Liquidity builds but borrowers hold

Banks are desperate to lend to meet their budgets for the year but many borrowers, for various reasons, are holding back. The result is that pricing is continuing to compress. It is an unusual situation for the bank market which has had its own way for the past five years. EuroWeek's loans team - Taron Wade, Adam Harper and Charlie Corbett - investigate.

With only the very first signs of a resurgence in mergers and acquisitions activity, volumes in the Euroloan market flattered to deceive in the third quarter. Indeed, despite the fact that borrowing volumes rose 21% in the first nine months of this year compared to the same period last year, deal count fell 12% - evidence of the presence of jumbo refinancings that have mainly driven borrowing.

"There was a lack of significant activity in the third quarter with one of the quietest months of August on record," says Sean Boylan, head of transaction management in loan syndications and trading at BNP Paribas in London. "Figures for volumes have been inflated by a few jumbo refinancings, and it is deal count that provides a more accurate picture of business flows."

The market has started to see some indications that M&A activity is re-emerging with the £950m Taylor Woodrow acquisition, the Eu900m Atos Origin transaction, the Eu700m facility for Spanish supermarket chain Capraba and the £145m Isoft deal all coming in the third quarter.

However, these transactions have not been enough to soak up the excess liquidity which has meant that pricing has continued to grind in, in some cases to razor-thin levels.

"The market remains very liquid across the range of products," says Chris Baines, head of European loan distribution at SG in London. "With demand still exceeding supply in many areas, lead banks have the confidence that transactions will be well supported in the market, provided they are well structured."

This glut in liquidity has driven a compression in spreads further down the credit curve. "The current buoyant market for corporates has enabled some triple-B rated household names to benefit from aggressive terms that used to be only possible for single-A credits," says Baines. "Pricing is falling and maturities are being pushed out for the best triple-B names, albeit on smaller transactions."

Fergus Elder, co-head of loan capital markets at JP Morgan agrees. "Pricing has deteriorated for all but the most sensitive names," he says.

This trend also shows no signs of stopping as long as M&A financing remains so sparse. "For the right credits, banks are generally asset hungry," adds Charles Griffiths, vice president in the syndications group at Bank of Tokyo-Mitsubishi in London. "If the economic background remains benign we can expect some pricing compression for both recovery stories and some of the weaker credits.

In addition to lending to companies further out along the credit curve, banks are also looking increasingly outside of Western Europe for assets. Eastern Europe - especially Russia - has experienced an uptick in demand that has allowed borrowers to achieve very fine pricing. Lenders have also turned to the Middle East and Turkey to seek greater returns.

"There has been a dearth of transactions, but also a dearth of pipeline building that has led to concerns about people making budgets," says JP Morgan's Elder. "This has caused banks to become markedly more aggressive in regions where they have not been traditionally been aggressive."

Some believe this will only continue into next year. Others however, are more optimistic that conditions are only a result of the overall economic environment.

"There is a cyclical nature to the market, and this has been a quiet quarter in one of those years in which we are on the downside of the cycle," says BNP's Boylan.

UK the main prize
Although signs of M&A activity are only slowly emerging, the UK is looking like Europe's best hunting ground for the loan banker's trophy business. Despite this, the third quarter has seen UK issuance, usually more than that of France and Germany combined, fall below Germany's $36.105bn in figures published by Dealogic. "Acquisition finance looks to be the market saviour at the moment, and that includes MBOs and LBOs," says Ian Fitzgerald, head of distribution and syndication at Lloyds TSB in London.

HSBC surprised an unsuspecting market early in September by announcing a £950m deal supporting housebuilder Taylor Woodrow's acquisition of competitor Wilson Connolly. Elsewhere, all four UK clearers combined to arrange a £145m loan to support the acquisition of Torex by fellow IT services provider Isoft. "I would expect more M&A activity in the UK," says Richard Munn, managing director of loan capital markets for Deutsche Bank in London. "The economy is holding up better than elsewhere in Europe offering more opportunities for the strong to buy the weak."

But the most exciting M&A activity could be yet to come. Having received clearance from the Department of Trade and Industry, UK supermarket chain Wm Morrison looks likely to proceed with a new bid after it has negotiated the required disposal of 53 of its own stores with the Office of Fair Trading. ABN Amro, which supported the retailer's last bid with a £2bn loan, is in pole position to arrange any new financing.

Music publisher EMI is also circling Warner Music with an exploratory $1.6bn bid that has attracted great interest in the loan market.

Yet however appealing a large event-driven financing for EMI in the future may be, its £300m club deal signed at the beginning of October was more typical of the moment, with Royal & Sun Alliance, Scottish & Southern and Ireland's Electricity Supply Board recently deciding to go down the same self-arranging route.

