French margins set to fall further
Deep liquidity and a limited number of lending opportunities have meant that banks have been willing to extend loans to French borrowers at razor-sharp price levels this year. And as the pipeline remains thin, observers expect pricing to continue to fall in the second half of 2004.
At the time, the deal looked as though it had been priced perfectly sensibly. Veolia Environnement?s five year revolver, on which BNP Paribas, Deutsche Bank and SG acted as bookrunners, was increased from Eu3bn to Eu3.5bn in response to a healthy 60% oversubscription rate, with participating banks clearly attracted by the out-of-the-box margin of Euribor plus 37.5bp.
What a difference five or six months make. With Air Liquide having recently seen its Eu1bn five year loan priced at 27.5bp over Euribor, some in the market believe that come year end banks may well look back at the Veolia transaction as the most over-priced transaction of the year.
Bankers say that the combination of sustained levels of liquidity in the loans market, twinned with the absence of meaningful outlets for that liquidity in areas other than lending, have driven pricing in the French market down to surprisingly low levels. In turn, that has encouraged a host of borrowers to explore the opportunities that the loans market is providing to refinance existing facilities at much more aggressive terms.
While the headlines early in the year suggested that France was on the threshold of a fresh merger wave, with Sanofi-Synthélabo?s Eu55bn acquisition of Aventis seen as a groundbreaker that would fuel an escalation in demand for event-driven facilities, bankers say that the Sanofi deal has been very much the exception rather than the rule.
Nevertheless, jumbo facilities such as the Eu12bn loan backing the Sanofi deal and the Eu10bn one and five year refinancing for France Télécom have helped to propel France into top spot in Europe?s syndicated loans market. That means that France leapfrogged the UK in the first six months of 2004.
Stephen Swift, head of European loans distribution at SG CIB in London, says that trends in the French market are not much different from those that characterise the broader European loans market. ?But the volumes we are seeing mean that the French market is amplifying those trends and tendencies in the way that the German market did 18 to 24 months ago,? says Swift.
?That was a time when we had a series of jumbo deals for borrowers such as Siemens, E.On and VW coming with no price premium for size, and highly aggressive terms and conditions. This year we?re seeing a similar pattern in France with borrowers capitalising on the liquidity in the market to extend maturities and renegotiate the terms of their facilities.?
Hans Fuchs, managing director in the loans syndication department at Barclays Capital, also identifies burgeoning liquidity as a key influence in pricing in the French loans arena. ?The French banks are very liquid and prepared to be extremely aggressive on pricing in order to defend long standing domestic client business in the face of heightened international and domestic competition,? he says. ?A decade or so ago, which was the last time we saw such a massive decline in pricing in the loans market, that was not always the case.?
Jean-Claude Gruffat, chief executive of Citigroup in Paris, agrees that competition is an important cause of the downward pricing in the market, in terms of spreads and fees. ?Pricing is now about a third or even a quarter of what we were charging 12 or 18 months ago,? he says, ?with many deals done purely for relationship reasons or league table purposes. I would say that competition is even more intense in France than in Germany, where some of the local Landesbanks and universal banks have been hurt by a number of transactions, which has made them credit shy. But when you talk to the leading French banks, they say they still have substantial excess lending capacity.?
Downward pressure on pricing has also been a by-product of a more benign macroeconomic environment. ?We have seen the credit cycle in France turning and becoming much more positive,? says Julian van Kan, head of European, Middle Eastern and African loan syndications and trading at BNP Paribas. ?Much of that has come on the back of the improved performance of euro zone economies. But a number of French companies have also seen their credit profiles improve as a result of successful asset disposal programmes.?
A good example of that process, and of how it has fed through into pricing in the syndicated loans market, has been provided this year by the energy, water and waste group, Suez, which in the summer of 2003 signed a Eu2.5bn five year deal at a margin of 47.5bp through six banks.
Less than a year later, Suez attracted demand of more than Eu6bn for a Eu4bn facility it raised through nine banks paying a sharply reduced margin of 27.5bp. That was impressive for a borrower with a split A2/A- outlook, although Standard & Poor?s (S&P) revision of its outlook on Suez from negative to stable at the start of June attested to the strength of the company?s turnaround story.
S&P said the ratings action reflected Suez?s reduction of its net debt from Eu26.3bn at the end of 2002 to Eu15.4bn by the end of 2004, with Eu11.2bn of the reduction attributable to disposal proceeds and Eu1.3bn to favourable foreign exchange fluctuations. ?Net debt is expected to fall further, to Eu14bn by mid-year 2004, partially due to Suez?s sale of communication assets M6 and Noos in early 2004,? added S&P. ?Management remains committed to improved credit quality and to ensuring that free operating cashflow covers dividends by 2005.?
