On the Mend

When the credit crisis hit, leveraged finance lawyers were among the first to fall. They are still in the doldrums, but there’s light at the end of the tunnel. After some serious market reshaping, LB asks which firms will reap the rewards when the market finally returns.

To say that leveraged finance lawyers have had it tough in the last few years is the ultimate understatement. Some feel like they’ve been to hell and back.

In the immediate aftermath of the Lehman Brothers collapse, the banks shut down and the mass deleveraging began. In law firms, the screws began to tighten, and slowly but surely a raft of banking lawyers exited the big teams: some to build practices elsewhere, others to start drawing pensions.

‘We’ll see a lot of activity next year with
Irish banks who, up to now, have tended
to adopt a “wait and see” approach.’
Libby Garvey, Matheson

In 2007, £145bn was spent on leveraged finance deals, compared to just £29bn this year. Lawyers are trying to keep busy, but it’s a whole new world out there. Banks are no longer the be-all and end-all for leveraged finance partners, with high-yield bonds providing additional financing when needed. And it is needed, often. As leverage returns, it’s all to play for – the banks aren’t necessarily the dream clients they once were, and the American law firms, with their depth of knowledge in the high-yield space, have a new advantage to capitalise on.

The ‘Big Three’ of leveraged lending – Allen & Overy (A&O), Clifford Chance and Linklaters – were the major players in the boom time, but practically any firm could get in on the leveraged finance action in those heady days. ‘You could buy a banker a beer and probably get a deal,’ recalls Stuart Brinkworth, a banking partner at Hogan Lovells.

But those days are over. When the markets return to form, whenever that may be, the competition is going to be fierce.

 

Keeping busy

For a start, in the last few years the role of the acquisition finance lawyer has changed beyond recognition. Most have kept the wolf from the door, and stayed close to clients, by morphing into restructuring specialists.

It’s no surprise. In 2007, the terms that banks were offering sponsors were incredibly generous. The arrangement fee for setting up loans was about 1%, and the amount of leverage offered was almost beyond belief by today’s standards. Kohlberg Kravis Roberts & Co (KKR)’s leveraged buyout of Alliance Boots in 2007 contained only 18% equity; today’s deals contain very little debt. As Malcolm Hitching, head of finance for the UK and EMEA at Herbert Smith Freehills, says: ‘In the boom times you were seeing deals done with almost no equity in there at all.’

Now those loans have reached maturity and, given market conditions, the need to refinance has thrown up new challenges that often fall to the lawyers who worked on the original deals. For those struggling to keep up with debt repayments, or simply looking to renegotiate terms, leveraged finance lawyers are the people to turn to. What’s more, the banks aren’t in a hurry to cement losses on their balance sheets in today’s environment, so if sponsors aren’t in a position to repay, they’re often able to negotiate a little wiggle room.

‘The loans are not always in great shape, so if you just move the repayment date two years down the path, this is better for the bank,’ says Nick Syson, co-head of the leveraged finance practice at Linklaters.

And as banks continue to deleverage to get their balance sheets in order, they have also been selling portfolios of loans to third parties. Kristen Roberts, a partner in the finance division at Herbert Smith Freehills, says: ‘Over the last few years we’ve seen a wave of loan extensions through amend and extend exercises. That, and the unwillingness of certain financial institutions to crystallise losses on their balance sheets, are two of the principal reasons why we haven’t seen the vaunted wall of distressed M&A’.

But others are sceptical as to how long this policy can be used. Libby Garvey, a partner in the banking and financial services department at Matheson, says that it will only work for so long before banks get impatient.

‘We’ll see a lot of activity next year with Irish banks who, up to now, unlike their non-Irish peers in the local market, have tended to adopt a “wait and see” approach, taking increased affirmative action, with a lot of focus on the enforcement or indeed the sale of distressed corporate and property loans as the culture of “amend and extend” draws to a close,’ she says.

‘Where vendor finance is available, this
is typically only accessed as a last resort.’
Robert Cain, Arthur Cox

The fact that the amount of deals has reduced, and their size shrunk considerably, doesn’t mean there’s nothing for banking lawyers to do. ‘As long as there is something happening, there’s a chance for lawyers to be gainfully employed,’ says Charles Cochrane, a banking and finance partner at Clifford Chance. Last year he advised a six-bank consortium when Swedish alarm maker Securitas Direct was bought by private equity houses Bain Capital and Hellman & Friedman.

