The only constant in the European loan market at present, according to Mathias Noack, co-head of debt capital markets EMEA at MUFG, is an abundance of liquidity. “It is a borrower’s market”. Two days after Noack made that remark, as part of a panel at the Loan Market Association’s annual conference in London in September, there were signs that investors are starting to push back – though they may have a long way to go.
A banker on a panel at the event noted: “There has been a really quite exceptional change in European loan documentation standards over the last two years.” The standards became looser because many borrowers started to tap into the US market, which was perceived at the time to have more liquidity. That meant better pricing, as well as a deeper ability to do loans without financial maintenance covenants. Once European borrowers got the flexibility which came from using US style documentation, they did not want give it up, which is why, in some respects, the banker said, “Europe has ended up with documentation worse [ie even more flexible] than that in the US”. However, the borrowers did not have it entirely their way. While loan covenants have become much looser in European leveraged loans, the assignment of the loans has become more restrictive, James Slessenger, head of the European covenant analyst team at Xtract Research, said. Many borrowers, for example, now stipulate that their loans may not be sold to “loan to own” investors. Some also try to prevent their loan becoming part of a collateralised debt structure or of a total return swap, something that banks could find “impossible to police”.
The question is whether investors have now taken as much risk as they are willing to shoulder in their search for yield. It may be that they have. The US$7.25bn leveraged bond and loan financing for Avantor, a life sciences company, had to undergo a thorough overhaul of documentation to tighten covenants, boost yield, and deal with investor concerns about, among other things, calculation of EBITDA. (This was announced after the LMA conference.) Covenant Review, a covenant research firm, said it was an important victory for investors and “a message to underwriters that they can’t push covenant boundaries so far in the future”. However, some noted that, even after the changes, the leverage on the deal was still 9x and that, “if it cleared the market, it would still be a bad thing”.
There is no question that abundant liquidity has stoked fierce competition among lenders. A banker at the LMA conference noted an “accelerating disintermediation” in the market with borrowers unwilling to pay for some services and increasingly self-arranging loans, also pointing out that automation was making increasing in-roads in the loan market as banks strive for greater efficiency and lower costs.
Bankers talking anecdotally during the interval agreed that many banks had no choice but to accept some very thinly priced deals or lose their connection with the customer. However, Roland Boehm, divisional board member, corporates international at Commerzbank, and departing chairman of the LMA argued that loans remain “the financial instrument of choice for liquidity when a client needs to act quickly”.
Even there, though, life may not be easy for lending banks. Business for event-driven loans is dominated by the biggest players and the EC is due to launch a study of competition in the EU syndicated loan market in Q4 2017. Those banks that have limited access to business like underwriting are active in riskier deals such as greenfield and brownfield infrastructure financing and in longer-term lending. Again, with a marked loosening of terms.
When it comes to the outlook for the future, Nick Jansa, global co-head of leveraged debt capital markets at Deutsche Bank, believes that the next 12 months will see “a lot” of M&A activity in Europe, mainly driven by private equity funds that have a lot of “dry powder”.
Speakers at the conference also expect that the prospect of a gradual tick up in policy rates may well encourage some borrowers to refinance ahead of any increase in borrowing costs.
Ouida Taaffe is the Editor for Financial World, the official journal of The London Institute of Banking & Finance.