In tandem with the aggressive prices they have been commanding on their refinancing facilities, French borrowers have also been successful in driving increasingly hard bargains in terms of documentation. Bankers say that that is a pan-European phenomenon which has at least in part been driven by the ratings agencies. ?I believe that some of the pressure on documentation has come from comments made by the ratings agencies, which are now reverberating through loan agreements and removing much of the protection that banks have come to expect,? says Swift at SG CIB.
But it is not just the ratings agencies that have influenced documentation in the broader European syndicated loans market. Van Kan at BNP Paribas says that the increasingly popular US private placement market has also played its part in encouraging borrowers to push for looser documentation. ?Last year we started to see French borrowers find their way to the US private placements market and that process has continued this year,? he says.
He adds that although the US private market has been friendly towards unrated European borrowers, the market?s documentation requirements have also been attractive for rated companies.
Unsurprisingly, those same borrowers have used the precedent of lighter documentation in the US private placement market as a way of putting pressure on their relationship bankers in Europe to make compromises in discussing loan terms.
As an example, van Kan says that MAC (material adverse change) clauses, which are not generally a requirement in the US market, are being renegotiated with increasing frequency by French borrowers. Some arrangers, he adds, have risen to the bait, using flexible documentation as an entrée into the loans market.
But van Kan says that increasingly favourable terms for borrowers have not been restricted to less burdensome MAC clauses. ?We?ve seen a dilution in merger, acquisition and disposal language,? he says. ?That has been driven by competition, with banks outside the top three coming in and bidding on transactions based on weaker documentation.?
All these influences, says Citigroup?s Gruffat, have left borrowers seeing syndicated loans as a much more user-friendly alternative than the bond market. As he points out, borrowers such as Suez having pushed maturities in their facilities beyond the usual five years means that the bond market is finding it increasingly hard to compete. ?The loans market used to be restricted to three to five years,? he says, ?but we?re now seeing borrowers raising seven year funding with reduced covenants and the flexibility of multi-currency drawings.?
Two obvious and closely related questions follow the strength of demand for facilities in the French loan market in the first half of 2004. First, can activity be sustained in the second half of the year, with France retaining its position at the top of the tree in terms of European volumes? And second, has pricing in the market finally bottomed out?
Second half blues
Given their experience in the first half of the year, lenders are hesitant about making categorical forecasts on either of these questions, although the consensus seems to be that volumes in the second half are unlikely to match those in the early months of the year. ?I doubt whether volumes can continue to expand at the same rate we saw in the first quarter,? says Swift. ?We?ve seen so many large corporates in the refinancing market that we have now probably passed the peak period.?
More difficult still, say lenders, is to judge whether or not pricing can continue to fall. ?You could ask if companies are getting their timing right as far as refinancing is concerned even today, when pricing appears to be at an all time low,? says one banker. ?Given the continued build-up in liquidity in the banking market, the answer is that we just don?t know.?
Van Kan at BNP Paribas agrees that forecasting future price trends is hazardous. ?We are already seeing A+ rated issues at 25bp fully drawn,? he says. ?But if you look at how we?re pricing on grids at the moment we could realistically see pricing below 25bp before too long.?
Quiet LBO market
While France ended the first half of the year in the unfamiliar position of having been Europe?s largest syndicated loans market, activity early in the year in the leveraged sector was more muted.
In its overview of activity in the first quarter of 2004, S&P described the French leveraged loan as having been ?quiet?, accounting for just 7.4% of all new issuance. Bankers report that since then activity in the leveraged market has picked up markedly, although much of the activity has been accounted for by small ticket transactions below Eu100m.
The year?s largest transaction in the leveraged market is the facility backing the buy-out of the fashion retailer, Vivarte, by PAI, with Barclays Capital, Calyon, Natexis and Royal Bank of Scotland the mandated lead arrangers for just under Eu970m of senior debt.
Not far behind the Vivarte deal, in terms of size, is the planned buy-out by 3i of the transport services company, Keolis, which is being sold by BNP Paribas and SNCF. Calyon, HSBC and ING have been mandated as lead arrangers of the senior and mezzanine package of about Eu500m supporting the buy-out.
Again, bankers say that the pick-up in volumes in the leveraged loans market has at least partially been a by-product of high levels of liquidity among lenders. That has not gone unnoticed by equity sponsors which, in the words of one banker, are ?falling over themselves to get deals done?. That process, he adds, is driving leverage to unprecedented levels. ?We?re seeing leverage at 5.5 times and more, which would historically have frightened people to pieces, but those levels no longer seem to be scaring lenders away.?