As the market has evolved, so too has the role of a leveraged finance partner. David Trott, head of the banking practice at Freshfields Bruckhaus Deringer, says: ‘The most significant source of work for leveraged finance lawyers has been in the restructuring of transactions that were done in the boom years from 2005 to 2007.’ Last year the firm advised the cross-over creditors of German cable network primacom on its restructuring and refinancing via a share pledge enforcement and debt-for-equity swap, for example.

‘The general sense in the market is that US firms should be the first point of call for high-yield transactions,’ says Lee Cullinane, head of London leveraged finance at White & Case. He says that a third of his work at the moment concerns restructurings and refinancings with the certainty of ‘new money’ deals difficult to predict other than in the short term. This year the firm represented Jefferies & Company and its affiliates on the recapitalisation of Klöckner Pentaplast, one of the world’s largest suppliers of plastic films, and the provision of approximately €665m of new debt facilities provided by Jefferies to fund the prepayment of existing senior facilities of Klöckner Pentaplast as part of the recapitalisation.

However, the new deals will come. Keeping busy is one thing; preparing for the next uptick is quite another.

 

Keeping in touch

Maintaining strong relationships with both the bankers and the borrowers will be critical to success when the leveraged finance market returns. While the banks are undoubtedly the most prolific deal generators, some of the big private equity houses are now formidably busy too when times are good, and, given that they pay all the fees for both their own lawyers and their banks’ advisers, it is little surprise that they are amassing a great deal of influence over the lawyers a bank chooses to work with.

Just like for the banks, the leading sponsor-side firms are Clifford Chance, Linklaters and A&O, although some would argue A&O has lost some of its market share since Tony Keal moved to Simpson Thacher & Bartlett in 2005, taking a significant chunk of the KKR banking work with him.

Mark Vickers, a banking partner at Ashurst, says: ‘The smart minds are with the banks,’ and views his firm as one of the leading bank-side advisers in the market.

But in truth the smart firms, and particularly the larger ones, do both.

‘We do a good mix of sponsor side and bank. Successful firms will have a good balance of working for their sponsors and their creditors,’ says Stephen Kensell, co-head of the global banking practice at A&O.

‘The private equity market has not returned
in force at the same levels as the years 2005 to 2008.’
Nelson Raposo Bernardo, Raposo Bernardo

But being seen to be hedging your bets too much can have its downside. Banks aren’t keen on being beaten up by a sponsor’s adviser one day, only to be pitched to by the same lawyer the next. And sponsors, in turn, want to be assured that their lawyer is thrashing out the best deal, without fear of upsetting the banker on the other side of the table.

So there’s a clever path to be trodden, and some do it better than others. On the bank side, A&O advised banks including Deutsche Bank and UBS when CVC Capital Partners acquired Danish telecoms company Sunrise for £2.1bn back in 2010, with Kensell taking the lead. A Latham & Watkins team led by partner Jayanthi Sadanandan acted for CVC. For sponsors, Allen & Overy advised Cinven on a E295m all-senior debt facility for its acquisition of the SLV Group in May 2011.

Herbert Smith Freehills has done some notable work on the sponsor side: acting for The Blackstone Group in July last year on the £124m acquisition of Tangerine Confectionery, and advising Bain Capital-backed WorldPay in 2010 on the finance aspects of its separation from The Royal Bank of Scotland (RBS) – a major deal worth in the region of £2bn. On that deal, Bain turned to Kirkland & Ellis’s European finance group senior partner Stephen Gillespie for financing advice, and the senior lenders used Ashurst partners Nigel Ward and Jane Fissenden.

One of the biggest changes since the heady days of 2007 is the musical chairs that has taken place among the key individuals doling out the work. As the big banks have scaled back their teams, law firms have seen their key contacts heading elsewhere – sometimes to other lenders, but also to private equity firms.