Julian Taylor, head of distribution for HSBC in London, believes the number of self-arranged deals will continue to grow for as long as the market lacks supply and mandates are so keenly contested. "I can fully understand why borrowers do it," he says. "They want to maintain equality between all their main relationship banks."

As the only major M&A driven deal in the second half of 2003, Taylor Woodrow has been alone in countering the trend of borrowers seeking smaller bank groups and tighter pricing for refinancings. "Taylor Woodrow has increased the cost of raising liquidity because it needs to raise new money from a new bank group," says HSBC's Taylor.

The deal pays a margin of 105bp, which also makes it one of the few deals in the third quarter to be genuinely interesting to the secondary market, along with the £1.25bn refinancing for cross-over credit Yell, which paid 150bp out of the box.

But while club deals are usually a sign of a closer and more exclusive relationship between a borrower and a small group of banks, Royal & Sun Alliance's decision to award £30m of ancillary business in the form of a rights issue to Cazenove, Goldman Sachs and Merrill Lynch - three houses outside the borrower's traditional lending group - made its relationship banks seethe. The deal was eventually closed oversubscribed, with Goldman and Merrill joining, but Barclays, Bank of America and BayernLB leaving the facility and some banks joining for uncharacteristically small amounts. It was also obliged to pay a margin of 125bp to refinance a 1998 facility that paid 22bp, bankers say.

Germany: no longer special
There is no longer anything different about Germany as a European loan market, says Dietmar Stuhrmann, head of Europe, Middle East and Africa loan syndicate at Dresdner Kleinwort Wasserstein in Frankfurt. "As an international product, the syndicated loan has arrived in Germany," he adds. "Bilaterals have turned out to be unpredictable and treasurers value the legal commitment, discipline and uniformity of syndicated loans."

Steady but unspectacular dealflow in the third quarter has demonstrated two things. First, that M&A activity is still a distant horizon as the German economy remains stagnant - there have been no major event driven financings.

Second, the heavily supported stream of deals for well known investment grade corporates shows that the flight to quality continues.

David Bassett, head of European loan distribution at Citigroup in London, sees this as a sign of increasing maturity in lenders to German corporates. "Banks are picking winners," he says. "For the right names, the long term survivors, there will be tremendous support."

This was certainly true for Linde's Eu1.8bn 364 day and five year facility, which raised Eu3bn in syndication; for Hannover Re's $1.25bn LC facility, which raised nearly $2bn and was increased to $1.5bn; and for Degussa's Eu2bn loan which attracted nearly Eu3bn in commitments. Deutsche Telekom's renewed 364 day facility also enjoyed strong support, with two banks that had exited the facility in 2002 - Mizuho and NordLB - rejoining this year.

DrKW's Stuhrmann attributes these oversubscriptions to frank communication between borrowers and relationship banks. "We have a very intense dialogue with clients about the quality of relationships," he says, "and treasurers understand the need for banks to cross-sell." This means that the days of inviting 60 banks into a facility are over - borrowers know exactly who their relationship banks are, and many commitments are even received before the facility is launched.

But despite the growing internationalisation of the loan product, some bankers feel that the rules of engagement can still be slightly different in Germany. There remains a higher degree of cross-shareholding between banks and corporates than elsewhere in Europe. For example, WestLB owns a 25% stake in tourism and logistics operator TUI, Allianz (Dresdner's parent) and Deutsche Bank own 17.66% and 8.84% stakes respectively in HeidelbergCement; and Deutsche Bank owns 12% of DaimlerChrysler. Those banks have all won mandates for the three companies' most recent deals.

"It isn't a completely level playing field like the UK or France," says one banker, who also acknowledges that cross-holding is declining. Secondary market professionals also say that Germany can be a difficult environment for loan trading - more prevalent borrower consent issues mean that it does not have great secondary liquidity.

France perks up for final quarter
BNP Paribas' Boylan believes the French market is replicating last year, where there was little third quarter activity before a flood of refinancings in the last quarter. "Our flow of mandates from the French corporate market is currently at the highest level it has been for almost 12 months," says Boylan.

Signs of this are already emerging, and not only for refinancings. IT services provider Atos Origin mandated ABN Amro, BNP Paribas and Lehman Brothers to arrange a Eu900m facility backing its acquisition of SchlumbergerSema at the very end of September. Communications agency Publicis is said to be sounding out banks for an imminent Eu1bn loan and retail group Casino is soon to come to the market for the same amount. Loans for Ciments Français, Elior, JC Decaux, Rexel and Société Foncière Lyonnaise are also in the bidding or mandate stages.

