Renewed concerns about sovereign debt sustainability in peripheral Europe, rising sovereign credit spreads and worries that the European Central Bank’s Long-Term Refinancing Operation (LTRO) – by encouraging banks to buy home market government bonds – has bound their fates even closer to the troubled sovereigns, made for a tough start to the second quarter for debt market bankers who thought the good times had returned at the start of 2012.
"The first quarter of this year has been quite spectacular, with volumes much higher than preceding quarters," says Richard Boath, co-head of global finance, EMEA, at Barclays. "There have been a lot of large deals from big-name corporates that don’t come that often, issuing across several currencies at once and at low absolute rates and spreads: SABMiller, BHP, Heineken, Fiat. The volumes have been off the charts," he says. "And there’s still a lot of money to go to work, but I can’t see the second quarter being quite so good." He adds: "What could yet make the third and fourth quarters busy for us is a pick-up in M&A, which is what a hungry loan market is crying out for given the weak flow there so far this year."
At RBS, Richard Bartlett, head of corporate DCM and risk solutions, EMEA, says: "We had a quite excellent first quarter. But when you unpick it all what really leaps out is the low volume of syndicated loans banks are witnessing. That’s a potential issue looking forward. M&A has been quiet for quite some time already and if corporates aren’t taking out big syndicated loans now, there’ll be less bond market refinancing in the quarters ahead."
The first-quarter global syndicated loan volumes were indeed poor, according to Dealogic, amounting to $715.8 billion, down 21% on the $909.6 billion recorded during the first quarter of 2011 and the lowest quarterly volume since the first quarter of 2010 ($543 billion).
Global syndicated loan revenues were down even further for the first quarter, coming in 43% below the level in the first quarter of 2011 and suggesting that the big adjustment in the terms of trade between banks and borrowers – in which lenders strive to pass on both their own higher funding costs and higher costs of capital for holding loans – has not been achieved.
In Europe, Middle East and Africa (EMEA), the trend is even more marked. First-quarter volumes reached $142 billion via 222 deals, down 47% on the $269.2 billion recorded during the same period in 2011.
The last time first quarter syndicated loan volume sank this far in Europe was before the financial crisis, before the bursting of the dotcom bubble, even the Asian crisis and LTCM fiasco, back in the first quarter of 1997.
It has been the weakest first quarter for EMEA syndicated loans in 15 years and there is no sign that either volumes or earnings are likely to get better soon.
In Central and Eastern Europe, loan volumes at the start of 2012 are 80% down on a year ago. Across EMEA, syndicated loan fees were down 50% compared with the first quarter of 2011, even though leveraged loans accounted for 30% of European volume, the highest proportion since 2007.
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| Shaun Dreyer, head of investment-grade loan syndication at Bank of America Merrill Lynch |
Not everyone has given up on the syndicated loans market. Shaun Dreyer, head of investment-grade loan syndication at Bank of America Merrill Lynch (BAML), tells Euromoney: "The lack of volume in the first quarter was absolutely not a reflection of banks not wanting to lend. Rather it was supply driven. It was borrowers not wanting to borrow." The ECB’s April lending surveybacks this up. It shows that the net tightening of credit standards by euro area banks declined in the first quarter. Banks say this was off-set by a marked fall of 30% for the quarter in demand for loans from corporates.
Dreyer points out that a lot of corporates raised five-year syndicated loans in 2006 and 2007 towards the end of the leverage boom and, as the two-year refinancing bulge threatened from the start of 2011, strove to get ahead and refinance these last year.
Lack of confidence among corporates might have led to low volumes of M&A-related syndicated lending, but deals can be done. Dreyer says: "Loan volume may have been light in the first quarter but the market tone is much, much better now. Deals are certainly financeable."
And BAML has shown its own appetite, for example, sole underwriting the $4 billion bridge loan for Zurich-based power and automation company ABB to buy US-based electrical components maker Thomas & Betts in January. "There was an overwhelming positive response from the 15 or so banks that we approached to syndicate down our risk," says Dreyer. "You don’t often get 100% acceptance – it exceeded all expectations." It is noticeable that the one big climber in the European loan bookrunner rankings this quarter – BAML is up to sixth from 17th one year ago – is a US bank with a high exposure to US borrowers.
However, Dreyer’s claim that declining loan volumes reflect reduced appetite to borrow rather than reduced bank capacity to lend does not tell the whole story. Single A-rated non-bank borrowers are paying around 100 basis points over Euribor for loans. Banks are funding closer to 250bp over Euribor.
Syndicated lending makes no financial sense for banks, except for the tight handful that can make up the loss through charging for other services, such as interest rate and currency risk hedging, DCM take-out and M&A advisory.
