Gloves come off in the fight for leveraged finance

Louise Bowman
Published on:

Fed gets tough with Credit Suisse; cov-lite loans on the rise in US and Europe

There are growing signs that the US regulators’ patience with bank lending practices in the sub-investment grade market is wearing thin. As Euromoney has reported, guidance from the Office of the Comptroller of the Currency (OCC), the Federal Reserve and the FDIC that banks should not write weakly covenanted loans to corporates that would increase the latter’s leverage to more than six times ebitda has been largely ignored by many banks.

According to S&P, LCD total debt levels for US LBOs have hit 6.62 times in the third quarter of 2014 – higher than the 6.23 times they were in 2007. And we all know how that panned out.

In a sign that the gloves are now coming off, the Federal Reserve wrote a 'Matters requiring immediate attention’ letter to Credit Suisse over the summer, demanding that it rein in lending that does not comply with the guidelines.

The Swiss bank is seen as among the most aggressive lenders in the leveraged finance market and has lent to a series of transactions that do not meet the requirements.

Matters requiring attention

The letter is also a sign that the Fed – which regulates foreign banks in the US – is reacting to criticism from domestic lenders that it has not applied the  lending guidelines as stringently as the OCC has. Other non-US banks have received less serious 'Matters requiring attention’ letters from the Fed. 

As the US regulators get tougher on leveraged lending  there are signs that European corporates are also taking on board the strong message being sent from across the Atlantic – unfortunately not on leverage though, but on weaker loan documentation. While leverage in Europe  has yet to reach the heights regained by the US leveraged finance market, there has been a sharp increase in the volume of covenant-lite lending in the region.

By July this year cov-lite issuance in Europe had hit €14.6 billion according to S&P LCD. In 2007, just before the market crash, cov-lite lending for the entire year in Europe was only €8.1 billion. Indeed, by July 2014 39% of institutional loans issued in Europe year to date had no maintenance covenants – up from 21% in 2013 and 7% in 2007.

So far, so predictable. Where the US leads, Europe usually follows. Between 15% and 17% of outstanding leveraged loan inventory in Europe is now cov-lite (at the end of 2013 it was just 6%) while in the US it is more like 50%. Nearly 40% of new loans in Europe are cov-lite (These figures will have been heavily influenced by the €3.7 billion of cov-lite loans that formed part of Numericable’s acquisition of SFR) – in the US new issuance is now nearly 70% cov lite – indeed, since 2007, the percentage of outstanding leveraged loans containing three or more maintenance covenants has decreased from 43% to 12%.

"Cov-lite issuance is growing in Europe and it will be a material part of the calendar," says the head of DCM at a large US bank in London. "Such loans are fine for larger LBOs where there is liquidity, but are not suitable for smaller deals."

Thierry de Vergnes

The challenge in Europe is that a lot of deals are small. And if investors are going to hold small, illiquid loans they might be better off holding amortising, covenanted term loan As rather than bullet cov-lite term loan Bs. In the US,  the loan market is very similar to the bond market in that there is free tradability of debt, while in Europe cov-lite loan investors need to look very carefully at restrictions on the tradability of these instruments.

"Loan market characteristics are moving towards bond market characteristics," says Thierry de Vergnes, managing director and head of debt fund management at Lyxor Asset Management in London. "If we continue to see this convergence, it will be super-concerning. If you have a liquid market for loans, then cov-lite isn’t a problem. In Europe the loan market is not liquid for all loans. Therefore you have to select cov-lite loans which are large enough to be sufficiently liquid."


In July this year German pharmaceutical company Aenova Group refinanced existing senior debt incurred when it was acquired by BC Partners from Bridgepoint in August 2012 via a €470 million six-year cov-lite term loan B arranged by Deutsche Bank and JPMorgan. The cov-lite refinancing also included a £30 million six-year term loan B. The refinancing was used to pay a dividend to BC Partners and follows on from their timely exit from UK mobile phone distributor Phones 4U last September.

Also in July Belgium-based consumer foods business Continental Foods, which was purchased by CVC Capital Partners in October 2013, refinanced €320 million of senior acquisition debt with a €425 million cov-lite loan to finance a €160 million dividend to CVC.