LONDON, May 11 (Reuters) - The prospect of a long awaited string of new underwrites is unlikely to alleviate the pressure on lenders’ earnings from European leveraged loans as sponsors continue to drive down fees and pricing protection.
Bankers have experienced a real squeeze on fees since the last quarter of 2016, competing to work on a flood of best effort repricings and add-ons for a small flat fee and in some cases for free, in a bid to keep people busy, earn league table credit and position themselves well for the chunkier, more profitable event-driven underwrites.
However, now those new underwrites are on the table, bankers have been frustrated to find that the compression of fees has migrated to buyout financings, as sponsors strive for best terms.
“It is brutal out there. We are having to run faster and jump higher to make the same amount of money as in the past,” a head of DCM said.
Bankers have put up more resistance to an erosion of underwriting fees and the reduction has been slower than the cuts seen on best efforts deals. However, bankers are still conceding to taking on more risk for a lower payout, as they compete to win deals.
“When underwrites come, fees are not usually something people give up easily as there are mouths to feed. It doesn’t mean there isn’t pressure to do so but it is not the same pressure as seen on best efforts. If you give up on this, you might as well shut up shop,” a head of leveraged capital markets said.
Sponsors are asking banks to accept underwriting fees as low as 1.25%-1.5%, a drop on the standard 1.75% payout seen for the past 12 months or so. Before that, underwriting fees could pay as much as 2%-2.25%.
“We were itching to underwrite something but we lost it as the sponsor was pushing a 1.5% fee for a primary LBO and a really risky underwrite,” a leveraged loan banker said.
Fees are the one thing left that sponsors can get banks to compete on after documentation has weakened across the board in Europe, with the wide acceptance of covenant-lite and other high-yield bond style features.
The European leveraged loan market has adopted much of the weak documentation from the US, but has not kept the same discipline as the smaller US banking community when it comes to standardised fees.
“We get all the bad from the US, like weakening docs and lower pricing and none of the upside like standard, set in stone fees,” a head of leveraged finance said.
It is a further hit to banks, which have already seen a deep cut in underwriting fees, having lost around 2%-3% on underwriting and syndicating subordinated paper, such as second-lien loans, as sponsors opt to pre-place them with cash-rich funds.
“The disintermediation of bankers on subordinated debt last year took out a large chunk of fees on what was the more profitable work. Now there is pressure on underwriting fees for senior paper and banks are accepting it as they can’t compete on docs or anything as they are all so loose as a standard now,” the head of leveraged finance said.
In addition, to the overall cutback in fees, the portion of fees a bank receives on any individual deal is also in decline, as sponsors appoint a larger line up of bookrunners and MLAs to each mandate.
“There are larger and larger bank groups on underwrites as sponsors need to do favours for more and more banks after they’ve done repricings and refinancings for practically free. We need to be making 50% of a deal, not 17.5%-20%. Banks are getting a smaller piece of an ever crappy pie,” the head of leveraged finance said.
Most banks sought to win a spot on a €3.175bn jumbo buyout financing for German drugmaker Stada. The benefits of such a large deal are expected to be diluted once the large fee is split between the eight or nine banks that were mandated on it.
As sponsors try to keep banks happy, even smaller €400m-€500m deals are mandating four to five banks.
“Underwritings need a lot of work -- human resources, capital markets, origination etc -- suddenly the deals are not so compelling. If you only have €100m of a large deal, then a 1.25%-1.5% fee means you’re making maybe €1.25m-€1.5m. It is a lot of work for not a huge amount compared to what it would have been before a load of banks were appointed,” the head of DCM said.
Sponsors are also putting pressure on pricing flex, reducing the protection that underwriting banks have when a deal goes wrong.
Sponsors are now asking banks to agree to around 100bp of flex, compared to around 125bp earlier this year and 150bp last year. One senior banker said a sponsor was pushing the bank to accept flex as low as 75bp.
Europe’s leveraged loan market is extremely hot, with far more demand than supply. However, there has been some pushback from investors to very aggressive terms and banks will be wary of agreeing to more restrictive flex provisions.
“Flex isn’t a problem when everything is flying out of the door but it only takes one deal to go wrong,” a capital markets head said.
With so much money to put to work in a low yield environment, banks are having to stay competitive. While some banks may be able to hold out on some deals and say no to tighter fees and reduced flex, many will be willing to do them.
“It’s getting harder and more and more deals make less economic sense but ultimately, you don’t get paid for not doing deals,” a second capital markets head said.
Editing by Christopher Mangham
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