The syndicated loans market has grown rapidly in recent years, driven primarily by an increase in corporate takeovers, private equity transactions and infrastructure deals. Strong liquidity means there is plenty of cash to invest, and banks are willing lenders. Joanne Hart reports.

The syndicated loan market used to be the poor relation of the investment banking community. Considered a small step up from straightforward corporate banking, syndicated loan specialists were scorned by most investment bankers, who felt their lines of business were more sophisticated, more lucrative and far more exciting. But times have changed. The syndicated loan market has taken off in recent years and in 2006, global volumes reached nearly £3500bn, including just under $1300bn of European deals.

The market has doubled in size over the past six years and the shift has been driven primarily by an increase in corporate takeovers, private equity transactions and infrastructure deals. In 2004, more than 70% of loans were corporate refinancings. By last year, that figure had dropped to 43%, while 48% of deals related to mergers and acquisitions (M&A) activity of one kind or another.

Big deals

As the purpose behind deals has changed, so have deal sizes. In the past 12 months, more than 80 deals have been concluded with a value of over $1bn. And within that number, some truly enormous loans have been syndicated, such as the €35bn deal for Porsche when it bought Volkswagen.

“This market is characterised by exceptionally strong liquidity and a relatively benign credit environment, and the situation is unlikely to change in the near future,” says Steven Victorin, head of global loans, Europe and North America at Citigroup Global Markets.

According to some estimates, there is $2000 trillion of freely available cash floating around the global capital markets, looking for a home. “This money needs to be invested and there are not enough opportunities for it to be invested at the speed at which it needs to be,” says one senior banker.

What this means is that borrowers in search of cash do not need to look very far to find it. Banks are willing lenders and there are swathes of new providers of capital, too: hedge funds, insurance companies and other institutional investors.

Fundamentally, the loan market can be broken down into four constituent parts: traditional corporate refinancings; event-driven loans to corporates; loans to private equity vehicles that fund acquisitions; and loans to finance the purchase of infrastructure assets. Each of these sectors has different characteristics, different structures, different pricing and different maturities.

There have been relatively few plain vanilla corporate refinancings lately and rates are at historic lows. “Companies spent the past few years refinancing debt and locking in low rates for the next five to seven years,” says Ian Fitzgerald, head of loan syndications at Lloyds TSB corporate markets division.

Event-driven loans to corporates are on the increase, however. Takeover activity is rife throughout Europe and companies are turning to their banks to provide the means with which they can fulfil their corporate ambitions.

“There is substantial appetite among banks to support clients making acquisitions. People prefer to back companies that are growing and acquiring, rather than those that are being bought. Banks also hope to get ancillary business if they back companies in M&A situations,” says Chris Baines, managing director, European leveraged capital markets at Société Générale.

Compensation premium

And there is the added bonus that event-driven deals carry a premium, to compensate lenders for the perceived added risk involved in M&A and to attract new lenders. “Volkswagen has an outstanding corporate facility priced at a spread of 12.5 basis points (bp). But the Porsche loan to finance the VW takeover was priced at a spread of 40bp to 50bp, so banks were getting an enhanced yield for what was effectively the same credit,” says Julian Taylor, managing director, syndicated finance at HSBC.

These corporate deals tend to be financed by a group of relationship banks, ranging in number from eight to as many as 30, depending on the size of the deal. Bankers report that, with larger deals, they have some sway on the pricing front because they are being asked to lend significant amounts of capital.

“If you are asking banks to put up $1bn-plus apiece, there is a limit to the amount of bargaining you can do. Clients have to accept that they will need to pay a premium because they are borrowing a lot of money,” says one banker.

Secondary market

Despite greater churn in the debt markets, bankers argue that investment grade financing is still relationship driven and that relatively little is sold on in the secondary market. Nonetheless, the secondary market has mushroomed as both investment grade, and to a much greater extent, leveraged loans are traded with increasing frequency.

“Most firms have their own stand-alone secondary trading desks with independent trading strategies beyond solely providing liquidity to a firm’s bank debt portfolio,” says Mr Victorin.

Purchasers of secondary debt include institutional investors and hedge funds who see this sector of the market as a source of diversification. They are also attracted to the yields available on non-investment grade debt. “Yields have come down but, relative to other instruments, they are quite attractive,” says Mr Baines.

