing benchmarks. So far in 2008, the clearest indication of the new pricing paradigm has come from France, where Lafarge completed a €7.2bn facility supporting its acquisition of Orascom Cement. The facility closed oversubscribed and at the time of mandate the borrower said the credit dislocation has resulted in around a 50bp price increase.
"Since the credit market crunch of last year, pricing has clearly risen in Germany," said Christoph Weaver, head of German Origination at RBS. "However, there has not been a large deal to test the German market so there is not a great deal of clarity at the moment. On a wider sector basis Lafarge has certainly provided a benchmark."
Unlike the traded products, lending is primarily a relationship business where banks are willing to provide well priced funds in the expectation they will have access to borrowers' ancillary business. What Continental and Lafarge illustrated is the syndicated loan market is open, but relationships are paramount. The borrowers that have worked over the boom years to put together a well defined banking group will now reap the benefits with continued access to well priced capital. In the easy money era of the past five years credit committees were willing to accept promises of "jam tomorrow", but this no longer applies. Today banks want concrete evidence that relationships work both ways.
That is not to say loan pricing has not increased: the average European bank is now funding itself somewhere in the 30s, so the type of razor thin pricing available over the past few years is no longer tenable. On rough basis, bankers now suggest where a borrower in the A rating range would have paid 20bp, it can now expect to pay between 30bp and 35bp, rising to around 45bp for a BBB style corporate – up from around 27.5bp. Despite this increase, bankers say it is important not to overstate the matter: "borrowers read the newspaper headlines like everyone else and have been in general surprised that the price increases have not been larger," added Christoph Weaver, at RBS.
Pricing is not helped by difficulty in the wider credit markets. Over the past few years, the CDS market has become an increasingly useful tool against which a borrower's relationship price can be measured. However, the CDS price is now subject to wild fluctuations, reflecting market difficulties rather than actual credit issues. This makes it exceptionally difficult to price new money debt, and bankers are once again returning to more traditional lending practices.
"CDS remains a point of reference but it is just one point," adds Roland Boehm at Dresdner Kleinwort. "When looking at loans, lenders now assess their existing relationship, the borrower credit profile, further opportunity for cross-sell as well as the CDS and bond yield".
These factors all add up to a difficult market, one that is not conducive to the type of price driven opportunistic borrowing that has been common in recent years. Large German corporates have typically spent the last few years putting in place five-to-seven-year sizable – and tightly priced – back up lines. The majority of corporate Germany is therefore safely tied up in long term loans, and refinancing business will be thin on the ground this year.
The market for undrawn back-up lines was not helped by Porsche's decision to draw on its back-up line to invest in "free of risk" securities earlier this year. Back-up lines are for general corporate purposes; lenders generally have little control over their use when drawn. However, lenders – and other corporates – were shocked by Porsche's decision to draw for such a purpose when lenders are facing severe capital constraints and increased cost of funds.
Volumes in 2008 will be reliant on corporate expansion activity through mergers and acquisition. Bankers are confident that a reasonable sized acquisition loan is able to clear the market, but there is debate weather the super-jumob in the tens of billions of Euros is still plausible in today's market.
"Super jumbos are not totally impossible in the present market environment but any loan that involves large holds over a long period is more very difficult right now," said Matthias Gaab, head of loan capital markets, Frankfurt, at Deutsche Bank. "In this context deals reliant on bond market or asset disposal take outs rather than cash generation or asset disposals are going to be more risky. The situation is evolving rapidly and it is difficult to predict where the market will be in six months."