Germany has established a claim to be Europe’s leading loan market. Not only did the country’s corporates borrow more in the first quarter than those from any other EMEA jurisdiction, they provided some of the year’s most significant deals, which are quietly setting a lead for others to follow. David Cox reports.
Over the past decade Germany has moved from a relative backwater to Europe’s largest loan market. This reflects the evolution of German corporate funding from its roots as a bilateral dominated house bank system, to the active and sophisticated user of the capital markets it is today.
This sophistication has enabled borrowers in Germany to navigate the sometimes treacherous conditions of the loan market over the past 18-months. In 2009 this delivered continued access to liquidity in very difficult markets, be that through a forward start or even a stressed refinancing. Moving into 2010, improved markets mean corporates can now exploit the stronger market tone and lock in better terms.
The improved tone in 2010 does, of course, benefit Europe as a whole. But German corporates have been among the frontrunners in the loan market, pushing terms and setting new benchmarks. This partly reflects the relatively strong position of many in the German corporate sector at the onset of the downturn. Long used to managing relationships through the house bank system, German corporates used this experience during the boom, putting in place five or seven-year back-stop facilities through a core group of banks.
Rather than concentrating exclusively on price, the best corporates built relationships that would see them through the downturn. “German companies are extremely market and price conscious. At the same time they pursue and pay particular attention to how they can leverage cross sale opportunities for and from their banking group,” said Roland Boehm, global head of debt capital markets loans at Commerzbank. “There is a real awareness in Germany of what can and cannot be done with banks.”
This focus on relationship has allowed German corporates to negotiate a number deals that have become benchmarks for the wider European market. Key among these was Henkel which, along with Philips, the Dutch electronics group, put in place one of the year’s key refinancings. In early February both borrowers launched refinancing that repriced the market for top rated corporates. Henkel’s facility was structured as a €700m five-year loan paying a drawn margin of 75bp over Libor. At this level the personal care group was paying the type of margin that was seen for three-year money just a month or so before. At a stroke both Henkel and Philips stretched the corporate market from three to five years without necessitating a higher yield.
With a track record in the market and the promise of ancillary business keeping the banks on side, Henkel cleared the market with ease. For top credits at least, this success signalled a clear shift in market sentiment in borrowers’ favour, after around 18 months of sometimes very tricky market conditions.
While this shift reflected banks’ improved liquidity and their renewed desire to lend, it was also driven by a market that remains subdued. Although Germany is now the largest market in Europe, with its companies borrowing US$19.3bn across 18 loans in the first three months of the year, that European market is itself at its quietest for a decade.
Competing for a shrinking pie
The dearth of supply has ensured that banks will listen to corporates’ requests. The quarter has produced several interesting deals – not limited to top tier corporates such as Henkel. Companies further down the credit spectrum have also taken advantage.
Hella KGaA Hueck, a borrower from the tricky automotive sector, was one of the few German borrowers in 2009 to put in place a forward start agreement. These credit-crunch innovations are essentially loans with delayed drawdowns, ensuring borrowers were funded through the cycle when syndicates looked shaky.
Even if most forward starts are still in place, the improvement in market sentiment means the need these structures has largely fallen away. Hella KGaA Hueck was the first borrower in Europe to revisit its forward start when it refinanced a €400m agreement with a conventional loan. Despite coming in a sector that could not have achieved a straight refinancing in 2009, the borrower closed the facility oversubscribed with a 100% hit rate. Ultimately, the group opted not to take the loan beyond US$300m but the strong reception suggested – for Germany at least – the improvement in sentiment is not limited to the top tier.
“Blue chips are leading the way in the recovery in the loan market,” said Boehm. “However, Germany’s large group of large Mittelstand companies are also closely following the trend and taking advantage of better markets.”
The ability of German corporates to stay at the vanguard of 2010’s loan market recovery reflects the highly internationalised nature of the country’s export driven economy. While still supported by a strong and loyal domestic base, Germany’s loan market has been historically open, with strong participation from non-German lenders.
And while other markets such as the UK have seen an exodus of foreign lenders in the wake of the credit crisis, Germany has enjoyed some protection. The international outlook of many of its companies offered banks cross sale opportunities.
The underlying strength of the market should keep Germany delivering interesting deals in the first half of 2010. Among these will be a refinancing for HeidelbergCement, which is in talks about replacing the remainder of a €8.7bn facility from last year. That loan was effectively a stressed refinancing that, if not completed successfully, could have threatened the firm with bankruptcy.
Since the loan was completed, HeidelbergCement’s fortunes have turned around. Even with this improvement (the company is rated BB- from a low of B-), the borrower is still far from a top drawer credit, but with most refinancing activity this quarter focused around the higher end of the rating spectrum, a new loan from HeidelbergCement could provide a litmus test of demand for weaker credits.
The dangers of success
Some fear that the improvement in markets could paradoxically see borrowers take a step back. With margins now firmly on the way down, it is arguably rational to wait in the realistic expectation of better pricing tomorrow. However, unlike in the cycle that ended in 2006/2007, there are structural reasons making rock-bottom pricing levels unlikely.
“There is unlikely to be a new wave of early loan refinancings in the coming quarter, as most borrowers continue to see the market as overly expensive compared to two or three-years ago,” said Matthias Gaab, head of loan capital markets, Frankfurt, at Deutsche Bank. “Even as pricing falls, with many banks funding around the 50bp mark, once pricing gets below 60/70bp then risk premiums diminish and could put a break on some margin reductions.”
With refinancing unlikely to provide strong deal flow, the most interesting transactions could be in the new money space. “The sentiment in the market has improved and there is appetite for underwriting good quality credits. And as long as there is the option to reduce exposures through the capital market this appetite is likely to remain,” said Gaab.
The pipeline flow for acquisition linked loans is said to be weak, but Germany has provided one of Europe’s key new money deals: Merck KGaA, the pharmaceutical firm, funded its acquisition of Millipore Corp - in the first instance - through a loan.
Although, the facility was easily placed in the loan market its journey reflects the loan market’s place as one funding tool in a wider capital market kit. The acquisition was initially supported through a €5.2bn loan, which was drastically reduced to €1bn after the company sold a hugely successful bond. For companies like Merck, long term funding in the bond market is simply more attractive than what the loan market can offer.
“Clients look for solutions – they don’t focus on products as banks tend to do,” said Boehm. “The bond market has been there to provide solutions for clients over the past year, but this should not be seen as a bonds versus loans situation. As a product syndicated loans offer a lot of flexibility and they will continue to have a secure place in corporates’ financing requirements in the future.”
It is this flexibility that bankers say ensures the continued viability of the market, despite the bond market dominating the headlines over the past 18-months. But it does not mean volumes will recover to their pre-crash records any time soon. A mixed funding picture is likely to be the norm for the coming cycle.
“Borrowers are now focused on diversifying their funding base,” said Gaab. “Where before a 70/30 bank/bond split was normal now large corporates are looking for a 50/50 or even 40/60 bank/bond mix”.