A Year of two halves

History will remember 2007 as a year characterised by two polar halves, with the first six months reflecting buoyant European credit and equity markets fuelled by unprecedented private equity activity. But while holidaying bankers celebrated, the global tide turned leaving many high and dry in the second half of the year. The impact of investing in US sub-prime mortgage-backed assets, including the exotic products such as 'ninja' loans (no income, no jobs or assets) resulted in significant write downs. The resultant haemorrhaging of confidence and liquidity in the credit markets led to them closing for business in August with banks unable to syndicate the EUR75-80bn of LBO debt even at discounted levels.

Margin spreads on leveraged loans widened as investors began demanding compensation for their risk, with pricing reverting to 2004/05 levels. In recent months, little movement has been seen in the jumbo deals although mid-market transactions financed by club debt packages have progressed. Underwriting banks continue to hold a large volume of debt that they cannot syndicate to other potential participant banks and funds. This has in a large part been due to the high-leverage, cov-lite structures and thin pricing that reflected the significant competition for assets earlier in the year.

Institutional liquidity has in the main evaporated and buyouts must now be structured to appeal to bank buyers. Arrangers are nervous about launching deals for fear of failure or because it will be too expensive - until this confidence reverts, the market will continue to face stagnation. Improvements in the market that occurred in late Q3 and early Q4 were reversed as banks started to write off significant sub-prime debts and negative sentiment returned.

Mid-market deals are being funded, although sponsors need to focus on club deals and joint mandates, rather than on the traditional fierce competition between arrangers. Several leveraged loans including the LBOs of One Austria and PHS Group have been restructured with decreased leverage and more favourable pricing to the arrangers. The financing backing Bain Capital's acquisition of UK catering company Brakes has not yet been launched, but has been restructured to include a new junior PIK tranche. The disappearance of CLO and CDO warehouses will make larger deals difficult to fund as banks struggle to syndicate underwritten deals. Hedge funds in particular will be interested in the surplus of paper in the market because they will be prepared to take the risk and return of higher leverage deals.

As the operating environment for European companies has become increasingly tough, it has placed further pressure on buyouts completed earlier in the year that supported significant debt structures. Underperforming companies are likely to face difficult discussions with banks regarding covenant resets or capital repayments. In order to access further liquidity, companies will require a supportive equity sponsor or face aggressive pricing from special situation debt providers. Businesses with loans that were structured with exotic clauses or no covenants are at risk of only taking action when they run out of cash, by which time the options available are limited.

Today's illiquid market conditions are likely to dominate the loan markets for the foreseeable future. The weakening of the secondary market has left large underwritten loans on banks' balance sheets, with a significant pipeline still to be syndicated. Recent revisions of pricing and restructuring to lower leverage have led to the relaunching of several loans. Exotic debt structures incorporating elements such as cov-lite and second-lien instruments are now history, with the mezzanine market making a strong resurgence. Given the events of the past few months it is worth bearing in mind that the FTSE 100 is currently where it began 2007. Maybe we should all bear in mind that there will always be opportunity in uncertainty and thus the maxim bringing us in to 2008 must surely be 'Fortis fortuna adiuvat!'.

Daniel Morland is managing director of the debt advisory group at Close Brothers Corporate Finance.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Industry
• UK / Ireland
• DACH
• Nordics
• France
• Southern Europe
• Benelux
• CEE