IFR-European firms advised to diversify funding

(The following story appeared in the May 14 issue of International Financing Review, a Thomson Reuters publication).

By Alasdair Reilly

LONDON, May 14 (IFR) - Corporate borrowers in Europe face a long period of uncertainty as banks contemplate a wave of complex new regulations set to be implemented by international regulators over the next few years that will cut banks' lending capacity and force an increase in funding cost, speakers told the Association of Corporate Treasurers' annual conference in Liverpool last week.

Corporate borrowers will increasingly seek to source their funding away from the syndicated loan market as they continue to deleverage and could even start to make deposits in a radical role reversal and become net lenders to banks.

The main thrust behind the new global legislation, including the Basel III accord, is to ensure that banks are able to survive shocks without needing massive taxpayer bail-outs and to prevent a repeat of the events that followed the collapse of Lehman Brothers in autumn 2008, when the syndicated loan market almost ground to a halt.

As the new regulations are not yet set in stone, the final impact on lending is difficult to quantify, but lending will be limited by the requirement that banks hold greater levels of liquid assets going forward, which will increase banks' operational costs and make lending much more expensive. How the banks respond to this challenge will be critical.

"Clearly they [banks] are going to have to offload underperforming businesses, they will optimise returns in their core businesses, they will continue deleveraging, and they will no doubt create balance sheet strength. They will centralise capital allocation, and they will centralise risk approval and they will become smarter at capital allocations", said Michael Kirkwood, chairman of ONDRA Partners and non-executive director of UKFI.

Relatively low activity in Europe's investment-grade loan market this year has been characterised by a continuing wave of cut-price corporate refinancings as highly rated borrowers take advantage of a window of opportunity to refinance their existing debt for up to five years at reasonable prices.

Improved loan market conditions and high levels of bank liquidity have cut borrowing costs for Europe's top companies as banks fight to win mandates and gain access to lucrative ancillary business, but smaller companies have become increasingly cautious in the face of uncertainty.

"The big numbers say that as long as you are towards the top end of medium to large size of business, we're seeing lending growing, debt capital markets are there anyway and other forms of finance; we're seeing growth in that sector," said Angela Knight, chief executive of the British Bankers' Association.

"In the smaller end what we are seeing is very rapid payback of loans and overdrafts and what we're also seeing is a very fast increase in deposits. So it seems to us that businesses that are run by people are doing what people do when it looks uncertain for them - you save your money and you pay off your debt," she added.

OVERLY RELIANT

After the credit crisis and subsequent liquidity squeeze, many borrowers that had become overly reliant on bank financing were forced to seek funding from the capital markets, as affordable, long-term financing became unavailable in the loan market.

"Corporates went to the bond market regardless of the regulation or de-regulation of the banks. They wanted to be less dependent on the banks for credit. They opted for the bond markets to diversify their funding," said Barbara Ridpath, chief executive of the International Centre for Financial Regulation.

Borrowers fear being left high and dry again after the new regulatory frameworks are implemented. This is forcing borrowers to reassess their reliance on bank financing and to seek alternative sources of finance from the bond market, private placements, equity, quasi-equity, commercial paper, and also institutional funds such as the Prudential/M&G UK Companies Financing Fund.

"Many people are wondering whether this is the watershed moment, where Europe begins to look more like the US with a much more diversified funding base," Ridpath added.

Barratt Developments is the latest company to borrow from the Prudential/M&G UK Companies Financing Fund. The UK homebuilder took a 10-year, 100 million pound term loan as part of a 1 billion pounds refinancing package. Barratt, like many other capital-intensive companies, has already diversified its funding through private placements.

As much as banks need to assess which kind of companies they want to do business with in the future, borrowers will also need to find out more about the banks funding them to see which are strategically challenged and might prove unreliable. Banks will actively chase borrowers with large ancillary wallets as they are able to offer the banks side business to offset margins that are below the cost of funds at banks. Borrowers on the other hand will have to determine which banks are acting decisively and getting fit for purpose under the new regulatory regime.

"Bank credit is going to become scarcer and more expensive - it has to be, if you have to have so much more capital you have to charge for it, unless you have so much collateral business that you can subsidise the lending side," Kirkwood said.

"The collateral non-capital intensive businesses you have available to offer are gold dust, spend it wisely. A bond mandate given to a non-credit provider is, arguably, wasted gunpowder," he added.