Thanks to the regulatory constraints imposed on the banks in the wake of the financial crisis, debt for buyout deals has become much harder to come by in recent years. Banks have sold off assets, allowed existing loans to expire and restricted new credits – with the result that nearly five years after the collapse of Lehman Brothers, obtaining senior debt is still a challenging task for many GPs. Last year, banks provided $99.4 billion of debt in Europe, well down on the $133 billion borrowed in 2011, but more than the $75.5 billion in 2010, according to data provider Dealogic.
Challenges remain, says Mark Hudson, a senior partner at Graphite Capital. “Before the recession, for a £100 million deal, banks might have provided £60 million of debt and the remaining £40 million would be equity. Today you would be fortunate to get £50 million of debt and £50 million of equity.” Often during the boom years, GPs would only have to go to one bank to finance a deal. In today’s market, club deals are much more the norm, where often “the most conservative banks determine what the package is like”, says Hudson.
Obtaining senior debt is particularly challenging in the lower mid-market, many industry sources say. “It’s generally harder to obtain leverage for companies with EBITDA of less than, say, €15 million as the management team has a bigger impact on the business and there can often be risk concentrations around customers and suppliers,” says Ken Goldsbrough, a managing director at Houlihan Lokey.
In addition, banks have – often under pressure from governments – retreated to their domestic markets. The UK is the perfect example of this, says Ed Cottrell, head of growth & acquisition finance team at Investec. “Before the crisis, you had Icelandic banks, Irish banks, [and other] European banks operating quite comfortably in the mid-market, including French banks and Scandinavian banks. On top of that, you had all the high street banks actively participating in the lower-mid market. Right now, there’s only a handful. Lloyds, RBS, HSBC are still there for the lower mid-market – and that is about it.”
However, multiples are rising. In Q1 of this year, average leverage levels in mid market deals have gone up to 4.8x EBITDA, from 4.4x EBITDA last year, according to David Whiteley, managing director and head of leveraged loan syndicate at Lloyds Banking Group. “Leverage is definitely drifting upwards – and that is on the back of the very strong liquidity we see in the bond market and the loan market,” he says.
Financing for mid-market transactions is still available – although as one European-focused GP puts it, it helps considerably to have a “long-standing relationship and a good track-record”.
Mike Tilbury, a senior partner at Graphite, agrees. “We have done a lot of deals with RBS, Lloyds, HSBC and GE in recent years. Barclays is also increasingly coming back into the market and Santander has built up a team of experienced bankers,” he says.
But although debt multiples appear to be creeping up again, even in the mid-market, Cottrell doesn’t believe this is down to the banks. “It’s not like banks have suddenly woken up and have said: we are lending again. It’s more of a response of debt funds justifying their expensive rates by pushing debt multiples up – and that is warming up the market.”
BREAKING WITH THE BANKS
Europe is slowly moving into the same direction as the US, where corporate financing is less reliant on the banks, says Goldsbrough. Due to looser terms on repayments, non-bank lending can often provide GPs with a greater level of flexibility. “Some firms that are investing in a growth company may want to use the cash flow for add-on acquisitions or capital expenditure, rather than for paying off senior debt, which can be a reason for them to bypass the banks,” he says.
Other GPs are looking to diversify their lending base on the basis of past experiences, according to one investment banker. “Some have been burnt by restructurings and are keen to avoid working with banks. Even though lending from credit funds can be more expensive, it can be an option if they believe the performance of the underlying company may fluctuate in the coming years. They’d rather pay a little more for leverage and have more leeway than sticking to traditional bank financing with strict repayments and covenants.”
Borrowing in the institutional market is actually becoming cheaper for LBO borrowers, one pan-European focused GP points out. Because so much money has poured into high-yield bond funds in the last several months, this has driven down the costs on bond issuance, he says. “The difference between a bank loan and issuing a bond has narrowed; in some cases bonds are even cheaper.”
Additionally, a lot of European borrowers have gone to the US [institutional] market, because they feel the terms are more attractive than in Europe. “With the larger deals, commercial banks find themselves increasingly out-competed by the institutional market,” he adds.
Then again, banks have also benefited from the improved conditions in the institutional market. Before the credit crunch, deals above €400 million were generally underwritten by banks and then distributed in this market, but between 2008 and 2009, banks were nervous about this, the GP points out. “[Due to the recovery in the institutional lending market], investment banks are more comfortable to underwrite those structures – and that is clearly helping borrowers to finance new deals.”
Indeed, the current market is pretty active, according to Giles Borten, head of leveraged finance, EMEA and APAC and co-head of corporate capital markets EMEA at UBS. “We have had a busy quarter, albeit one that has been dominated by refinancing and recapitalisations,” he says.
Ciara O’Neill, a managing director at DC Advisory, strikes a similar note. “In the first quarter of this year, refinancings have exceeded new loans for the first time in three to four years. There’s a very strong debt market. So it’s a good time for borrowers to look at their capital structure either to refinance or to re-leverage, if that’s the right thing to do for the company’s balance sheet,” she says.
But while banks are still lending, “what they want to hold on balance sheet is a small fraction of what it was at the peak”, says Robin Doumar, managing partner at Park Square Capital. This creates “a massive supply-demand imbalance,” he argues.
Overall, banks remain cautious, agrees the European-focused GP. “Underwritings into the institutional market have become more aggressive. [But] when it comes to banks taking assets and holding them in a club deal, they remain quite conservative. This market is moving at a slower pace than the institutional lending market… banks are still a little scared from the credit crunch.”