Just two of the many examples: John Empson, who had been a managing director with J.P. Morgan, joined KKR in 2008 as managing director, while Jonathan Hosgood jumped ship from Barclays Capital in 2009, where he was co-head of the leveraged finance department, to join BC Partners’ team.

The savvy players will have kept in touch with everyone, but you can bet not everyone has, so there will be opportunities when the music eventually stops.

 

Banks and bonds

One firm that has considerable experience advising both banks and borrowers is Latham & Watkins. In 2011 Brian Conway, a partner in the firm’s finance division, advised BC Partners on the financing of its €1.8bn acquisition of Com Hem, the second largest Swedish broadband and telephone provider, from The Carlyle Group and Providence Equity Partners. Freshfields, led by Trott, acted for the banks.

And Latham is also adept at advising banks in leveraged finance deals. This year it acted for Goldman Sachs and Barclays on Terra Firma Capital Partners’ acquisition of Four Seasons Health Care for £825m. The team on that deal was led by capital markets partner Jocelyn Seitzman and banking partner Sadanandan, while Slaughter and May acted for Four Seasons.

‘We feel that to be an effective adviser you need to represent both banks and issuers or sponsors, and the understanding of the market that you obtain by representing banks enables you to understand the issues and better advise companies who aren’t familiar with the product,’ says Richard Trobman, co-chair of Latham’s London corporate department.

This firm is a market leader in advising on high-yield transactions in the UK, according to The Legal 500, and with banks still rather unwilling to lend without onerous conditions, it is to high-yield bonds that sponsors are increasingly looking for finance.

‘The maintenance covenants in a bank loan contributed
significantly to trouble experienced by companies in 2008 and 2009.’
Richard Trobman, Latham & Watkins

‘The maintenance covenants in a bank loan contributed significantly to trouble experienced by companies in 2008 and 2009. With high yield, absent a failure to pay interest, you can’t default just because your business suffers as a result of general economic conditions,’ says Trobman,

The growing importance of the high-yield bond market is apparent to Trott too: ‘The growth of high yield in Europe has already been well documented. Capital markets will play an increasing role in financing of corporates and corporate transactional activity, as Europe will shift towards the US funding model, where banks only fund 30% of the overall market debt needs.’

Here the US law firms have a clear advantage given the far greater sophistication of high-yield markets in the States. But the UK-based firms are moving fast to catch up, with A&O hiring leading US-qualified bond lawyer Kevin Muzilla as a partner from US firm Milbank, Tweed, Hadley & McCloy in 2009. ‘That shows how deeply committed to leveraged finance we are. We’re acting for both banks and sponsors on a wide range of deals, including bank-bond structuring,’ says Kensell. In April last year Muzilla advised Dematic, and Triton Private Equity as financial sponsor, on Dematic’s $300m high-yield notes offering, for example.

Clifford Chance has also got a high-yield bond specialist in the shape of US-qualified partner Michael Dakin, who joined the firm as a partner back in 2005, having learnt his trade at US firm Cahill Gordon & Reindel in New York. It has been further bulking up its London high-yield team recently, with Fabio Diminich joining as partner from Latham & Watkins in October last year.

Dakin sees the importance of bond work but thinks it highly unlikely that bonds will ever replace the banks. ‘You hear hyperbole about the bank facilities going the way of the dodo, but that can’t be the case because structurally it doesn’t work,’ he says. ‘Working capital is a bank facility and no-one has invented a bond that can provide a working capital facility.’

Dakin advised Heidelberger Druckmaschinen on a €300m high-yield bond issue connected to the refinancing of the company, which also included a €500m revolving credit facility. Cravath, Swaine & Moore and Hengeler Mueller advised the banks, led by Deutsche Bank, in May last year.

Other US firms are getting in on the high-yield action. Shearman & Sterling represented Bank of America Merrill Lynch, J.P. Morgan, Barclays and other initial purchasers on Albéa Beauty Holdings’ €585m notes offering, which closed in October. ‘Bond structures are nothing new. Current financing trends continue to favour bonds or a mix of bonds and bank loans. This obviously puts firms that can credibly deliver both in a good position,’ says Jacques McChesney, a partner in the corporate group at the firm in London.

Having the combination of bank and bond expertise is certainly getting more important in the European leveraged finance market. The Americans may have the first-mover advantage, but the big English firms are shaping up for the battle, even if they may find it tough to immediately convince the clients they can handle both.

