Europe’s loan backlog failing to clear

There has been almost no movement in the European leveraged loan backlog since mid-August. Despite ongoing fundraising by alternative asset managers and banks for hung debt vehicles liquidity has yet to return to the debt markets.

The European leveraged loan backlog has fallen by just €1 billion ($1.45 billion) to €75 billion in the two months to mid-October, according to a report by rating agency Standard & Poor’s.

The amount had gone down due to a handful of deals completing, according to Taron Wade, one of the authors of the report at S&P. The figures did not include any new agreed deals since mid-August or the completion of the £750 million (€1.08 billion; $1.56 billion) Alliance Boots mezzanine tranche. Sources in the market have said the mezzanine debt on the Boots deal was syndicated.

However, S&P said €22 billion of debt is in the process of syndication. Nearly €10 billion of these transactions have undergone structural or pricing changes, while the remaining €12 billion of loans were postponed or mandated for syndication but were never sold on the market. This latter group of loans has been launched again into syndication, Wade said

The level of issuance by collateralised loan obligations, debt securities backed by leverage, stood at around €1.6 billion from August to the end of September, the rating agency said. This compares to the first three quarters of 2007, where €25.9 billion was issued across 52 vehicles, which itself was down proportionally from the €38.6 billion of CLO issuance in 2006 across 86 vehicles. The forward pipeline of deals as of 18 September was €7.5 billion across 19 vehicles, it said.

Private equity firms, banks and alternative investors are also looking to pick up debt from hung deals.

Yesterday Lehman Brothers raised $670 million (€464 million) for a hung bridge fund to invest in leveraged buyout-related debt. The fund will employ 3.5 times leverage, bringing its total available capital to $3 billion.

Numerous US firms such as distressed debt investor Oaktree Investment Management and TPG are raising $3 billion and $1 billion, respectively, for hung bridge funds. KKR Financial, the listed investment vehicle of the US buyout firm is also raising $1 billion for a debt fund to accompany a cornerstone investment of $1.5 billion made by KKR Financial.

In Europe, hedge fund GLG is raising $300 million for a similar fund. The newly appointed head of the leveraged debt unit of a large European buyout house told PEO he suspected current debt pricing would lead to most large buyout firms setting up a programme to buy debt. His rationale was the pricing was too attractive an opportunity to pass up. Hung debt has traded sometimes as low as 94 percent to par.

The change in the markets is not altogether unwelcome, according to S&P. Wade said: “Three months ago the market was over-exuberant. Credit quality had been in decline since 2004, covenant restrictions had dropped away and leverage had increased dramatically.”

While the current lack of liquidity is undesirable, the difficulties will hopefully lead to more sobriety and more focus on credit fundamentals, she said.