Debt: borrowing terms improve as competition intensifies

The marked improvement in the availability and affordability of leveraged finance witnessed in the first half of 2014 led many in the market to fear a return to overly aggressive structures – albeit limited to jumbo deals or very high-quality assets.

One year on, has this started to spread down the market? "Recently, a number of credits that could be perceived as relatively average in terms of quality have managed to reach very high levels of leverage with aggressive pricing," a debt adviser recently told unquote", highlighting the fact that sustained competition among lenders has made it a very good time for GPs indeed.

According to Investec Corporate & Acquisition Finance's Viral Patel: "We have seen a resurgence in the CLO market, which provides captive capital for buyout transactions. As a result, more underwriters are coming to the market with a view to providing products to CLO funds. Furthermore, there is more private debt capital available at the mid-market level and the senior debt market has also been very active."

However, this influx of capital struggled to find a home for some time at the start of the year, notably due to lower levels of refinancing activity following the most recent wave in 2014, when sponsors were opportunistic in taking advantage of favourable terms. On the new-money front, the sluggish start to 2015 in the European buyout market also meant that opportunities to deploy debt capital in high-quality transactions were few and far between.

According to the latest figures compiled by debt advisory firm Marlborough Partners, European leveraged loan volumes totalled €15.9bn in Q2, a €4.5bn drop on the figure recorded in the previous quarter. The slowdown was particularly pronounced in the UK, with a total loan volume of €2.9bn – a third of the activity witnessed over the same period last year.

"European covenants are still pretty relaxed at the moment, but they do feature in the vast majority of deals, unlike the US where close to 90% of large-cap deals are cov-lite."

Romain Cattet, Marlborough Partners

Shrinking covenants
Unsurprisingly, these converging trends have meant that a more relaxed approach to covenants is definitely taking hold. Says Patel: "We are seeing more borrower-friendly terms in market transactions, such as cov-lite or cov-loose appearing in mid-market deals whereas previously these features were limited to jumbo deals."

The popularity of unitranche debt has had a noticeable impact in the mid-market, with banks having to adjust their covenant requirements on the senior side to remain competitive. "At the large-cap level, it is more of a US import but the trend remains the same: increased competition among debt capital providers has led such structures to spread within the market," says Patel.

Romain Cattet, a partner at Marlborough Partners, agrees that terms and conditions for European loans are getting increasingly closer to US ones, but argues that Europe is not yet a proper cov-lite market: "This remains the preserve of a limited number of very high-quality deals – even though cov-lite structures should theoretically be more in demand for complex credits. European covenants are still pretty relaxed at the moment, but they do feature in the vast majority of deals, unlike the US where close to 90% of large-cap deals are cov-lite."

In any case, pricing has followed a similar trajectory. Unitranche is now priced in the region of Libor + 6-7%, depending on the credit, but in most cases lower than it was 12 or 18 months ago. In the bank loan market, Patel highlights that most facilities are also under pressure by 50-150 basis points.

High-yield, however, has not been as fruitful for sponsors looking to leverage new deals or refinance existing portfolio companies. "High-yield has not been particularly popular so far this year, which is not surprising given the general anticipation of rising rates leading to less liquidity flowing into this market," says Cattet. "Besides, the favourable conditions on the loans market, with terms and conditions at the upper end of the market being very close to what high-yield can offer, have also had an impact: there haven't been that many issuances, and those that went through were priced at a fairly high level."

"There has definitely been some leverage creep, between half to a full turn of EBITDA."

Viral Patel, Investec

Nevertheless, the sheer amount of options available to sponsors on the bank and alternative-lending fronts means that structures remain fairly aggressive compared to post-crisis standards, and can in some cases be seen as a return to trends last spotted in the mid-2000s. Says Patel: "There has definitely been some leverage creep, between half to a full turn of EBITDA. Some advisers are also trying to raise second-lien tranches on deals. Second lien has been out of favour for some time now – sponsors are paying higher prices on average and tend to hold onto some equity to grow businesses through bolt-on acquisitions, so on the way in they tend to put in more aggressive and flexible structures."

Recent jumbo deals have indeed featured significant amounts of leverage. The Linxens deal, for instance, is believed to have featured debt worth nearly €1bn (including a second-lien facility). According to a market participant, this would equate to around 6.7x the company's EBITDA. When Astorg bought the company in 2011 for around €600m, the leverage ratio stood closer to the 4.5x mark, the same source adds.

Steady on
From looser covenants to tighter pricing, all these trends can be seen as a continuation of the already very favourable landscape that took hold in 2014. With more large, syndicated transactions coming to market in recent weeks, and the mid-market segment still looking set for lower volumes as seen in the first half, there is little scope for things to change dramatically as the market emerges from the summer lull.

The Greek crisis is arguably the one development that could have negatively impacted the debt market towards the end of Q2, but even then, the consensus is that debt providers mainly took the turbulence in their stride. "A lot of deals went through syndication successfully in the past few weeks – including very large transactions such as Verallia or Linxens – so the impact really hasn't been felt that much," Cattet says. "Processes may have been delayed slightly at the beginning of July when the crisis hit its peak, but this didn't prevent activity from going back to normal shortly after."

Patel agrees that with the Greek discussions being so prolonged, the markets largely kept to business as usual, although the situation did create unwanted uncertainty at the larger end of the spectrum: "On the surface, we haven't really heard of deals being put on ice in the mid-market because of the Greek bailout. This has probably impacted the larger buyout markets, where underwriters go on risk with their balance sheet and there is a need to quickly find willing participants to take up the debt without flexing the deal too much amid market uncertainty caused by events such as Greece."

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