Despite falling levels of borrowing across Europe, French issuance so far in 2003 ($66.145bn) has outstripped volumes for the first three quarters of 2002 ($45.008bn). The difference is even greater if France Télécom's loans are not included - they accounted for Eu15bn in 2002 and Eu5bn in March this year.

But one London banker believes the stronger recent volumes are not necessarily signs that the borrower base in France is growing. "In France, you are now seeing underlying cycles in the loan market coming to bear - there are lots of refinancings for deals from the late 1990s coming through," he says. The banker adds that, of late, France has not seen major corporates making their loan market debut. This trend has been seen as part of the consolidation of syndicated loans in Germany, with E.On and RWE last year and with retailer AVA in the third quarter of this year.

One fascinating story in France during the third quarter was troubled engineer Alstom. Loans bankers watched carefully as the European Commission and French Ministry of Finance negotiated a restructuring deal that would not infringe EC regulations on state aid to troubled companies. Under the terms of the restructuring, a group of 30 banks led by Alstom's biggest creditors will raise over Eu1.563bn, with the government supplying Eu300m of that figure.

Have Alstom's continued difficulties made banks more adverse to French corporates? Not so, says one banker, "This was a situation that could have happened to a borrower of any nationality," he notes, "if anything, it should comfort lenders that the French state has shown its willingness to support essential industry."

In the French LBO market, ING has starred during the third quarter, leading the Eu1.015bn debt facilities backing the buy-out of Materis and the Eu390m senior debt and Eu75m in mezzanine supporting the acquisition of Terreal by Carlyle.

Heineken highlights the Netherlands
There was a strong dealflow for corporate refinancings in the Netherlands during the third quarter. The market warmly received a Eu600m deal for post and distribution services company TPG, a Eu1.5bn deal for coatings and chemicals manufacturer Akzo Nobel, a Eu1.25bn revolver for food group Royal Numico and a Eu500m 364 day facility for energy distributor Eneco.

The launch of a deal in October for brewer Heineken was also eagerly anticipated but the loan - which came out at Eu1.2bn - is extremely finely priced at 22.5bp, and some bankers believe the company may be building up a war chest.

While the Netherlands' economy experiences 0% growth, though, bankers are downbeat about the prospects of lucrative, event-driven financings in the short term. "I do not expect to see much M&A activity in the Netherlands this year," says Rob Engelschman, director of loan syndications at ABN Amro in Amsterdam. "But I think there will be more event-driven business in the second half of 2004." Mandates from the Netherlands are being contested more and more by international banks, Engelschman adds.

Spain and Switzerland
Borrowers from Spain and Switzerland also tapped the loan market during the third quarter. A Eu700m loan supporting the Eu420m acquisition of Alcosto by rival supermarket chain Caprabo has just been launched into general syndication. There was also the general syndication phase of the Eu1.65bn acquisition loan for the Sacyr-led buy-out of Empresa Nacional de Autopistas (Ena).

And in Switzerland. the two Sfr300m five year revolvers for retailer Coop and sanitary technology firm Geberit were both heavily oversubscribed.

Noises off for Nordic region
In sharp contrast to the first half of 2003, the third quarter was remarkably quiet in the Nordic Region. During the first half of the year, borrowers raised $29.7bn, which exceeded the $27.5bn total raised in 2002, but it was only a few transactions that made headlines in the third quarter, including the buy-out of Danske Traelast and a new facility for Vattenfall Treasury.

"The third quarter wasn't anywhere near as busy as the first two quarters of the year, but that is very typical of the market," says David Roberts, head of syndications at Nordea in Stockholm.

Michael Dicks, head of debt capital markets at SEB in London agrees that this is not unusual. "Everyone is on vacation at the start of the third quarter, so deals are not mandated until the beginning of the fourth quarter," he notes.

There were a handful of signings at the beginning of July, such as the Eu200m multi-currency revolver for Swedish security company Gunnebo, the Eu340m five year loan for Finnish electricity provider Hafslund and the $185m loan for aluminium smelting company Nordual.

But the only fresh facility for paper-hungry investors was the five year Eu600m loan for Vattenfall Treasury. The Swedish energy utility had last tapped the market in 1996 for a $600m seven year term loan. The refinancing of the 1996 deal was in line with the larger market trend this year for borrowers to refine their relationship groups and also reduce maturities from seven to five years.

On the previous facility, Vattenfall had only one mandated lead arranger, JP Morgan, and 15 banks that acted as participants, whereas Citigroup, Deutsche Bank, SEB and SG led the new transaction.

