Banks tailor loans for ECB repo

European banks are asking local companies to write syndicated loans under domestic laws instead of English law, so that the banks can raise cheaper funding from the European Central Bank.

With many of Europe’s banks having difficulty in accessing the bank funding market, the ECB expanded its long-term repurchase operation in December to make cheap, long-term cash available to banks in exchange for collateral. But only loans documented under domestic European law are currently eligible for use as collateral, while loans documented under English law are not permitted to access this funding.

“We might see more loans documented under Italian, Spanish and French law to facilitate funding through the repo market”

A recent €2bn refinancing for Italian power company Enel was presented to banks under Italian law, one banker said, and top Spanish companies including Gas Natural have also discussed similar loans.

The move, which is worrying other international banks, points to a more fragmented syndicated loan market and could add extra layers of complexity to lending in incorporating both English and European laws. But it makes sense for the eurozone’s cash-strapped banks to tailor their capital markets products this way.

“We might see more loans documented under Italian, Spanish and French law to facilitate funding through the repo market,” said a head of loan syndications.

While lending under domestic law could slash funding costs for some European banks, more international banks fear a lack of transparency under more “borrower-friendly” legal jurisdictions and increased redenomination risk if the euro collapses. Nearly all lending in Europe, the Middle East and Africa is currently documented under English law, which is favoured for its clear and transparent bankruptcy provisions.

Many international banks are wary about lending under domestic law after suffering heavy losses following the collapse of Lehman Brothers in countries such as France, which have lower recovery rates and higher losses for lenders in the event of default or collapse.

Enel leads the way

A–/A3 rated Enel has been talking to banks about a €2bn refinancing since early November after lenders said the company needed to pay a higher interest margin than the 250bp that it was initially targeting. The new deal carries all-in pricing of 350bp.

Spanish utility Gas Natural had previously tried to document an existing loan under Spanish law but was unsuccessful, one banker said.

The ECB extended the maximum term of its repo to three years from 13 months in December to provide unlimited long-term liquidity to the market. It also widened the acceptable collateral and cut the reserve ratio from 2% to 1%, in order to free up more collateral for inclusion.

Any loans used as collateral for the ECB repo would be subject to a haircut of 10% for Single A rated assets and 17.5% for Triple B rated counterparties, a banker said.

“If you go around providing liquidity to European banks, how are they ever going to get off this drug?”

Law firms are currently discussing the differences between legal jurisdictions with lenders and helping them to understand any additional risk. A possible compromise could see provisions included for banks to lend under English law and domestic law.

“Banks are worried about local law and redenomination risk. We may end up going down a route where you see loans with a local law tranche and an English law tranche,” a head of loan syndicate said.

Concerns are lingering, however, that the infusion of cash from the ECB is removing the need for the more disciplined approach to loan pricing imposed by cash constraints.

“It is worrying that the ECB has opened up its coffers so easily. It is giving the market some stability and that’s why it’s in better shape, but if you go around providing liquidity to European banks, how are they ever going to get off this drug?” the loan syndicate head asked.

Additional reporting by Stephen Jewkes