Germany 2007 - Loan enigma
The German loan market is proving something of a mystery. After years of lagging the UK and France, the German market finally looked like it had come of age in 2006 with a string of jumbo acquisition financings. However, Germany has begun 2007 with a whimper and the market is now under pressure to prove it is not a just one-year wonder. Nachum Kaplan reports.
This time last year Germany had booked more than US$50bn worth of loans, against just US$1.5bn for this year so far. The scale of last year's acquisition boom always meant that a repeat performance in 2007 would be difficult to achieve but nobody expected such a dramatic fall.
One reason that the sharp drop in volumes is surprising is that there are plenty of good reasons to believe that the German loan market's long-term growth prospects are excellent and even though some monster M&A deal's like E.On's €37.1bn loan supporting its bid for Endesa and Linde's £8.9bn backing its purchase of Britain's BOC inflated volume data, there was growth in the number of deals, which is indicative of trend growth.
"There was a lot of M&A in Germany last year so as a result volumes went up significantly but if you look at the number of deals, they have also grown substantially," said Matthias Gaab, managing director and head of German origination at Deutsche Bank. "This is because of a shift in which the loan product has become more accepted. There is still twice as many deals done in the UK and France so, given the size of the German economy, there should be more room for growth. The growth potential is in the large mid-caps because most of the big companies have syndicated credit lines in place."
It is hardly surprising that bankers expect significant growth in the middle market because it is here that the strength of the German economy lies. German has many world leading companies, but only now are they beginning to match their technical sophistication with capital markets sophistication.
"Germany has reached its proper place in the syndicated loan market with a leading share in Europe in 2006 in terms of volume. It has world-leading companies but they have traditionally relied on the house bank principle and bilateral financing but they are now embracing the syndicated loan product," said Roland Boehm, co-head of loan markets at Dresdner Kleinwort. "What has led to the change? One is that Germany has become a very open market so there is room for foreign providers. Secondly, banking consolidation in Germany has made corporates cast their nets more widely. Mid-cap names are now looking more closely at the syndicated loan product."
That foreign banks are aggressively pushing the syndicated loan product in Germany shows that German banks are hardly alone in thinking that the market has strong growth potential. And while this obviously means strong competition for German banks in their home market, it is also a sign of market maturity.
"On non-M&A deals our biggest competitors in Germany are not the German banks," said Christoph Weaver, managing director, Loan Capital Markets at RBS. "On these deals, borrowers tend to choose a German bank and foreign bank so we're competing with foreign banks here. On acquisition deals borrowers are seeking the right expertise for a specific deal so that makes it a fairly level playing field for German and foreign banks alike."
International banks are also playing a role in developing the German loan market by helping educate German borrowers, especially mid-cap ones, about the syndicated loan product.
"Foreign bank competition in Germany actually helps the market as a whole because their pitching to German companies helps broaden the market for the syndicated loan product," said Michael Legeland, head of loan distribution at Commerzbank Corporates and Markets. "This helps German banks too, because if borrowers do decide they want to do a syndicated loan, they often still feel more comfortable doing it with a local bank they have broad relationship with."
It certainly makes sense for foreign banks to push syndicated loans in Germany. Foreign banks that want to build a strong position in the German market need to invest time and money in relationships and syndicated loans are the ideal way for banks to build relationships. This means that German and foreign banks alike are encouraging borrowers to use syndicated facilities rather than bilateral lines. And this is why the issue of education is an import one in the German market where many issuers and potential issuers are unfamiliar with the syndicated loan product.
Many companies are comfortable with their present banking arrangements and need to be convinced of the benefits of syndicated loans. The advantages of syndicated loans include borrowers being less reliant on one or two banks and therefore in a stronger negotiating position because if they cannot get what they want from one bank they can turn to another bank. In the present market, which is awash with liquidity, this may not seem like much of an advantage but when the credit cycle turns there is a clear benefit for borrowers. The more banks a company has to turn to in a credit squeeze, the stronger its negotiating position will be and more the likely it will be to secure the necessary liquidity lines.
This education process is already starting to pay dividends as it has created something of a virtuous circle. "It's become something of a self-fulfilling prophesy. Companies can see the benefits that other companies have got from doing a syndicated loan so want to do one as well. In M&A scenarios, banks with a syndicate in place are better placed to put financings in place," said Dresdner's Boehm. "Five years ago there were only a few very top borrowers in the market, now the mittelstand have become more familiar with capital markets and the syndicated loan product."
Educating mid-cap borrowers about the benefits of syndicated loans is important for two other reasons as well. Firstly, where is future acquisition growth in Germany is going to come from?
Mid cap growth
Many bankers think that mid-cap companies are inherently more dynamic and more likely to pursue acquisitions than larger companies. In addition mid-cap acquisitions are generally more credit-transforming than ones undertaken by larger companies. And given that the environment for acquisitions is good, it makes sense for lending banks to target mid-cap companies.
"Clients remain in acquisitive mode," said Deutsche Bank's Gaab. "They need to take corporate action to get their growth rates up so the mindset is there for acquisitions. The liquidity is there so there is scope for companies to pursue acquisitions."
RBS's Christoph Weaver agreed that M&A would continue to be a theme in the German market, this year's lack of volume notwithstanding. "I expect Germany to keep growing. There will be more large M&A transactions and some refinancing of last year's M&A financings, although these might be smaller because they will have been refinanced in other capital markets as well."
The second issue concerns banks, and in the German context German banks, having learned from their mistakes.
German banks got hit quite hard in the last downturn and one reason for that was that risk was not spread widely enough. "After several years of bad debts, German banks have learned from past mistakes and now want to have the minimum or near minimum exposure to a company that is required to maximise the relationship and syndicated loans are good product to achieve that with," said Commerzbank's Legeland
Legeland is certainly right the syndicated loans are a good product through which to spread risk. After all, that is the whole point of syndicated loan. One bank might not be willing to take the risk of lending a company a billion euro but 10 banks might well be willing to lend that same company €100m each.
All the pieces seem to be in the place for the German market to keep on growing but it could well be some time before it regularly matches the UK and French markets in terms of volumes. The UK market is the most mature in Europe and it has managed to end most years as Europe's biggest even if it is not the most exciting. The French market, which has surged since 2002, has still not managed to overtake the UK despite some spectacular years. This suggests that while the German market might be growing quickly, it will be some time before it can match the UK and French markets in any given year.
But while Germany might be some way off having a loan market to match its economy, the potential for growth is there and the banks are ready to drive that growth. The German loan market is land of loan market opportunity.