What are the current features of the European lending market?
Volumes have gone up; total LBO volumes for the five months to end May were €17 billion versus €10 billion for the same period last year. However, 70 percent of that €17 billion are refinancings of old deals; only 30 percent of activity is related to new deals.
Some of the [refinancings] relate to deals that were done in 2006, 2007 and are just aimed at extending the tenures of the original deal. The second type of refinancing relates to dividends, so maybe the original deal had 5x debt versus EBITDA and the deal is now deleveraged to 2x so [GPs are] looking to take leverage levels back up to take a dividend out. A lot of [GPs] would prefer to sell a business… but if they can’t do that because the price isn’t acceptable, they may try to get some of their original investment back by a dividend recap, such as Bridgepoint’s refinancing of Pret a Manger in recent weeks.
What is the current availability of leverage in Europe?
Leverage multiples have gone up in recent months; from an average of 4.4 times for Q4 2012, to 4.8 times in the May quarter. There were some deals with a higher amount of leverage in them; Ista [in which CVC acquired a majority stake in April] had over 7x leverage in it, but that’s an incredibly strong credit, so that’s not average, but leverage levels are creeping up driven by strong investor demand.
Another key feature in the market is the level of repayments of loans. Going back a few years ago, there were about €150 billion leveraged loans in the European market in total. That has now dropped to about €100 billion. A lot of these deals are being repaid with a high yield bond.
What are the advantages of using high yield bonds?
High yield bonds tend to have slightly more favourable terms. If a business wants to make an acquisition, it’s quite easy to tap a bond and raise some more money. If you were to do that with a loan it would be administratively more difficult and time consuming.
The high yield market is a little bit more expensive compared to a loan. But if you do get a loan, you’ll have a full suite of covenants, but with high yield bonds you’ll just have incurrence-based covenants which are far less restrictive to a borrower. Most loans have an amortising strip on them, so every six months you have to pay [back] some of the loan, with a high yield bond you just repay it at end of the five or six year period so that’s an advantage on the cash flow side.
Is the surge in the use of alternative financing – such as high yield bonds – a trend that will continue in Europe?
Historically the European loan market always had a full suite of covenants on their deals. But because the US market and the high yield bond markets don’t need [these covenants], these markets are more attractive to raise money, so there’s an argument that the larger deal end of the European market needs to have a rethink about being less restrictive on covenants to compete with high yield and to compete with the US.
Are there any risks with high yield bonds – such as overlevering?
The more debt you put in a deal, the more risk there is and the less attractive it will be to investors, but there’s just such strong demand from investor base now that they are willing to accept quite full leverage. Most leverage loans issuers we see are rated B flat or B plus. There’s a limit of how much leverage you can put in a deal because rating agencies will downgrade the issuer to a B- and if that is rated a B- it is a failed syndication; very few investors will buy that loan.
What is the outlook for the next few months?
In terms of liquidity, the [debt markets] seem quite strong at the moment and this is partly driven by a demand for yield as interest rates are so low and people need to invest and get some sort of return. The key risks in the market are about external shocks, so another problem in the euro zone or unrest in the Middle East for example, but failing that, if we start to see some slow improvements in the various economies in the euro zone hopefully we will see some more M&A activity.