Amid a dearth of alternative investment grade lending opportunities, banks continue to provide their relationship clients with aggressively-priced syndicated loans. Unless M&A activity increases this year, bankers fear loan pricing could fall even further. Joanna Hickey reports.

Against expectations, the age-old practice of relationship lending is still alive and kicking. Banks are still extending loans to clients at irrationally low prices in the hope of obtaining future, higher-yielding ancillary business.

Despite the wider financial markets’ woes in the past three years and predictions that banks would stop loss-lending and focus on return on capital, syndicated loan pricing has been on a downward trajectory. The average pricing of a European investment grade refinancing and standby facility was 53.7bp in 2003, down from 73.4bp in 2002, while in the US the average spread plummeted from 80.8bp in 2002 to 56.7bp last year, according to Thomson Financial.

Aggressive pricing

Pricing has now reached extremely aggressive levels. A and AA rated credits are getting spreads an estimated 10bp lower than a year ago. The average spread for a A to AA rated French and German corporate ranges from 17.5bp to 25bp over Euribor for five-year money, while BBB to BBB+ rated credits are now paying 45bp-50bp over Euribor.

Thus borrowers are firmly in the driving seat when it comes to negotiating both pricing and structures. Given the ongoing lack of M&As and the favourable pricing conditions, refinancings dominated the investment grade loan market in 2003. Vast refinancings included Daimler-Chrysler’s E13bn loan, E.On’s E7.5bn deal, Volkswagen’s E10bn transaction and BMW’s $7bn loan. All of these carried very competitive pricing.

“It is very much a borrower’s market at the moment. Loan pricing fell in the US, Europe and Asia last year and has the potential to reduce further,” says Atiq Ur Rehman, head of European and Asian loans at Citigroup.

Supply-demand imbalance

Although the improving economy, unprecedented liquidity in the global bond markets and recovering equity markets have all helped push down loan pricing, the main reason for such aggressive loan terms is that banks’ demand for assets is outstripping the supply of deals in the market.

In terms of supply, the absence of M&A and telecom financings in the past three years severely curtailed previously lucrative lending opportunities for banks. Demand is also high because of banks’ strong liquidity, following an extremely positive year in the bond market. In addition, although overall lender levels have fallen amid bank consolidation and loan portfolio retrenchment, Europe in particular remains over-run with banks.

“Europe especially is over-banked, which creates pricing pressures among banks – particularly in their respective home markets,” says Mr Rehman.

While 2002’s big theme of improving return on capital prompted predictions that relationship lending would fall and loan pricing would rise, the lack of M&As has forced banks to worry more about top-line growth. “The M&A downturn has hit corporate finance earnings at banks, shifting their focus from return on capital back to top-line growth and revenue. The pressure to preserve client relationships to benefit from future business has led to banks offering aggressive loan terms,” says Mr Rehman.

Taking a gamble

Although a few banks have taken a hard line on cutting ties with corporates that do not deliver sufficient knock-on business, new banks are always breaking onto the scene, trying to bag new clients by extending cheap loans and gambling that future business will make up for it.

While banks continue to see loans as the cornerstone of their client relationships, the path is open for borrowers to dictate their terms. Chris Baines, head of loan distribution at SG CIB, says: “Some banks may have stopped supporting tightly-priced loans if they feel ancillary business has been insufficient. But for many banks, the brink of a recovery is not the time to pull out of relationships. Most banks are willing to take the view that they will get future business and continue to provide finely-priced financings to their closest relationship borrowers.”

With too many banks chasing a finite number of deals, competition is cut-throat. And mandate-grabbing techniques are usually based on pricing. “The number of active lenders has fallen from more than 60 before 1995 to about 25 last year,” says Julian van Kan, head of loan syndications and trading, EMEA at BNP Paribas. “Yet there are still more lenders than deals. And the banks that remain are extremely aggressive: many are seeking to become arrangers for the first time and so are offering very low pricing and fees. All lenders are long on capital and under pressure to lend – banks need assets on their books.”

Distribution success

Bagging mandates by pitching low pricing is one thing, but if an arranger encounters resistance further downstream and cannot distribute its deal, pricing will not stay low for long. However, the relative lack of supply has forced lenders lower down the syndicate tombstone to clamour for paper, too – however low yielding.

Thus, despite falling pricing and shrinking syndicates, the refinancings done during the past year have been successfully syndicated. Substantial oversubscriptions were achieved for the likes of BMW with its $7.5bn jumbo, despite the fact that it paid spreads of just 20bp and 25bp for one-year and five-year money.

“The syndication of most loans has continued to be a smooth process and deals continue to close oversubscribed. The global loan market remains relationship-driven and, although structural flaws or client-specific problems may detract banks from supporting a client, tight pricing rarely will,” says Richard Cartledge, global head of syndicated finance at HSBC.

Thus arrangers are not being forced to search far outside a borrower’s bank group to place a deal. While a few banks that are new to a corporate may support a deal with small tickets in the hope of breaking into a relationship, relationship banks in general have been increasing their tickets and absorbing far more than previously.

Hinging on M&A?

With more refinancings likely to take place this year, only the much-desired return of M&A could now stop the downward pricing spiral. “If large, transforming M&A returns, pricing could rise. M&A loans usually pay a significant premium driven by size, confidentiality and new money needs, etc. A robust acquisition finance market can have a positive spill-over effect on the terms of standby and refinancing loans,” says Mr Rehman.

However, if M&A activity does not pick up substantially, spreads will at best remain at their current low levels or, at worst, fall even further this year. Credits in the BBB+ to BBB- bracket are deemed especially likely to fall, with the average BBB to BBB+ spread likely to drop from 45bp-50bp over Euribor in the past two years to less than 40bp this year. In addition, commitment fees, upfront fees and structures are under pressure, with borrowers demanding fewer, lighter covenants.

Some bankers feel that a rise in investment grade loan pricing is unlikely this year, whether or not M&A activity picks up. “Even if M&A does return, we don’t see substantial premiums on acquisition financings – there is just too much liquidity in the loan market. There is not enough pressure to force pricing up – as shown by the amount of paper at or near par in the secondary market,” says Mr van Kan.

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