After one of the toughest years ever for the European investment grade syndicated loan market, it was not until November and December that bankers allowed themselves to summon up the courage to look forward to 2010.
The numbers speak for themselves: over 1,330 European investment grade deals with a value of Eu476bn were arranged up to the end of November in 2009, compared with 1,731 deals for Eu715bn in 2008.
While the loan market slumped, companies found that retail and institutional investors in the high grade bond market had developed a seemingly endless appetite for corporate paper. With borrowers making the most of this alternative source of funding, the volume of European corporate bonds issued soared to record levels.
"The bond market has eaten into the syndicated loan market in 2009, and maybe some of that market share has been lost forever," says Stuart Frohmaier, head of loan syndicate, Western Europe, and loan syndications, EMEA, at WestLB. "It was interesting to watch last year as the loan market has really been left behind by appetite for bonds."
The swing to the bond market is seen by some as a necessary over-correction after a long period during which bank financing dominated."In looking at historical volumes over a longer period of time, for example the last 10 years, theres been a steady relationship between the bond and loan market volumes," says Rebecca Manuel, joint head of EMEA syndicate at Royal Bank of Scotland. "However, in 2005 to 2007, there were huge volumes in the loan markets, but these were outsized volumes rather than levels that could be sustained long term. Looking ahead, we see the markets reverting to a more normalised relationship between loan and bond volumes."
The changing funding model may also show that European companies have been moving closer to their US cousins, where corporates have always been more reliant on bond financing. Whereas around 80% of the eurozone non-financial credit instruments have traditionally been loans, in the US the split is closer to 50:50.
There are, of course, fundamental differences between the European and US markets: US bond investors are less restricted by tax laws on what paper they can buy, while many European companies are more suspicious of being beholden to the rating agencies than their US counterparts.
However, corporate funding officials are bullish about the future importance of the bond market for their funding needs. A survey for the Confederation of British Industry in November revealed that half of UK companies plan to use less bank debt for their funding needs, while 26% will issue more bonds.
"Over the next three years, we would expect the bond market in Europe to increase," says Jan Kjærvik, head of group finance and risk management at AP Møller-Mærsk. "It will probably not become as important a funding source for large corporates as in the US, but we may see up to around 60% of funding done through bonds. The banks, with higher funding costs than before, are being cautious about their balance sheets and corporates have incentives to look at other sources of funding."
Others agree that European companies will be looking to diversify their funding models away from loans and issuing more bonds."I would agree that Europe is generally moving more to a US-style model of financing," says Sven Schneider, head of corporate finance at Linde. "Banks liquidity will be tight for the foreseeable future and there will be a shift towards bonds."
Loans: a flexible friend
Like many European corporates, gases and engineering firm Linde diversified its funding in 2009 to avoid a reliance on bank financing."For us, its important to have access to all different markets and financing instruments available," says Schneider. "We have a very conservative approach to financing and want to be diversified. We all know that the willingness of banks is limited, so there is a tendency to shift as much of the funding as possible to other sources."
This cautious approach led the triple-B rated borrower to issue its debut Eurodollar bond, a $400m deal priced at 90bp over mid-swaps, in November. In July, it joined a run of borrowers to secure a forward start facility with a Eu1.6bn deal to extend a loan maturing in 2011.
The prevalence of the forward start facility showed borrowers wariness of bank liquidity last year. Worried about future lending conditions, corporates were keen to secure financing, and in the first half of the year a flood of forward starts was launched.
AP Møller-Mærsk secured funding years ahead of its maturity date at the start of the year, when it extended $3.134bn of a $6.5bn loan facility that was not due until 2012.
"If the relationship between the bank and the corporate is strong, and there are no credit issues involved, it is also possible that a forward start of existing credit facilities (priced below prevailing market terms as to margins) can be agreed, creating a win-win situation," says Kjærvik at AP Møller-Mærsk. "Corporates want the extension to increase the duration of funding, and banks want to secure higher margins."
Although forward starts were initially disdainfully viewed as cushy instruments that allowed borrowers to achieve sub-market pricing while still maintaining long-term maturities, they soon became illustrative of the inventiveness and flexibility of the loan market.
This ability of the loan market to innovate and create new products to suit the market environment demonstrates why bank financing remains a key instrument in any corporate treasurers arsenal.
"The bond market may be able to provide longer tenors, but it does not provide the same price flexibility, confidentiality, a fast response and prepayment options as loans," says Julian van Kan, global head of loan syndications and trading at BNP Paribas. "Prepaying a bond involves costs associated with the marked value and the opportunity cost of an investor holding the bond to maturity, whereas with a loan the fees on breaking are associated with the break funding costs in the event that it is drawn."
2010 the year of the loan
Despite the drop in the numbers of new deals launched in 2009, the death knell for the European loans market may have sounded too soon. Bankers in the sector are increasingly optimistic about the market this year, and many expect volumes to rise in the first quarter.
"I think that corporate treasurers are looking a lot more carefully at which particular market they should tap, but the syndicated loan market is now staging a recovery," says Richard Hill, head of loan syndication, EMEA, at WestLB. "We can all see that theres definitely an improvement in the amount of liquidity available from the bank market. The issue now is actually trying to find the demand to test this supply."
Other officials agree that bank liquidity is improving, and that whereas in 2009 deals were mostly refinancing backstops, there is now capacity for funding new lines.
"The dynamic is coming back towards the loans business, and you can already see that more bank capital is becoming available," says Van Kan. "Banks in general should do rather well this year: some will have done rights issues, seen overall improvements in operating revenues, a slow down in writedowns and overall return of some confidence all of this should mean a more willing appetite to expand lending."
The loan market can not only provide corporates with more flexible funding than other products, it also has a depth of liquidity that companies will have to tap into for their future high financing needs.
Nearly Eu1tr of European loans are set to mature in 2010 according to Dealogic. Although it is not possible to ascertain how many of these loans have already been completely or partially refinanced, bankers expect corporates financing needs to grow this year, in part because many had reduced their spending throughout the last year, as a result of the economic downturn, and will see their funding needs increase this year as conditions continue to improve.
"[The market] didnt do much acquisition financing last year," adds Frohmaier. "That will come back, and the more mid-market trade-led deals will be largely financed in the loan market. Weve seen some bond issuance financing acquisitions, but I dont think that this will turn out to be the standard methodology for most corporates."
While some in the loans market have eyed the continuing success of European corporates bonds with suspicion, others have recognised that a strong bond market can only drive confidence in other sectors too. With loan pricing coming down and companies moving away from a reliance on bank financing, it is likely that European firms will come out of the crisis with a healthier and more diversified funding model."What we saw last year was the clear willingness of corporates to access markets across the spectrum," says Manuel. "Theres a more balanced approach, and an understanding of the interdependence of the capital markets as a whole."