These non-bank investors are also heavily involved in the primary loan market, specifically in leveraged deals arranged for private equity firms and infrastructure transactions.

“In private equity sponsored takeovers, a bank or group of banks will underwrite the financing and will then syndicate the debt, as is the case with corporate deals. The difference is that the liquidity in sponsor-driven transactions tends to be split equally between banks and funds,” says Mr Taylor.

In other words, half the debt is sold to non-bank investors, much of it packaged up by investment banks into collateralised loan obligations (CLOs). These are fixed-rate instruments and they are a widespread feature of the below-investment-grade loan market.

“The leveraged market’s growth has been driven by strong supply and demand dynamics in the context of a very supportive credit market. Private equity sponsors have supplied the opportunities by leveraging the funds at their disposal when making acquisitions, whereas CLOs and other institutional funds have been the key demand drivers, bolstered by an increasingly large pool of investors keen to purchase leveraged assets,” says Mr Baines.

The plentiful supply of loan capital has allowed private equity firms to target larger and larger acquisitions, such as the recent proposed takeover of UK pharmacy chain Boots by US giant KKR – the first time a FTSE 100 company has been acquired by a private equity bidder.

Lenders offer more

Demand for leveraged debt has also increased the amount of money investors are prepared to lend. “Last year, private equity-sponsored deals were successfully completed with a leverage of five to seven times their target company’s Ebitda [earnings before interest depreciation and amortisation]. This year they are being offered seven, eight or even nine times Ebitda,” says Mr Taylor.

Institutional investors are prepared to participate in more leveraged financings to ensure that their specific yield requirements are met. “They have a range of funds under their management, each with relatively rigid return requirements ranging from about 2% to 5%,” says Mr Taylor.

Nonetheless, pricing is under pressure, predictably enough given the appetite for deals. Spreads are not going down as rapidly as in recent years but new phenomena have entered the market, particularly a practice known as ‘reverse flex’ and another known as ‘repricing’.

In the first instance, the arrangers of a deal will syndicate it at a certain price, say 250bp above Libor, at which point it is heavily oversubscribed. The arrangers will then return to the syndication group and ask how many of them are prepared to commit at a lower level, say 225bp. Some would-be participants may bow out but enough stay in to ensure the deal is done. This is reverse flex and it is increasingly prevalent.

Repricing is also on the increase, whereby loans are repriced some time after they have been syndicated, to reflect either an improved performance on the part of the borrower or changing market conditions.

“Repricing can be done too soon. The deal for the French cable company Numericable, for instance, was repriced three months after launch and that did not go down well. But the Automobile Association deal was recently repriced after a couple of years and that went pretty smoothly,” says a source.

Tranche creation

Banks have also become adept at creating different tranches within leveraged and infrastructure debt, each of which has a different risk profile and maturity.

“Most deals have a combination of senior debt and subordinated debt and there can also be tranches in between, which rank pari passu with the senior debt but have a slightly different profile and a slightly more generous yield,” says one banker.

Looking ahead, most bankers believe the outlook is benign, at least for the short-term. “There is huge demand for debt, driven by M&A activity. On the supply side, the investor base has grown dramatically,” says Mr Victorin.

“People are chasing yield, they are chasing funded assets and they have become more adept at analysing and understanding risk.”

ISLAMIC SYNDICATED LENDING

Islamic syndicated lending is on the increase. Arranged for Islamic borrowers who do not subscribe to the concept of interest, the deals involve both Islamic and conventional banks. The key point is that they allow Islamic companies and institutions to raise substantial sums of money while remaining true to shariah law.

“These deals are syndicated just like ordinary syndicated loans but they are structured in a different way,” says Fahad Qassim of Dubai Islamic Bank.

The two most popular types of deals are leasing (ijara) transactions and sale (murabaha) structures. In the first instance, a group of banks will buy an asset that belongs to the borrower, give the borrower the funds and then lease the asset back to the borrower. In the second instance, the bank group will purchase a specific asset for the borrower and sell it back at a fixed profit margin.

“The market is growing fast. Clients are becoming more knowledgeable and many banks are keen to participate in this sector,” says Mr Qassim.

New lending structures are being devised all the time but deals have one thing in common: they must be secured against specific assets.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter