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Monday, 23 October 2017

Changes afoot

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One topic dominating conversation in the EMEA loan market as the half year approaches is the lack of deals. Plummeting dealflow shows that the loan market is still at the forefront of bank deleveraging, and is being used as a key tool to help banks manage capital ratios.

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Only US$261bn of syndicated loans had been completed in EMEA by the end of May – 37% lower than the same period of 2011 – when US$415bn of deals were logged. The slump shows that companies are changing their funding strategy as the bank market gets less predictable.      

Banks need to boost capital ratios by raising equity, selling businesses or deleveraging and lending less is the easiest option. Borrowers know that loans will be less freely available and have been diversifying by raising debt in the bond markets.

“It’s all about low volume; there’s just no opportunities. The overriding factor at the moment is the lack of flow and the major issue is getting deals in. It makes everything very difficult to call,” a loan syndicate head said.

A quick look around would show a functional market, if on the quiet side, supported by strong liquidity. All deals launched so far in 2012 have sold well, which has created more downward pricing pressure, in contrast to a cautious late 2011. 

Thorny issues

Scratch the surface, however, and more complex thorny issues surface through patchy data which show an increasingly fragmented and regionalised loan market in the throes of major change, that is grappling with numerous regulatory, macroeconomic and capital issues.

“The market looks great right now from a borrower’s perspective; liquidity looks great. But banks have more fundamental problems than deals written this year would suggest,” the syndicate head said. 

Benign, if nervous, loan market conditions contrasted starkly with the broader capital markets as the eurozone crisis deepened again in May, when Greece’s exit from the eurozone looked increasingly likely and swathes of Italian and Spanish banks were downgraded.

The intensifying eurozone crisis is putting a brake on lending. The second quarter is usually one of the busiest of the year, but volume was down 28% on the first quarter at the end of May, and the number of deals is down a whopping 58%.

EMEA liquidity was eased by the European Central Bank’s long-term refinancing operation in February which allowed banks to continue lending. Many banks, however, are increasingly wary about underwriting liquidity that may not exist as the crisis deepens.   

“Going forward, you have to assume there will be a higher level of caution. The banks downgraded will have less capacity and the points around capital will crystallise quicker for banks downgraded. They will be aggressively selective,” the syndicate head said.

Aggressive competition for scarce mandates and income has, however, forced some banks to waive fundamental questions around liquidity costs to keep doing business, and banks keen to maintain relationships with borrowers and grab ancillary business, are carrying on regardless.

The EMEA loan market was expecting lower volume after much refinancing was brought forward last year, but bankers expected this to be offset by higher pricing. Rising volatility has however choked off M&A financing and the market is now facing the harsh reality of lower dealflow and pricing in a riskier environment.

Frenzied bidding for debt packages such as the €2.75bn financing backing German utility E.ON’s sale of its Open Grid Europe gas distribution business was attributed to LTRO liquidity, which, although helpful, is postponing a long-anticipated pricing correction.

“Pricing is idiosyncratic per market – we’re back to pre-euro pricing. We’ve moved from a euro market to more discrete markets”

One bidding tree on the OGE sale received support from more than 20 banks and the unexpected success of the deal saw €250m commitments reduced to around €130m. 

Pre-euro pricing?

The EMEA loan market has reverted to a series of local sub-markets with discrete pricing catering to domestic liquidity and supported by local banks, with the possible exception of Germany which has managed to maintain an international banking contingent due to the strength of its economy.

“Pricing is idiosyncratic per market – we’re back to pre-euro pricing. We’ve moved from a euro market to more discrete markets,” a second syndicate head said.

Loan pricing has held up so far this year, but the influx of LTRO liquidity coupled with a lack of demand by companies is piling pressure on lenders. Loans such as the €2.5bn loan for Pernod Ricard raised 100% oversubscriptions in May.

“With the result we’ve got on deals such as Pernod, it’s impossible for the next investment-grade deal not to price tighter,” a senior banker said.

Spain and Italy – the only peripheral countries still able to borrow – are paying a significant premium over the rest of Western Europe to cover domestic banks’ higher funding costs as government bond yields and CDS soared.

Spanish pricing has averaged 200bp so far in 2012, pulled by a refinancing of up to €1.2bn loan for Spanish utility Iberdrola, which was priced at 150bp, due to the company’s international business mix and strong international banking relationships.

Iberdrola’s lenders had the choice of lending to a term loan or revolving credit and to participate under English or Spanish law to allow the deal to be used as collateral to raise funds from the ECB – all measures designed to boost liquidity.

Italian pricing of 287bp in the year to date, will be further boosted by the €11bn loan backing the demerger of gas grid operator Snam from Italian utility Eni, which is expected to be priced at 300bp–350bp with an anticipated A rating.

The same deal for a comparably rated UK company would be priced very differently. Average UK pricing of 114bp is lower than France at 136bp.

Unsurprisingly, Germany is managing to access the most competitive pricing in  Western Europe, averaging 62.5bp, followed by Nordic borrowers at 80bp.

“Pricing is very fragmented, you have to be careful not to use a German comp like Henkel for a UK name; it won’t work,” the senior banker said. 

Dollar funding remains scarce in the EMEA market – particularly in the Middle East, Russia and Central and Eastern Europe – but the dollar premium has eased slightly from around 50bp in late 2011 to about 25bp.

Nerve-wracking underwriting

Life in the investment-grade loan market is far from straightforward but banks are still willing to underwrite deals which are generally well received with little to look at otherwise.   

Underwriting is a more nerve-wracking decision in the leveraged loan market which has to factor a closed European high-yield bond market and recent weakness in the US leveraged loan and high-yield bond markets into the distribution equation.

Banks are pressing ahead with two jumbo underwrites of about €3.5bn backing the private equity buyouts of German bandages maker BSN Medical and UK frozen food maker Iglo Group, despite deteriorating market conditions.

Banks and investors are wary of a repeat of last year’s expensive pile-up, when a clutch of deals underwritten before the summer struggled to sell and had to be offloaded at deep discounts, bringing significant losses for arranging banks. 

“What can happen in 30 days? Well quite a lot actually,” the second syndicate head said.

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