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Loan syndication departments have been working at fever pitch since last year. But they continue to suffer dangerous pressure on margins, while maturities are stretched and covenants become sketchier. The competition is tempting them to take higher risks for less reward. That will continue until a shock kicks on the cycle. In 1995 volumes hit their highest-ever levels $374.2 billion compared with $178.2 billion in 1994, tailing slightly to $180 billion in the first six months of this year. Yet at the beginning of the 1990s the market was bleak, for both borrowers and lenders, before it warmed up. The syndicated loan market tends to follow a cycle. Many larger corporates have taken advantage of the recent ludicrously low pricing to refinance their medium-term debt, and lock it in for five years or more. Refinancings, via revolving facilities, have dominated the scene for the past 18 months. Some lenders are now wondering where profit-making deals will come from after 1995’s record refinancing-fuelled boom. The pace hardly slackened this year. Grant Johnson, head of loan syndication at NatWest Markets, comments: “The market remains strong an endless stream of banks still seem ready to participate in the right deals.” But as margins thin under competitive pressure from investment banks, some banks have taken on wider risks with lower credits. Johnson notes that “with competition so intense to win mandates at the arranger level, pricing for investment grade credits has been driven down dramatically. But nobody likes booking loans at the current level: banks are therefore migrating to other areas where the returns are greater.” Despite the drop in volume since last January, one arranger says that banks are looking hard at the risks and even turning down a few deals which they regard as too finely priced for the credit. Sean Boylan, director in syndications and loan distribution at BZW, agrees that these are “times when banks must be very careful in their lending policies”. Alarm bells began to ring in mid-1995. Bankers once regarded a 10 basis point (bp) margin and 5bp commitment fee as the absolute lowest limit of pricing for a top-quality corporate name. Last August BTR almost breached these levels coming to the market with an 11.5bp margin and 6bp commitment fee for a £700 million ($1.2 billion) five-year revolving credit. Since then banks have thought more carefully about what precise “ancillary business” they gain from these loss-leading “relationships”. One arranger, closely connected with the BTR transaction, commented: “If you are going to gain ancillary business at such low rates you have to ask how profitable is that business? Relationship banking seems largely to be a thing of the past.” Arrangers say that syndicate members are now insisting that borrowers outline what further business can be expected from a harshly-priced or less profitable deal. This caution is not applied universally, because bankers admit that the climate still favours borrowers. “Prices are at or bumping along the bottom” is a common complaint. And volumes have steadily decreased this year. Chris Scott, head of loan syndication and placement at Sumitomo Bank, says it could be worse. “There is still downward pressure on margins and pricing,” he says. “We have not reached the levels of the late 1980s. We are close to 1989, but not quite there yet.” At that time, when British Steel came to the market it achieved a margin of 5bp. Electricidade de Portugal commanded a 15bp margin for a 10-year loan and Merrill Lynch, ridiculously, arranged a 21-year loan for the same company, with Japanese life assurance firms participating, at 55bp below Libor. Now for higher-quality borrowers NatWest Markets’ Johnson echoes many when he says: “I don’t see any further reduction in price for investment-grade credits.” But not all market participants share his view. Leonard Seelig, managing director of loan syndications at NationsBank in London, not only admits that pricing is fundamentally at the lowest levels, but also warns that “the market is not impenetrable the right name would probably get a cheaper price”. Brenda Mills, first vice-president at Union Bank of Switzerland (UBS), agrees: “The major companies are still able to squeeze the last cent out of the market.” Where prices will still drop Seelig believes there will be a continuing squeeze on prices for lesser-quality credits as banks covet their more attractive returns and offer to refinance their credit facilities. Andrew Swinburne, managing director global syndicated finance at Chase in London, sees prices flattening out at the higher-quality end of the spectrum, but he agrees with Seelig that lower-quality credits are taking the opportunity to refinance at lower prices. For example, the Hellenic Republic recently came to the market with a term loan, priced for the first three years at 45bp over Libor and increasing to 50bp for its last two years (an average margin of 47.5bp over Libor). No commitment fees were offered, although generous participation fees accompany different-sized portions of the debt. Last year the margin was 80bp. Few other countries have utilized the bank market this year. Spain has not returned to the market after its successful Ecu5 billion ($6.35 billion) five-year revolving credit of last July. It could be that most countries’ loan refinancing needs are satisfied: Spain would find it hard to improve on last year’s cheap 4bp margin and larger countries, such as Sweden, can find cheaper funding in the capital markets. Most sovereign activity has come from emerging lesser credits, principally in the Middle East, where banks are letting margins fall and tenors increase. In March, for example, the State of Qatar improved its pricing to 50bp over Libor for a $250 million seven-year term loan; last October it achieved only 60bp