Given the increasingly fast convergence between markets on both sides of the Atlantic, it came as no surprise when
With speculation that a European record-breaking
“The structure can take the form of anything from a traditional bank loan document with no maintenance covenants to a bond-like indenture in loan form,” said Matt Naber, managing director and head of European loan syndicate at Morgan Stanley.
What has emerged on the one European deal syndicated and the one mandated so far is a very simple – brutally so, even – form.
“On the World Directories and Trader Media deals covenant-light has meant the deals have covenants based on the incurrence of new debt or payments outside of the bank’s security net – that means the credit is tested when an event like a refinancing or an acquisition triggers the test, rather than on a regular quarterly basis,” said Neil Thomson from Apax Partners. “Classic leveraged loan maintenance covenants test interest cover, leverage, cashflow and capex on a quarterly basis. Removing these increases the borrower’s flexibility and therefore control.”
In practice, what this does is tip the balance of information flow and control even more firmly in favour of the sponsor and out of the hands of investors.
“It is clearly in the borrowers’ interest to have the best covenant arrangements. In this instance, that does mean lenders and borrowers are directly opposed,” said Apax’s Thomson. “Borrowers want lighter covenant and lenders want heavier.”
Lenders share that perception, albeit more ruefully. “We would rather not do this but from an investor perspective we have to follow the market. Long only funds need to be invested,” said one leading institutional investor.
While liquidity remains high, and investors are forced to chase a limited supply of loan paper, there is no reason to expect any real pushback in Europe, at least where the credits involved are highly regarded.
Thomson is keen to point out how unusual the two deals so far are, downplaying the extent to which they are precedent deals. “Both World Directories and Trader Media are unusual credits and particularly suitable candidates for this,” he says. “World Directories is already a high-yield name, operates in a well understood business and is not highly leveraged based on comparable transactions. Trader Media is also not leveraged to its maximum capacity.”
But investors are more resigned to the spread of the practice at least in the short to medium term. “There is nervousness in Europe about the trend. Liquidity has meant dilution of returns and protection for investors. At the moment, it is a borrowers market, but that could change,” said Adam Hewson, senior managing director with GE Commercial Finance.
When it does change, that pushback is likely to be swift, if only because a change in investor supplication is likely to be prompted by a pick-up in defaults rates.
Defaults remains at historically low levels but there is fear among investors who are now being presented with deals where, according to one: “There is now the real prospect that the first time we get to sit around the table with a distressed company is only after it defaults.”
For lenders, that is a daunting prospect, particularly when the US deals that pioneered the trend are more likely to provide Chapter 11-style lender protections not necessarily available in Europe.
While the trend is seen as a US import, the more pertinent precedents are in the European high-yield space. The deals that we are now seeing in European loans follow a precedent established in the high-yield market with deals such as NXP. The convergence is not just between the US and European investor base but also between the high-yield and leveraged loan investor bases.
“Covenant light has been around in the high-yield market and institutional investors, who tend to invest across both high yield and leveraged loans, are more comfortable with it than banks,” said Hewson.
The European leveraged loan investor base, however, is not a mirror of either the US loan market or the high-yield market. On European leveraged loans banks make up around 50% of the investor base. In the US, it is more like 20%, and banks tend not to hold high-yield paper.
“The relative strength of the banks in the European investor base could limit the development of covenant-light deals, in particular when a business plan requires substantial undrawn facilities such as capital expenditure, acquisition and revolving credit facilities. There are banks that at the moment will just not underwrite these deals, for example,” said
That is something sponsors and underwriters are aware of. Indeed, Neil Thomson makes the same point and outlines the effort to make some concessions to banks. “The targeted investor base is more funds than banks. But the revolver on both deals, for example, is super senior, which does help get the banks over the covenant-light hurdle.”
Where deals rely disproportionately on bank investors for successful syndication, the practice is more likely to be limited, if applied at all. Where funds are investing and demand for paper is high, then sponsors will push for all the concessions they can get. As one investor pointed out: “It’s here, the worry now is what’s next?”
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