Latham has been involved in the development of the European high-yield market since its birth in the late Nineties. All five of its bond partners are homegrown. Trobman says they impress those across the table, and it gives the firm a clear advantage: ‘We have worked opposite sponsors, who, having seen our work on the other side of deals, have come across to us on future deals,’ he says.

 

Bank on it

When the market returns and the banks eventually start lending again, it’s clear that they are only going to do so on their own terms. In 2007 the acquisition finance market was a borrowers’ playground, with terms weighing heavily in favour of the sponsors. That won’t be the case again for a while.

‘The market doesn’t have the same risk appetite, and capital is more expensive,’ says James Tsolakis, head of legal services, corporate and institutional banking, at RBS. ‘The covenant-lite deals have left the market. As part of structuring a deal you want to have a more robust covenant package to mitigate the risk that is inherent in any transaction.’

And although the UK has experienced some banking problems, countries such as Portugal and Ireland have faced severe difficulties that have led to well-documented International Monetary Fund bailouts and other external intervention.

The downgrading of Portugal’s debt rating by agencies such as Standard & Poor’s and Moody’s caused the economy even greater problems.

‘The effect of the downgrade was a massive surge of interest paid by the country and the most interest is paid by Portuguese companies and especially banks,’ says Nelson Raposo Bernardo, global managing partner at Portuguese firm Raposo Bernardo.

For leveraged finance, the impact has led to the whole process of leveraged buyouts becoming more complicated. ‘For an operation in Portugal, in the past our main contact was a Portuguese bank, but today the probability is that our main contact is a foreign bank that is financing a subsidiary of our clients,’ he says.

Today Nelson Raposo Bernardo has to liaise with many different countries for a leveraged finance deal which, before the crunch, could have been done domestically.

The Irish banking system suffered particularly hard and has been undergoing a degree of reform for some time. Banks have been moving property portfolios into the National Asset Management Agency, a government body that banks can use to deleverage themselves of riskier assets.

‘From a legal documentation perspective, we already see a far greater deal of emphasis on increased cost provisions and the desire to allocate risk onto borrowers,’ says Robert Cain, a partner in the financial regulatory group at Irish firm Arthur Cox.

‘We do a good mix of sponsor side and bank.
Successful firms will have a good balance.’
Stephen Kensell, Allen & Overy

As the banking system among the much-maligned ‘PIIGS’ countries (Portugal, Italy, Ireland, Greece, Spain) is hardly inebriated with credit at the moment, borrowers are again having to look at alternative sources of funding for their deals.

‘A number of the private equity houses have raised debt funds, which can be deployed by way of senior finance,’ says Arthur Cox consultant Aiden Small.

‘In the future it is expected that non-bank lending, for instance through insurance companies and funds, will become more common in the Irish market,’ he adds.

Some Irish firms continue to do deals in a difficult market. Matheson advised on the €149m acquisition of GE Capital’s Woodchester Home Loans by Australian company Pepper Home Loans Group.

‘There are still a number of leveraged finance transactions being completed. However, it is probably fair to say that these are typically smaller deals and less high profile than previously,’ says Cain.

 

Private equity returns

One of the most notable features of the financial crisis was the absence of private equity in the global M&A market. Once major players, they had to take a back seat as corporates fought for assets, because the very model of a private equity deal is leverage dependent. In the US, the private equity market has this year begun to make a strong recovery as the lending markets have bounced back and the high-yield markets remain strong. In Europe, the recovery may be slower to materialise as a result of the sovereign debt crisis.

Ireland was one of the casualties of the crisis but private equity is picking up in the region slowly. Private equity houses bidding for Irish assets are looking to the international banks and debt funds for senior financing, with some funds looking to use a mix of debt and equity alongside the bidder.

‘Where vendor finance is available, this is typically only accessed as a last resort,’ says Cain. A private equity house in Ireland might be in the lucky position of being able to fully fund its own investments but this is unlikely for a bid for a major asset.

