There’s a vaguely familiar ring to the headline: “S&P in warning over leveraged loans”, in Thursday’s FT. Maybe because in February, a report – also in the FT – was headlined: “S&P warns of growing risk in leveraged loans”.
The latest problems highlighted by S&P are much the same as in the February report: surging levels of leverage in deals, rising purchase-price multiples and a steadily growing risk of corporate defaults etc etc. But in its latest report, S&P warns about loosening standards in Europe of private equity loans to fund buyouts – largely due to dwindling cash reserves that companies have on hand to cover debt.
As the Wall Street Journal noted in April, the dust is “thick enough on Europe’s €58bn ($92bn) stockpile of leveraged loans to write ’sell me’ in it with a finger”. While the US backlog was cut by half from about $225bn last September, European volume increased 14 per cent over the same period.
Many transactions in Europe have been done in local regions, where bank investors may have strong relationships and are comfortable with the credits, an S&P research analyst told the FT. While buyout bosses say they are becoming choosier about which deals they finance, industry executives say S&P’s bleak findings may have been skewed by a growing number of smaller deals
How times change, says Loanradar’s Tom Freke in his blog Cash and Burn. Just 12 months ago, one of the main complaints in the market was that banks were taking too long to decide whether to support leveraged loans if they took two weeks. Over-excited hedge funds, meanwhile, would commit to deals within hours, sometimes ahead of launch, sight unseen.
Now, syndications of leveraged loans take several weeks if not months to roll through the market, even for good names. Mainly, says Freke, this is due to changed investor demand. “Not only has it shrunk dramatically, but no-one can be sure where it is. Demand now seems to come mostly from banks, though there are some funds around, many of which are mezzanine investors, an asset class that has recently made something of a comeback.”
Then there is the leveraged loan overhang, he adds. Despite some recent positive events, such as the sale of some Alliance Boots debt, there remain other elephants in the room. AA-Saga, Endemol and Telenet to name just three.
And those once-eager funds have evaporated from the scene, as have many of the structures that supported them, the CLOs and the like. As a result, the ‘wall of money’ that washed over the market in 2006 and 2007 has gone, with the market survivors left trying to pick up the pieces, he adds.
But there are still new deals in the primary market. CVC, for example, this week won the bidding to acquire a minority stake in Germany’s Evonik, with eight banks willing to stump up the financing backing the private equity company’s €2.4bn offer. As the FT reported, it’s one of the biggest private equity deals since credit markets crashed last year and, notes Freke, its arrangers make great play of the strong lender protection on offer and the considerable amount of cash equity cushion in the deal.
The final size of the debt has not been announced, but judging by recent trends, he adds, expect it to be smaller than the €2.4bn acquisition amount, possibly by some way, with CVC putting a healthy amount of its own funds into the deal.
Yet, whatever the offering, appetite for leveraged loans remains highly uncertain, he says. Meanwhile, S&P’s overall message – that investors should increase vigilance on deals with loose structures – is likely to resonate, pressuring arrangers and private equity sponsors to focus on providing appropriate levels of comfort in case of a downturn in economic performance. As a result, concludes Freke, “hard numbers are likely to be more convincing than soft soap”.