Leveraged loans: European loan market in late funding frenzy
Leverage up, covenant protection down; up to 15 new CLOs in Europe by year-end.
As Euromoney went to press, private equity sponsor CVC Partners was putting the finishing touches to a €2 billion debt financing for its €3.1 billion purchase of 76% of German energy-metering firm Ista from Charterhouse. The deal exemplifies several themes in European leveraged finance of recent years: it is a secondary buyout, and the senior debt will likely include both loans and high-yield bonds – taking advantage of the stellar growth in capital markets liquidity in recent years. Where it does not look like many of its recent forerunners, however, is in its leverage: 7.25 times ebitda. No matter how good the credit is, that should be cause for concern. The Ista financing, which is being led by Deutsche Bank, is the latest example of the increasingly aggressive terms now being seen in leveraged finance on both sides of the Atlantic. In Europe the situation is being exacerbated by the market distortion caused by many European CLOs reaching the end of their reinvestment periods this summer. Many of these pre-crisis deals have triple-A borrowings and are desperate to do deals almost at any price to stay invested. This will create acute distortion in the market until at least June.
“Older vintage CLOs are keen to invest cash ahead of their close,” says Ian Brown, managing director and head of acquisition finance at Lloyds Bank in London. “That is what is driving the market at the moment but that bid will decline in strength over the course of the summer.”
Until that happens terms in the market are likely to get tested further. Another recent deal, a €350 million seven-year senior secured trade for Charterhouse-owned French catering business Elior, raised eyebrows when it included a portability clause. Such a clause enables the financing structure to survive the takeover of the issuer by another company that assumes the borrowing even if it is an inferior credit. “This is very unusual for a loan deal,” one leveraged finance banker tells Euromoney. “It is the first time I have seen this for a very long time. It has always been sacrosanct that a bank can choose its borrower.” But far from acting as a disincentive, the deal attracted over 300 investors and a book of close to €3 billion in mid-April. The deal was led by Crédit Agricole, HSBC, JPMorgan and Nomura.
If things carry on like this there could be many more examples of borrower-friendly financings in the European market. “The next three to four months will be tricky in Europe,” says David Whiteley, managing director, leveraged loan syndicate at Lloyds Bank in London. “Many CLOs are facing the end of their investment periods and are keen to invest available funds to capture management fees.”
Conditions in Europe are still a far cry from those in the US. According to Dealogic, by April 19 US leveraged lending stood at $313.3 billion year-to-date, the highest such volume since 2007 and up 30% on the same period last year. Over half of these new-issue loans are covenant-lite – even in 2007 only 25% of new loans were cov-lite. Although there has yet to be much cov-lite issuance in Europe there has been a surge in floating-rate note issuance in response to CLO demand.
|Charles Bennett, head of loan sales at Credit Suisse|
“In general, the closest thing to covenant-lite lending in Europe is FRNs,” says Charles Bennett, head of loan sales at Credit Suisse in London. “As mostly senior secured instruments, with a non-call period, [floating rate notes] carry incurrence covenants. Coming at Euribor plus 500 basis points and above, depending on the credit, these can be very attractive to CLOs.” This demand has also led to rampant amend-and-extend activity from corporates eager to take advantage of buyer appetite. Indeed, 47% of all deals tracked by LCD in the first quarter of the year refinanced existing debt, either by amending and extending or by refinancing into the capital market. “The overwhelming interest of the existing cadre of CLOs is to remain invested,” says Bennett. “They are, therefore, keen to negotiate sensible amend-and-extend terms for borrowers, where appropriate.”
Bennett explains that the concern in the market over these vehicles could to some extent be based on a misunderstanding. “CLOs are able to carry on reinvesting at the end of their reinvestment period as long as they meet certain strict criteria – this is not widely understood,” he says. “They may have different documentation for each deal but most are able to roll into amended transactions. The pinch point of maturities for loan extensions in the market is therefore more towards 2018 and 2019, reflecting the legal maturities of the CLO vehicles.”
Many asset managers have also switched from CLOs to managed accounts, so the impact of the former has been reduced: according to Fitch, CLOs are now just one-third of total assets under management of the top-five CLO managers in Europe, compared with two-thirds in 2008. “There is exuberant fund behaviour now,” says Whiteley, “but during the next few months some of the steam will come out of the market as a number of CLOs reach the end of their investment periods – the managed funds are sometimes more cautious than the CLOs as they are under less time pressure to invest,” he says.
Consolidation by firms such as Blackstone GSO, 3i and Pramerica means that there has been a 25% drop in the number of active CLO managers in Europe since 2008. But the new-issue CLO market continues to grow. “Every CLO manager in Europe is being courted by the active investment banks,” says Bennett. “Credit Suisse reopened the market with Cairn, many have already mandated others for a new deal, and we confidently expect around 12 to 15 new CLOs in Europe by the year end.”