Midsize European companies that can’t obtain credit from ultracautious banks are turning to an old source of financing: loans from pension funds and insurance companies arranged through fund managers. Harking back to the heyday of private placements in the late 1970s and 1980s, this incipient trend offers a potentially attractive opportunity to institutional investors yearning for yield. Such loans can return as much as 4 to 6 percentage points above LIBOR, plus an upside tied to any appreciation in the underlying companies’ stock.
At least one money manager has sought to capitalize on the phenomenon by setting up a special-purpose fund. In late 2009, London-based retail and institutional fund manager M&G Investments launched the UK Companies Financing Fund and persuaded pension funds and insurers to seed it with $1.6 billion. M&G’s parent, insurance company Prudential, put up £500 million ($780 million). Another investor: the London Pensions Fund Authority.
“The banks are having to shrink their balance sheets,” says Bernard Abrahamsen, head of institutional sales and distribution at M&G. “Their ability to lend, particularly to small- and midcap companies, is therefore constrained. There are plenty of very good small- and midcap companies that will have a tough time refinancing.”
The fund made its first investment in June, extending a £100 million ten-year loan to British trucking company Stobart Group to repay bank debt and finance development of London Southend Airport, which Stobart had bought in 2008. Stobart officials say they like the flexible structure — which will be used to finance other unspecified capital projects — and the security of the loan. M&G’s fund intends to provide five- to ten-year credits and contends that its loans are on equal footing with bank debt in case of default.
Banks’ reluctance to lend is also reflected in the vast expansion of European corporate bond markets over the past couple of years. Companies that have historically borrowed through banks, such as Virgin Media and Thomas Cook Group, have come to the corporate market.
According to Dealogic, European investment-grade companies issued $582 billion of debt in 2009 and a further $172 billion year-to-date through August 19. The volume in the high-yield market during the same period was $33 billion, almost equal to the whole of 2009 — already a record year, with deal flow of $35 billion.
More-recent data from Morgan Stanley indicates that from September 2009 through this May, European companies’ balance-sheet ratio of bank loans to bonds shifted dramatically, from 40-60 to 30-70.
The realignment may be lasting. “This is a supply-and-demand phenomenon,” says Michael Dolan, senior credit analyst at Fidelity Investments in London. When banks withdrew credit facilities, corporations began to fundamentally reassess their loan books, he explains.
Fidelity and other institutional investors now believe that a long-term trend is under way. “The U.S. has always had broad capital markets, but European companies have tended to seek out bank lending,” notes Johan Jooste, a portfolio strategist at Merrill Lynch Wealth Management. “The credit crunch has forced European companies to shift.” As the trend creeps down the credit curve, adds Jooste, it is creating new opportunities in the high-yield market.
European banks are not likely to resume lending to small and midsize companies with the old gusto when their current sovereign debt travails ease. Higher capital requirements coming under the new Basel III accord will make such loans less profitable.
Robert Gardner, co-CEO of U.K. pension fund consulting firm Redington, points out that banks traditionally funded long-term loans with short-term funds, and that has “proved a weak option.” Where will the capital for small and midsize companies come from instead? “Pension funds and insurance funds are the natural option.”
