The loan market fights back

Louise Bowman
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Europe’s great disintermediation is stalling. Yield-hungry institutional investors are driving demand for loans at the riskier end of the credit spectrum. Banks, pumped with ECB-printed liquidity and desperate to put their capital to work, are getting off the fence. It could be music to Mario Draghi’s ears. But is a sudden turn away from the bond markets, at increasingly aggressive lending rates, what Europe really needs?

loan market illustration-300 (2)
Illustration: Paul Daviz
The career policy-maker leans forward in his chair, with a clear sense of purpose. "If disintermediation doesn’t happen now in Europe, it never will," he tells Euromoney.

He’s just spent the last 10 minutes explaining in weary detail how Europe desperately needs a deepening of its capital markets to kick-start its economy back to life. Top of his agenda is "a US-style junk bond market – although of course we need a better name for that." 

Ever since the financial crisis, European policy-makers have encouraged a transition of corporate financing away from a bank-dominated, loan-dominated market towards one of US-style corporate-bond issuance. A painful bank retrenchment has forced Europe’s corporates to wean themselves off dependence on a few relationship banks and embrace the capital markets. 

But it’s not quite going to plan. Many banks have stopped deleveraging. Loans are back. Corporates are even refinancing bonds at cheaper rates provided by the swollen ranks of suddenly eager lenders.

"A couple of years ago people thought that the bond market would eat the banks’ lunch, but that is now reversing," reckons Graeme Delaney-Smith, head of European direct lending and mezzanine investments at Alcentra, the sub-investment grade debt manager owned by BNY Mellon. "There is a huge investor base that used to do high-yield bonds that now wants mid-market loans. We will see more primary deals done in the loan market." 

The relative strength of the loan market is increasingly apparent not just in the volume tables but on the ground as well. It is the result not just of the weight of institutional money chasing the loan asset class but also of a phenomenon that according to the more hysterical end of the popular press no longer exists: European banks lending money to corporates and households. 

Years of cheap central bank liquidity might finally be bearing fruit. The January 2015 ECB bank lending survey, which took place between December 8 and 20 last year, must be music to Mario Draghi’s ears: credit standards for all loan categories continued to ease with banks reporting increasing competitive pressures across all loan categories. They indicated a considerable narrowing of margins on average loans, though only a slight narrowing of margins on riskier loans, suggesting a further intensification in banks’ risk differentiation.

The survey also found rising net demand for loans related to fixed investment, recording the first significantly positive contribution since mid-2011. "The change in bank attitude became noticeable in the second quarter last year, around the time that the ECB looked at conditionality for the TLTRO [Targeted Longer Term Refinancing Operation]," says Gildas Surry, senior credit sector specialist at BNP Paribas. "The steepest drop in bank lending volumes was between the second quarter of 2013 to the second quarter of 2014. The inflexion point took place there. With the blessing of the ECB some banks realized that they would have a very limited number of excuses to not lend." 

The challenge for non-bank lenders is to prove they are stable long-term lenders and not just opportunistic credit funds
Symon Drake Brockman

The bank lending market in Europe is a very long way from being fixed. However, there certainly seems to be a marked shift in attitude. "We are seeing a change in behaviour by the banks in Europe," says Brian Jacobsen, chief portfolio strategist at Wells Fargo Asset Management. "The banks are beginning to lend to the private sector. We have seen an increase in lending to non-financial corporates and households since November last year." 

The return of the European loan market is, of course, about more than the banks. Institutional investors are increasingly important lenders. In a December report entitled 'Don’t call it a comeback…well actually, it is’, Barclays analysts forecast between €55 billion and €65 billion of institutional loan issuance across European currencies this year. And 2014 was the first year in which institutional lenders accounted for more lending than the banks in Europe: they now have a 60% share of the loan market. 

"Institutional lenders are trying to do as much as they can in non-investment grade syndicated lending," says Symon Drake Brockman, managing partner at Pemberton Capital Management, a London-based asset manager. Drake Brockman ran the debt and credit businesses at RBS between 2001 and 2009. In July last year Legal & General took a 40% stake in Pemberton and the two formed a strategic partnership for the development of a direct-lending platform aimed at mid-market companies across Europe. "CLOs and credit hedge funds see the fees and opportunities in the non-investment grade market as very attractive," Drake Brockman adds. 

Many banks now find them very attractive too, so the loan market in Europe is the focus of unprecedented attention. "The US high-yield and US loan markets all sold off last year, as did the European high-yield bond market," observed one loan fund manager at a recent Leveraged Finance conference in London. "The one market that hasn’t moved is European loans. Spreads are tighter and covenants are weaker, so the loan market will be very interesting this year."