Lenders have been anxious to gain relationship traction as borrowers develop new bank groups, particularly since there are a limited number of large corporates in the region.

The other prominent transaction was the buy-out of Danske Traelast by CVC, which resulted in the syndication of Eu733.73m of senior debt. Due to a strong oversubscription in senior syndication, the deal did not progress to a general round.

Dankse Traelast is indicative of the increasingly more vital role buy-outs have started to play in the syndication market in the region as private equity houses not based in Scandinavia have begun to scour the region for deals. Bank of America Private Equity sponsored the secondary buy-out of Paroc Group earlier in the year and ABN Amro is in the process of finalising the purchase of Swedish company Global Garden Products. CIBC and Royal Bank of Scotland will be arranging the debt financing on the Global Garden Products deal.

This sparse transaction calendar over the past three months has resulted in an excess of funds put to work for banks looking to invest in the region. "Liquidity has increased quite a lot during the last month," says Nordea's Roberts. "Many banks that are active in the region are very under-lent. While there is resistance to pricing going any lower, there is certainly a lot of liquidity around," he says. "It will be interesting to watch how it expresses itself - hopefully it won't express itself through a decrease in pricing."

Bankers remain confident that there will be adequate deal flow to go head to head with investor demand before the year is up. "There is a lot of business in the pipeline - several borrowers are considering launching deals before the end of the year," Roberts says. "There is great anticipation for the fourth quarter and there will be a lot of mandates coming out in the next two to three weeks," agrees SEB's Dicks.

Calm returns to Middle East
After a jittery first half to the year, the Middle Eastern loan market came alive in the third quarter. Many borrowing timetables had to be reorganised due to the war in Iraq during the spring but the market rapidly returned to normal soon after the conflict.

The removal of Saddam Hussein neutralised what had been the region's greatest threat and encouraged borrowers to tap the loan market and banks to be more comfortable with lending to the region. "Following the end of the war in Iraq stability has returned to the gulf region" says Raouf Jundi, vice president of the syndications group at Bank of Tokyo-Mitsubishi. "Atmosphere in the Middle Eastern loan market has improved considerably."

This better financial environment was reflected by the recent S&P upgrades assigned to Saudi Arabia, which was awarded an A rating for the first time, and Qatar which was raised to an A+ from an A-.

One of the more notable developments in the region has been the increased appetite among lenders for financial institution risk. At least four Middle Eastern banks have come to the market since June, the same amount that came to the market during all of 2002. Deals included Emirates Bank's impressive $300m facility, which was oversubscribed by $100m with banks being scaled back, and a first time visit to the market by Al Ahli Bank of Kuwait for a $100m deal.

Bankers have put the increased activity on the financial institution side down to a growing trend among Middle Eastern banks for intra-regional lending that has also acted to keep pricing down. "The recent trend has been for Middle Eastern banks to look outward more," says Kim Humphreys, head of corporate and sovereign syndications at Mizuho in London. "This has been evidenced by an increase in intra-regional borrowing that has kept a lid on upward demand for pricing".

Project financing in the region continues to be characterised by long maturities, lower pricing and decreasing interest from the bigger international banks. The long awaited $1.77bn Umm al Nar power and water project financing was finally signed in mid-September but not without contention. Some in the market suggested that many of the arranging banks failed to raise as much as they would have liked. Although the deal was fully underwritten, some lenders had reached their country limit ceilings and so could not provide as much as they had originally planned.

The large mandated lead arranger groups which now characterise most project finance deals are one way banks have found to reduce the risk but this strength in numbers strategy can often cause problems and lead to protracted negotiations. A banker at the time described the final stages of putting together Umm Al Nar's arranger group as "a tortuous process". "It was not really clear who was running the deal at some points," he added.

The margin on the Umm Al Nar facility is 110bp over Libor up to the completion of the project. Thereafter it will be 100bp up to year seven, 115bp up to year 10, 130bp up to year 13, 155bp up to year 16 and 165bp out to maturity. Mandated lead arrangers of the deal are Abu Dhabi Commercial Bank, Abu Dhabi Investment Company, Abu Dhabi Islamic Bank, Bank of Tokyo-Mitsubishi, BayernLB, First Gulf Bank, Gulf International bank, HSBC, ING, KfW, Mizuho, National Bank of Abu Dhabi, SMBC and WestLB.

The $907m Sohar Oil refinery project was launched into general syndication in early October, again with a characteristically large lead arranger group. The group comprises ANZ Investment Bank, Arab Bank plc, Bank of Tokyo-Mitsubishi, BNP Paribas, Crédit Agricole Indosuez, Gulf International Bank, HSBC, Mizuho, SG, and SMBC.