June 9, 2020 / 2:04 PM / a month ago

Banks balance appetite for high-quality loans while managing risk

NEW YORK, June 9 (LPC) - As immediate requests for liquidity due to the Covid-19 crisis start to flatten, banks, lending to highly rated companies, are looking ahead at how they can keep up business momentum and simultaneously protect themselves from potentially higher costs of funding and deteriorating credit risk.

The forward-looking approach is a delicate balancing act of developing new business and addressing client needs while making sure to mitigate the effects of another economic downturn if the pandemic has a second wave.

The bank market has been relieved of some pressure on lending capacity in the last month. Several investment grade companies are paying down some of their pandemic-related liquidity facilities with proceeds from corporate bond issuances, such as Southwest Airlines and PayPal, which both issued bonds last month and committed part of the proceeds to paying down credit facilities.

Still, lenders are aware that despite pay downs, outstanding loans still exceed pre-pandemic levels. Despite their appetite for new-money deals, banks are grappling with how costly it is to hold large funded loans on their balance sheets.

“We’re still funded much higher than we were,” said a senior banker. In March and April, there was a deluge of drawdowns in response to the pandemic’s economic disruption. Then companies asked for incremental short-term facilities and amendments to existing agreements to get them through the crisis.

Regardless of the uptick in short-term liquidity requests and draw downs, investment grade lender capacity is robust amid a thinner pipeline of event driven financings. Through April this year, investment grade loan volume is down 5% year on year.

“I think the balancing factor for the market is that there isn’t much merger and acquisition financing. In a normal market, you’d have some bridge financing, so from a bank capacity standpoint everything that has come to market has gotten absorbed fine,” the banker said.

SHOWING RESTRAINT

While capacity has remained in place, lender vigilance around credit risk and portfolio quality is an ongoing priority.

“Many banks were supportive during the initial pandemic wave, stepping in to provide incremental liquidity and to help get companies through the next few months,” said Dan Chapman, managing director of loan syndicate and sales at US Bancorp, adding that “lenders remain focused on providing credit to key relationships.”

In May, companies like Fortune Brands, HP Inc, PepsiCo, General Motors Company (GM), and others signed 364-day revolving credit agreements, as previously reported by Refinitiv LPC. Even companies that had multi-year agreements decided to refinance with short-term loans rather than five-year loans. In April, GM refinanced approximately US$6bn in short-term loans, including a US$1.95bn, 364-day loan and a US$4bn, three-year loan. A US$10.5bn, five-year facility was not refinanced, as previously reported by Refinitiv LPC.

“Today, while many borrowers are busy refinancing revolver draws in the bond market, I-grade lenders are reluctant to go beyond 364 days due to Covid-19 uncertainties,” Chapman said.

In April, the market for five-year tenors dropped for the first time since the Great Financial Recession (2008), making up a 6% market share, according to data from Refinitiv LPC.

Chapman believes the return to longer tenors will be gradual, and pricing will remain elevated.

“I’m hearing that three years is the new five years, and even three-year deals are rare. The market is not ready to go back to the way it was yet,” he said.

According to a Fitch Ratings report from June 1, the risk for American corporate issuers to become “fallen angels” or to lose their investment grade rating, remains high. So far, downgraded debt across more than two dozen fallen angel issuers has neared US$200bn, according to the report. Since the pandemic began, another 29 issuers have been downgraded to BBB-, just one notch above junk territory.

A second wave of downgrades due to deteriorating economic conditions could increase sub-investment grade downgraded debt to US$400bn, Fitch says.

Tighter terms including minimum liquidity requirements for borrowers and higher pricing are being implemented as a safeguard during this uncertain time. Only time will tell if that becomes the new reality for the investment grade market.

“Banks are going to continue to be cautious and address the needs of their clients,” said the senior banker. “Things have improved, but we are not out of the woods by any means.” (Reporting by Daniela Guzman; Editing by Michelle Sierra and Kristen Haunss)

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