‘Working capital is a bank facility and no-one
has invented a bond that can provide a working
capital facility.’
Michael Dakin, Clifford Chance

Another wounded EU member state is also seeing a slight indication that private equity is returning. Private equity in Portugal, according to Nelson Raposo Bernardo, is mainly originating from sovereign wealth funds from overseas, and companies with state capital. However, ‘The private equity market has not returned in force at the same levels as the years 2005 to 2008,’ says Nelson Raposo Bernardo.

In Ireland, Apollo Global Management acquired MBNA’s €650m Irish credit-card portfolio this year, in a deal done by A&L Goodbody and led by partner Peter Maher for Apollo.

According to Herbert Smith Freehills’ Hitching, five years ago the leveraged finance market in the UK was about private equity ‘in the traditional private equity sense’. This is no longer the case as private equity houses are competing with sovereign wealth funds, pension funds, hedge funds and real estate funds.

‘For me one of the interesting shifts is that there is no longer a delineation between private equity on the one hand and others on the other. We are now talking about financial buyers,’ he says.

Getting to know the sponsors just got a whole lot more complicated.

 

Still an appetite

Latham banking partner Chris Kandel thinks that the key driver of new deals now will be a combination of US liquidity and European assets. ‘There is the appetite in Europe for making acquisitions, but not necessarily the liquidity. So some of what we’re seeing is European corporates or sponsors accessing the liquidity in the US market to fund acquisitions in Europe,’ he says.

Last year Ashurst advised a syndicate of banks including Ares Capital Corporation, Bank of America, BNP Paribas, Crédit Agricole Corporate & Investment Bank, Goldman Sachs, HSBC Bank, Mizuho Bank and Royal Bank of Canada on the £579m acquisition of Environmental Resources Management by Charterhouse Capital Partners. Dickson Minto advised the acquirer Charterhouse.

Ashurst, led by Mark Vickers, also got the call on private equity house Cinven’s acquisition of Mercury Pharma Group for £465m this year. Clifford Chance acted for Cinven, with a team lead by partners Brendan Moylan and Jonny Myers, while Linklaters London private equity partners Alex Woodward and Richard Youle led for seller HgCapital. Ashurst advised the banks, including Jefferies, Lloyds Banking Group, RBS and Mizuho.

‘Before there was so much competition among the banks that sponsors could drive very competitive terms,’ says Syson. Today the desire to get involved is tempered, with banks remaining reluctant to lend, but there are lenders still out there keen to do the right deals.

‘We haven’t felt a lack of deals. At the moment there’s money to be put to work,’ says Kensell. This was demonstrated last year when the firm won a mandate to advise the mezzanine lenders KKR Mezzanine Fund and Crescent Capital Sankaty on Bain Capital and Advent International’s acquisition of RBS’s payment processing unit WorldPay.

Matthew Cottis, the co-head of Hogan Lovells’ banking practice, says: ‘Banks are still doing new deals – just because some banks have sold some portfolios of old leveraged buyouts does not necessarily mean they’ve exited the market. Many still have teams doing new leveraged finance deals.’ Cottis and his team advised Ares and Babson Capital Management as mezzanine lenders on the leveraged buyout of Xafinity worth £190m in 2010.

Big deals remain few and far between, with one partner saying: ‘The mid-market is the market now.’ That’s bad news for smaller firms looking to get in on the action. These days it’s commonplace to see the likes of Linklaters and Clifford Chance involved in deals worth sub-£500m.

 

Arrivals and departures

In 2009 there was a mass exodus of leveraged finance partners from A&O (see ‘Crash of the Titans’, LB194, page 38). Andrew Bamber, Ian Borman, Jacqueline Evans, David Lines and Mark Wesseldine all left when the market was at an all-time low and there simply wasn’t the work to go round. Since then, even rivals describe the team as ‘formidable’. The five partner exits were attributed to the drop off in the market, and the downsizing was described as a ‘business decision’ by Kensell.

The A&O moves weren’t the only personnel changes in the leveraged finance market while things were quieter, as firms have taken the opportunity to reshape ahead of any anticipated upturn.

Linklaters lost Stephen Lucas to Weil, Gotshal & Manges last year, where he is now the London head of banking. ‘It wasn’t our choice for him to go. He was very talented and we wish he was still here,’ says Syson. However, Linklaters in turn got Chris Howard back from Freshfields in 2010, after he’d left them to join Freshfields as a partner in 2004 while still an associate at Linklaters.

