Syndicated loan specialists in EMEA, weighing up how the market will evolve in 2023, find it difficult to know which way to jump. Will the forces of recovery, or disruption, prevail? But they all agree on one thing: there will be risk.
After a bruising year, with Russia’s invasion of Ukraine and much higher inflation than almost anyone had predicted, loans bankers are not confident that the worst is behind them.
“The market development next year could go in two directions,” says Reinhard Haas, global head of syndicated finance at Commerzbank in Frankfurt. “If there would be peace in Ukraine, financing conditions would be easier and the outlook more reliable. The conditions might not go back to pre-war times, but it would likely be less volatile than at present. However, in the hopefully unlikely event [of] a further escalation of the conflict, uncertainty will likely rise even more, and markets might encounter a very difficult period.”
Despite the events of 2022, EMEA’s investment grade loan market has remained stable and continued to function at a fairly even pace.
Overall syndicated lending in the region reached €729bn in the first three quarters of 2022, in 1,250 transactions, says BNP Paribas. This was about 19% down on the volume by that point of 2021, but 2021 was the busiest year in the past 15, with a full year total of €1.26tr. The pace of lending in 2022 was roughly the same as in 2019, 2017 or 2016.
Nevertheless, no one would call it an easy year, and in leveraged finance it has been extremely difficult.
Even though overall volume figures are not bad — levloan borrowing was about €220bn by mid-November according to Dealogic, similar to the full year figures in many recent years — the conventional institutional leveraged loan market all but dried up for weeks at a time, leaving banks unable to clear underwritten loans from their balance sheets.
More angst to come
The stressful macroeconomic backdrop, which perturbed the leveraged market so much, making it hard to execute deals, “is not going to change in the first half of next year,” says Ben Thompson, head of EMEA leveraged finance capital markets at JP Morgan in London.
However, levfin bankers will have plenty of work to do. “2023 will be the year to start addressing maturities which are due in 2024 and 2025,” Thompson says.
Daniel Rudnicki Schlumberger, head of EMEA leveraged finance at JP Morgan in London, expects volatility to stay for the next nine to 12 months. “We are going to have some market windows and some periods of stress,” he says.
Up to now, the market has been dealing with anxiety about credit risk and credit pricing, rather than actual losses. But that reckoning will have to come. “The market is still trying to figure out who are the credit winners and who are the losers, but this will take time, as it did during the pandemic,” says Rudnicki Schlumberger.
The difficulties of leveraged finance could even contribute to economic weakness. “It is really difficult to price risk, which could keep the market from recovering quickly and could lead to a more drawn-out recession,” says Sabrina Fox, CEO of the European Leveraged Finance Association in London.
Tentative recovery
In investment grade, conditions should be easier. Haas believes the market will return to higher volumes, but it is hard to predict how soon.
“The market is finding new ways of addressing issues: supply chains are being repaired, there is increasing talk about China regarding the loosening of its zero Covid policy,” he says. “Once this is implemented, it is likely to lead to increased economic activity. So there are some chances for a pick-up in volume, albeit not a massive one.”
Apart from the war in Ukraine, the big determinant of activity is likely to be interest rates, which will be driven by inflation. Most firms expect this to stay high, at about 5%-6% in the EU.
Carlo Fontana, head of global syndicate at UniCredit in Milan, does not expect a big drop in yields, but adds: “we should see a normalisation”.
As a result, he says: “There will be intermittent market access in the short term, but the overall context will remain more or less similar [to 2022]. That said, we may see an uptick late in the second half of 2023, perhaps slightly earlier, as the market always anticipates economic recovery predictions.”
Prospects for a healthy loan market in 2023 are helped by the fact that banks appear to be in good shape, with enough capital and access to cash to lend for regular business.
“If a company’s financials look good, banks will be [interested] as they are very eager to lend to high-performing names,” says the head of syndications at a bank in Europe.
Nevertheless, in a survey of senior loans bankers conducted by GlobalCapital in November, most respondents said they expected competition among lenders to stay the same or decrease in 2023.
“There are going to be less asset takers in the European syndicated loan market than in pre-pandemic times,” says Haas, “but we do not expect changes to be particularly disruptive as the volume contribution of these investors has not been very substantial in the past couple of years.”
There is not a direct correlation between the eagerness of banks to lend and the size of syndicates, but these factors may be connected.
“We have seen a trend over the years of syndicates getting smaller,” says the head of syndications. The main driver is a rationalisation of syndicates. For companies, “there is no point having 20 banks but volume [of borrowing] for only 10,” he says. It makes sense for banks, too. “Banks are becoming more focused on what they invest in, choosing specific asset classes and doing them well.”
Margins are picking up
While some bankers believe loan volumes could rise in 2023, there is little expectation of margin tightening.
Credit spreads on investment grade loans were much slower to rise in 2022 than those on corporate bonds, partly because of the relationship nature of the loan market. But they did widen later in the year.
“The pricing movement in the IG space has been more visible as of late, but increases are not as wide as market indicators would have suggested,” says Haas. “It is unlikely for margins to explode unless a catastrophic scenario occurs, but there will be continued [upward] pressure for some time.”
For the more leveraged companies, this could be painful. Many have hedged interest rates, but those hedges will be coming to an end in the next couple of years.
“As hedges come off or issuers refinance into a higher margin, high cost of funds environment, the pressure on cashflow is obvious,” says Charlotte Conlan, head of leveraged finance at BNPP in London.
In their most optimistic moments, bankers hope for a revival of mergers and acquisitions. The rough economic environment in 2022 led to a fall in corporate acquisitions of around 27%, according to EY, the professional services firm.
In the EMEA loan market, M&A financing made up 17% of volume up to the third quarter, according to BNPP, below the 20% average of the past seven years and notably below the 22% in 2021.
“For banks, what makes the outlook seem either good or bad is the number of M&A deals,” says the head of syndications, alluding to the fact that these loans pay better. “Maybe next year will be more active in those terms, as there is a lot of cash out there.”
However, the heavy clouds on the economic and geopolitical horizon are not encouraging anyone to predict this with confidence.
ESG is the key
One trend bankers are willing to back without hesitation is green and sustainability-linked lending.
According to Dealogic data, in 2022 up to November 20, there had been €192bn of such loans in EMEA, about 19% of all lending.
Market participants expect 2023 to bring a “push on green”, says the head of syndications. “Banks are increasingly being encouraged to move to sustainability and, on the borrower side, it is pretty much embedded” in corporate behaviour.
“ESG is an imperative now,” says Fox at ELFA. “It is not just a nice-to-have feature anymore, it is [necessary to] access to financing.”
Haas agrees. It is not so much that borrowers with poor ESG characteristics will pay higher margins, rather that “the liquidity pool for borrowers with no ESG concept is likely to shrink,” he says. “It is estimated that around 20%-25% of portfolio managers in the industry have policies that impose growing portions of ESG investment, and we believe that this tendency will continue.”
It is harder for small and midcap companies to shoulder the costs of developing ESG policies and linking their loans to them.
Nevertheless, says Haas: “On the borrower side, there is a lot of activity around this topic in one way or another. Especially in larger companies, ESG-compliant debt issuance is becoming commonplace.” GC