A return to reality

The first round of commitments backing the £11bn funding of Alliance Boots is due at the end of this week and the message back from the bankers is not good. ‘Highly challenging’ to ‘possibly undersubscribed’ is the pessimistic expectation.

The follows weeks of volatility in the European leveraged finance market where secondary market declines have generated some real pain for investors. The market remains volatile, with the benchmark iTraxx Crossover swinging 70bp wider over just two days last week to a record 312bp. That makes protecting high-yield bonds about 60% more expensive than five weeks earlier. As bookrunners and arrangers will be acutely aware, the balance of power between lenders and borrowers has undoubtedly moved back in favour of the former – albeit from being skewed hugely in the other direction.

Already we have seen the syndication backing the circa €1bn acquisition of Dutch retailer Maxeda by KKR, Cinven and Permira pulled. The syndication of the loan backing the €1.4bn acquisition of Talkline by Permira sponsored Debitel was also delayed. The Debitel deal was planned as a cov lite issues and will probably be altered before returning to the market. And last week, Spinger Science and Business the publishing business owned by Candover and Cinven pulled an aggressive planned refinancing.

So it seems the surge of European toggle-to-PIK, covenant-lite and excessively leveraged deals now look ever more like top of the market trades and investors will be slow to give so much ground again. Through the first half of the year sponsors were able to push for the most favourable structures, pricing and leverage to support buyout deals as they siphoned excess liquidity into a limited pipeline of deals.

Lenders bowed to pressure to back ever less favourable deals at least in part because of a perception that they were insulated by the security offered by a secondary market where most loan deals traded above par. That situation has been reversed and the effect, though bruising, has been to return an air of reality to a market that had become increasingly divorced from its groundings. The biggest question now is how long that new sense of reality will last. Certainly, a host of leveraged finance deals in the pipeline are now impossible – at least in their current form – and the summer is certainly a write-off. But conditions might well have stabilised by the autumn. Default rates are still extraordinarily low, the real cost of borrowing remains relatively cheap and corporate earnings are likely to remain robust. Indeed, the upward interest rate pressure is a reflection of strength across the European economy. Perhaps most importantly, bank and institutional investors are still sitting on huge amounts of money and will not be able to stay out of the markets for long. The pressures that forced them to back deals that they – and everyone else – knew had lost the connection between risk and reward have not gone away. In the absence of an external shock, the European leveraged finance market is likely to be back and swinging soon enough.