White & Case suffered a devastating raid of 13 partners by Latham & Watkins in 2010, affecting London and the Middle East, and including the co-head of the banking practice Kandel and three other banking partners: Conway, Sam Hamilton and Sadanandan.

But the firm was bolstered by the arrival of Cullinane and Jacqueline Evans from Mayer Brown last year and Cullinane expects the team to grow as the US firms benefit from the greater use of high-yield bonds. ‘You’ve got to be American to do high yield,’ he says.

Herbert Smith Freehills lost Chris Fanner, a leveraged finance partner, to SJ Berwin this year. Hitching says: ‘Every firm in the City at our level has lost partners.’

In the mid-market, Stephenson Harwood has continued its raid on SNR Denton’s banking practice this year by adding Susan Moore and Elizabeth Elliott to its ranks. This follows banking head Jayesh Patel and James Linforth joining Stephenson Harwood back in 2010.

‘The market is not expanding at a rate where firms can afford to keep adding on endless leveraged finance partners unless they are winning market share from someone else who is losing it,’ says Cottis. Nevertheless, the merry-go-round has made for some interesting new-look practices, ready for action and fighting for new instructions.

 

New recruits

However, it is a tough time to move if you’re in leveraged finance, with track records hard to demonstrate. Jason Mann, director of partner search and recruitment firm Mouland Mann, believes that potential lateral hires in the leveraged finance space have got to think very carefully about the relationships they have with banks when choosing a new firm.

‘The provision of legal services to banks is heavily panel driven. If a lateral partner candidate does all or the majority of his work for one bank, he would have to think very carefully indeed about joining a firm not currently on that panel,’ he says.

Jonathan Firth, managing director of recruitment specialists Michael Page, adds that despite difficult market conditions, a lateral with a good client base will prove attractive to a firm.

According to Firth, important criteria for a leveraged finance partner include the ability to prove that they are self-sufficient. This means bringing strong bank clients and a proven track record of success to the firm. ‘For instance, it would be difficult for a banking lawyer at a major law firm to be hired on the basis of borrower relationships only,’ he says.

Scott Gibson, partner at legal recruitment consultancy Edwards Gibson, believes that it is less likely for a partner to be hired for their sponsor-side relationships, as the private equity houses tend to have stronger ties with corporate partners rather than those on the banking side.

As the market has changed, with fewer new deals and more restructurings needed, versatility is key for a lateral hire. Although firms will often have a restructuring practice, leveraged finance partners have been getting into this space as well.

While Firth says that it is important for partners to become more versatile in the current climate, Gibson adds that conflicts could arise if a leveraged finance partner tries to get involved in restructuring if a firm already has a dedicated restructuring practice.

All in all, now is not an easy time to move. ‘There’s no concerted push for firms to grow in leveraged finance at the moment,’ says Gibson. Firms may talk about new deals but there is nowhere near the amount of activity in the market as there was during the boom.

‘Leveraged finance was once the driving force behind some law firms’ banking practices,’ says Firth. ‘Post crisis, we have seen a decline in buyout activity and obviously this has driven down leveraged markets. However, even in difficult times, there will always be an appetite for quality leveraged finance partners.’

The leveraged finance market is now a completely different beast to that of five years ago. Relying on banks to completely fund a deal is probably a thing of the past, as maturity terms have shortened, leverage has reduced and covenants have tightened up. Some say there are banks that still have an appetite for these deals but with further regulation, European leverage finance deals are likely to contain more high-yield bond financing.

As high-yield bonds steal a march, and US sponsors continue to drive the mega-buyouts on this side of the Atlantic, stateside firms might just have a new edge. But the traditional heavy hitters in the leveraged finance space are catching on quick. A&O and Clifford Chance spotted early on the importance of having US-qualified bond partners in their teams. Others should pay close attention before they are left behind.

In the words of Neville Eisenberg, managing partner of Berwin Leighton Paisner, ‘You can’t have a finance team without a leveraged finance practice.’ Even if it might be a lot easier said than done. LB

 

david.stevenson@legalease.co.uk