LMA syndicated loan conference highlights

Syndicated loan volumes in Europe are up this year. But trading issues threaten the market’s full revival

Europe's banks are underlent. This was the clear message from the Loan Market Association's (LMA) syndicated loan conference, held in London last month. After years of wading through post-crisis reforms and shoring up their balance sheets, the region's traditional lenders are back in business. The catch, however, is that they now face stronger competition in the form of the debt capital markets which have proved a resilient – and mainstream – source of finance during the banks' hiatus.

The bond market coming to the fore has also highlighted syndicated loan products' shortcomings – specifically regarding secondary loan trading. Paper-based settlement, aggressive borrower terms, and, to an extent, cov-lite are all damaging loans' liquidity.

EMEA syndicated loan volumes may be up on last year, but if the banks want to increase their market share, they will need to iron out some of these structural shortcomings.

The outdated settlement system used in Europe's secondary loan market must standardise and improve if it is to compete with the bond market, panellists warned. It's impeding the region's leveraged loan market at a time when regulators are trying to unlock capital flows, and must be pushed up banks' agenda.

"Settlement needs to be far more of an issue and made much more of a priority" Martin Horne, Babson Capital Europe

The paper-based settlement process has contributed to the European secondary loan market's reputation as the biggest inefficient trading market globally. Panellists lamented the lack of progress on what is now a longstanding problem. "Settlement needs to be far more of an issue and made much more of a priority than it has to-date," said Martin Horne, managing director at Babson Capital Europe. "I would welcome standardisation and hope those running these banks and departments give it the attention it deserves as it is reducing liquidity."

Indeed, a lack of standardisation and market-wide requirements for agencies is one of the market's major gripes. Settlement businesses can be set up and run to their own internal standards with little regulatory scrutiny of their practices.

Stricter oversight and collaboration regarding these timelines would significantly improve confidence and liquidity in the secondary market.

"Anyone who manages a large amount of institutional loans will be aware of situations where they have traded on a loan and six months later it hasn't settled," said Horne. "These are practices we should be running out of our market."

It is situations like this which, some panellists believe, justify the introduction of changes whereby agents are held accountable for transfer delays.

Growing competition from Europe's bond markets – which benefit from an electronic transfer system – should be another catalyst for standardised settlement processes.

"To fully benefit from the accelerating trend towards institutional investors, the market must streamline its processes," said Charlie Bennett, Credit Suisse's co-head of loan sales and trading, leveraged finance. "This will be vital to scale up the European loan market to its full potential."

Today, most issuers size their tranches in different markets based on pricing and demand. But as competition between the bank and bond markets continues to grow, loan settlement timelines and processes could increasingly impact investor demand, and in turn, become bigger considerations for issuers.

"There is little doubt that addressing these settlement issues will become more important as the market develops," added Bennett.

The US secondary loan market also settles via a paper-based system, but its processing times are significantly shorter than in Europe. Craig Scordellis, senior portfolio manager at CQS, urged delegates to look at the US's success regarding standardisation. "That was through lobbying, banks working with institutions, and educating the regulators."

"If we can work together I think we can make a lot of progress on settlement issues in Europe," Scordellis said. However panellists also highlighted the settlement hurdles created by the EU's fragmented regulatory and tax framework. There are also confidentiality issues under European law that create transfer restrictions that do not exist in the US.

Issues surrounding white lists in loans to financial sponsors are also damaging secondary market liquidity, and may not achieve borrowers' intended goal. The practice sees private equity borrowers include in their facility agreements a list of pre-approved buyers of the loan.

It is becoming increasingly prominent in Europe, and is creating further issues for the already struggling secondary market.

Scordellis said the introduction of the lists is not a problem per se, but it can present challenges for loan managers. This is exacerbated by the fact the white list applies to subsequent transfers, which further limits the willingness of buyers to agree to take on the loan.

"For example how can we expect the large intermediaries to step up without having a buyer on the other side, given their universe of buyers has been restricted?" he said. This is because the white list will invariably not include distressed investors and those who would buy debt to ultimately control the business, resulting in a lower liquidity.

The standard white list language prohibits entities in the borrower group from unreasonably withholding approval of a transfer. In theory, this should provide some relief for those in the secondary market. But in reality, it has been of little use.

