Aggressive debt structures filter down from large- to mid-market

Some of the notable trends highlighted by the quarterly publication include higher leverage, typically in the region of 5x as opposed to c4.3x last year, as well as a greater proportion of cov-loose structures. The pricing of senior debt structures also appears to be mirroring that seen for larger loans, with margins of around 4.5% on average. Maturities are also increasing while equity cushions are now closer to 40% as opposed to the 50/50 split that was prevalent just a few months ago, according to Marlborough.

Furthermore, non-amortising debt is gaining in popularity, with term-B-only structures increasingly common in the mid-market. This is down to a large extent to a move by senior lenders to counter the popularity of unitranche solutions, which partly stems from the flexibility afforded to the business when it comes to servicing the debt.

"The institutional market is also coming down in size," adds Marlborough partner David Parker. "So whereas 18 months ago, €250m was the point at which one could access the institutional market, it is now moving closer to €150m. Combined with the pressure from alternative lenders, the bank market has had to adapt to remain competitive. Dropping amortisation is one of the easiest ways to do that, provided the bank is comfortable that it is lending to a strong credit."

"A lot of the characteristics of the US lending market have permeated into Europe, including cov-lite and second-lien" - David Parker, Marlborough Partners

Although cov-loose structures are becoming increasingly common further down the value chain, Parker believes there is only so much convergence we will see between the large- and mid-market, though. "For instance we are not expecting to see cov-lite structures proliferating in the mid-market anytime soon," he explains. "Institutions don't necessarily need covenant protection at the larger end of the spectrum since they can sell out of a position if needed. You just don't have that option given the illiquidity of the mid-market."

At the larger end of the market however, cov-lite structures are definitely gaining ground. According to the report, 14% of all European outstanding loans lacked maintenance covenants as of Q2 - a significant increase on the 6% recorded at the end of last year. The market is increasingly influenced by US structures: there, cov-lite issuance accounted for 62% of all new institutional issues in H1 2014.

Second-lien on the rise
It is not just cov-lite structures that paint a picture of a market increasingly influenced by the US. Thirteen second lien facilities have been issued in Europe so far this year, when there were none in 2013, according to Marlborough's report. Even though the volume of second-lien issuance is almost negligible compared to total institutional loan volume, the contrast with the previous five years is striking.

"What's really been driving this is the US market, which has been a ‘first plus second-lien' market for a long time," notes Parker. "Many European borrowers started tapping into the US market around 12-18 months ago so European lenders have inevitably had to compete. A lot of the characteristics of the US lending market have permeated into Europe, including cov-lite and second-lien."

Although pricier, the appeal of second-lien for borrowers stems in part from the cheap call protection when compared to bonds. Some borrowers also like the fact that second-lien is a loan, bypassing the cost and inconvenience of running a bond issuance, especially if a first-lien loan is already being marketed.

Full steam ahead
The combination of these trends has unsurprisingly resulted in a particularly buoyant leverage market across the board in Q2, with total private equity loan volume in Europe reaching €22.3bn. The uptick was also noticeable in the UK, with the €8.3bn of total loan volume there dwarfing the €1.6bn witnessed in Q1 and comfortably exceeding the €5.3bn issued over the same period last year.

Europe-wide, average senior and total leverage multiples reached 4.8x and 5x respectively, compared with 4x and 4.7x for the whole of 2013. Average equity contributions stood at 43.6% but equity cushions in secondary buyouts reached their lowest level since 2007 at an average of 42%, according to Marlborough.

Drawing comparisons with 2007 inevitably begs the question of whether the market can safely cope with increasingly large amounts of leverage deployed in increasingly aggressive structures. "It is only something to be worried about if interest rates increase significantly," says Parker. "That said, a rise wouldn't affect borrowers straight away given bonds are fixed rate and in most loan deals borrowers hedge out the floating rate and convert these deals to fixed for at least three years, mitigating the impact in the medium term."

Similarly, Parker doesn't expect other market factors to significantly alter the state of play for the rest of 2014: "At the moment, we are not seeing any market reason that could lead to a massive pushback. Market participants were particularly wary of some form of indigestion kicking in given the number of deals in the market, but for the time being these deals are still being done. The fact that we are hitting record highs on a number of criteria doesn't automatically mean that things won't keep moving in the same direction in the coming months."

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