Bonds steal thunder from loans in Europe
When the going got tough, banks were quick to bring down the shutters and cut off loans to European companies, forcing them to seek other sources of funding. The result — a dramatic shift to the bond markets, where corporates borrow directly from investors.
This failure of the banks to be there when borrowers needed them most could spell the end of the European syndicated loan market as the powerhouse of corporate finance activity in the region, marking a longer-term shift in the funding mix for European companies from loans to bonds.
The European loan market had already fallen to $867 billion in 2008 — from a record high of $1.7 trillion during the leveraged loan frenzy of 2007. Nevertheless, it remained a mainstay of the relationship banking model. This year the decline has continued, as European loan volumes have fallen by 35 percent year-on-year to $225 billion, with leveraged loans down by some 62 percent, according to Thomson Reuters data.
Meanwhile, Eurobond issuance is up 38 percent year-on-year, reaching $1.4 trillion of new bonds so far in 2009. 2008 was itself a near record year for new issues in the Eurobond market, just below the $3 trillion issued during the whole of 2007.
In the past, bank lending was more often than not loss-leading — a simple device for luring a company in through the doors in order to sell it costlier advice on areas such as mergers and acquisitions. It was also an integral part of most companies’ funding plans.
But the days of banks providing dirt cheap loans are unlikely to return as regulators impose tougher capital requirements. The result is that one of the main benefits for companies of the using the loan market will disappear.
Chief financial officers and treasurers were happy to play along while banks offered them blockbuster loans to fund their acquisitions, allowed them to keep shareholders sweet by funding share buybacks or enabled them to roll over more expensive existing credit lines. The headline costs were low, the deals were supposedly confidential and companies could get at the money quickly and with relative ease as and when they needed it.
But the tightening up of this market, driven in part by the need for banks to reduce their lending to bolster their balance sheets and in some cases by the disappearance of once regular lenders, has played havoc with this cosy relationship. Companies that had relied on their relationship with banks to provide them with liquidity suddenly found their calls went unanswered.
Their often urgent need to refinance loans, roll over existing bonds or raise new money to fund acquisitions forced them to look elsewhere. And the one market where investors — most notably large pension funds — have been willing to invest in 2009 has been the so-called investment grade credit market.
Big name companies which met the requirements of the credit ratings agencies and achieved this stamp of approval found they could issue bonds, almost at will.
Barclays Capital analysts Puneet Sharma and Aziz Sunderji argued in a recent note that the reduction in loan volumes to European corporates is partly due to lower levels of corporate activity and investment, as well as the availability of an alternative in the form of an active bond market and the pressures on bank balance sheets.
There has indeed been a sharp decline in M&A activity from the boom year of 2007, but there are still blockbuster deals being done. Drugs group Roche is a prime example of a large corporate borrower which would in the past have used the syndicated loan market but opted to issue bonds instead. In Roche’s case it successfully raised a lot of cash, some $30 billion, to fund its purchase of Genentech .
Having seen Roche tap the European and U.S. corporate bond markets, the world’s largest drugmaker Pfizer Inc, issued its own bonds in the U.S. to help fund its purchase of Wyeth . It has now embarked on a roadshow to meet European investors as it looks to raise cash to fund the rest of the $68 billion takeover.
As corporate issuance in the Eurobond market has raced ahead and broken records during the first four months of the year, there have been rich pickings for the investment banks involved. There’s no doubt they still have an important role to play, as the underwriters there are good fees to be made, with the banks taking a cut of the total amount raised.
But the banks should not be complacent. The threat of disintermediation is always there once issuers and end investors realise they can team up directly to meet each of their needs, and potentially cut out the middle man.
Meanwhile there are dangers too for companies, with the possibility that the bond market seizes up overnight and closes off their funding. Corporates with lesser credit ratings may also find it hard to access the bond markets, while banks may also be less willing to lend to them.
— At the time of publication Alexander Smith did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.
(Editing by David Evans)