Risk, rights and rewards are being rebalanced toward borrowers and away from lenders in the European LBO loan market because of a wide range of seemingly small changes to loan agreements. Unless and until the supply demand mechanics of the European LBO market significantly tighten, further weakening of lenders positions is likely, perhaps, trending more towards the borrower-friendly bullet loans common in the US.
In the context of rising credit risk and falling credit quality, Standard & Poor’s has reviewed documentation from a range of European issuers. It seems that there have been negative developments in a number of areas including loan pricing, lender voting rights, financial covenants, cash sweeps, pricing and repayments. “With heightened credit risk, investors ought to be scrutinizing loan agreements more closely to ensure that their expectations for the credit are not undermined by loose documentation,” said Marc Lewis, Standard & Poor’s recovery analysts.
Financial sponsors are now able to borrow more and repay less, with fewer restrictions and for lower cost than has historically been the case.
Although other areas of European LBO loan agreements have remained relatively untouched it is not inconceivable that further liberal use of risk-based leverage rachets – the main instruments of market rebalancing – could further erode lender’s rights in areas, such as: reporting requirements, default timing and interest rates, cross-default thresholds and clauses relating to full prepayment on change of control.