Lender frustration with slow LBO market grows

Despite signs that activity is picking up, conversion rates remain poor, prompting European bankers to compete increasingly aggressively for the few mandates in the market, says a new survey.

Although there are signs that buyout activity in the UK and continental Europe may recover to a more healthy level by early 2003, the conversion rate of potential deals that currently surface in the market is still poor, according to a new survey published by the UK private equity practice of Ernst & Young.

As a result, the European leveraged market is becoming increasingly competitive, with debt providers becoming more aggressive in their pursuit of buyout mandates from equity sponsors, the survey says.

Banks were also found to be trying harder to develop creative funding structures and integrated funding solutions tailored to match the need of businesses that are undergoing a change of ownership. Hence there has been an increase in asset backed lending particularly in turnaround situations, and in the use of securitisation techniques in mid-market deals that would previously not have been considered appropriate.

Neil Patey, leader of Ernst & Young’s private equity division, confirmed that lenders were becoming increasingly frustrated with the sustained lack of deal completion. 'Bankers have budgets and money to spend. They do want to spend it wisely, but there is now more pressure to deploy capital, and whereas six months ago the bank’s terms were a lot tighter, they are now more willing to review them, and to look at anything that comes up as long as it looks like a sensible solution', Patey said.

The survey, based on interviews with 22 European and North American banks operating in Europe, found debt to equity ratios had not yet adjusted significantly. The minimum equity requirement for a typical senior only transaction currently varied between 40 and 45 per cent, while deals involving mezzanine required a 30 to 35 per cent equity tranche. According to Patey, equity portions are currently approaching the lower end of these ranges as lenders resort to more generous debt offerings when competing for business. However Patey said he did not expect equity requirements to fall below these thresholds any time soon.

Despite the current draught of deals, bankers are optimistic that 2003 will restore a more satisfactory level of activity. Their responses to Ernst & Young revealed a shared sense that vendor price expectations are aligning with the market’s appetite for deals, and that more vendors are genuinely looking to sell businesses, typically in auctions.

The point that vendor expectations are coming down may come as a surprise to equity sponsors, many of whom continue to complain that a sufficient correction has still not materialised. However, as Neil Patey commented, 'the proof of the pudding is in how many auctions get pulled because sellers hold on to unrealistic price expectations, and I haven’t seen many of those lately.'