Over the last 12 months the UK loan market consolidated its position as the dominant force in Europe, and even showed some of the first signs of a pick-up in merger and acquisition activity. But bankers became concerned about the increasing presence of club transactions, threatening to undermine their roles on deals. Adam Harper reports.
On paper, the UK’s loan market performed well last year. It has traditionally been about twice the size of the French and German markets combined, and 2003 was no exception. Most bankers are confident that the size of the UK economy and its strength relative to the euro zone economies will ensure that it remains the dominant market.
As Ian Fitzgerald, director and head of distribution and syndication at Lloyds TSB in London, says: “The UK has been the largest single loan market in Europe and will remain so for the foreseeable future.”
UK volumes as of early December stood at $150.9bn — just above the combined French and German total of $150.5bn, according to Dealogic.
And, statistics aside, some bankers are unsettled by trends that emerged during 2003.
In particular, many see the growing popularity of club and self-arranged transactions as a worrying phenomenon, although this is by no means confined to the UK. The trend in the UK is being driven by the liquidity both of banks and prosperous British companies. “The club route is the simplest route for corporate treasurers as they can escape the potentially contentious issue of giving one bank lead status,” says Fitzgerald.
He sees September’s £145m loan backing the merger of software companies Torex and Isoft as a classic example of a club deal. Both companies had relationships with the four UK clearing banks — Barclays Capital, HSBC, Lloyds TSB and Royal Bank of Scotland — and wanted to keep them all on a level footing. All four were named mandated lead arrangers, with Lloyds the co-ordinator because it had banked both companies in the past.
There was a glut of self-arranged loans for large and well known UK companies last year. Among them, a £300m deal arranged for EMI in September; Great Universal Stores’ $750m deal secured in November; a £450m loan for Granada, also arranged in November; and a contentious transaction for Royal & SunAlliance that raised £400m in September.
Declan McGrath, head of syndications for UK and Europe at Royal Bank of Scotland in London, says the trend is a sign that borrowers are growing more astute and demanding.
He is inclined to look on the positive side. “It is better to lend something than nothing at all,” he says. “Clients recognise they can’t feed the five thousand, so they make firm commitments to a smaller group. Club deals in the main are for lesser rated credits who pay well and share their ancillary business around.”
While self-arranged deals make life simpler for borrowers, bankers find them frustrating and are worried about the threat to the arranging bank’s role in syndication and distribution. Houses committing £100m to join the self-arranged GUS loan at the top tier were awarded bookrunner status, ironic for a genre of transactions that diminishes bookrunning duties.
“In self-arranged deals, arranging banks have no real control over the constituency of the bank group,” says Ed Flanders, a managing director in syndicated finance origination at HSBC in London.
“There are some additional execution risks in this type of situation because arrangers can’t control the process. This trend has to be slightly worrying for everyone, but when companies need acquisition finance in a week, there is no doubt they will be mandating lead banks to secure that and syndicate that for them.”
Martyn Powell, global head of loan markets at ABN Amro in London, also has reservations about self-arranged loans. “Ancillary business commitments have to be given to banks because they don’t get anything directly from the deal,” he says. “Banks sometimes also feel that they are not being listened to if a borrower goes down the self-arranged route — it can be bad for relationships.”
Lenders are prepared to live with club deals as long as they achieve their return on equity targets through a fair slice of ancillary business. But if relationship banks are snubbed for valuable fee-paying business, the results can be spectacularly messy.
A right royal mess
In October, Royal & SunAlliance created a storm in the UK loan market by mandating three investment banks that had not been lenders to the company to co-ordinate its £960m rights issue.
To make matters worse, the troubled insurer had been clubbing a £400m loan since June. When its relationship banks discovered the mandate had gone to Cazenove, Goldman Sachs and Merrill Lynch, they were incensed. Bank of America, Barclays Capital and BayernLB left the facility, having been lead banks in RSA’s last deal in 1998. Whether their decision was motivated by anger over the rights issue or concerns about the credit — or both — is not clear.
But bankers say that Citigroup, a top five equity capital markets bookrunner, was so aggrieved that top level RSA management appealed for the bank to commit. “It was clumsy of [RSA] not to mandate one of the commercial banks for their rights issue,” says Fergus Elder, co-head of syndicated loans at JP Morgan in London.
When Citi had been persuaded, the bank appeared to register its displeasure by committing £25m, the same amount committed by investment banks Goldman Sachs and Merrill Lynch, and not £50m, the ticket level for the other commercial relationship lenders.
Bankers say that RSA’s actions were unusual, and that most borrowers look after their relationship banks. But, tellingly, the deal was still completed, even raising an oversubscription of £100m.
Because it was so liquid, the market was especially hungry for new money merger and acquisition deals in 2003 rather than the staple diet of refinancings offered over the past two years. It wanted companies to respond to rising economic confidence and equity valuations with logical acquisitions. But, once again, the M&A portions were meagre.
Lloyds TSB’s Fitzgerald believes the UK market is more dependent on M&A than its peers in continental Europe, where large standby facilities like DaimlerChrysler’s Eu13bn deal help to maintain volumes. About 40% of UK volumes over the last four years have come from M&A-related deals, he says. According to Dealogic, UK M&A was worth $46.8bn across 30 deals in 2002.
