Nathalie Tidman finds lawyers bemused by crazy pricing and a wall of debt
‘Short of Trump nuking North Korea, I can’t see any immediate problems on the horizon,’ reflects Latham & Watkins partner Christopher Kandel. It is safe to say finance advisers believe the recent bonanza of European leveraged finance activity will continue through 2018 on the back of another record year for the European market.
Levels of bond and loans issuance through 2017 were brisk, driven by perennially-low interest rates, fierce competition among lenders and the continued vogue for loose covenants. Last year saw a 76% spike in European high-yield bond issuance with €93.6bn recorded, according to Standard & Poor’s (S&P) data, compared with €53bn in 2016. S&P found leveraged loans surged too, with €120bn borrowed in the European market, up 73% from €69.7bn in 2016.
While levels of debt spiked during 2017, market veterans note that underlying volumes were more modest, with deal value inflated by a handful of big-ticket transactions like the €5.4bn takeover of German listed pharmaceuticals company STADA by buyout heavyweights Bain Capital and Cinven. The deal was backed by a €1.7bn term loan and €1.075bn bond, with Kirkland & Ellis fielding a team under City partners Matthew Merkle and Neel Sachdev for the sponsors. The acquisition of STADA, which closed last summer, was one of the largest private equity acquisitions in German history and comes amid a run of marquee European buyouts.
Other notable deals included the £9.3bn takeover of UK payment processor Worldpay by US firm Vantiv, as well as Hellman & Friedman’s $5.3bn takeover of Nets, Scandinavia’s largest payment processor. The Nets takeover is backed by a €2.36bn leveraged loan on cov-lite terms, across a revolving credit facility and two Term Loan B packages. Latham advised Hellman on financing, with Freshfields Bruckhaus Deringer handling corporate.
The confluence of investors hunting yield, improvement in European banks’ balance sheets, a buzzing collateralised loan obligation (CLO) sector and an excess of debt providers is further stoking the market in ways not seen since before the banking crisis.
‘Before the crisis, you had three or four cov-lite deals – now it’s the dominant product.’
Christopher Kandel, Latham & Watkins
In response, pricing has plummeted. With even favoured loans moving at 425bp over Euribor inter-bank interest rates during 2016, seasoned lawyers looked in bemusement as pricing tightened to the 350bp range through 2017 for many deals. The most favoured borrowers could see deals getting away for as little as 300bp.
‘The leveraged finance market has been incredibly strong,’ notes Sachdev. ‘The balance now sits with the borrower. You are seeing some unbelievably tight pricing.’
This dynamic also manifests in the continuing spread of lenient, cov-lite packages. ‘It’s about as borrower-friendly as ever,’ agrees Kandel. ‘Before the credit crisis, you had three or four cov-lite deals – now it’s the dominant product.’
Ashurst’s Paul Stewart comments: ‘It’s a very hot market to be a loans lawyer. The market has been hot since the summer, on both refinancing work and M&A.’
One potential fly in the ointment is regulators’ attempts to curb aggressive debt levels, with the European Central Bank last year issuing new leveraged-lending guidelines. The guidelines came into force last November and assert that any transaction with a leverage level in excess of six times total debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ‘raises concerns’.
While few advisers are losing sleep – the guidelines will not directly apply to the majority of leveraged players, including direct lenders – some have flagged concerns. The restrictions will only apply to European banks, but there is an expectation that most arrangers will demand leveraged finance documents comply with these guidelines so they can go out to the widest possible syndication.
The two big trends that are expected to run through 2018 are the flood of refinancing work and the proliferation of cov-lite loans. The three Rs – refinancing, recapitalisation and repricing – characterised the market in 2017 as borrowers took advantage of ideal conditions. This year, some lawyers are predicting as much as €1trn of European refinancings to come to market as packages secured between 2009 and 2011 come up for renewal.
As loan documents progressively import bond terms, the market is more often bypassing high-yield notes, even on some of the largest acquisitions, which traditionally have been hard to back without the bond markets.
‘Historically, bonds have been more flexible than loans, but since 2015/16 you see bond terminology in loan docs,’ says Stewart. ‘Now pretty much every deal looks like a bond.’
Such was the demand for the €2.2bn term loan underpinning Lone Star Funds’ 2017 acquisition of German building company Xella Group from PAI Partners and funds managed by Goldman Sachs’ investment arm, a proposed bond sale was ultimately dropped.
‘It’s been a mix and match approach since 2009,’ reflects Allen & Overy banking co-head Philip Bowden. ‘We used to have a loan product that was static. Now there’s an explosion of products.’
All of which begs the question of how long leveraged finance work will keep fuelling law firms. At one of the City’s largest leveraged teams, Kandel concludes: ‘The only thing you know is that this can’t last forever.’ Latham is currently debating when the time will be ripe to start bulking up its restructuring team. It looks like the answer is still: not quite yet.