The $2 trillion syndicated loan market is not about to shut down, as the bond market has from time to time shown itself disposed to do. But, after last year’s telecom lending fiasco, the jitters caused by the incipient US economic downturn and the threat of a spill over into Europe, corporate borrowers can expect tougher terms from their core banks.
As ever, it is lower grade corporates that will have to bear the brunt of what is likely to be a sharp pricing tick up. “Banks will be more selective this year and they will also be looking at more cautious structures, which basically means lower debt multiples,” says the head of loan syndications at one of the top three European banks. “Uncertainty brings a flight to quality, so the pricing on deals for the likes of Unilever will not go up, but there is going to be a noticeable trend towards differentiation.” For one thing, debt structures will be less aggressive as people build a more pessimistic outlook into their cash-flow forecasts.
Lenders have taken note of the credit quality trends and the fact that, last year, US rating agency Moody’s downgraded more than three times the number of existing corporate loans than it upgraded. But it has taken some time for the cold reality to sink in and in the process a number of the bulge bracket players have suffered severe pain.
There is nothing like the promise of a fast buck to bring out the lemming qualities in a banker. When it’s not lending to Latin American oil producers or property companies with a hole in the ground and planning permission, the banks are falling over one another to lavish their shareholders’ money on other hot sectors, such as telecoms. Almost $210bn went into this industry last year, and it was smiles all round until the rating agencies decided that maybe the operators had gone a trifle over the top in those UMTS licence auctions. The upshot is that the banks will be managing the telecom loans extended last year simply by not adding to them – at least not on such happy terms. Investment grade telecoms, according to analysts, could see pricing rise by 15 to 20 basis points this year, while lower grade operators are facing increases of 100 basis points or more.
The US Federal Reserve set the tone at the end of last year with some sobering words on the outlook for syndicated lending to corporates: “Looking ahead over the next year (2001), more than half of domestic banks and two thirds of foreign banks indicated they anticipate a further tightening of standards and terms on loans.” This trend began to take hold in the final quarter of 2000, when around a third of US and European banks reported a tightening of the loan terms for large and mid-cap corporates.
However, the outlook is not entirely gloomy. “There is still a market for good corporates to raise relationship funding, which will continue to be the tightest priced deal in the market,” says a UK banker. “If a company is looking to raise core capital for general purposes from its relationship banks this will be done on the understanding that it provides a foot in the door for other services. There will continue to be very strong demand in the right sectors for deals with sensible structures and pricing.”
The M&A activity that characterised 2000 is still alive and kicking and much corporate restructuring remains to be done in Europe. This will continue to feed investment grade and leveraged buy-out markets in 2001, particularly in Germany, where corporates are planning mergers and disposals ahead of next year’s abolition of capital gains tax. The recent big sell-offs by Mannesmann and Siemens are just the first part of this. However, in contrast to the lending jamboree that took hold of the industry in the first half of last year, banks are going to be more selective.
Although banks in the UK and Europe have at last committed themselves to serious consolidation, so that the number of players is falling, there is still a broad range of banks willing to lend money to the right credits outside the telecom sector. On the LBO side in particular, an important driver of momentum will be the growing role of the institutional non-bank investor, such as GE Capital, Prudential Portfolio Managers, Axa and other US and European insurance companies and pension funds.
But with increasing concern over credit quality comes the inevitable step up in pricing. This is likely to be most obvious in the relative pricing between bonds and loans. If an investor can buy BT at 100bp over Libor for three years, the banks will be questioning the wisdom of syndicating a loan at 35bp or 45bp over. One banker says that possibly the only reason for making that kind of loan will be the prospect of seeing substantial ancillary business that boosts the overall return. In other words, the appetite to make loans is there, but the favoured customers will be those who show a willingness to throw additional business to their banks by bringing them into their re-structuring and expansion plans.
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