This makes M&A more the lifeblood of the market than a luxury. But by early December 2003, there had been a mere 18 deals, raising $18.3bn.
Cadbury Schweppes completed the only jumbo M&A loan in the UK last year. It mandated Bank of America, BNP Paribas, HSBC, Lloyds TSB and Royal Bank of Scotland to arrange a $6.1bn loan to support its acquisition of US gum company Adams.
The first quarter deal was unusual for relying on the arrangers to bring in Cadbury’s relationship banks, rather than holding a sub-underwriting stage. Many bankers thought it underpriced for a BBB+ credit. The out-of-the-box margin was Libor plus 42.5bp for the 364 day tranche; 52.5bp for the three year; and 55bp for the five year.
It was hardly a spectacular acquisition premium — syndication was a drawn-out process with banks grumbling about the pricing and Cadbury’s refusing to publish financial projections for the merged entity.
Ultimately, it was an acquisition facility with relationship pricing and a relationship rationale. “If we want our relationship with Cadbury’s to continue we really don’t have much choice but to join,” one banker told EuroWeek in February.
There was a handful of more traditional M&A deals during the year. HSBC underwrote and arranged a £950m loan to back Taylor Woodrow’s acquisition of rival housebuilder Wilson Connolly in September. Paying an out-of-the-box margin of Libor plus 105bp, the deal was a success. It achieved a 100% hit rate in senior syndication and did not need to proceed to a retail phase. In another sector, market research company Taylor Nelson Sofres signed a £490m acquisition-related loan in July. The oversubscribed deal supported TNS’s purchase of NFO Worldgroup and was arranged by Barclays Capital, Lloyds TSB, Royal Bank of Scotland and SG.
The acquisitive academic publisher Taylor & Francis tapped the market for a £165m acquisition loan in April and returned in November with a £240m deal to refinance that loan and support its purchase of US publisher Dekker.
In a quiet market, Tim Ritchie, global head of loans at Barclays Capital in London, sees a chance for lenders to do more business with smaller companies. “There was event-driven activity in the UK middle market last year,” he says. “Some banks reduced numbers of clients in this market, or pulled away from smaller clients, leaving opportunities for others.”
Heard it in the pipeline
Although M&A dealflow is far from heavy, loans bankers are encouraged by what they hear from their corporate finance colleagues and predict a steady upturn in event-driven financings in 2004.
JP Morgan’s Elder puts the UK in pole position for M&A deals this year. “The UK’s industrial base is more developed and there are proportionately fewer privately held companies, for which it can be difficult to arrange deals,” he explains. “The UK’s economy is growing faster than its European counterparts, which will be a stimulus for syndicated loans.”
M&A-Driven Loan Financings in the UK, 2000-2003 ($bn)
The UK market enjoyed some successful deals in more unusual areas last year. It responded with great enthusiasm to the £963m Skynet 5 PFI/PPP loan, which provides finance for the UK Ministry of Defence’s £1.6bn Skynet 5 military satellite communications project. The deal was arranged by BNP Paribas, CIBC and HSBC.
Bankers say the proximity of the UK government to the credit, the scarcity value and the 15 year tenor — shorter than the normal 20 or 25 year project financings — were all instrumental in the deal’s success. Skynet 5 had achieved a stunning 300% oversubscription when syndication was closed in August.
Directories business Yell also impressed the market with the £1.2bn refinancing launched after its initial public offering in July. The IPO raised £433m of new money and enabled equity sponsors Apax Partners and Hicks, Muse, Tate & Furst to cut the cost of Yell’s debt. Whereas the Yell buy-out in 2001 had carried leveraged margins of between Libor plus 237.5bp and 550bp, the company was able to refinance at 150bp via ABN Amro and HSBC.
Some bankers feared that Yell’s refinancing would not thrive because it was a BB+ deal, priced as a corporate loan but without the relationship angle. There was also the suspicion that it would confuse banks, which wouldn’t know whether to handle it as a corporate or sponsor-driven loan.
But the Yell loan confounded its critics, closing after an oversubscribed senior syndication phase and trading up to par in the secondary market. The paper paid a margin well in excess of a relationship-driven corporate deal.
One of the UK’s most well known corporate names, retailer Marks & Spencer, made its loan market debut in 2003 with a £1.25bn three year deal, increased from a launch amount of £1bn. The A3/A rated firm borrowed through Marks & Spencer Finance, giving the loan the extra attraction of a 20% risk weighting. In line with other single-A rated European borrowers, the loan paid a tight margin of Libor plus 20bp, with a commitment fee of 10bp.
Back to normal
But this is all a far cry from the heady days of 2000 and 2001 when telecoms mergers and financings lit up the market. Many bankers believe the boom years were an aberration. Royal Bank of Scotland’s McGrath points out that there has not been much difference in volumes year on year over this period if telecoms deals are taken out of the equation.
Lloyds TSB’s Fitzgerald agrees: “We have now returned to a consistent market dominated by standbys, and with occasional M&A deals — it’s post-boom normality.”