for a five-year term loan. Last April the Sultanate of Oman gained even slimmer prices for its seven-year loan, although it has to pay more than Qatar in participation fees. Both still await signing. Looking to the east Emerging market credits elsewhere, particularly in eastern Europe, have proved popular with lenders looking for greater returns for their money. In June the National Bank of Hungary took advantage of increased bank competition by refinancing (through Deutsche and other arrangers) its $200 million five-year loan of last year. The original loan was coordinated by NatWest Markets, which had a margin of 150bp and a participation fee of 85bp for $10 million. Hungary’s rapidly improving credit quality, and the banks’ increasing willingness to lend and soak up assets, meant the loan was refinanced at a heavily-reduced margin of 50bp. The amount was increased to $250 million and the participation fee reduced to 30bp for $10 million. Summing up the pricing situation, Bruce Roe, a director at CS First Boston, says that the market has “got to a level where pricing is not going to go much lower until the credit environment changes”. That change could be under way. Banks are now looking for more structured corporate deals and it is these that are starting to drive the market in a significant way. This is partly because most refinancings have already been serviced. Fritz Kropatscheck, head of syndicated loans at Deutsche Bank in Frankfurt, estimates refinancings have dropped to around 30% of transactions this year; while Swinburne at Chase believes volumes have been sustained this year by leveraged buy-outs (LBOs), structured deals and project finance transactions. “Most of the new money borrowed has been related to acquisitions,” says David Roberts, head of the newly-established syndications team at Den Danske Bank in London. This is a new development for many banks. They are keener to arrange lending rather than to be just one of the participants: arranging also means greater fees as it involves both corporate finance departments and lending desks. And banks are also driven by the competitive atmosphere. But, again, caution doesn’t go amiss. Tim Ritchie, head of syndications and loan distribution at BZW, warns: “You can’t cherry-pick when dealing with sophisticated clients. Most successful banks are not just arrangers but lenders too.” Perhaps his words follow BZW’s recent need to reoffer the £2.35 billion loan it arranged for UK company Railtrack in a secondary sell-down. Since privatization in May, Railtrack’s ratings have improved to A+ with Standard & Poor’s and A2 with Moody’s. Rival banks did not complain about the pricing so much as the political uncertainties accompanying the deal. Some, however, stated that perhaps the pricing was just too slim. Railtrack, like National Grid before it (whose BZW-led loan also had to be sold-down a second time), were both new borrowers: they attracted keenly competitive bids from banks looking for lucrative long-term relationships. It could also be that Ritchie’s comments along with those of other top arrangers are directed at investment banks which, driven by their corporate finance teams’ requirements for their clients, have tried to establish a presence in an already overcrowded market. This was highlighted last September when Goldman Sachs was an arranger and underwrote a significant amount of PowerGen’s £800 million five-year revolving credit. Terence Hughes, executive director of the European loan group at Goldman Sachs, insists that this merely reflects Goldman’s client-based approach. Investment banks claim that loans are another product that they, as providers of all the financial services their clients need under one roof, can offer. NatWest Markets’ Johnson warns that investment banks “will find it hard to compete in a market driven by capital base”. But a number of banks are following their investment banking colleagues down the “one-stop shopping” route. Mills of UBS says: “We work very closely with the corporate finance desk. Right from the origination phase we find no need to go outside the bank for advice. Our job is to deliver to our customer the best possible solutions.” Towards universality Products ranging from MTN programmes, bond underwriting and senior debt facilities, to equity offerings and acquisition advice might be offered by these new universal banks. Bruce Carnegie-Brown, managing director at JP Morgan, which has long claimed this universal approach, says: “These markets overlap far more than they did 10 years ago.” When CS First Boston links with Credit Suisse’s capital base from next January, as Credit Suisse First Boston, the new structure might well challenge Chase’s dominance in cross-border transactions. Carnegie-Brown cautions that banks should “never be complacent in this business”. The market was refuelled in 1995 by refinancing and in 1996, so far, by acquisitions and restructuring the utility, telecommunication and media sectors in the UK and Scandinavia. But many lenders are pondering where the deals will come from next year after the UK general election when acquisitions activity is expected to decline. Many cite continental European acquisition-based transactions and emerging market project financing. But perhaps UBS has the right approach by developing project bonds. Mills thinks this could be an exciting innovation, one which not only utilizes UBS’s capital base and capital market bond underwriting teams, but also produces improved yields and, of course, security by combining the bank’s credit skills and distribution capabilities. This sounds remarkably like the project bonds of the 19th century which financed American railroads. But, as mentioned before, this market is cyclical perhaps this will help banks break the ice with new borrowers. Top 10 arrangers of syndicated loans
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