While the UK has been among the hardest hit bank lending markets, in other parts of Europe banks are more willing and able to lend on local deals. But a return to more normal lending conditions won’t happen overnight and buyout houses may find themselves behind corporate or residential mortgages when it comes to obtaining loans.
Karsten Langer, a partner at Riverside Europe Partners, says that in Continental Europe banks are doing deals closer to home, as everyone has become more cautious, adding: “The banks want to focus on financing businesses that they really understand, as they’re trying to bring their risk profiles right down.”
He expects deal structures to change, with a continuing increase in the amount of equity that deal sponsors put in. Equity investment increased in the past year, according to the EVCA, and could continue growing to above 50%, believes Langer.
“I’m also expecting a return to deal structures that require more vendor finance, earn-outs and so on, and less reliance on third party debt, at least until the lending market returns to normality,” he says.
The main European governments have pumped huge sums of money into their financial markets, in an attempt to limit the damage. On October 13 France’s President Nicolas Sarkozy announced that members of the euro had agreed a co-ordinated response to the banking crisis.
France announced it that would guarantee interbank lending worth €320bn and pump nearly €40bn into its banks. Germany announced more than €400bn in loan guarantees and €80bn for its banks. The Spanish government said it would guarantee as much as €100bn in bank debt and was willing to inject new capital into the banks, if required.
Italy also announced a plan to guarantee bank debt, although the government said it did not expect banks to seek funds from it in the short term. Austria announced that it would provide up to €85bn in guarantees and €15bn in fresh capital for its banks, while Portugal also announced a package of support measures.
Germany’s Chancellor Angela Merkel said the rescue package announced by European governments represented “a new financial market charter, but it could only be worthy of the name if it is followed by a second element, namely a change in international rules”.
Jonathan Trower, head of the European debt advisory team at Close Brothers Corporate Finance, says it is still too early to differentiate between how the debt markets of different European countries will perform.
But he adds that what does seem clear is that it is currently easier to get debt finance in local markets rather than international ones, saying: “If you have a modest-sized deal, it’s easier to get finance from a club of lenders in Manchester or Frankfurt than in London.”
Opinions differ on to how long the current credit squeeze will continue. Ian Hazelton, CEO of Babson Capital Europe, says that the outcome of the various banking support packages in Continental Europe is still unclear. But he adds that finance for LBOs is not on the radar of the banks right now.
“I think this will be a long haul,” he says: “Primary issuance has virtually ground to a halt and the real problem is that market prices are such that it is quite tough to make a deal look attractive.”
The market is in a hiatus, says Hazelton, but whether that lasts two months or two years is not yet clear. “The financial woes are beginning to feed through to the real economy but nobody knows quite how bad things will get,” he says.
While it is hard to make concrete predictions about the development of the debt markets in different countries, there are some indicators among the larger economies.
In the UK there is still uncertainty about which banks are still active in the lending market at present, says Adrian Lurie, an investment director at mezzanine provider Indigo Capital. “In Germany, for example, leverage multiples have remained relatively full at least up until this summer,” he says. “In contrast, in France lending multiples reduced fairly rapidly.”
In Italy, the headlines have been dominated by some of Prime Minister Silvio Berlusconi’s populist declarations, such as threatening to change the rules in order to prevent foreign funds from acquiring Italian quoted companies.
Despite this kind of rhetoric, there will probably be some kind of co-ordinated response across Europe to regulation, says Tim Green, managing partner at GMT Communications Partners, an investor in the media and communications industry.
Green says: “I think there will be some form of co-ordinated regulation of the financial system, probably carried out by separate bodies in a co-ordinated way, or possibly from a central body that could cover the global system.”
Lurie points out that it has been increasingly challenging since the end of last year to raise senior debt, at least at historic levels, and that mezzanine providers have benefited from this.
“As the banks have become more cautious on lending we’ve been getting more calls and, in the last few weeks, it’s become less clear which of the banks have appetite for funding buyouts at all,” he says.
Lurie adds that at the same time as the banks are becoming increasingly cautious, many independent mezzanine providers are eager to invest.
“If you want to get a deal off the ground and need committed capital, an independent mezzanine fund is potentially a solution,” he says. “Mezzanine providers have moved higher up the list of people to ring when you’re trying to get a deal done.”
At present, says Lurie, the number of banks willing to write new business has undoubtedly shrunk, adding: “Those banks that are in the market for new deals have increased pricing and tightened terms substantially, and there has also been a general increase in terms applicable to mezzanine financing.”
The current credit crisis is not just an issue for buyouts in Continental Europe, but also for private equity houses’ portfolio companies. Green at GMT Communications says the message for the vast majority of private equity houses is to make sure their own companies have sound balance sheets and no concern over cashflows.
“It’s become increasingly clear, across Europe, that we’re going into recession and it’s not a good time to be forced to restructure finances,” he says.
But Green adds that, ultimately, the banks will have to get back into doing what they need to do, which is lending money to make returns for shareholders, saying: “The debt market will come back but the banks will take a tougher view on pricing.”
PE houses that focus on a growth strategy will be in a better position than those relying more on financial restructuring and engineering, he says.
“The latter will find it hard because in the brave new world there will be more bank regulation and possible restrictions on leverage, as the governments haven’t made these bailouts in order to see the banks lending ‘recklessly’ again,” Green says.
It is clear that there will be much less finance for private equity in Continental Europe from the investment banks, not least because there are so few of them remaining but also because the deal-driven banks were financed by the wholesale markets, which are much harder to access due to the increase in Libor and higher risk premiums.
That means that commercial banks will be asked to take up more of that role.
Karsten Langer of Riverside Europe says: “There will be more finance sought from banks that rely on deposits as a core source of capital to make loans and these banks tend to be more relationship-driven rather than deal-driven.”
While there has been, understandably, intense focus on the crisis in the financial system in recent weeks, there are also grounds to be positive, according to some advisers.
Close Brothers’ Jonathan Trower says it is easy right now to think that the markets are completely closed and will remain that way for a long time. “But the loan market has always been pretty resilient,” he says, acknowledging that there are issues that need to be resolved. “The markets will reopen, perhaps in a slightly different way, and I think it will be a matter of weeks rather than months.”
What form will be that reopening take? According to Trower, it will be a continuation of the trend of the past 18 months, in other words lower leverage, higher pricing and more conservative structures that contain more amortisation.
While optimistic about the reopening of markets, Trower warns that the climate for some private equity deals will have shifted. There is a limit on how far the lenders can go on pricing, he says, but not on how low the leverage can be or how high the equity contributions.
“What that means is that a lot of deals that made sense from a private equity perspective in the past might not do so in the future,” says Trower.
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