As the second quarter began, the warning signals kept coming. By April 18, just looking at rated corporates – which by common consent are highly solvent borrowers in a world of credit-constrained sovereigns and banks – Dealogic had recorded just 35 syndicated loans in Europe this year, the lowest number of transactions during a similar period in a decade.
The anecdotes are not encouraging either. One banker reports back after a meeting with his M&A colleagues. Half a dozen M&A deals the firm had been hoping to execute this year simply fell away the moment risk aversion and financial-market volatility picked up over Easter. They won’t now happen.
But do not think that borrowers have simply stopped borrowing. Dealogic notes that US-marketed syndicated loan volume by non-US borrowers totalled $15.9 billion in 2012 for the year to the end of the first week in April, the highest volume during a similar period since 2007. Debt market bankers also report that UK and European borrowers have been big users of the US private placement market, where the relative illiquidity and tighter covenant packages than in the bond market invite closer comparison to syndicated loans, albeit ones provided by non-banks.
The collapse of syndicated loan volumes in Europe looks to be the most obvious symptom of a banking system in a state of near meltdown.
The estimates for deleveraging still to come from continental European banks, including even those with decent quality asset portfolios but now struggling with much reduced access to and higher cost of wholesale funding, are worrying. In its latest Global Financial Stability Assessment, the IMF suggests that 58 large EU-based banks could shrink their combined balance sheet by as much as $2.6 trillion (€2 trillion) through end-2013, or almost 7% of total assets. About a quarter of this deleveraging is projected to occur through a reduction in lending,
Morgan Stanley’s base case since the start of 2012 has been that European banks could delever by between €1.5 trillion to 2.5 trillion up to the middle of 2013 and that, in the absence of any deposit growth, deleveraging in the next five to six years, could climb to €4.5 trillion.
Restricted lending
At the start of April, the firm’s bank analysts reported back from the presentations and discussions on the fringe of Morgan Stanley’s latest financials conference. They stated: "Notwithstanding the huge benefits of the LTRO, most banks were still looking to reduce cross-border lending and to be very prudent on domestic lending."
| Bank lending falls sharply in Q1 |
| EMEA loan volume by region |
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| Source: Dealogic |
In Dealogic’s EMEA loan-volume analysis, the three leading countries in most quarters are Germany, France and the UK, with Spain some way behind in fourth. Even in the UK, whose banks are at one remove from the eurozone crisis, loan volumes are not impressive. The popular villain in the UK remains – probably for a generation – the banks now accused of having taken state support and not repaid it in higher volumes of lending. Some voices are now daring to protest that regulators might share some of the blame. Alastair Ryan and John-Paul Crutchley, bank analysts at UBS, pointed out in a note last month that a well-capitalized and well-funded UK banking system is shrinking lending.
"It is becoming increasingly apparent this is because bank regulators become especially risk-averse in the aftermath of a crisis, and demand banks are capitalized and funded against a situation worse than the one just experienced, regardless of the cost," they state.
"This was evidenced at the end of March by the [interim] Financial Policy Committee [FPC], the UK’s new macro-prudential regulator. Following a set of results showing banks’ credit risks had declined, funding mix and term structure had improved, and capital ratios had reached long-term highs, the FPC actually turned up the dial in its capital expectations."
The committee urged banks to raise more external capital as early as possible, apparently ignoring the dismal returns and poor growth prospects they are now offering shareholders.
The very purpose of banks, the need for them to exist and to extend credit, is now up for debate across the continent. A further contradiction to Dreyer’s assertion that low loan volumes reflect low borrowing supply is evident in the capital markets, once a second-choice venue for European corporates to raise funding that over time will become their primary source as new regulations make banks the worst imaginable corporate vehicle to house bank loans.
Analysts at Morgan Stanley and Oliver Wyman, in a recent report, Decision time for wholesale banks, see the industry’s radical transformation approaching fast. Banks will no longer be the primary source of credit.
"In Europe, historical data would imply around $1 trillion total net new lending will be required to support 1% to 2% GDP growth per annum until 2017," the report states. "We estimate banks in Europe will struggle to deliver more than $400 billion of credit over the next five years given constraints on funding as well as leverage under Basle III."
The capital markets will have to shoulder even more of the load than they have already. Investors can hire-in the credit analysts to run loan portfolios, and before long some will probably be hiring loan originators too, to take big primary positions.
There are other things that banks can do that might promise better returns to their investors and take advantage of investments already made in financial infrastructure. Morgan Stanley and Oliver Wyman analysts suggest: "Lending used to be the hook into corporate clients, whereas we think cash and payments will be the anchor in future."