"How can we expect the large intermediaries to step up without having a buyer on the other side, given their universe of buyers has been restricted?" Craig Scordellis, CQS

"More importantly than the white list itself, it is a surprise to me how owners of businesses and business themselves have interpreted the transferability language in loan documentation," Scordellis said. The onus is on sponsors to take a measured approach to this approval, and for the market to cooperate in creating best practice. "Standardisation of transfer language is key, without this there will be varied interpretation of transfer language which can lead to a more aggressive approach," Scordellis added. This is particularly important given the relatively standard transfer language used in Europe's high-yield market.

In an audience vote at the LMA conference, two-thirds of delegates agreed that sponsor white lists had significantly impeded secondary market liquidity when it matters.

Sponsors want the white lists to stop distressed buyers – including hostile funds – from buying the debt to control the fate of the company. But not all are convinced it is achieving this goal.

"The sponsors are using the white list to serve a particular purpose, but I'm not sure if the list is fully serving that purpose," said Dagmar Kent-Kershaw, head of credit fund management at ICG, "And in the process, it might be damaging liquidity and the market."

The white list is an impediment, but she said that if those buyers want to get hold of the paper – they will. There are ways for non-approved entities to acquire loans through sub-participations and other avenues. In addition, once the company defaults, the white list falls away and is not binding.

Despite well-publicised concerns over the rise of cov-lite lending in Europe, many panellists were unphased by the development. Some believe that borrowers' willingness to ask for more aggressive terms is actually a sign of a healthy and stable primary market.

In the aftermath of Lehman's collapse, the secondary market was wary of the structure. The collateral loan obligations (CLO) that followed tended to have very restrictive requirements regarding loans subject to minimal covenants.

But as cov-lite has, and continues to evolve, Scordellis said the CLO language around cov-lite is opening up a bit more.

Inevitably, the key is having the release mechanism that is a fluid secondary market. "As credit managers we would prefer to not have cov-lite, but we would be more willing to take a cov-lite loan in a situation where we thought there would be good liquidity in the future," said Kent-Kershaw.

Project finance’s new liquidity problem

Weak dealflow and growing competition from institutional investors has stymied European banks' return to project finance. Bankers are disappointed by this year's project loan volumes, but agree the future of infrastructure funding depends on further progress being made by the debt capital markets. The region's biggest banks are underlent, and an increasing number are now ready to offer tenors of up to 25 years. But while overall syndicated loan volumes for EMEA have rebounded, year-to-date syndicated project loan volumes are down 30% from last year. "This is a bit of a disappointment compared to the leverage and corporate syndicated market," said panellist Mathias Noack, global head of loan syndication at UniCredit Group. "Volumes are down and geo-political tensions mean some large projects are being delayed for the time being," he added. Central and eastern Europe is one of the areas hardest hit, and banks are relying on deals that have stalled in the pipeline. When they do come to market, they could be spoilt for choice of lenders. "I do believe that bank appetite has come back and well-capitalised banks dedicated to project finance are willing to lend very long-term," said Janin Campos, BBVA's head of corporate syndicated lending for EMEA & Asia. London's Intercity Express Programme, for example, reached financial close earlier this year with the backing of six banks. Banks may be looking at new structures, and good credit stories. But, as noted by Noack, the rise of project bonds has led to tremendous amount of competition in the project finance area, and acute levels of funds in many regions. The number of infrastructure debt funds and institutional investors able to accommodate project bonds' idiosyncrasies has surged over the past 12 months. Many of them have also been hit by the shortage of dealflow, and haven't been able to deploy their funds as quickly as they hoped. Competition from project bonds is, however, a necessary for Europe to develop a sustainable post-crisis project finance market. "I am convinced that this is the only way forward," said Campos. "The EU and national government initiatives, as well as banks and institutional investors working together, are what's going to improve long-term sustainable finance." Some panellists praised the progress made by the European Investment Bank's 2020 project bond scheme in promoting the debt capital markets as a viable project finance alternative. But others were more sceptical, especially given the 2020 scheme has supported just five deals that have reached financial close since the scheme's launch in mid-2012. "At some point banks will have to grapple with the fact that it will be very, very expensive for them to lend at very long tenors," said Roland Boehm, global head of debt capital markets at Commerzbank. "So I am surprised that there hasn't been more progress in terms of project bonds."